Extracting development profits as capital and at lower rates of tax
A fairly common practice is to set up a new company for each development and then liquidate the company when the property is sold, in the hope that the distribution is eligible for Entrepreneur’s Relief and thereby benefits from a 10% tax rate, saving as much as 28.1% when compared to the rate payable on an income dividend distribution.
However, beware recent anti- avoidance legislation if you subsequently start up a ‘phoenix company’.
New legislation, effective from April 2016, means that a distribution in a winding up is treated as an income distribution if all the following conditions are met:
a) immediately before the winding-up the individual held an interest of more than 5% in the company, and
b) at the time of the winding-up, or at any time in the preceding 2 years, the company was a close company, and
c) at any time in the 2 years after the winding-up the individual (or a person ‘connected’ with the individual) carries on the same or similar trade that was carried on by the company (or an effective 51 per cent subsidiary company) either by himself, in partnership, or as a participator in a company which carries on such a trade.
d) the purpose, or one of the main purposes, of the winding-up is the avoidance of Income Tax.
An outright sale of the shares to 3rd party, or a distribution on liquidation where the director/shareholder retires, are not normally caught by the new rules. In many other cases it will be more difficult to successfully argue that one of points a-d does not apply. Questions such as ‘when is a trade similar? , or ‘when is tax avoidance one of the main purposes’ may have to be answered.
If HMRC are successful in invoking this legislation you will pay tax at Income Tax rates and a penalty charge if you haven’t disclosed all relevant circumstances on your tax return. So don’t gamble, seek advice before you make detailed plans!
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