It is human nature to treat change with some apprehension. This can sometimes be the case even if it is for the better.
However, any change that clearly makes life simpler is more readily accepted, although this does seem to be particularly rare these days as far as tax is concerned.
HMRC recently issued Extra-statutory concessions: Technical consultation on draft legislation, seeking views on the legislative effect that is being given to some concessions (see ESCs to be legislated).
This follows the House of Lords’ decision in R v CIR ex p Wilkinson  STC 270, which raised issues about the validity of ESCs and the extent of HMRC’s discretion to make and apply them under their care and management (now ‘collection and management’) powers in TMA 1970, s 1(1).
The Wilkinson case concerned HMRC’s refusal of a widower’s claim to widow’s bereavement allowance. The taxpayer argued that s 1(1) gave HMRC a discretionary power to grant concessions, which could include making allowances to widowers.
However, the House of Lords dismissed his appeal. Lord Hoffmann said that HMRC’s powers under s 1 should not be construed ‘so widely as to enable the commissioners to concede, by extra-statutory concession, an allowance which Parliament could have granted but did not grant’.
Legislation was recently introduced to allow HMRC to continue applying ESCs that might otherwise fall outside their discretionary powers.
Finance Act 2008, s 160 allows the Treasury to give effect to existing HMRC statements, e.g. ESCs, statements of practice, Revenue interpretations, decisions and press releases, including powers to modify existing concessions, and to amend, repeal or revoke any enactment or instrument, whenever made.
The consultation document divides the existing ESCs between:
- those that can be legislated under s 160 (or other powers);
- concessions that can remain as such because they are considered ‘intra vires’, i.e. within HMRC’s discretionary powers and are linked to other ESCs in the s 160 category; and
- those where ‘clarification’ is needed before legislation is drafted; this includes ESC C16 (‘Dissolution of companies under s 652 and s 652A Companies Act 1985; distributions to shareholders’).
The story so far…
Extra-statutory concession C16 broadly allows distributions to shareholders on the dissolution of a company to be treated as capital distributions within TCGA 1992, s 122, as opposed to income distributions within TA 1988, s 209, if certain conditions are satisfied and assurances are given to HMRC.
This article deals with the dissolution of private companies. While it is not primarily concerned with those ESC C16 requirements, it is worth mentioning a few practical issues regarding the concession.
The first practical issue is that two additional conditions are listed in HMRC’s Company Taxation Manual (at CTM36220), which are not listed in ESC C16. HMRC’s manuals do not carry the force of law, but they are generally a useful guide of HMRC practice and are perhaps worthy of particular note in the context of concessions.
The first additional condition is that the company is not the subject of an investigation. The second additional condition is broadly that the company is not potentially ‘caught’ by the transactions in securities anti-avoidance provisions of ITA 2007, s 684 (formerly TA 1988, s 703) in respect of the following (listed under sub-paragraphs (e) or (f) of CTM36875, but paraphrased below):
- transfers or sales of the company’s assets or business to another company with some or all of the same shareholders followed by the liquidation of the former company or the sale of shares in either company;
- capital receipts by the company’s (or group’s) shareholders following a demerger or reconstruction from the sale or liquidation of one demerged company where the same shareholders retain an interest via another company involved in the transactions.
HMRC officers should not automatically refuse to apply ESC C16 if the company and its shareholders fail to meet all the relevant conditions. They should instead refer the matter to their technical specialist colleagues for further consideration.
A further practical issue is what happens if the company has already made distributions as part of the dissolution process, without having sought HMRC’s prior approval to apply ESC C16.
I recently dealt with a case in which an HMRC officer refused an application in those circumstances. However, after pointing out that HMRC’s own guidance allows for concessionary treatment even after a company has been dissolved (CTM36230), happily the HMRC officer relented and applied ESC C16 with retrospective effect.
ESC C16 in practice
The concession is intended to benefit companies and their owners by saving the costs associated with a formal winding up.
In addition, potentially lower rates of capital gains tax in recent years; business asset taper relief, where it was available prior to 6 April 2008 and the single 18% rate in the current tax year reduced by entrepreneurs’ relief, if applicable, means that capital distributions are very often more attractive to the company’s shareholders than those liable to income tax.
