If you’re thinking about closing your limited company and taking the remaining profits as a capital distribution, you should be aware of HMRC's 2-year rule or the Targeted Anti-Avoidance Rule (TAAR), as it's technically called.

It’s HMRC’s way of stopping “phoenixing” which is when someone shuts down one company, pockets the profits at a lower capital gains tax rate, and then starts up a very similar business shortly after.

Here’s what you need to know.

First up: how capital distributions are normally taxed

When you close a company and take out any remaining profits, it’s often possible to treat that money as a capital gain, rather than income.

That’s great news if you're eligible for Business Asset Disposal Relief (BADR), as you’d usually pay just 18% tax on those profits, instead of higher dividend rates (up to 39.35%).

But, and it’s a big but, HMRC can reclassify that capital gain as income (e.g. dividends) if they think you’re trying to get around the rules.

The TAAR: what it is and why it matters

TAAR stands for Targeted Anti-Avoidance Rule, and it kicks in when all four of the following apply:

1. You close your company and receive a capital distribution (typically via Members Voluntary Liquidation or informal strike-off).
2. Within 2 years, you’re involved in a similar trade or activity whether as a sole trader, a partner, or even through a new limited company.
3. The main purpose (or one of the main purposes) of closing the old company was to get a tax advantage i.e. paying lower Capital Gains Tax rather than dividend tax.
4. HMRC believes your intention was to avoid higher income tax on those profits.

If all of that sounds a bit subjective, it is. HMRC looks at your actions, timing, and intentions.

So... can I start another business after closing my company?

Yes — but with caution. Here’s the key question: how similar is the new business?

• If you close a software consultancy and start another software consultancy within 2 years - red flag.
• If you shut down a design agency and open a bakery - probably fine.
• If your spouse or a business partner sets up a “new” company doing the same work for the same clients - also a red flag.

The more it looks like the new business is just a continuation of the old one, the more likely HMRC is to apply TAAR.

What happens if HMRC applies the rule?

They’ll reclassify your capital distribution as income, which means you’ll pay dividend tax rates on that money instead of Capital Gains Tax.

So, if you’ve already claimed BADR and paid 18% tax, you may end up with a retrospective tax bill and possibly interest and penalties.

Avoiding trouble: best practices

Here’s how to stay on the right side of the rules:

• Don’t plan to close and restart the same trade within 2 years. Wait it out if needed. If a contract has come to an end and you're moving into permanent employment, we also advise that you give it a month or two in this permanent employment to make sure you're happy and don't have the urge to return to contracting/freelancing in the near future. 
• Keep things clearly separate. A new company doing totally different work is much less risky.
• Document your intentions. If you’re retiring, leaving freelancing permanently, or genuinely changing career - make a note of that in your records.

• Get professional advice. Before looking to close, always speak to your Mighty accountant - we're happy to advise you!

   

Final word

TAAR isn’t about stopping you from moving on, it’s about stopping tax avoidance.

If you can't see yourself starting a new business in the next couple of years, and your next steps are genuine and not just a way to access your company profits at a lower tax rate, you’re probably fine. But if there’s even a small chance that HMRC might see your new business as a continuation of the old one, it’s worth treading carefully. 

In short: don’t risk it. Play it smart, and stayTAARtally informed (apologies, we couldn't resist). Got questions? Just email your dedicated Mighty accountant or support@mightyaccounting.com and we'll be happy to help.