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Background

This extra statutory concession came into being almost 40 years ago to allow companies to be wound up without the process and cost associated with a formal liquidation.  The purpose was to provide a simple way of closing down companies that are no longer required and it allowed the distribution of assets to be treated as capital receipts rather than income distribution, which not only put the shareholders in the same position as they would be in a formal liquidation, but this treatment also allowed the shareholders to benefit from Entrepreneur’s Relief and its predecessor, Taper Relief; which it must be acknowledged, can produce a more favourable tax outcome than if the distribution was be treated as an income distribution.

The concession was formally published as ESC C16 during the 1980s as part of an agreement with the Revenue to publish such concessions. There are two points that should be highlighted and the reason for this will become clearer below. Firstly, and in common with all ESCs, concessions are not available for the purpose of evading tax; and secondly, there was no limit to the amount which could be distributed, nor any guidance issued that stated the matter must be referred to Head Office for approval.  Finally, as with all concessions, HMRC do not have to agree to the concession and can block the winding up – indeed the winding up cannot take effect without HMRC’s agreement.

Why has HMRC sought to give legislative effect to ESC C16?

The background to this measure is the House of Lords' decision in R v HM Commissioners of Inland Revenue ex parte Wilkinson [2005] UKHL 30 which clarified the scope of HMRC's administrative discretion to make concessions that depart from the strict statutory provision. HMRC state that “Legislating ESC C16 is part of a legislative programme intended to give statutory effect to existing ESCs where these may exceed the scope of that discretion.”

There is nothing contentious here, but in the initial consultation HMRC proposed a limit of £4,000 on the amount which could be distributed under ESC C16, which understandably was use to neither man nor beast. It seems that this figure had its origins in the issue of Bona Vacantia which relates to companies that had been closed and had share capital which was either left inside the company and so passed to the crown by default, or a distributable reserve was extracted by an illegal dividend where the right to pursue the shareholders for that amount passed to the crown.

The Treasury Solicitor's Office agreed that small sums of non-distributable reserves of up to £4,000 could be extracted without a claim being pressed by its claim, provided that the persons extracting the cash had permission under ESC C16.

Following responses to the Consultation, HMRC has lifted the limit to £25,000 which can be treated as a distribution of capital (which with Entrepreneur’s Relief could result in a tax charge as low as 10%) and anything above this amount must be treated as income which via the form of a dividend would attract tax at a rate of 32.5% or even 42.5% subject to the shareholder’s other income in that tax year.  Yes, it’s a step in the right direction, but as many small businesses over the period of their lifetime will have much more than this amount in distributable reserves, it is clearly far short of what is needed.

This decision certainly flies completely in the face of HMRC’s stated policy objective in the Tax Information and Impact Note: “To allow shareholders in small businesses to withdraw the fruits of their investment at the end of a company's life in a tax efficient way.“

You can avoid this issue by going through the formal winding up procedures under the Companies Act.  But even if you can find a liquidator that charges substantially less than HMRC’s estimate of £7,500 (I have received ballpark estimates that a straightforward members’ voluntary liquidation might cost closer to £4,000), it is still a considerable cost and you would have to do the calculations (and take into account the additional delay) to determine for any amounts over £25,000 whether using ESC 16 and paying additional tax or going through the formal winding up process would be more beneficial.

Strangely, HMRC acknowledges that the enactment of formal legislation is designed for anti-avoidance reasons and hence the imposition of a monetary limit of £25,000. Yet in its own impact assessment, it envisages that there will be a negligible impact on Treasury receipts – so one has to ask: “why bother with this measure?”

HMRC’s summary of impacts states: “The change will not increase HMRC processing or compliance resource costs. The £25,000 ceiling will provide inbuilt protection against avoidance/evasion.”  So it won’t increase compliance costs, but it won’t reduce them either; it won’t bring in considerably more money, but as HMRC acknowledge it will increase the costs incurred for those making considerably larger distributions.  So how does it help either simplify the system or reduce the burden to small businesses or even the Treasury itself?  Well, plainly it doesn’t; so surely the measure fails on all reasonable ways of measuring its impact.

The Impact summary goes on: “Legislating this concession will have a positive impact on investors in small businesses. Small firms' representatives have engaged with the consultation and welcomed the proposal to legislate the ESC - the ceiling on distributions has been increased in response to their concerns.”

As we have already seen, how HMRC believe this will have a positive impact on investors in small businesses is totally unclear and the opposite appears to be the case!  They are correct that Small firms' representatives have engaged with the consultation and welcomed the proposal to legislate the ESC in the sense that a) they responded to the consultation and b) they wanted clarity, but a reading of the some of the responses would not lead anyone to believe that they were ‘delighted’ with the initial consultation.  Yes, the increased ceiling on distributions has been welcomed – but only because the initial ceiling was ludicrously low – but it is hard to find anyone who believes that the £25,000 is anywhere near enough.

PCG are currently investigating ways to put pressure on the Government to increase or remove the limit of £25,000.

This information has been provided by Paul Mason of Abbey Tax Protection, Abbey Tax operate the PCG members Tax helpline.

Useful Links

• Related Member Q & A: It's not about getting closure (ESC)
• Members can get further advice and guidance by contacting the Tax helpline here>
• Further information on taxation can be obtained in our resources section here>
• For more details and benefits of PCG membership click here>

Source: PCG - Closing your company? A lesson in spin: the enactment of Extra-Statutory Concession C16 (published on 5th January 2012)

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