What are the options when your client closes their company?
Winding up
There are many reasons why your client might want to wind up a profitable, cash rich company. Company directors can fall out and wish to go their separate ways, meaning the existing company will need to be closed down.
Alternatively, the director shareholder might be looking at retiring, or the company could have been set up to fulfil a specific project which has completed. There would therefore be no need for the company to continue existing. What options could you consider for any clients looking to close their company down?
Striking off
Where the assets that need to be distributed, e.g. cash, do not exceed £25,000, it might be advantageous to use striking off as an alternative to a formal liquidation. This means that the money is distributed to the shareholders, and an application is then made to Companies House to strike the company from the register.
Pro advice. The application is made using Form DS01 (see Follow up ).
There are two main advantages to using this method. Firstly, it costs significantly less than a formal liquidation (just £10). Secondly, as long as the distributions do not exceed £25,000 they will normally be treated as capital, rather than income, in the hands of the shareholders, allowing them to utilise their annual allowance (£11,700 for 2018/19).
Pro advice. The shareholders can also offset capital losses if they have any.
If you are looking to use this method for your client, make sure all assets, including reserves, are distributed. Anything that is still sitting in the company when it is struck off legally becomes property of the Crown.
Always best?
Don’t assume that striking off will be the most beneficial way to get the assets out, as depending on the shareholder’s other income and gains, paying a dividend might be a better option.
Example. Tony wants to liquidate his company in 2018/19 and plans to use striking off to ensure capital treatment applies to the £13,000 cash in the bank account. However, you consider his situation and see that he has no other income in the year, but sold a rental property for a large gain at the start of the year.
As Tony has no annual exemption to use, and tells you that he has no capital losses brought forward, he would be better off taking the cash out as a dividend if possible as he could utilise his personal and dividend allowances, meaning no tax is payable. If, for some reason, the company can’t legally pay a dividend, the next best option would be a salary payment, as the personal allowance could still be used.
Liquidations
If striking off is used and the money withdrawn exceeds £25,000, the distributions will be taxed as income. As discussed above this could be beneficial in some circumstances, but for higher amounts it’s likely to be expensive, especially if the income is taxed at the higher or additional rate.
Solvency
If the company is solvent, a members’ voluntary liquidation (MVL) could prove to be the most cost-effective method for clients in this position. An MVL is a more formal process, involving a liquidator being appointed.
The directors will be required to make a declaration of solvency, stating that they believe the company can pay its debts within twelve months. Making a declaration without reasonable grounds can result in serious penalties, including disqualification and potentially even imprisonment in cases of deliberate fraud.
Income v capital
The liquidator will distribute the assets and charge a fee for their services. The advantage of an MVL is that the distributions can be treated as capital, even if they exceed £25,000. Entrepreneurs’ relief can apply to restrict the tax to just 10%. Compared with the top 38.1% rate for dividends this represents significant savings of up to £28,100 for every £100,000 withdrawn.
Pro advice. Advise your clients to ask for a quote before appointing the liquidator, even if this is only a best estimate. The fee could be higher than any tax savings enjoyed by securing the capital treatment.
An MVL will almost always be the best option from a tax perspective where there are significant assets sitting in the company. However, there are traps to look out for.
Anti-avoidance
If the directors are winding up to go their separate ways, consider whether the targeted anti-avoidance rule (TAAR) will cancel the capital treatment. The TAAR was introduced in April 2016 (see Follow up ) and is aimed at preventing “phoenixing”, i.e. where profits are accumulated in a close company, distributed to the shareholders as capital, only for the same or a substantially similar business to be started by any of the same people (or anyone connected to them) later on. If the TAAR applies, your client has to self-assess the distribution as a dividend rather than capital.
Pro advice 1. The TAAR only applies if the new business commences within two years of the date the winding up commenced, so if your client could delay the new venture for longer than that there should be no problem.
The TAAR also stipulates that to apply, one of the main purposes of the winding up must be to avoid or reduce the income tax charge. It is therefore possible that an MVL to allow a number of directors to go their own way won’t be affected as the decision is being made for genuine commercial reasons. It will be important to keep evidence of the decision-making process, e.g. solicitor’s letters, meeting minutes etc., in case HMRC challenges it.
Pro advice 2. If you think the TAAR will apply, consider alternatives such as a statutory demerger or company purchase of own shares instead.
Interest trap
As a company in an MVL is solvent, there may be corporation tax to pay on profits to the date of the winding up. The payment due date is nine months and one day after the end of this accounting period. Following the decision in Burlington Loan Management Ltd and Ors v Lomas and Ors [2017] EWCA Civ 1462 (see Follow up ), HMRC is now demanding that statutory interest at 8% is payable from the date of the winding up order, even if the due date hasn’t passed.
The change in practice is a result of HMRC’s interpretation of insolvency law, where statutory interest is payable on all future and contingent debts once those debts are proved during insolvency proceedings. This is an untested area, and HMRC might use the decision as a springboard to charge statutory interest on all tax debts during an MVL.
Discounting
One way you could mitigate the charge is to discount the debt. This is permissible under insolvency rules in England and Wales (see Follow up ), and should reduce the value of the tax debt for the purposes of calculating the interest. However, you will need to work with your client’s insolvency practitioner to achieve this. The position in Scotland is less clear cut, and there are no specific rules regarding debts and MVLs.
Form DS01
HMRC guidance - TAAR
Burlington Loan Management & Ors v Lomas & Ors [2017] EWHC Civ. 1462
Insolvency rules - discounting
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