What is a Special Purpose Vehicle and what are the tax implications?
A Special Purpose Vehicle (SPV) is an entity set up for a specific business project or type of activity. By using a new entity, the SPV’s activities are separated from any existing businesses of the owner.
An SPV could be used for a short-lived project or for a longer-term business activity. It could be a partnership or an LLP but in this article we have considered the use of companies as SPVs, where the SPV is owned by individual shareholders.
Why use an SPV?
There may be a number of commercial reasons for running the SPV’s activities in a separate company. For example,
- To keep the SPV’s projects independent and isolated.
- To enable different streams of investors to participate in different types of projects.
- To potentially enable a project to obtain finance more easily.
- To separate the risks of the new project from those of existing businesses.
- To provide a layer of protection for the owner of the business. As the liability of a corporate shareholder is limited, the SPV should shelter them personally from financial risks within in the SPV.
Potential tax implications
A corporate SPV is no different to any other company in the way that it is taxed on its profits and activities. For example, Corporation Tax, VAT and PAYE apply in the same way as for other companies.
Companies generally pay lower rates of tax on their income than individuals (the top rate of corporation tax is 25% compared with 45% for individuals). However, another layer of tax is then paid personally by the shareholders when funds are extracted from the company.
If funds are extracted as dividends, the individual shareholders are taxed on the income at rates of 33.75% and 39.35% for higher rate and additional rate taxpayers respectively.
But, if the company is wound up once the special project is completed and the funds are distributed to the shareholders as part of the winding up process, a much lower tax rate of between 10% to 20% could apply to those funds.
This is because the shareholder would be treated as effectively disposing of their shares, with the monies received being liable to capital gains tax on disposal rather than income tax. Capital gains (for higher and additional rate taxpayers) are generally taxed at much lower rates than dividend income.
Not only are the tax rates lower but, where Business Asset Disposal Relief (BADR) applies, lifetime capital gains of up to £1M per shareholder are taxed at 10%, with only the excess being taxed at 20%. This is likely to result in a significant tax saving when compared to dividend extraction whereby a rate of 33.75% kicks in once total income exceeds circa £50K.
Therefore, if capital treatment is secured, the shareholder is likely to pay much less tax on extraction of funds when the SPV is wound up.
However, capital treatment is not always guaranteed, particularly if the shareholder is involved in a similar business activity soon after winding up the company.
Where a shareholder is involved in multiple SPVs, carrying out similar activities consecutively, they need to consider whether any anti- avoidance rules could apply to prevent them from obtaining capital treatment.
The first anti-avoidance rule to consider is the ‘TAAR’.
Phoenixism and the TAAR
The Targeted Anti-Avoidance Rule (TAAR) was specifically introduced to target ‘phoenixism’. Where it applies, any tax advantages obtained are wiped out.
The aim of the TAAR is to prevent income from being converted into capital, where it would otherwise be taxed as a dividend.
For example, if profits are accumulated within a company (rather than being distributed by dividend) and capital treatment is obtained by winding up the company, it could be said that those profits have essentially been ‘converted’ from income into capital.
Take the situation where Mrs Brown runs her trade through a SPV company for a couple of years. She doesn’t take any monies out as dividends. At the end of the second year she has built up a lot of cash in her company. She decides to wind up the company, and pays capital gains tax on the funds extracted at 10%. She opens a new SPV company a few days later and carries on the same trade as she did previously. At the end of another couple of years, she winds up SPV 2 and takes those monies out, claiming capital treatment. She sets up SPV 3 a few days later and repeats the process. Mrs Brown has obtained a tax advantage but, in substance, nothing has really changed as she is still carrying out the same trade. The main reason for winding up the companies was to convert what would have been dividend income into capital, and thereby achieve a tax saving.
This is known as ‘phoenixing’. Mrs Brown’s business has risen each time like a phoenix from the flames.
The TAAR aims to target the situation where the shareholder becomes involved in a similar business soon afterwards, essentially where the original business has not really ceased, and has mainly been closed in order to obtain a tax advantage.
When does the TAAR apply?
The TAAR applies where all of the following four conditions are met:
a) The individual held at least 5% of the ordinary shares and voting rights in the company that was wound up.
b) The company was a ‘close company’ (very broadly, this means that it was controlled by five or fewer shareholders).
c) The shareholder continues to carry on, or be ‘involved with’, the same trade/ activity or a trade/ activity ‘similar’ to that of the wound up company, at any time within two years from the date of the distribution.
