By | 8 February 2011

ESC C16 is a very useful concession for taxpayers. By way of a brief reminder, ESC C16 broadly allows distributions to shareholders by a company that has ceased business and is awaiting dissolution to be treated as made in a formal winding up for tax purposes, if certain conditions are satisfied and assurances given to HMRC. Distributions under ESC C16 are therefore treated as capital distributions, as opposed to income distributions.

ESC C16 will soon be coming to an end. On 13 December 2010, HMRC issued a consultation document on draft legislation to replace a number of concessions, including ESC C16. The consultation ends on 7 March 2011, and it is likely that legislation to replace ESC C16 will then be introduced shortly afterwards. Unfortunately, the proposed legislation in the consultation document, if enacted, will severely restrict the application of the ‘old’ ESC C16 treatment.

Proposed changes

The draft legislation amends the Corporation Tax Act 2010 (Part 23) on distributions, by adding a new section to Chapter 3 (‘Matters which are not distributions’). The proposed new section 1030A (‘Distributions in respect of share capital prior to dissolution of company’) applies where the striking off procedure (in CA 2006, s 1000) has commenced, or if the company makes (or intends to make) a striking off application (under CA 2006, s 1003), and in either case the company makes a distribution in respect of share capital in anticipation of its dissolution. The normal tax treatment of distributions is switched off if two conditions (A and B) are satisfied. Condition A is broadly that the company has (or will) collect any amounts due, and has paid any liabilities owing. Condition B is that total distributions do not exceed £4,000.

Even if these conditions are satisfied, the above tax treatment can be reversed if, within 2 years of the distribution(s), the company has not been struck off, or if the company has failed to deal with its debtors and/or creditors, as mentioned above (CTA 2010, s 1030B).

The explanatory note to the proposed legislation states: “Informal consultation with accountancy practitioners confirmed a continuing need for the concession in relation to micro and small businesses. The draft legislation is therefore subject to a £4,000 ceiling on distributions, which is broadly equivalent to the cost of winding up a small company.” Of course, £4,000 is also the upper limit for the Treasury Solicitor’s concessionary practice of waiving the Crown’s right to funds under ‘Bona Vacantia’ on the unauthorised return of a company’s share capital.  

As indicated in my article ‘No ESCape’ (Taxation, 30 September 2010), the original purpose of ESC C16 according to HMRC was so that “companies may arrange to finalise the tax position of a trading company as though a formal winding up had taken place, but without incurring the extra costs involved in such action.” In other words, ESC C16 was intended to save the professional fees of a liquidator. However, in practice HMRC did not impose an upper limit on the level of distributions under ESC C16, and I have seen instances of the concession being applied to companies with very substantial cash balances. The proposed introduction of a £4,000 upper limit is therefore an unwelcome development – unless of course you happen to be a liquidator!

All bad news?

However, if the proposed legislation becomes law, it is not necessarily all bad news. The higher rate of capital gains tax of 28% from 23 June 2010 means that income distributions may be preferable for individual in some cases. For example, the effective rate of tax on an income distribution for a higher rate (40%) taxpayer is 25%, which compares favourably with the 28% rate of CGT for those in the higher rate income tax bracket.

On the other hand, to the extent that distributions fall within the 50% income tax bracket, the effective rate of tax on net income distributions is 36.11%, which is clearly less attractive than a 28% CGT rate.

Capital distributions are particularly attractive if entrepreneurs’ relief is available, resulting in a 10% CGT rate. The proposed £4,000 ceiling on capital distributions under the statutory version of ESC C16 means that many company owners will need to pay for the ‘privilege’ of claiming entrepreneurs’ relief. According to HMRC’s estimated cost of winding up a company, that will mean professional fees of at least £4,000. This cost will need to be factored into the equation when comparing capital and income distribution treatment for tax purposes.

Have your say

In practice, there was seemingly no upper limit to the amount of distributions under ESC C16. It is therefore disappointing that HMRC should seek to introduce an upper ceiling now. Legislating for ESCs should mean giving them the same statutory effect as the concessionary treatment they replace in my view. This is perhaps another case of HMRC moving the goalposts.

I hope that professionals respond to the consultation on the proposed legislation, and that HMRC’s attempt to introduce an upper limit on distributions under the statutory version of ESC C16 is strongly resisted.

The above article is reproduced from ‘Practice Update’ (January/February 2011), a tax Newsletter produced by Mark McLaughlin Associates Ltd. To download current and past editions of Practice Update, see the Newsletters section.