Section 396B ITTOIA 2005 treats a distribution in a winding up as dividend income, not capital, if the shareholder had at least a 5% interest in a close company, is involved in the same or a similar trade or activity within two years of the distribution, and it is reasonable to assume a main purpose of the winding up was to reduce income tax. Amounts up to the shareholder’s base cost are excluded, and there is no statutory clearance.

What problem is the rule aimed at?

Normally, cash paid out by a liquidator is not an income distribution: section 1030 CTA 2010 takes distributions in respect of share capital in a winding up outside the distributions rules (CTM17310), and for capital gains tax they are capital distributions under section 122 TCGA 1992 (CG58620). That makes winding up attractive because capital gains tax rates, and Business Asset Disposal Relief, are usually lower than dividend rates.

HMRC’s manual at CTM36305 describes the target as phoenixism: a dance instructor who, instead of taking dividends, winds up his company each year to receive its profits as capital and then starts a new company carrying on the same business. Section 396B, inserted by Finance Act 2016, applies to distributions in a winding up made on or after 6 April 2016, whenever the winding up started. Section 404A ITTOIA 2005 applies the same treatment to distributions from non UK resident companies.

Which conditions must all be met?

The rule applies to a distribution made to an individual in respect of share capital in the winding up of a UK resident company only if all four conditions in section 396B are met and no exclusion applies.

  • Condition A: immediately before the winding up, the individual has at least a 5% interest, meaning at least 5% of the ordinary share capital and at least 5% of the voting rights through that holding. Joint holdings are apportioned by value.
  • Condition B: the company is a close company when wound up, or was close at any time in the two years ending with the start of the winding up.
  • Condition C: at any time within two years beginning with the date of the distribution, the individual carries on, or is involved with, a trade or activity that is the same as or similar to that of the company or an effective 51% subsidiary.
  • Condition D: having regard to all the circumstances, it is reasonable to assume that a main purpose of the winding up, or of arrangements it forms part of, is to avoid or reduce income tax.

What counts as carrying on a similar trade?

Condition C is met if, within the two years, the individual carries on such a trade alone, is a partner in a partnership that does, is a participator with at least a 5% interest in a company that does or is connected with one that does, or is involved with a connected person carrying it on (section 396B(4)). Connected is defined in section 989 ITA 2007, read with sections 993 and 994 (CTM36335).

HMRC says the condition is deliberately wide (CTM36320). Its examples include:

  • a car washing company owner who carries on through a partnership with his wife and adds air fresheners: the same or similar trade (CTM36325);
  • a builder with two companies who winds up one and keeps the other with a similar trade: Condition C met;
  • a recruitment consultant who retrains and sets up an IT consultancy: unlikely to be similar, even with some of the same clients;
  • an accountant who winds up her company and becomes an employee of her husband’s new accountancy company: Condition C met, because she is involved with a connected person’s similar activity (CTM36330).

The rule also reaches investment businesses and holding companies of trading groups, not only trades (CTM36325).

How does HMRC apply the purpose test?

Condition C on its own does not bring the rule into play; Condition D narrows it. Section 396B(6) says the circumstances to consider include the fact that Condition C is met. CTM36340 lists the factors HMRC looks at, including:

  • whether there is a tax advantage, and whether its size is consistent with a decision to wind up to obtain it;
  • how closely the later activity resembles the old one, and how far the individual’s working practices have changed;
  • special circumstances, such as short term consultancy to the buyer of the trade;
  • any pattern of previous companies with similar activities being wound up;
  • other, commercial reasons for winding up, and linked events such as a sale of the only trade to a third party.

HMRC states that simply not paying a dividend before winding up does not by itself mean the purpose test is met. Where someone stays involved only as an employee with no influence over the new business, or the winding up is part of restructuring the commercial architecture, Condition D is less likely to be met. The individual self assesses on their own view of their purpose, and HMRC can only displace it where that view is not reasonable (CTM36340).

What is excluded?

Section 396B(7) excludes the part of a distribution that does not exceed the amount that would give no gain for capital gains tax, so the return of the shareholder’s base cost is never taxed as income. It also excludes distributions of irredeemable shares, which protects reconstructions such as a liquidation in which members receive shares in a continuing subsidiary (CTM36345). Cash paid alongside shares is not protected by that exclusion. A liquidation used to split businesses between shareholders is covered in our page on demergers.

What does it cost if the TAAR applies?

Illustration only, based on HMRC’s example at CTM36345. An IT contractor subscribed £1,000 for his shares, winds up the company, receives £100,000 and carries on the same work as a sole trader. Assume all four conditions are met, he is a higher rate taxpayer, and ignore bands.

Treatment Calculation Tax
TAAR applies: £99,000 is a distribution (£99,000 less £500 allowance) at 35.75% £35,214
Capital with Business Asset Disposal Relief, if available (£99,000 less £3,000 annual exempt amount) at 18% £17,280

The rates are the 2026 to 2027 dividend higher rate and the Business Asset Disposal Relief rate for disposals from 6 April 2026. Whether BADR is available is a separate question; see Business Asset Disposal Relief.

Can you get clearance?

No statutory clearance exists for section 396B. HMRC’s view at CTM36350 is that a non statutory clearance would rarely be appropriate, because the applicant knows their own purpose; it might help only where there is genuine uncertainty about how a specific rule applies to a proposed transaction. A clearance under section 701 ITA 2007 for the transactions in securities rules does not extend to section 396B. Equally, where section 396B applies there is no income tax advantage, so the transactions in securities rules cannot also apply to that amount (CTM36350).

What should shareholders and advisers do?

  • Record the commercial reasons for closing at the time the decision is made, because HMRC tests purpose by reference to what was known then but will look at what happens afterwards (CTM36340).
  • Watch the two year window from each distribution, including interim distributions, and remember that involvement through a spouse’s or relative’s business can count.
  • Treat a pattern of closing and reopening similar companies as a strong warning sign.
  • Self assess on a reasoned view: if the TAAR applies, the distribution is taxed as a dividend rather than as a capital gain, and the return should reflect that.

The wider steps of a solvent closure are covered in closing a limited company.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.