ESC C16 & BVC 17

Hello – I’m Paul Soper and this is an extra edition in the series of Podcasts as usual intended primarily for practitioners – especially small practitioners, but, as ever, if you are a reasonably financially literate taxpayer or an accounting student you should enjoy it too – if enjoy is the right word! You can read the text of this podcast at my website http://www.Taxationpodcasts all one word.com.

There has been a considerable amount of confusion in the last couple of weeks over changes to two Extra-statutory Concessions – one, BVC17 being withdrawn, and the other ESC C16 being translated into legislation with significant new restrictions being attached.  The concessions came from different government departments and as they are both concerned with the same basic situation it is probably not surprising that this confusion has occurred.

First of all here are a couple of examples of situations where the concessions might be relevant.

John is a computer consultant and has worked for the last 10 years through a company.  He now wishes to retire.  The Company has two £1 shares in issue, both owned by John.  The company has accumulated reserves amounting to £55,000 and all outstanding debts have now been paid.

Fred has a small technology company which he started 10 years ago with a friend, and he has recently accepted a very well paid offer to work for a multinational, one of the conditions of which is that he works exclusively for them.  He wants, with the consent of his friend, to extract the reserves that he has built up in the company, currently amounting to £140,000 in total.  There are 10,000 £1 shares in issue, 8,000 owned by John and 2,000 by the friend. No claim had been made under the Enterprise Investment scheme.

Both John and Fred could appoint a liquidator to bring their companies to an end, and the sums that they extract will be treated as part-disposals from a Capital Gains Tax perspective, both will be entitled to Entrepreneurs’ Relief and these gains will be chargeable at 10%.  The problem is that liquidation does not come cheap – the liquidator assumes a personal liability in the winding up and so must make quite detailed investigations before distributing what is left.  In recent years government estimates of the cost of a straightforward liquidation have been made in the region of £4,000 to £7,500.

But there is an alternative course of action that John and Fred could have used to get the money out of their companies – it is called ESC C16 and is a revenue concession, at the moment, which recognises the cost of liquidation and allows the taxpayer who applies for the relief, provided they give certain assurances to the revenue, to pay a dividend, which would normally be taxable as income, but treat it instead as though it was a liquidators’ distribution which would only be subject to CGT at the Entrepreneurs’ relief rate of 10%.

They have to assure the revenue, amongst other things, that the company is ceasing to trade and will not carry on a business in future, that all outstanding debts have been or will be paid, that the information required by the revenue to determine the outstanding corporation tax liability will be provided and that the shareholders will accept the CGT liability.  Increasingly HMRC have also been asking for assurances that the trade is not going to continue inside another company or group.  Oh – and one more thing – the company must allow itself or present itself to be struck off by the Registrar of Companies under (in the words of the concession) section 652 or 652A of the Companies Act of 1986.

The most recent company legislation is found in the Companies Act of 2006, this became fully operational in late 2008, and the equivalent provisions are sections 1000 and 1003 of this later Act.  The published revenue concession has not been updated for the change in statutory references.

So both John and Fred could use this mechanism, even though Fred’s company has considerably more to distribute, but there is one fly in the ointment.  For John it is not very important as there are only two shares in issue but for Fred it is more of a problem.  C16 depends on the payment of a dividend, and a dividend cannot legally exceed the distributable reserves of the two companies, in John’s case this will leave £2 inside the company, hardly a concern, but in Fred’s case £10,000 – share capital in a limited company is not distributable.  To get this out would have required a formal liquidation – that is until October of 2011.

First let’s consider what would have happened before October to Fred’s money.  He could have walked away from the company leaving £10,000 inside it and it would then have become the property of the Crown under the Bona Vacantia principle, Bona Vacantia is also the name of a department of the Treasury Solicitor’s Office which deals with ownerless property.

Fred could have paid a dividend of the whole of the company’s reserves including the share capital but the excess of £10,000 would have been an illegal dividend and the same Bona Vacantia department would have the right to pursue Fred and his friend for that money on behalf of the Crown.

A couple of years ago the Bona Vacantia department tried to help out by reaching an agreement with the accounting bodies that an amount not exceeding the cost of a straightforward liquidation, which they estimated at £4,000, could be extracted and they would not pursue the Crown’s rights if the company had permission under ESC C16.  This was contained in an extra statutory concession document called BVC17 and available on their website.

At the time they also pointed out that as a result of the Companies Act 2006 there were other courses of action open which would avoid the problem anyway.

Fred couldn’t use BVC17 because his sum exceeded £4,000 but he could make a declaration of solvency under the 2006 Act and reduce his share capital to a figure of less than £4,000 and then apply for C16 approval.  He could apply to have his company reregistered as an unlimited company in which case all of it’s reserves would become distributable – non-distributability is the price paid for limited liability.

Even if he had, in error, walked away from the company and had allowed it to be struck off the 2006 Act allows a company to be resurrected within 6 years (previously 12 months only) and so put this right and legally extract the money.