Distributions made in respect of share capital in a winding up are specifically excluded from being ‘distributions’ in tax terms (TA 1988, s 209(1)).
However, the distribution of assets by a company followed by its dissolution under Companies Act 1985, ss 652 or 652A does not amount to a winding up for the purposes of TA 1988, s 209(1).
HMRC generally consider that a company is wound up either by a court order or voluntarily by company resolution in accordance with the Insolvency Act 1986, Part IV (CTM36105).
Extra-statutory concession C16 therefore is based on the fiction that the company has been formally wound up for the purposes of determining the tax treatment of distributions during the dissolution process.
Companies Act 1985, s 652 (‘Registrar may strike defunct company off register’) and s 652A (‘Registrar may strike private company off register on application’) are being replaced by largely equivalent provisions in Companies Act 2006, Part 31, chapter 1 (‘Striking off’) and secondary legislation with effect from 1 October 2009.
Both sets of provisions deal with company dissolutions. They are not concerned as such with the distributions of assets on a winding up. As HMRC put it:
‘Dissolution under s 652 is not considered to amount to a winding-up under the Insolvency Act. You should not refer to it as a winding-up, nor as an “informal liquidation”’ (CTM36205). However, the ESC C16 process is still commonly referred to as an ‘informal winding up’.
Problems with ESC C16
Notwithstanding HMRC’s comments above, in practical terms the ESC C16 process typically involves the distribution of a company’s assets, including the repayment of its share capital represented by those assets.
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 its winding up (CA 2006, s 829(2)).
A problem with ESC C16, as highlighted in the Wilkinson case, is that it is a deeming provision for tax purposes. It has no application for company law purposes. It does not allow assets representing share capital to be distributed, and such an action is therefore unlawful in company law terms where the concession is applied.
A further problem with ESC C16 is that in the absence of a winding up (or certain other procedures, such as making the company unlimited to enable it to reduce its share capital), the company’s share capital, and any other property and rights still held not repaid or transferred prior to dissolution are strictly ‘bona vacantia’ and become assets of the Crown, Duchy of Lancaster or the Duke of Cornwall.
However, in practice the Bona Vacantia division of the Treasury Solicitor’s department will allow up to £4,000 to be repaid without seeking recovery as an unauthorised distribution (see form BVC 17, Guidelines about the distribution of a company’s share capital, on the Bona Vacantia website).
Reducing share capital
What if the company’s share capital exceeds £4,000? Previously, reducing share capital was (and still remains) possible with the court’s approval. Alternatively, as mentioned, some private companies re-registered as unlimited for the same reason.
However, since 1 October 2008, private limited companies have been able to reduce their share capital, using a solvency statement procedure introduced in Companies Act 2006 (ss 642 to 644) and supporting Regulations (The Companies (Reduction of Share Capital) Order, SI 2008 No 1915).
A private company can reduce its share capital by special resolution, supported by a solvency statement, a memorandum of capital (or a statement of capital as defined in Companies Act 2006, s 644, with effect from 1 October 2009) and a statement of compliance by the directors.
The Companies (Reduction of Share Capital) Order 2008 prescribes the form in which such solvency statements must be made. Companies House has not yet produced standard documents for the new capital reduction procedure, and companies (or their advisers) must therefore produce suitable documents themselves.
The company can reduce its capital in any way it chooses, including repaying share capital in excess of the company’s ‘wants’. However, there are certain conditions attached to the capital reduction procedure.
For example, there must be at least one member holding a non-redeemable share following the reduction (s 641(2)). The procedure is also subject to anything in the company’s memorandum or articles preventing a reduction of the company’s share capital.
The company’s directors must make a solvency statement up to 15 days before the passing of the special resolution. A copy of the solvency statement and resolution, and the memorandum concerning the company’s share capital and directors’ compliance statement, must be delivered to Companies House within 15 days of the resolution to reduce the company’s share capital being passed. The capital reduction will not take effect until Companies House registers the relevant documents.
