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Serial wind-ups will pay dividends

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by Contractor Weekly

Some contractors still not aware of distributions legislation

In April 2016, legislation was introduced to counter the practice of opening and closing companies at regular intervals and to prevent shareholders of close companies from escaping an Income Tax charge on the final distribution of company assets. In the vast majority of one-man personal service companies that will be cash and unless that cash is a capital distribution and subjected to Capital Gains Tax, it has to be treated as a dividend and taxed either at 7.5%, 32.5% or even 38.1%, depending on the taxpayer’s total income in the tax year.

Sections 396B and 404A ITTOIA (Income Tax (Trading and Other Income) Act) 2005 contains a Targeted Anti-Avoidance Rule (TAAR), the purpose of which is to treat a distribution from a winding up as if were an income distribution, ie a dividend, if the main purpose or one of the main purposes of the winding up is tax motivated and within two years after the distribution:

  • the individual carries on a trade or activity which is the same as, or similar to, that carried on by the company;
  • the individual is a partner in a partnership which carries on such a trade or activity.;
  • the individual, or a person connected with him or her, is at least a 5% participator in a company which at that time carries on such a trade or activity, or is connected with a company which carries on such a trade or activity; or
  • the individual is involved with the carrying on of such a trade or activity by a person connected with the individual


There are two exclusions that apply even where all of the conditions of the TAAR are met. One involves a shareholder receiving shares in a new company and that new company receives all the assets of the old company. The other exclusion is to ensure that the original subscription cost of the shares is not taxed.


Example (per HMRC Company Tax Manual (CTM) 36345)

Mr A is an IT contractor who provides his services through his own PSC. Mr A’s only investment in the company was £1,000, which he used to subscribe for 1,000 £1 ordinary shares. He winds up the company and continues to provide an identical service as a sole trader. The amount of the distribution in the winding up is £100,00 but only £99,000 is treated as a dividend.

Similar trade or activity

‘Similar trade or activity’ is not further defined in legislation and is a deliberately wide-ranging term designed to prevent arguments that a new company is not carrying on the same trade as the wound-up company because of changes to the business model.

In some cases it will be obvious if the new business is a replicant of the old but HMRC’s CTM36325 provides some examples of other scenarios which may arise.

Mr E the builder

Mr E runs his building business via two companies. Company 1 specialises in loft conversions, and Company 2 specialises in extensions. Mr E winds up Company 1 but the trade of Company 2 continues.

As Mr E continues to be involved with a trade that is similar to that of the company that is wound up, then, provided all other conditions are met, the final distribution will be treated as a dividend.

Mrs D the recruitment consultant

After three years of training part-time, Mrs D winds up her recruitment company and starts a new company that offers her services as an IT consultant. Some of her new clients are businesses she dealt with in her previous company.

Although Mrs D is still a consultant, the trade has changed significantly and it is unlikely that it would be viewed as the same or similar to the carried on by the wound up company. It does not matter that she continues to deal with some of the same clients because the nature of the service she is providing is different.


Like ‘similar trade or activity’, ‘involved with’ is not defined and is potentially wide in scope. It is designed to prevent the TAAR being avoided by connected parties working together to circumvent the other conditions.

HMRC’s CTM36330 provides three examples of this test.

Example 1

Mrs C is an accountant who runs her business through a company. Her husband is a self-employed lion tamer. Mrs C winds up her company and starts work for a newly-formed company owned by her husband, providing accountancy services.

Mrs C continues to be involved with the same trade or activity as the wound-up company was involved with (the provision of accountancy services), even though she is now an employee rather than business owner. She is connected to her husband and so the condition is satisfied. 

Example 2

Instead of going to work for a newly-formed company, Mrs C, from Example 1, goes to work for her sister’s pre-existing accountancy practice, which the sister operates as a sole trader.

Mrs C is connected with her sister, and she is continuing to be ‘involved with’ the same or a similar activity, and so the condition is met.

Example 3

Mr B is a fitness instructor who provides his services through a company. After suffering an injury he winds up his company and starts work as a journalist. Mr B’s wife is also a fitness instructor and she offers her services as a sole trader, before and after the winding up of her husband’s company. Mr B provides no services to his wife’s business at all.

Mr B is not ‘involved with’ a similar trade or activity after the winding up of the first company, even though his wife is.

Motivated by tax

Ultimately, the legislation is asking whether the individual that has received the distribution is continuing what amounts to the same business, having extracted the accumulated profits in a capital form. This is inevitably a question of judgment to be made on the basis of facts in individual cases.  HMRC’s CTM36340 provides some guidance as to some of the issues that are likely to be relevant:

  • Is there a tax advantage, and if so, is its size consistent with a decision to wind-up a company to obtain it?
  • To what extent does the trade or activity carried on after the winding-up resemble the trade or activity carried on by the wound-up company?
  • What is the involvement in that trade or activity by the individual who received the distribution? To what extent have their working practices changed?
  • Are there any special circumstances? For example, is the individual merely supplying short-term consultancy to the new owners of the trade?
  • How much influence did the person that received the tax advantage have over the arrangements? Is it a reasonable inference that arrangements were entered into to secure this advantage?
  • Is there a pattern, for instance have previous companies with similar activities been wound-up?
  • What other factors might be present to lead to a decision to wind-up? Are these commercial and independent of tax benefits?
  • Are there any events apparently linked with the winding-up that might reasonably be taken into account? For example, was the only trade sold to a third party, leaving just the proceeds of the sale?

Requests for clearance

The legislation does not provide a statutory clearance procedure. Whilst there is a non-statutory clearance procedure this would not be appropriate unless it is limited to the application of specific rules in the legislation where there is genuine uncertainty about their application to a specific proposed transaction.

Whilst the transactions in securities legislation does provide a statutory clearance procedure under s.701 Income Tax Act 2007, this does not extend to s.396B/404A ITTOIA 2005. However, HMRC’s CTM36350 states that clearance may still be relevant to the extent that s.396B/404A does not apply.

I am still coming across a few contractors who are continuing to close down their PSC’s every few years and start up a new company as a tactic to avoid IR35. In the past they have been able to claim Entrepreneurs’ Relief and pay Capital Gains Tax at 10% on the final distribution but that has now been closed off by the TAAR. So unless these freelancers are happy to pay the appropriate amount of Income Tax on their final distributions they need to re-think their IR35 strategies.