This condition is deliberately widely drafted to try to catch a broad number of potentially abusive situations. Its scope covers both trading and investment businesses. It will apply wherever the shareholder continues to carry on a similar activity after the sale, whether directly (for example by setting up a new SPV with the same business and shareholder structure) or indirectly (for example, by working for a similar business which is carried on by ‘connected’ persons, such as their spouse or siblings, particularly if they become a partner or shareholder of that business).
d) It is reasonable to assume that the main purpose, or one of the main purposes, of the winding up is the avoidance or reduction of a charge to income tax.
This means that even if conditions 'a' to 'c' are all met, the TAAR won’t apply unless tax avoidance is one of the primary motives for winding up the company.
The aim of condition ‘d’ is to establish whether it is ‘reasonable’ to assume that the main reason for winding up the company was to effectively convert funds from income into capital, in order to obtain a tax saving. As this is a subjective test, shareholders may be unsure whether they fall foul of it or not.
There may be many commercial reasons for winding up one SPV and starting another which have nothing to do with tax, as noted at the beginning of this article. It will be necessary to consider all these reasons in the round and reach an overall conclusion as to whether condition ‘d’ is met or not.
HMRC say that key points to consider include (CTM36340):
- The extent to which the trade/ activity carried on after the winding up resembles the trade/ activity of the wound up company.
- The extent of the involvement of the shareholder in the new business entity.
- Whether there is a pattern, for example if previous companies with similar activities have been wound up.
- Whether there are other commercial reasons for winding up the company, independent of tax benefits.
- Whether there are any special circumstances- for example if the shareholder is just providing short term consultancy advice to the new owners of the trade.
- Whether the size of the tax advantage obtained is consistent with a decision to wind up the company to obtain it.
It is helpful that HMRC confirm in their manuals that a decision not to pay a dividend before winding up does not in itself mean that the main purpose test is met.
However, they go on to say that the shareholder will know what their main purpose was and should self- assess their position on that basis. But if HMRC think the individual’s decision is not ‘reasonable’ HMRC will apply the TAAR (CTM36340).
How can you be sure if the TAAR applies or not?
Unfortunately, there is no statutory clearance procedure specifically for TAAR legislation, so we cannot ask HMRC for clarification in that way.
HMRC does provide ‘non- statutory clearance’ in some circumstances, but only where it considers that there is genuine uncertainty as to how legislation applies to a specific proposed transaction. Therefore, there is no guarantee that HMRC would respond to a request for ‘non statutory clearance’ in connection with the TAAR, although it may be worth writing to them to see if they reply.
Where the position is not entirely clear, another option could be potentially to request clearance under the ‘transactions in securities’ legislation. This is the second set of anti-avoidance rules to consider.
Transactions in Securities (TiS) rules and SPVs
The TiS rules can also apply to ‘phoenix’ situations. If so, the impact is similar to the TAAR as the distribution received by the shareholder on winding up will be taxed as dividend income rather than as capital, thereby removing any tax advantages.
The TiS anti-avoidance rules apply where there are all of the following:
- A ‘transaction in securities’ (this includes a disposal of shares on winding up a company), and
- The individual receives ‘relevant consideration’ (this includes funds extracted from the company on winding up), and
- The main (or one of the main) purposes of that transaction is to obtain a tax advantage.
Therefore, it will be key for the shareholder to be able to demonstrate that the winding up was carried out predominantly for commercial reasons, rather than to obtain a tax advantage.
Again, this is a subjective test, but fortunately, statutory clearance is available under the TiS legislation.
Clearance granted under the TiS rules will not specifically provide clearance under the TAAR. However, in both rules there is a commercial purpose test to be passed (that is, the transaction must not be mainly for tax avoidance). Where HMRC give clearance that this test is passed under TiS, it may also mean the transaction is more likely to meet the commercial requirements under the TAAR. Obtaining this should give an SPV shareholder more clarity as to their tax position before their company is wound up.
Shareholders operating separate business projects through separate corporate SPVs will be treated for tax purposes in the same way as any other corporate shareholder.
However, care should be taken at the point the SPV is wound up as capital treatment for the shareholder should not be expected as a forgone conclusion.
Shareholders winding up SPVs and becoming involved in similar business activities soon afterwards are much more likely to be caught by the anti-avoidance rules and should seek professional tax advice.
Of course, it is possible that the tax difference between capital and income could shrink in the future, particularly if a new government were to introduce legislation to align the tax rates. But, for now, the difference remains stark and protecting the tax saving by reviewing these rules and considering their application is key.
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