My client wishes to arrange for his company to be placed into members’ voluntary liquidation. The intention is that the company will continue to trade as the order book is run off, and my client will use distributions made during the liquidation to repay loans made to him by the company. Can the payments made during the liquidation be treated as capital for all tax purposes, or will HMRC use the revised transaction in securities legislation of ITA 2007 s 687 to argue that there is an income tax advantage? Also, will it be possible to benefit from entrepreneurs’ relief if the liquidation continues for some time, given that my client will be a director only up to the date that the liquidator is appointed?
If the client wishes to liquidate the company with the intention that the liquidator will continue to trade the company and make a series of payments in liquidation, then he may fall foul of the anti-avoidance rules found in ITA 2007 ss 682–702.
The relevant law was updated in Finance Act 2010, and therefore the previous judicial guidance cannot be wholly relied upon. This is a new area of law and, if the client wishes to go ahead with this, it would seem that the only option is to follow the clearance procedure, otherwise there is uncertainty and risk.
The conversion of income to capital, so that liquidation proceeds are received instead of dividends ,constitutes an ‘income tax advantage’ within ITA 2007 s 684(1)(d) and s 687.
A person is liable to counteraction of such an income tax advantage if:
The only point in doubt is whether a liquidation amounts to a transaction in securities. Section 684(2) defines ‘transactions in securities’ as ‘a transaction, of whatever description, relating to securities’.
On the plain meaning of the words, it would seem that a liquidation is a transaction of some description, and that it relates to securities (which, under s 713, include shares). However, in CIR v Laird Group plc [2003] UKHL 54, Lord Millet said, at para 37:
‘The distribution of the undistributed profits of a company in liquidation to its shareholders is not a transaction relating to securities because neither the shares themselves nor the rights attached to them are affected by a payment which merely gives effect to the shareholders’ rights; they receive only what is already theirs.’
Lord Millet’s judgment was given in the context of the previous legislation in ICTA 1988 ss 703–710. This was rewritten as ITA 2007 ss 682–713. The objective of the rewrite was to preserve the effect of the existing law, and Lord Millet’s remarks would therefore be equally applicable to that legislation.
However, FA 2010 made changes to the law, substituting new ss 682–687 for the former ss 682–694. If Lord Millet’s conclusions relied on features of the old law that are not replicated in the new, then it has no application to the new legislation. That would not mean that a liquidation definitely was a transaction in securities, but simply that the point fell to be decided anew on the basis of the new legislation. Lord Millet’s comments were based on ICTA 1988 s 703(2), which became ITA 2007 s 684(3) as originally enacted. In the current legislation there is no equivalent of s 703(2), so we are cast back upon the plain meaning of the words ‘transaction, of whatever description, relating to securities’.
The HMRC corporation tax manual says at CTM36850:
‘an ordinary liquidation (in which a company is wound up following the complete cessation of its business or the transfer of that business to a person unconnected with its original shareholders) is not within the scope of this avoidance legislation. This legislation can however apply to counteract a tax advantage obtained in consequence of the combined effect of a transaction and the liquidation of a company.’
This paragraph does not address the basic question of whether, as a matter of law, a liquidation is within the terms ‘transaction in security’, and it may be that the guidance has not been updated for FA 2010. Accordingly, Lord Millet’s dictum in Laird may still stand, but this is by no means certain and the client would be advised to seek HMRC clearance before proceeding.
The client also asks whether the payments received in liquidation will qualify for entrepreneurs’ relief. The legislation relating to entrepreneurs’ relief is set out in TCGA 1992 ss 169H–169S. Often in a liquidation situation, a company ceases to trade, a liquidator is appointed and the directors’ powers cease on this date, and the shareholder qualifies for entrepreneurs’ relief by reference to the last day of trading (provided the disposal takes place within the following three years). Here the circumstances are different, as the liquidator will be continuing to trade the company. The company will continue to qualify as the shareholder’s personal trading company if the shareholder is an employee of the company at the date the liquidator is appointed and continues to be so.
An alternative, less aggressive, solution for the client may be to continue to trade the company, running off the future order book and drawing the funds needed to fund his lifestyle and repay company loans as income distributions. This will leave a balance to be paid out of the company in a normal liquidation. In this scenario, the forward order book can be fully invoiced out, the cash can be collected and the company can then enter liquidation in the normal way.
