The ‘phoenixism’ anti-avoidance legislation in question at ITTOIA 2005, s 396B (‘Distributions in a winding-up’) is a curious animal in various ways. It complements changes to the transactions in securities (TiS) rules in ITA 2007, which now specifically identify a distribution in a winding-up as a TiS (at ITA 2007, s 684(2)(f)).
A Trap for the Unwary
However, unlike the TiS rules, HMRC decided at the start that no clearance procedure would be available for ITTOIA 2005, s 396B, which may therefore present a dilemma for the taxpayer and their professional advisers. If applicable, section 396B ‘converts’ a capital distribution to a shareholder in a winding-up into an income distribution.
The application of ITTOIA 2005, s 396B is subject to four conditions (A-D), all of which must be met. Conditions A-C are factual tests, while Condition D involves a ‘main purpose’ test. HMRC argues that since they do not give rulings on questions of fact or purpose, a statutory or even an informal clearance procedure is inappropriate.
So, basically, it is left to the individual and their professional advisers to consider whether section 396B applies and to self-assess accordingly. It seems to me that the taxpayers who are most likely to be exercised by section 396B are those to whom, on the face of it, it might apply but probably does not.
Jumping the Hurdles
Conditions A and B are straightforward, while Condition C is more onerous and applies where the individual is involved in some way in a similar business to that of the defunct company during the two years from receiving a distribution during winding-up.
But it is quite widely drawn and concerns not only the subsequent interests and activities of the individual themself but also, potentially, those of relatives and other ‘connected’ persons. HMRC gives a number of relevant examples in its Company Taxation Manual at CTM36330.
It is Condition D at ITTOIA 2005, s 396B(5), however, which is the real crux of the matter. It basically asks whether it is ‘reasonable to assume, having regard to all the circumstances’, that the main purpose or a main purpose of the windingup was to avoid income tax.
Those circumstances ‘in particular’ include the fact that Condition C is met (ITTOIA 2005, s 396B(6)). That is to say, there must be a causal connection between the winding-up and obtaining of a tax advantage and the subsequent involvement in a similar business. The guidance does not give any examples but does propose (at CTM36340) a nonexhaustive list of issues that may be relevant.
The main purpose test is stated to be ‘subjective but may be inferred from objective characteristics having regard to all the circumstances’. We are also told that:
‘The individual will know their purpose and, if fairly described, can be confident that there will be enough supporting evidence (having regard to all the circumstances) for an officer to arrive at a sound conclusion’.
In any situation where ITTOIA 2005, s 396B potentially applies, it will most likely fall to the professional adviser to weigh the situation and form a conclusion in order to advise the client, which, properly documented, could form the ‘supporting evidence’ referred to.
Practical Tip
In considering Condition D, the main focus must be on the causal connection (or lack of) between the winding-up of the company and the subsequent involvement in a similar business. For example, suppose that two similar businesses (say, Company X and Company Y) had been run side by side for many years before it was decided to wind up Company X. Conditions A to C would be met but, having regard to all the circumstances, it is probably not reasonable to assume that winding up Company X had tax avoidance as a main purpose in concluding that Condition D is not met.