HMRC consultation into company distributions could have a significant impact on property developers

As part of the Government’s consultation into the taxation of company distributions it is proposing to change the rules which apply to distributions paid by a company on liquidation with effect from 6 April 2016. Such changes could impact on how returns from property development company structures are taxed.

Property developers commonly incorporate a UK limited special purpose company for a land development project. Once the land is developed, the developer typically sells the land (as opposed to the company) and sometimes the company is wound up with profits extracted as capital. A shareholder in a property development company can often achieve a 10% rate of capital gains tax through a claim for Entrepreneurs’ Relief.

The Government does not like the above structures if the shareholders simply set up new companies and start all over again – so-called “phoenixism”. 

Accordingly, the Government is proposing to introduce an anti-avoidance rule which will deny capital treatment from a distribution in a winding-up received by an individual where certain conditions are met.

Namely:

• the company is a ‘close company’;
• at any point in the two years after the distribution the individual is involved in a similar trade/activity; and
• the arrangements have a main purpose to obtain a tax advantage.

The proposals are important for property developers to be aware of because developers may plan to recycle the profits earned from a development project within two years of extracting those profits.

If the rules are enacted as proposed, we may see a rise in sales of the actual corporate vehicle and not the underlying land. The share proceeds would be taxed as capital. If the company can maintain the status of a trading company, then Entrepreneurs’ Relief may still be available. However, that may be difficult if there is no longer an intention to sell the property.

Developers who have commenced property development projects on the assumption that the development profits will be taxed as capital at a rate of 28% or 10% (depending on whether Entrepreneurs’ Relief is available) should review their plans.