The written solvency statement (within s 643) must be signed by each of the directors, stating that, in their opinion:
- at the statement date there are no grounds on which the company may be unable to pay its debts; and
- if a winding-up of the company is to commence within 12 months of the solvency statement, the company will be able to fully meet its debts within that period; or
- in any other case the company will be able to meet debts as they fall due during the year immediately following the solvency statement date.
The special resolution must also make any necessary alterations of the company’s memorandum by reducing its share capital and shares (s 641(1A)). There is no need for a supporting auditors’ report (in contrast to, for example, redemptions or purchases by private companies out of capital).
However, the directors must have reasonable grounds for the opinions expressed in a solvency statement delivered to Companies House, or otherwise a criminal offence is committed by each of them.
The company and its officers are also liable to a fine if the company files a solvency statement with Companies House that was not provided to the shareholders in accordance with the legislation.
This whole process should therefore not be taken lightly. Further information is contained on the Companies House website, and also on the Department for Business Enterprise & Regulatory Reform website.
The Act says that reserves resulting from a reduction of capital are not distributable (s 654(1)). However, this is subject to any Order to the contrary.
The Companies (Reduction of Share Capital) Order 2008 provides that reserves arising from the solvency statement procedure are treated as distributable subject to certain exceptions, and are treated as ‘realised profits’ falling within the Companies Act 2006 provisions regarding distributions (Part 23).
Capital reductions and C16
While repaid share capital can potentially be treated as a capital distribution for tax purposes, the capital reduction provisions do not seemingly affect the position regarding a company’s accumulated realised profits.
Their distribution remains subject to income tax in the hands of individual shareholders, subject to a formal winding up, or to the application of ESC C16.
Nevertheless, the solvency statement procedure followed by an application for ESC C16 treatment may be useful where, for example, the company’s share capital exceeds the £4,000 limit for bona vacantia purposes.
In appropriate circumstances, it may be possible to reduce share capital to within the Treasury Solicitor’s tolerance limit. The remaining share capital could then be repaid as part of the ESC C16 process.
A ‘capital distribution’ for capital gains purposes includes a distribution in money or money’s worth during the course of dissolving or winding up a company, unless the distribution constitutes income in the shareholder’s hands (TCGA 1992, s 122(1), (5)).
Capital distributions by companies to shareholders during a winding up, whether under ESC C16 or in a formal liquidation, are not normally treated as income payments, but as full or part disposals for the purposes of capital gains tax or corporation tax on chargeable gains.
Reductions in share capital under the new solvency statement procedure also generally fall to be treated as capital distributions to the shareholder.
Legislating for C16
HMRC’s technical consultation included ECS C16 in a category of concessions for which clarification is needed before legislation is drafted.
The department is understood to be preparing an external briefing paper explaining where clarification is required. The briefing paper was due to be released shortly after the time of writing this article.
It would be interesting to see if HMRC address the conflict between ESC C16 and company law in connection with distributions representing share capital made otherwise than in a formal winding up of the company.
However, it seems more likely that the concession will simply be added to the tax legislation in some form, and perhaps that the exclusion from the meaning of ‘distribution’ in TA 1988, s 209(1) will be extended to include distributions in the course of the voluntary striking off of a company.
What will happen to the assurances which are presently required to be given to HMRC as part of the ESC C16 application, and how legislative effect will be given to that process, remains to be seen.
The solvency statement route for capital reduction in private companies was introduced to provide a simpler and cheaper means for such companies to reduce their share capital than applying to the court under the Companies Act 1985 procedures, which continue to apply for public companies until 1 October 2009 when they are replaced by substantially the same procedures in Companies Act 2006.
The solvency statement procedure was not introduced with a particular view to dissolving companies and distributing realised profits, whether under ESC C16 or otherwise. However, it could be helpful, as explained above.
Giving legislative effect to concessions would seem to be a change for the better. However, it is perhaps premature to start celebrating the prospect of ESC C16 becoming law until we know the form it will take.
Watch this space.
This article was first published in ‘Taxation’ on 5 February 2009.