Clearly HMRC is taking – and will continue to take – a keen interest in the ways in which people are extracting money from their companies.
As my clients’ recent experiences reveal, the tax man is particularly intent on checking that company owners are paying income tax, either on earnings at rates of up to 45% (plus 2% national insurance) or on dividends, which attract tax at a rate of 38.1%.
In some cases, HMRC is seeking to apply the “Transactions in Securities” anti-avoidance rules which can allow it to tax capital payments to shareholders at dividend tax rates rather than at the capital gains tax rates (which may be as low as 10%). I’m currently assisting many clients who have been challenged by HMRC on this matter, and I’ve noticed a fact pattern emerging in which HMRC is enquiring into companies’ decisions to reduce their share capital.
Under new rules introduced by the recent Companies Act, it is now relatively easy for a company to reduce its capital and return cash to its shareholders. Where this is done, the amount concerned is treated as a capital gain and taxed at 10% for a trading company or 20% in other cases.
Let’s imagine I set up a company using 100 £1 shares. My company is very successful and five years later it is worth £1 million. At this point I put in place a holding company on top of the original company for commercial reasons. This allows me to issue 1 million shares in my holding company, increasing my share capital and making my balance sheet look stronger.
I later decide I don’t need such a large amount of share capital, so I reduce it to £100,000 and pay back the £900,000 to myself, leaving 100,000 shares in my company.
HMRC informs me that I should be taking any extra benefits from my company as dividends and paying income tax on them, but my defence is that I chose to reduce my share capital for commercial reasons. In many cases, HMRC refuses to concede, leaving the Tribunals or Courts to decide who wins the case. A lot of the cases on which I am currently advising involve companies which, like my imaginary example, had substantial share capital, often as a result of previous restructuring.
HMRC seems to be concentrating, for the moment, on transactions that occurred in the tax year 2015-16. For many of my clients, HMRC’s challenge will be unfounded, either because there was a genuine commercial reason for reducing the company’s share capital or because the Transactions in Securities rules do not apply for technical reasons.
Currently HMRC is on a fact-finding mission and is simply asking companies for information. Even if no formal challenge follows, fulfilling HMRC’s requests for information can be expensive and time-consuming. Also, HMRC is not going to go away – this legislation isn’t used lightly, so all enquiries must be taken seriously from the outset.
Shareholders are understandably concerned at what HMRC’s challenge might mean for themselves or their businesses – and whether these draconian anti-avoidance rules apply to them.
The Transactions in Securities regime, introduced in 1960, is one of the most abstruse elements of the UK tax code, and because of the extent of its complexity, it is essential that companies seek professional tax help.
Accountants should also advise companies who might be considering a share capital reduction that HMRC might require an explanation of their reasons for doing so.
As an expert on this legislation, I have written extensively about the subject and have more than 20 years’ experience. I can help with any challenges from HMRC, so please get in touch if you feel your reduction in share capital is being wrongly queried. Similarly talk to me if you would like further advice and information on the Transactions in Securities rules.