Joe Brough looks at tax issues for business taxpayers and their tax advisers when a company is coming to an end.
Owner-managers can spend a significant amount of time and energy building a successful and profitable trading company.
Whilst this article looks at where tax advisers can assist ensuring that profits are extracted in a tax-efficient manner over the company’s life, it is equally important that business owners do not fall at the final tax hurdle when the company is eventually dissolved.
Capital treatment on solvent liquidation
Where there are withdrawals of profits from a company which are not taxable as salary or benefits-in-kind, the starting point is that these distributions are subject to income tax as dividends.
For capital treatment to apply, the company will need to be dissolved, either by way of a liquidation by a suitably qualified insolvency practitioner or via an informal strike-off.
An informal strike off can be used when the reserves of the company are less than £25,000. If the relevant conditions (in CTA 2010, s 1030A) are met, capital treatment applies to distributions made in anticipation of winding up. This is useful, as it removes the need for the company to incur the costs of a liquidator.
Where reserves exceed £25,000 and the company is being wound up, a formal liquidation must take place, with any distributions normally being treated as capital distributions.
Under an informal strike-off, where capital treatment is claimed in anticipation of winding up, the company must be dissolved within two years of making the distribution. In addition, the company must have collected all its debts and paid all its creditors. If these conditions are not satisfied, capital treatment will not apply.
For companies with reserves in excess of £25,000, it may be tempting to simply declare dividends to bring the reserves below £25,000 before making a capital distribution of the remaining funds via an informal strike-off. Unfortunately, in this situation HMRC could argue that all the distributions were made in anticipation of winding up and seek to tax the whole amount as an income distribution, not just the excess over £25,000.
Dividend or capital?
Where capital treatment applies, the funds withdrawn from the company are subject to capital gains tax. If business asset disposal relief (BADR) is available, these gains will be taxed at 10%. If BADR is not available, the gains will be taxed at 10% for any part of the gain falling within the basic rate band of income tax, or 20% for any gains in excess of this.
Where capital treatment does not apply, the withdrawals are taxed as dividends at the individual’s marginal rate of tax. These are either 8.75%, 32.75% or 39.35% (for 2024/25), depending on the individual's total taxable income.
With the difference in dividend tax rates and capital tax rates, it is important to plan ahead to consider which option is the most tax-efficient. It should not be assumed that capital treatment will always result in the lowest tax liability, particularly where the reserves are below the £25,000 threshold. In some cases, it may be beneficial to withdraw earnings via dividends prior to winding up.
Example: Dividend or capital treatment
Alicia Ltd has reserves of £24,000. Esme, its sole director-shareholder’s only other income is a private pension of £5,000. Extracting dividends prior to winding up will produce the following result:
Dividend Capital
£ £
Distribution 24,000 24,000
Share capital - (100)
Dividend allowance (500) -
Available personal allowance (7,570) -
24/25 CGT allowance - (3,000)
Taxable 15,930 20,900
Dividend tax @ 8.75% 1,394 -
Capital gains tax @ 10% - 2,090
Business asset disposal relief
Where a capital distribution is made, a claim may be available for BADR, which applies to the first £1m of lifetime qualifying gains. A BADR claim is not automatic and must be made within twelve months, following the 31 January after the end of the tax year in which the disposal is made.
The qualifying conditions for BADR to apply are:
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the company was the individual’s personal company;
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the company was a trading company or the holding company of a trading group; and
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the individual was an officer or employee of the company or of one or more companies that are members of the group.
These qualifying conditions must be met for the period of two years ending with the date of disposal.
Where the company has been through a liquidation process, it is possible that the company may not have traded for a period of time before the distribution is made. In such cases, the legislation (TCGA 1992, s 169I(7)) states that as long as the distribution is made within a three-year period following cessation of the trade, and provided the qualifying conditions were met at the time of cessation of trade, BADR will continue to be available.
‘Anti-phoenix’ legislation
For some business owners, once they have closed their business, there may be a temptation to ‘keep their hand in’. They may therefore decide to restart their business in another guise in order to continue earning money.
Where a capital distribution is made, anti-avoidance rules are in place to prevent owners from setting up another business and continuing to benefit from capital treatment. A targeted anti-avoidance rule (TAAR) was introduced (by FA 2016), known as the ‘anti-phoenix legislation’.
When a capital distribution is made and the following conditions are all satisfied, the payment will be treated as a dividend distribution rather than capital.
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Condition A: The individual receiving the distribution had at least a 5% interest in the company immediately before the winding up.
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Condition B: The company was a close company at any point in the two years ending with the start of the winding up.
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Condition C: The individual receiving the distribution continues to carry on or be involved with the same trade or a trade similar to that of the wound-up company at any time within two years from the date of the distribution.
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Condition D: It is reasonable to assume that the main purpose, or one of the main purposes of the winding up is the avoidance or reduction of a charge to income tax.
It should be noted that the TAAR does not only apply to owners who set up another company; they also apply where a former owner subsequently trades in a qualifying capacity (e.g., as an unincorporated trader).
Pension contributions
In the trading periods up to cessation, consideration should be given to which expenses can be paid by the company which will continue to benefit the owner post-cessation. If the company makes pension contributions for a director prior to the trade ceasing, this will be a tax-free benefit for the director and a tax-deductible expense for the company.
Depending on the total level of retained earnings, making a pension contribution may also result in the company reducing its reserves to less than £25,000. This would then allow an informal strike-off to take place.
From 2023/24 onwards, subject to tapering provisions, an individual can contribute up to a maximum of £60,000 gross contributions per year. Where there is a carry-forward allowance of unused pension contributions, these can be carried forward for a maximum of three years.
It should be noted, however, that for the pension contribution to be tax-deductible, they must be made wholly and exclusively for the purposes of the trade. To prevent challenge from HMRC, where possible, it is advisable to spread the contributions over several trading periods prior to cessation.
Capital allowances
On cessation, the owner may wish to retain capital assets held by the company. They may consider purchasing the assets from the company for their open market value. In this case, the proceeds will be brought into the final capital allowances computation. For many businesses, where the annual investment allowance has previously been claimed, this will result in a balancing charge which is taxable on the company.
Another option is for the company to gift the assets. In most cases where the company receives no disposal proceeds, open market value is substituted for capital allowance purposes. However, for assets gifted to an employee where an employment tax charge arises under ITEPA 2003, no disposal proceeds are brought into account for capital allowance purposes.
Practical tip
On cessation, where reserves exceed £25,000, the owner may be content for the remaining reserves to be ‘drip fed’ out of the company if they are not required in one lump sum. Indeed, the company may even lie dormant for a time whilst holding cash whilst the owner waits to distribute the funds. Whatever action is taken, the time limits in CTA 2010, s 1030A and for BADR purposes need to be taken into account where capital treatment is the favoured approach.
