Proposed changes to company distribution rules create uncertainty for property developers, and potentially 28% more tax!
The government has released draft legislation which potentially brings capital distributions from a company in a liquidation into the income tax rules, so that they are instead taxed at dividend tax rates.
The rules affect close companies where the shareholder(s) carry on the ‘same’ or ‘similar’ trade or activity in a two year period after the liquidation (either directly or through another company), and one of the main purposes of the liquidation is deemed to be the avoidance of income tax.
A common structure for property developers is the use of a stand alone special purpose vehicle for each particular development. Such a company is then typically liquidated following the sale of the properties developed. This allows the developer to segregate the commercial risk of each development and to then cleanly remove the entity once the work has been completed. There may also be a different pool of investors involved in each development. It also has potential tax benefits with the capital distribution received potentially only being subject to a tax rate of 10% under the capital gains tax rules .
The use of the word ‘similar’ in the draft legislation could potentially catch property developers who go on to set up a similar structure for a new development within a two year period after the liquidation. Whilst there are often valid commercial reasons for doing this, these rules are likely to create a great degree of uncertainty.
The new rules are currently subject to consultation and it is proposed they will take effect for distributions from 6 April. It is not a coincidence that this is the same date that dividend distribution rates will be increased! A taxpayer caught by the provisions could suffer an additional 28% of tax when compared to the current rules (38% dividend versus a 10% capital gains tax rate).
It is crucial that the consultation process brings more clarity to these provisions, as part of this we would recommend that a clearance process is introduced to give taxpayers more certainty where their company is going through a liquidation.
For more informations regarding the proposed changes or to talk through the impact on your business, contact Menzies directly.