Phoenix is an act that some business owners practice whilst trying to dispose of their business.
An anti-avoidance rule was set up to put an end to this act when the business owners decided to sell liquidate or sell their business.
When this occurs, the taxpayer could be chargeable under capital gain tax or income tax.
What happens if the net gains are chargeable under a Capital gain tax?
When a business owner sells their business, they would usually get quite a large sum of money and the HMRC usually would take some of their proceeds.
The amount that is chargeable to tax is usually the net disposal proceeds from the sale of the business.
This is derived from the net sales and the net cost of the business.
If the business owner qualifies to be charged capital gain tax, he would have two options:
The taxpayer could pay tax at 18% or 28 % on the net proceeds if they do not qualify for Entrepreneurs relief.
What is the capital gains tax entrepreneurs’ relief with the act of phoenix?
This is the relief that enables the taxpayer to pay capital gain tax at 10% rather than 18% or 28%.
Hence, most business owners would rather prefer this option and ensure they do everything to qualify.
If you would like to read more on Entrepreneur relief, kindly click.
What happens if the net gain is chargeable under Income tax with the act of Phoenix?
When the net gain is chargeable under income tax, it is treated as a distribution that is made to an individual on or after April 6th, 2016.
Rather than applying the rates for a capital gain, the effective rate applicable could be up to 38.1%.
How an entrepreneur could be practising the act of Phoenix?
Whilst a shareholder of a business is running its business, every time they need to draw out money from the business it would be treated as income distribution and they would either pay tax on it as salary or dividend.
So, what some business owners did was to accumulate profit in their business and then pretend to sell the business and distribute the money as gains from the business hence paying tax at 10% rather than paying dividend tax at an effective rate of 38.1%.
This is an act of Phoenix. so to put an end to this act the HMRC has put in place targeted anti-avoidance rules to curb this practice.
Conditions to show that a business owner is practising Phoenix.
HMRC could investigate a business owner if they believe that ALL the four of the conditions explained below are met in the transaction of selling one’s business due to phoenix.
- The business owner has at least 5% interest in the company immediately before the winding up of the business.
- The business would have been a close company in the UK or would have been treated as a close company if the company is a non-UK company. a close company is one that meets any of the following conditions:
- It’s a limited company with five or fewer participants.
- It’s a limited company in which all the participants are directors.
- A participator is any person that has shares or interest in a company’s person too will be entitled to income or assets from the company either now or in future, whether directly or indirectly.
- 3. The person selling the business or receiving distribution continues to carry on or be involved with the same trade or trade like that of the company that has just been wound up or sold within 2 years after the distribution has been made. This taxpayer must ensure they are not connected in any way to this new business.
- Connected is defined in tax as the person’s spouse, the spouse or civil partner of the relative of the taxpayer, relative in tax means the brother, sister, ancestor, or lineal descendant.
4. There is reasonable doubt that the main purpose of winding up the business is the avoidance or reduction of a charge to income tax.
What happens if HMRC can prove an act of phoenix?
- The returns submitted would be reviewed and treated as income tax distribution.
- The taxpayer would be charged the right amount of tax.
- He would also be charged a penalty for submitting a return that does not reflect the right tax.
- Depending on how he corporates with HMRC, the rate applied on unpaid tax could range from 30% to 100% on the unpaid tax
- HMRC would also charge interest on the unpaid tax from the date it became due.
- If they can prove that the taxpayer has been involved with the anti-avoidance scheme they could give him also a penalty for not disclosing to the HMRC to be involved in an anti-avoidance scheme.
Conclusion on the act of Phoenix by taxpayers
These conditions must all be met for HMRC to prove that the taxpayers have been caught up by this rule.
Therefore the taxpayer must ensure that they can gather enough evidence to prove that the main purpose of winding up the business was tax avoidance.
Another way is to ensure that the time frame of 2 years expires before a similar business is set up by the owner of the business.
If you would like more advice on Phoenix, you can contact us by clicking