Bona Vacantia clearly then thought long and hard about the ease with which a legal distribution could be engineered and in October 2011 announced that they were withdrawing the concession BVC17 with immediate effect because it was no longer necessary – as they made clear in a frequently-asked-questions section of their website they were no longer going to pursue these sums on behalf of the Crown regardless of the amount involved, £4,000 or £4,000,000 it didn’t matter.  So good news for Fred.

However the revenue were also thinking about their concession C16 and the necessity to make it a legislative provision because of a House Of Lords decision in the Wilkinson case suggesting that these concessions were not within the revenue’s power except in cases where they had care or management of the tax system.  Recently the Supreme Court have ameliorated this ruling in the Gaines-Cooper case and indicated that concessions can be made if they increase the potential sums accruing to the exchequer.

In December of 2010 HMRC announced that a number of concessions would be made law including C16, however they designed the legislation so that the amount that could be extracted in this way would be limited to £4,000 – coincidentally the same as the BVC17 limit.

Implementation of this was then postponed because of objections made which required reconsideration but on 6 December 2011, at the same time as they released draft legislation for inclusion in Finance Bill 2012, the revenue announced that the legislation of C16 would go ahead but with a limit of £25,000 rather than £4,000 and this would take effect from 1 March 2012 – it was to be introduced by delegated legislation under powers conferred on them a couple of years ago.  If the distribution exceeded £25,000 the WHOLE amount would now be taxed as income not gain.

Now this will cause problems for both John and Fred.  John’s problem is greater than Fred’s because he has less money locked up inside his company and this is the patently unfair aspect of the proposal, it affects smaller taxpayers proportionately greater than it does taxpayers with greater sums to extract.

If John goes ahead after 1 March and extracts the whole of the amount available as a distribution he will be liable to income tax, not CGT at all.  To the extent that he is a basic rate taxpayer this is an advantage as the dividend will carry a tax credit which will extinguish his basic rate tax liability.  However, to the extent that he is a higher rate taxpayer, he will be liable to income tax at a rate of effectively 25% on the amount extracted – a 15% surcharge on top of the CGT liability which would have been further reduced by his annual CGT exemption of £10,600.  He could pay an initial dividend sufficient to bring his reserves down to £25,000 and then proceed using the new rules, but that would still be a 15% surcharge on £30,000 worth of reserves – a cost of £4,500.

In the document explaining what they proposed to do HMRC comment that they believe the cost of a straightforward liquidation to be £7,500 so John would not have the luxury of using a liquidator to extract his money as capital because it would be even more expensive.  If Bona Vacantia are right and the cost is closer to £4,000 (or even less as some commentators have suggested) he is still being required to incur a cost which before March 2012 he would not be required to bear at all.

Fred on the other hand has a much larger sum to deal with but although he is better placed to afford the services of a liquidator he will still be suffering additional expense which before March 2012 he would also not be required to incur but the effect on him is less.

Normally when HMRC legislate for concessions they undertake that the effect of the legislation is not to change the rules and when the draft legislation was put before parliament a year ago that is exactly what parliament was told – but that is clearly not the case.

 This is a fundamental change, and one that affects less well-off taxpayers to a greater extent than richer ones – this cannot be fair can it?

What’s the rationale behind the change?  HMRC claim that C16 was being used for avoidance or even evasion purposes – but a much greater problem according to Richard Murphy of Tax Research UK is companies being struck off without having made any returns or approaches to HMRC at all, a problem he estimates to be costing the Treasury BILLIONS!

HMRC will have the advantage of making this a self-assessment procedure as they will no longer have to consider applications under C16 but surely this will simply lead to more disgruntled taxpayers presenting empty shell companies for striking off and simply walking off with the cash without having paid either CGT or income tax on the distribution?

It is not too late to affect this proposal, write to the revenue pointing out how unfair this is for less well-off taxpayers, write to your MP who may object to the statutory instrument so that parliament has to debate the proposal, register your disapproval using my online petition at epetitions.direct.gov.uk/petitions/25190 – if you make your voice heard it may do some good, if you do not many of your smaller clients will be adversely affected by this proposal when they retire or cease trading.

Is there a solution?  Surely, other than abandoning the proposal, which is not realistic, raising the limit to a point at which the tax surcharge equated with cost of liquidation would be a first step – if the cost of liquidating is £7,500 then that would equal reserves of £75,000 not £25,000, perhaps increasing it to say £100,000 would allow a little extra advantage.

It cannot be to the revenue’s advantage in the long run to encourage yet more taxpayers to extract money and avoid all liability on it because the alternative is to deny them the benefit of a relief, entrepreneurs’ relief, which parliament has already decided should apply to taxpayers with lifetime gains of up to £10million.

This podcast was presented, written and produced by Paul Soper who asserts copyright therein.  The full text of the podcast can be read at my site taxationpodcasts.com. For further details of podcast production, particularly if you would like me to create them for you, contact me at Paulsoper, all one word, at mac dot com.

My next podcast, available next week, continues the examination of the Main Residence Exemption available for home-owners and some, I stress some, landlords.