On a legal footing
As indicated in my article ‘Don’t Wind Me Up!’ in Taxation on 5 February 2009 (available at the Mark McLaughlin Associates website) HMRC are replacing a number of Extra Statutory Concessions (ESCs), by making them law instead. One of these is ESC C16 (‘Dissolution of companies under s 652 and s 652A Companies Act 1985; distributions to shareholders’), which broadly allows distributions to shareholders on the dissolution of a company to be treated as a capital receipt (liable to CGT in the hands of an individual), rather than an income distribution.
However, comments in a recent consultation document suggest that HMRC may have some reservations about ESC C16 becoming law. It states:
“Initial reappraisal of this ESC led us to believe that the legislation required to formally implement it as it currently stands would significantly increase the length and complexity of the legislation. This is due to the fact that there would need to be an avoidance rule that prevent the legislation from being used to gain a tax advantage. HMRC is also mindful of the fact that winding up is the normal process for a company to end its existence and it would be inappropriate for HMRC to seek statutory backing for a practice which encourages companies to accept dissolution in preference to a formal winding up” (emphasis added).
“In addition, HMRC have concerns that ESC C16 has been and continues to be used for avoidance purposes. If ESC C16 were to be legislated it would have to be in a manner that gave no opportunity for abuse.”
What’s the problem?
So, one of HMRC’s concerns appears to be that ESC C16 is being abused. However, HMRC’s policy is that “a concession will not be given in any case where an attempt is made to use it for tax avoidance.” Similarly, a concession already given can be withdrawn if it has been abused. If HMRC consider that ESC C16 is being abused, why are they granting the Concession? Alternatively, if there is evidence that ESC C16 has been mis-used in a particular case, why not simply withdraw the concessionary treatment they have given?
Of course, when ESC C16 becomes law, HMRC will lose the discretion it previously had over whether to grant capital treatment to the taxpayer. As highlighted above, HMRC have indicated that an anti-avoidance rule will also be introduced to prevent the new law being exploited and a tax advantage gained. It therefore seems likely that there will be similar provisions to the income tax anti-avoidance rules regarding ‘transactions in securities’, so that capital treatment can be denied if the company’s dissolution was part of an arrangement that was wholly or mainly to avoid tax.
It also seems likely that any such anti-avoidance legislation will be subject to a statutory clearance procedure. In that respect, the taxpayer would be in a similar position as under ESC C16, in terms of having to ask HMRC for permission to apply capital treatment – a case of ‘out of the frying pan, into the fire’!
What is the real reason?
If HMRC are reluctant to give legislative effect to ESC C16, perhaps a clue to the reason is given away in the following question in the consultation paper:
“Have you any suggestions on ways to legislate this concession without HMRC being seen to be providing statutory backing for a practice, which encourages companies to accept dissolution in preference to a winding up.”
There is a non-tax problem with ESC C16. For company law purposes, a ‘distribution’ does not include the repayment of paid-up share capital, or a distribution of company assets to its members on a winding up (CA 2006, s 829(2)). ESC C16 is a deeming provision for tax purposes. It does not allow assets representing share capital to be distributed, so ESC C16 is therefore effectively commissioning an unlawful act for company law purposes.
HMRC are therefore in something of a dilemma, as they do not wish to be seen as ‘accomplices’ to an unlawful act! It will be interesting to see how HMRC deal with this problem when giving legislative effect to ESC C16. One can only hope that there is no adverse effect on what is a very useful, practical provision.
The above article is reproduced from ‘Practice Update’ (March/April 2009), a tax Newsletter produced by Mark McLaughlin Associates Ltd. See the Newsletters section.