When an individual shareholder sells shares in a ‘close’ family or owner-managed trading company, he or she will probably expect the proceeds to be treated as a capital receipt. If the individual is liable to capital gains tax (CGT) on the share sale, in many cases the tax rate will be 20% (for 2018/19), although the CGT rate could be only 10% if the conditions for entrepreneurs’ relief are satisfied and a claim is successfully made.
CGT or income tax?
The above CGT rates of 20% or 10% will normally be more favourable than if the share sale proceeds were subject to income tax and the shareholder was a higher or additional rate taxpayer. Of course, HM Revenue and Customs (HMRC) recognises this. There is anti-avoidance legislation (ie the ‘transactions in securities’ rules) whereby HMRC can broadly counteract an income tax advantage in certain circumstances where a main purpose of the share sale was to obtain the advantage.
In the above example, if the company had sufficient distributable reserves and HMRC successfully argued that the share sale was ‘caught’ by the transactions in securities rules (in ITA 2007, ss 682-713), such as if the shares were sold to another company owned by the vendor with a view to claiming entrepreneurs’ relief on the sale, the income tax advantage subject to HMRC counteraction would broadly be the difference between the CGT payable if the ‘relevant consideration’ was received as capital, and the amount due if the vendor had received a dividend subject to income tax instead.
Seeking the ‘all clear’
Taxpayers (and advisers) seeking certainty about whether HMRC considers the above anti-avoidance rules would apply may submit a clearance application in advance of the proposed transactions (under s 701). Of course, full and accurate disclosure is required so that any clearance given by HMRC can subsequently be relied upon. HMRC guidance on clearance applications is available on the Gov.uk website (www.gov.uk/guidance/seeking-clearance-or-approval-for-a-transaction).
Unfortunately, there is no right of appeal if HMRC refuses to give clearance that a transaction is not ‘caught’ by the transactions in securities provisions and that no counteraction notice ought to be served.
Taking a chance?
Some taxpayers may therefore prefer to ‘take a chance’ and proceed with their share sale as planned without submitting a clearance application, in the hope HMRC will not consider that the anti-avoidance provisions apply to their transaction.
HMRC’s compliance and counteraction procedures under the transactions in securities rules (which had not been updated since the introduction of self-assessment in the 1990s) changed in Finance Act 2016. HMRC may now enquire into transactions if there is reason to believe that the taxpayer could be liable to income tax under the anti-avoidance rules, by issuing an enquiry notice to the taxpayer.
This HMRC enquiry notice should not be confused with tax return enquiry notices. One practical aspect of the transactions in securities provisions is that taxpayers are not required to self-assess income tax liabilities under those rules. However, taxpayers will generally need to disclose the transactions on their tax return, and self-assess any CGT liability.
The normal time limit for HMRC to enquire into a tax return is twelve months after the day on which the tax return was filed (although that period can be extended if the return is submitted late), but HMRC may make an assessment within four, six or twenty years after the end of the tax year to which it relates (depending on the circumstances) if it ‘discovers’ an insufficiency of income tax or CGT.
By contrast, the time limit for HMRC to issue an enquiry notice under the transactions in securities provisions is within six years after the end of the tax year to which the income tax advantage relates (ITA 2007, s 695).
Following such an enquiry, if HMRC considers that the anti-avoidance rules apply, it may issue a notice showing the income tax advantage to be counteracted, and make adjustments to the taxpayer’s tax position. However, there is a right of appeal against a counteraction notice to the tribunal within 30 days. Alternatively, if HMRC considers that the anti-avoidance rules do not apply, it must issue the taxpayer with a ‘no-counteraction notice’.
The lack of an appeal procedure against HMRC clearance refusals means that some taxpayers may prefer to self-assess a CGT liability rather than apply for clearance, and take their chances on whether HMRC issues a counteraction enquiry notice. Some taxpayers may even wish to self-assess their tax liability on that basis despite clearance having been applied for and refused. However, the required full disclosure is likely to result in an enquiry and the issue of a counteraction notice. Advisers should also consider their obligations under ‘professional conduct in relation to taxation’ in relation to the tax issues and disclosures to HMRC.
The above article was first published in Business Tax Insider in June 2017 (www.taxinsider.co.uk).
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