Lee Sharpe looks at the options available to family companies whose owners are looking to wind the company up tax-efficiently.
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In case you had not noticed, the government – likely at HMRC’s cajoling – has been quietly whittling away any notional tax advantage to operating through a company; we are now at the point where, in many scenarios, it can be more tax-efficient to operate outside of a corporate wrapper, at least in terms of ongoing annual profits and income tax. We are a long way from the governments of the early noughties, when incorporation was actively incentivised.
This article considers various routes to extracting the residual wealth in a largely profitable (i.e., solvent) company – both the opportunities and some risks and traps to look out for.
We shall assume that the company is an owner-managed business (OMB) or company that is ‘close’ – meaning, broadly, that it is controlled by its shareholder-directors. Also, the company and its individual shareholder-directors are resident in the UK for tax purposes.
Finally, we are focusing on the taxation of the individual shareholder-directors, as the company has already paid corporation tax on its profits.
Selling on instead of winding up?
In a winding-up, the company will first typically liquidate its assets into cash – call in its trade debts, sell fixed assets such as equipment, customer lists or premises, and settle its liabilities (e.g., HP agreements, loans, taxes, etc.). This can be time-consuming, and it may trigger corporation tax on capital gains within the company on the disposal of its fixed assets. There may also be problems with claiming losses once the trade has ceased or significantly reduced; deciding precisely when a trade has ceased is important.
If the shareholders can instead agree to sell their shares to new would-be owners, potentially without disturbing the underlying business, their interest in the company ends (although the company does, of course, persist). In many cases, selling the shares is the easier option. But there are not always ready buyers.
A company sale by shares will practically always be treated as a capital disposal by the original shareholders and potentially eligible for business asset disposal relief (but see ‘Traps’ below).
A brief word on business asset disposal relief
It has also become progressively harder (and less rewarding) to qualify for capital gains tax (CGT) business asset disposal relief (BADR). However, it is still worth as much as £100,000 in tax saved – the cumulative lifetime allowance of £1 million at 10%, being the difference between the standard rate of 20% (above the higher-rate threshold for income tax) and the special BADR rate of just 10%.
For claims involving company shares, etc., most people will need to have, for at least two years:
- Held at least a 5% stake in the ordinary/voting share capital of the unquoted company; and
Have been employed by the company or been a director or other officer of the company.
- It is available only where the company has qualified as trading – so not for investment businesses such as property rental;
And, only when making a capital disposal of shares, etc., in the company (or certain associated disposals alongside, of assets owned personally but used by the company).
But having qualified, the shares do not have to be disposed of immediately on cessation of trade – there is basically a three-year ‘window’ following cessation.
When is a winding-up not a capital disposal?
A company’s distribution (i.e., effectively paying out those residual funds) is, by default, a distribution of income, thanks to CTA 2010, Pt 23 (largely, CTA 2010, s 1000). There are exceptions to this rule, but it is only brought within the scope of CGT if it is not caught first as an income distribution (TCGA 1992, s 122).
To emphasise, there is always a risk that a distribution on winding up a company will be taxed as if it were dividend income, unless there is a clear path to CGT treatment.
So, unless the shareholder can secure CGT treatment, they cannot claim BADR. This can prove expensive, with a tax rate as high as 39.35% instead of 20% under CGT (or as little as 10% while benefitting from BADR).
‘Small’ distributions: Dissolution by striking-off
CGT treatment is available for ‘orderly’ dissolutions under the striking-off process; ‘orderly’ meaning the company will settle all its liabilities and recover all debts to it. This is the enactment of Extra-Statutory Concession (ESC) C16, applicable from 2012. However, the new statutory tax approach is available only where the total distributions do not exceed £25,000 (CTA 2010, s 1030A).
This is a limit for the company overall and not ‘per shareholder’, as some might assume.
Another potential trap is that the limit does not simply apply to the last distributions made on winding up. If the company ceases to trade and does little more than follow the winding-up process after that, making distributions as it goes along, HMRC may well apply the £25,000 limit against all distributions made appreciably since cessation of trade, so those distributions will then be taxed as if they were dividend income, and not under CGT.
Formal liquidation or winding-up
Where the company has more than £25,000 to distribute, it will usually be better to formally appoint a liquidator as CTA 2010, s 1030 respects CA 2006, s 829, which states that a distribution of assets to shareholders on a formal winding-up does not count as a distribution of income (so will fall to be taxed under CGT). This may incur further professional fees, but the potential tax saving can be substantial. This is a ‘winding-up’, rather than the relatively informal ‘striking-off’ process above.
One might assume that the cost of appointing a liquidator is a guarantee of CGT treatment, but there are further possible issues.
(a) Anti-phoenixing legislation – Even if the company and its shareholders met all criteria at the time the company was wound up and rightly claimed CGT treatment and even BADR, there is then the risk of retrospective reclassification as income (i.e., dividend) instead of capital. The trigger for this is if the individual subsequently becomes involved in a similar business activity within two years of those distributions on a winding-up. Note that the ‘new’ business does not have to be in a company. However, HMRC does have to find that avoiding (or reducing) income tax was one of the main purposes of the winding-up (ITTOIA 2005, s 396B).
This is to prevent individuals from rolling up profits in a company and extracting them cheaply as capital on a winding-up instead of as dividends during the life of the company, on a ‘rinse and repeat’ basis. HMRC’s ‘Anti-Avoidance Spotlight 47’ published in 2019 suggested that HMRC even thinks it can use these provisions to combat company sales that it dislikes, as distinct from company dissolutions, although there is some doubt as to whether the legislation supports this.
(b) Joint liability notices – This is aimed at director-shareholders who have repeatedly been involved with companies that have been dissolved owing taxes to HMRC. In other words, insolvent liquidations (‘repeatedly’ here broadly means at least two such companies within the last five years). HMRC now has the power to make the director or shareholder personally liable for the company’s tax debts (FA 2020, s 100, Sch 13).
Not all phoenixes are bad phoenixes!
There are long-standing provisions that permit an OMB-type company to transfer trading losses and largely-favourable capital allowances treatment to a successor company that is under similar control (common shareholders) as its predecessor – subject to various criteria.
This is sometimes overlooked by the insolvency practitioner advising the company in distress, and I have saved one successor company over £300,000 in tax (the relief was more than £1 million) quite easily (CTA 2010, Pt 22).
The tax treatment of ending a company can become quite involved, and it is always better to take advice comfortably beforehand. Sometimes, it is possible to extract treasured assets instead of simple cash, and it may be better in some cases to keep the company ‘ticking over’ as a kind of pension, drawing dividends over several years instead of dissolving the company.