The main purpose of the rule is to prevent business owners from converting dividend income into a capital payment, to avoid paying income tax and instead of paying capital gain tax and reducing their overall tax liability. The technique is basically a tax evasion technique and HMRC discourages such practices.
This practice is generally known as ‘phoenixism’ (arising from the ashes).
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:
- An individual holds up to 5% of ownership in the right before the winding up.
- The company was a close company at any point in time in 2 years ending with the inception of the winding up.
- After winding the up the and receiving the distribution the person carries on and continues the same trade whether directly or indirectly or through a partnership owning up to 5% of the shares in the company within 2 years of winding up.
- It is clear the winding up is taken just for the sake of reducing the tax liability and avoiding paying high taxes.
The rules also apply to companies across the borders, in case a company which is non-resident is wound up.
For further in-depth guidance from HMRC on this topic please click here
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