Traditionally, the development of property for sale has often been carried out through a special purpose vehicle (“SPV”): once the development is completed, the properties sold and the financiers paid off, the company has been liquidated (usually with the benefit of CGT Entrepreneurs’ Relief) and a new company formed for the next project. It’s often commercially the most appropriate arrangement: the fact that it is also likely to have been very tax-efficient is a happy coincidence.
However, the viability of that structuring from a tax perspective has been called into question by the introduction (in 2016) of new rules on “phoenixism”. For a more detailed explanation of the background and the new rules in detail, take a look at our briefing here.
In summary, however, amounts received by shareholders on a liquidation of a company will be taxed as income (at rates of up to 38.1%) rather than as capital if, within two years of the amount being received, the shareholder:
- Carries on (either alone or in partnership) any activity which is the same as or similar to that carried on by the company; or
- Is “involved with” (the term is not further defined) the carrying on of such an activity by a “connected person” (broadly, a spouse, civil partner or relative); or
- Has (or is connected with someone who has) at least a 5% shareholding in a company that carries on such an activity.
There is a let-out (so that capital treatment continues to apply) only if:
- The company being liquidated is not a “close company” (but most private companies are in fact “close”); or
- The shareholder holds less than 5% of the company being liquidated; or
- It is reasonable to assume, having regard to all the circumstances, that avoiding tax is not one of the main purposes of the winding-up or of any arrangements of which the winding-up forms part.
In practice it’s the third condition which is often problematic, especially because the law provides that if, after the liquidation, you carry on a similar activity (etc), that fact is itself one of the “circumstances” to be taken into account in deciding whether you had an avoidance purpose in liquidating the company! Unfortunately, HMRC do not offer any advance clearance procedure and such guidance as is published is not very instructive.
Of course, there is often a very good commercial reason for liquidating an SPV on completion of a development: you may want different partners or financiers for the next project who may demand a “clean” company; or you may simply want to protect assets from exposure to trading risk. In such a case, avoiding tax may not be the main purpose of the winding-up but if, as is often the case, liquidation also offers a very tax-advantageous way of accessing value, how confident can you be that a court would not find that it isn’t one of the main purposes? There may be a particular risk to shareholders who are serial investors in development project SPVs, even if their co-shareholders vary from one SPV to another.
We think there are two certain ways to avoid the “phoenix” tax charge.
The first is to leave at least two years between the closure of one property development SPV and the start of the next. Some care is needed here though: actively looking for the next deal, lining up finance or even attending property auctions to keep abreast of the market are all likely to be activities that are “similar” to property development and must be eschewed for 24 months if you are to be safe. So that route is fine if you can spend a couple of years travelling the world and relaxing on some foreign strand before plunging back into the property world: but in our experience few property entrepreneurs are made that way.
The second possibility is to create a group structure whereby each SPV is a subsidiary of a holding company. After-tax profits in the SPV can be taken up to the holding company without any further tax charge and the SPV wound up; a new subsidiary of the holding company is then formed for the next deal and the process repeated as often as necessary for each successive project until final closure, at which point the whole structure can be wound up and profits extracted as capital. Note, however, that some lenders may be less happy to lend to a subsidiary than to a directly-owned “stand-alone” company.
There is one possibility that has been widely touted but should be regarded as high-risk, especially now that HMRC have expressed the view that it doesn’t work. That is to turn the SPV into a cash shell and, rather than liquidate it, sell it to a third party for a price more or less equivalent to the amount of the cash pile. For HMRC’s views on that, see our briefing note.
If neither of these “safe harbour” structures is appropriate, and you are determined (or obliged) to wind up a stand-alone SPV on completion of a project, it will be important to be able to demonstrate the compelling commercial reasons for doing so. And in some circumstances (especially where large amounts are involved), it may be possible to cover any residual doubt by taking out insurance against the risk of successful HMRC challenge to capital treatment.
Whatever structure you adopt, the most important thing is to have thought through the tax consequences before you start!
For more information, please get in touch with your usual BKL contact or use our enquiry form.