Donald Reid Group


Rules introduced with the Finance Act 2016 were intended to try to put an end to the situation where an entrepreneur formed a series of companies and took advantage of claiming entrepreneurs' relief on the cash released by liquidation rather than paying tax on the profits earned and withdrawn as dividend income.

There has always been an argument that this type of transaction would fail under the rules for transactions in securities but due to a lack of resources, HMRC very rarely challenged this.

The legislation does not refer directly to Phoenixism but has given a list of four conditions where, if applied, will treat the liquidation dividend as income for tax purposes.

The difficulty, which will apply, is that HMRC will not give advance assurance on whether capital treatment will be accepted and under the rules for self-assessment the tax payer has the responsibility for deciding how to treat this on their tax return.

Targeted anti-avoidance rule (TAAR) – the Conditions

A distribution in a winding up made to an individual on or after 6 April 2016 will be treated as if it were a distribution where certain conditions are met. For the rule to apply, all of the following conditions must be met:

Condition A
The individual receiving the distribution had at least a 5% interest in the company immediately before the winding up

Condition B
The company was a close company at any point in the two years ending with the start of the winding up

Condition C
The individual receiving the distribution continues to carry on, or be involved with, the same trade or a trade similar to that of the wound up company at any time within two years from the date of the distribution

Condition D
It is reasonable to assume that the main purpose, or one of the main purposes, of the winding up is the avoidance or reduction of a charge to Income Tax.

Conditions A and B are relatively straightforward as they define the target company and shareholder. Condition A has been re-defined by changes made in the recent budget and are discussed in our blog “Entrepreneurs relief changes – how will they affect you?” Condition B requires that the company be a close company when the liquidator is appointed or has been at any time during the two previous years immediately preceding the liquidation.

Conditions C and D are far less straightforward and ultimately will cause the most problems for taxpayers and their advisors Condition C is triggered if, at any time during the two years following the date on which the liquidation began, the entrepreneur is involved in a similar business. This is not restricted to another company but may also be triggered if he is trading within a partnership or operating as a sole trader providing consultancy services. Condition C can also be triggered if a person to whom he is connected, such as a spouse or business partner, becomes involved in a similar trade.

Lastly Condition D is the most difficult to assess and whether it can be said that the main purpose, or one of the main purposes, is for the avoidance of income tax.

Key Questions

The three key questions which need to be answered are:

  • How do we determine what is meant by the phrase “it is reasonable to assume”?
  • What is meant by the phrase “the main purpose”
  • Does the phrase “the avoidance of a charge to income tax “extend to the decision not to pay a pre-income dividend

Looking at these in order, HMRC should take account of the way the tax payer has disclosed the sum on the tax return and not simply take the view that it is not correct. Therefore it is up to HMRC to show that the view taken by the tax payer is unreasonable.

Looking at the second condition, rather surprisingly, it may depend on the facts of each case with the focus resting on what was achieved by taking the liquidation route rather than what the motive was to liquidate. We anticipate that this will be an area that HMRC will focus on as the very nature of an entrepreneur is that they will often have very diverse business interests and this could be problematical.

In the case of the Director who is retiring and not looking to start another business there should not be a problem but it is sometimes in the case of a disposal of shares to a third-party buyer, the entrepreneur may be offered a consultancy arrangement for a few years which could have the potential to mean there is no entrepreneur's relief on the share disposal.

Lastly HMRC has indicated the fact that a pre-liquidation dividend has not been paid will not be regarded as tax avoidance in these circumstances

Given the convoluted natures of this legislation and the fact that the individual has to self-assess the transaction, this is an area that needs to be looked at carefully each time a liquidation is considered.

If you would like to discuss Phoenixism and the rules relating entrepreneurs' relief, please do get in touch with the tax team at DRG Chartered Accountants.


DISCLAIMER: This information is for guidance only, and professional advice should be obtained before acting on any information contained herein. We will not accept any responsibility for loss to any person as a result of action taken or refrained from in consequence of the contents of this publication.



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