By Simon Renshaw, Director at AABRS
Phoenix companies have received a bad press in recent years and in some cases, rightfully so. However, the majority of businesses do not fail as a result of wrongdoing on the part of the company directors. In this instance, UK law allows new companies to be set up to carry on a similar business as insolvent companies, without attracting the scrutiny of HMRC.
But what is the phoenixing process and if this is a route you plan to use legitimately, how do you make sure you stay off HMRC’s radar?
What is a phoenix company?
A phoenix company is a brand new business that carries on the same work as an insolvent company that has come before. Essentially, the new business rises from the ashes of the insolvent business, hence the name. The insolvent company ceases to trade and will be dissolved, liquidated or be purchased out of a formal insolvency process such as administration. Existing contracts can be transferred to the new business and it can carry on much as before but without the insolvent business’s debts or trading name.
What rules govern the use of phoenix companies?
Given the above description, you could probably see why the ethics of phoenix companies have been called into question. The key to the legitimate phoenixing is for the directors of the insolvent company to prove that taking this route will maximise the creditors’ interests. That means they will receive more of the money they are owed through this approach than if another course of action was taken.
For phoenix companies to not be challenged by creditors like HMRC in the courts, the underlying assets of the old company must be sold to the new company at a fair market price, with independent valuations obtained and records kept. This avoids accusations that the directors have simply walked away from the insolvent company’s debts. A phoenix company can only come about where there is no hope that the insolvent company can be saved. The trading name of the new company can also be the same or similar to the insolvent business.
Anti-phoenixing rules introduced by HMRC
In some cases, phoenix companies have been used by individuals to avoid paying the income tax they owe. Subsequently, HMRC introduced new rules to clamp down on this practice. Phoenix companies will be challenged if:
- Shareholders must hold a minimum of 5% equity and a voting interest before the liquidation begins;
- The distributing company is currently or in the two years prior to liquidation a ‘close company’, meaning it has five or fewer participants;
- The recipient shareholders are seen to be involved in a similar business, within a two year period of shutting down the original company.
- Reasonable’ evidence suggests that the liquidation was prompted by a chance to pay reduced income tax.
Protecting your business
To make sure legitimate phoenix companies don’t wrongly show up on HMRC’s radar, it’s essential directors and owners protect themselves by keeping clear records in place which fully document the commercial reasons for the winding up. They must also have documents in place recording the valuation, marketing and sale of the old company and ensure proper disclosure is made when reporting the resulting gain.