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Extracting profits from companies - big tax rises on the way for many owner managed businesses

Many entrepreneurs who will be expecting to benefit from Entrepreneurs' Relief (ER) could be in for a nasty shock from 6 April 2016 as a consultation document on 'company distributions' has recently been issued by HMRC.  This proposes many anti avoidance measures to prohibit previously conventional routes for extracting cash from owner managed businesses (OMBs).

CGT to be replaced?
The proposals seek to reclassify capital gains as income, replacing Capital Gains Tax (CGT) which can be as low as 10% if ER is available, with income tax up to a maximum rate of 38.1% on distributions from 6 April 2016.

With the reform of dividend taxation from 6 April 2016, the majority of the proposals are expected to come into effect from the same date.  Capital reductions, voluntary liquidations, purchase of own shares and even some company sales after this date may have radically different consequences to the same transaction as undertaken before this date.

Currently a reduction of capital by the repayment of share capital or share premium to shareholders or a distribution to shareholders by a liquidator from a members voluntary liquidation (MVL) are not a distribution by the company under general principles.  In both cases these are treated as a capital transaction subject to CGT and, where applicable, ER.

The only exception to the above general principles is if HMRC can use existing anti-avoidance rules to:

•    reclassify the reduction of capital as a dividend; or
•    reclassify the distribution from a MVL as a dividend

The existing anti-avoidance rules do not explicitly include repayments of share capital or share premium and distributions from a MVL as transactions that can be reclassified.  Although it is understood that a combination of these types of transactions and a new issue of shares could result in the combined transactions being reclassified.

Taxation diary dates
After 6 April 2016, capital reductions and MVLs may be explicitly included within the remit of the existing anti-avoidance rules and a further Targeted Anti-Avoidance Rules (TAAR) will be introduced to target MVLs.  For capital reductions and MVLs the extension of the existing rules will generally make it much more difficult to claim ER.  For a MVL it may be possible to claim ER if the shareholders are no longer going to be involved in business activities going forward.