AccountingWEB: Enactment of ESC C16: Where are we now? 28 December 2011

AccountingWEB: Enactment of ESC C16: Where are we now? 28 December 2011 by CBW Partner, Andy White

A number of contributors took me to task, particularly David W who pointed out that it was the number 77 that went to Nether Wallop, and I confess that I have rarely encountered an issue that has prompted such a vehement response.

Fortunately, most of the attacks have been directed at the government, HMRC and the Treasury Solicitor. In my view, all of these organisations fully deserve the criticism that has been directed at them.

It gives me no pleasure that my warning has been proved right, despite the fact that my firm operates a vibrant and successful CR & I department so I suppose I should be grateful for the government’s largesse in ensuring that our income is boosted by some frankly bizarre decisions.

Let’s first review the position as it was and as it now is (or will be from March 2012).

For many years, ESC C16 has been used successfully by many small businesses to mirror the tax effects of a formal liquidation without going through the expense of that process. The concession was well-known, well-understood and well-used.

More recently, the Treasury Solicitor (for reasons unknown) drew everyone’s attention to the fact that a distribution of share capital without a formal liquidation was illegal and reserved the right to claim those assets under the rules of bona vacantia. However, for what appears to be practical reasons of cost, the TS agreed that no such claim would be made where the ‘illegal’ distribution was no more than £4,000. This is despite the fact that such a distribution would be legal in a formal winding-up so one wonders what motivated the TS to ‘stick his oar in’ when the whole purpose of ESC C16 was to mirror the tax effects of a liquidation without the cost.

It is interesting to note that, even then, the TS’s pronouncements were hardly a model of clarity and I have seen it argued in some quarters that the £4,000 limit applied to the entire value of the company’s assets, even those represented by distributable reserves. From March 2012, such arguments will become academic of course. Or will they?

In the light of company law changes making it easier for companies to reduce share capital, the TS announced that the concession was being withdrawn as it was no longer of any practical value. Even this announcement was mired in confusion. Initially, the FAQ said that (1) the guidelines were being withdrawn, (2) 'in practical terms', one could now distribute share capital of any amount prior to dissolution without approval from the TS and (3) there was no longer any need to contact the Bona Vacantia Division regarding distributions of any amount. Nowhere was there an unequivocal statement that the TS would not make a claim for bona vacantia irrespective of the amount of the share capital and the amount of the distribution.

Fortunately, this was hastily corrected and the TS website now confirms that no action will be taken irrespective of the amount of the distribution involved.

Then the government announced that, following the ending of the consultation period, the concession would indeed be enacted but the total distributions allowed would be limited to £25,000. Any more, and the entire distribution would be subject to income tax or, if capital treatment was required, a formal liquidation would be necessary.

So where does that leave us? Are we better off or worse off and has the government met its policy objectives?

I am put in mind of the traveller who asks a passer-by for directions to a particular destination to be met with the response “well, I wouldn’t start from here”.

Let’s go back to basics.

The enactment of the concession arises primarily from the decision in R –v- H M Commissioners of Inland Revenue ex parte Wilkinson [2005] UKHL 30 which suggested that certain concessions may go beyond HMRC’s administrative discretion. At the same time HMRC perceived abuse of the concession and the new legislation apparently seeks to address that issue.

The abuse is not specified although it is not hard to guess what it might be. Of course HMRC already has a raft of anti-avoidance legislation available to counter such abuse and indeed their own manuals state in CTM36220 that the first condition for agreement to ESC 16 is that the company is not one which, “if the distributions were made in a winding-up would be reported to the Anti-Avoidance Group (Intelligence) Clearance and Counteraction team in respect of Section 703 ICTA 1988 under sub-paragraphs (e) or (f) of CTM36875” Moreover, it is well-known that ESCs cannot be used for tax-avoidance.

It seems clear, therefore, that the government has decided that policing such abuse is too difficult and costly using the resources currently at HMRC’s disposal and the sledgehammer approach is more appropriate. As many contributors have pointed out, this will catch the innocent while doing little to stop the activities of the serial abusers.

We should of course be pleased that the original proposal to impose a £4,000 limit has been discarded in favour of a higher figure of £25,000, presumably as a result of the consultation. Was £4,000 originally chosen due to a government misunderstanding of the TS concession or were their motives more sinister than that? I cannot tell of course, but I invite you to look at the government’s own words. “The scope of the consultation”, it said “was to ensure that the draft legislation successfully preserves the current tax treatment” under the ESCs concerned. The Impact Assessment says that “the intention is to do no more than put the existing concessionary tax treatment on a statutory basis”. Both of these statements are untrue unless the harsh interpretation of the TS concession (above) was the correct one?

The new legislation cannot be used by companies with assets in excess of the modest sum of £25,000. The old concession could. In what sense is that ensuring “that the draft legislation successfully preserves the current tax treatment” (my italics)? And if” the intention is to do no more than put the existing concessionary tax treatment on a statutory basis” then they have failed lamentably.

Or consider the Tax Information and Impact Note of 6 December. The Policy Objective is apparently to allow “shareholders in a small business to withdraw the fruits of their investment……in a tax-efficient way” Does that mean that anyone who has built up reserves in excess of £25k over a lifetime is not running a “small business”.

In the same document, we find this gem: “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.”

Nothing wrong with that, you might think? However, what positive impact will the legislation have on investors in small businesses? It does not say. It is true that small firms’ representatives have engaged in the consultation and it is no doubt also true that they have welcomed the proposal to legislate. But do they welcome the actual detailed proposals put forward? The ceiling has doubtless been increased in response to their concerns. But have the much-vaunted small firms’ representatives expressed satisfaction that it has gone far enough?

There is no doubt the consultation was a partial success (a £4,000 limit being laughable) but the proposed limit is still far too low.

The government itself says “ESC C16 equalises the tax treatment of a company distribution made in such circumstances with the tax treatment of a company distribution made in the course of winding up, and is of particular value to small businesses where the cost of a winding up may be disproportionate”. Given their own view that the average cost of a winding-up is £7,500, are we to assume that it is their position that a cost of £7,500 in relation to a company with assets of £26,000 (almost 30%) is not disproportionate?

Moreover, there is surely nothing to say that the TS won’t change their practice and guidance again? TS have now confirmed they will not pursue companies using ESC C16 (and presumably the replacement legislation) but they could presumably change their minds again as it is still illegal under company law and I can find nothing in the proposed legislation that alters that fact. It is therefore still safer to go through CA 2006 process to reduce share capital first.

In my view more pressure still needs to be applied to try and persuade the government to look at the limit again. If there has to be a monetary cap, let’s make it something sensible that we can all work with.