Ken Moody looks at some important tax issues, which should be considered when winding up a limited company.
Where a company’s business has been sold or the trade has ceased, the shareholders may be left with a dormant company holding cash and possibly other assets, which would normally then be dissolved or liquidated.
Extra Statutory Concession (ESC) C16 allowed distributions in anticipation of informal dissolution of a company under Companies Act 2006, s 1003 to be treated as if they were capital distributions made by a liquidator in the course of winding-up. ESC C16 was legislated as CTA 2010 s 1030A, but only applies where the total funds distributed are not more than £25,000, and so in most cases it will be necessary to incur the costs of liquidation.
Corporation tax accounting periods
When a company commences winding-up (by passing a resolution or on presentation of a petition for winding-up) its current corporation tax accounting period (CTAP) ends immediately before the commencement of winding up. A new CTAP begins on that date and ends 12 months later, or when the liquidation is complete if earlier (CTA 2009, s 12).
Normally, a CTAP also ends when a company ceases to trade or be within the charge to corporation tax (CTA 2009, s 10). However, the appointment of a liquidator does not in itself cause the cessation of trade, and since the CTAPs in winding-up are as prescribed by s 12, the actual date of cessation may be relevant only for the purposes of terminal loss relief under CTA 2010, s 39 and for the application of the rules relating to post-cessation receipts and expenses (within CTA 2009, Pt 3, Ch 15).
Maximising relief for expenses, losses, etc.
Of course, insolvent or compulsory liquidation is not usually a tax planning opportunity, but in a voluntary liquidation the aim would be to ensure maximum relief for expenses and any tax losses, having regard to the CTAPs involved. For example:
- expenses incurred after the trade has ceased may not be relievable at all, and any allowable expenses should as far as possible be incurred or accrued for the period to cessation;
- closure costs, including some termination payments to employees, may not be allowable as not incurred ‘wholly and exclusively’ for the purposes of the trade but for the purpose of closing it down (e.g. see CIR v Anglo Brewing Co UK Ltd KB 1925, 12 TC 803); and
- the rules for carry forward/back of trade losses, loan relationship deficits, ‘Schedule A’ losses or their offset against total profits are different. A trading loss, for example, cannot be carried forward against non-trading profits and any unrelieved loss (after any relief under ss 37, s 39) would ‘die’ on cessation of trade. That might mean paying corporation tax on a capital gain arising post-cessation, which could have been mitigated by a trading loss for the period to cessation, whereas it might be possible to arrange for the disposal to occur prior to cessation.
It would require a further article (at least!) to consider these issues in detail, but as can be seen, given the opportunity, some forward planning might save significant amounts of tax.
Entrepreneurs’ relief
For capital gains tax (CGT) purposes, the receipt of a capital distribution in respect of shares is regarded as a disposal of an interest in the shares by TCGA 1992 s 122(1), bringing into play the part disposal formula in TCGA 1992, s 42 (see also HMRC’s Statement of Practice D3).
If entrepreneurs’ relief (ER) is available, the shareholder would pay CGT at only 10% (subject to a lifetime limit of £10 million).
ER is available for a disposal of shares or of interests in shares of a company, provided that:
a) the company is a trading company,
b) the shareholder is an employee or officer of the company, and,
c) the company qualifies as their ‘personal company’ (by holding 5% or more of the ordinary shares/voting rights),
for the period specified by either TCGA 1992, s 169I(6) or (7). The period specified by s 169(6) is one year, ending with the date of disposal, while s 169I(7) recognises that the trade may have already ceased and specifies a period of one year to the date of cessation, during which conditions (a) to (c) above must be met, and as long as the date of disposal is within three years of cessation. That would normally allow more than sufficient time to realise assets and wind up the company.
To qualify as a trading company for ER purposes, the company’s activities must not consist to a ‘substantial’ extent of non-trading activities (TCGA 1992, s 165A(3)). As many readers will be aware, HMRC’s rule of thumb of what is ‘substantial’ is 20% of turnover, assets and other factors viewed ‘in the round’ (see HMRC’s Capital Gains manual at CG64090).
Loans to shareholders, etc.
One problem, which might delay completion of the liquidation, is the recovery of any notional corporation tax paid under CTA 2010, s 455 in respect of loans to participators (e.g. shareholders). If such a loan is repaid, the s 455 tax is not repayable until nine months after the end of the accounting period in which the loan is repaid (perhaps by being offset against distributions) or released.
Tax is only repayable if the repayment or release is made in a CTAP, as HMRC warn at CTM61610, which even suggests that the inspector should advise the company if they are aware that this might apply. Now that liquidation rather than informal dissolution is probably the norm, and given that CTAPs in winding-up are prescribed by s 12, it seems unlikely that the repayment or release of the loan would occur outside a CTAP. Otherwise, retention of a small amount on bank deposit would ensure that the company remains within the charge to CT.
Transactions in securities
The transactions in securities (TiS) legislation at (for income tax purposes) ITA 2007, Pt 13, Ch 1 is mainly aimed at prevention of extraction of funds from a company in capital form which could have been used to pay a dividend.
The issue is not normally relevant in a winding-up, as a result of the combined effect of the decisions in Laird Group plc v CIR [2003] STC 1349 and CIR v Joiner [1975] STC 657 (and an application to HMRC for clearance under ITA 2007, s 701 would therefore rarely be in point). In the former case, it was decided that the distribution of profits of a company to its shareholders merely gives effect to the rights attached to the shares, and is not a TiS.
In Joiner, an agreement had been entered into between the liquidator and the company’s major shareholder for the transfer of the business to a dormant company owned by him in exchange for loan notes in that company. It was held that the liquidation agreement was a TiS. However (per Viscount and Lord Diplock), the liquidation of a company cannot in itself be regarded as a TiS.
If it were proposed to carry on any part of the business post-liquidation via another company, it is possible to envisage situations where this might not involve a TiS (but expert advice is recommended in those circumstances).
Practical Tip:
It is something of an ‘old chestnut’ as to whether the build-up of substantial cash balances in a company might jeopardise ER on disposal of shares in the company (whether by sale or winding-up).
It is unfortunate that the HMRC guidance at CG64060 states that:
“…the long term retention of significant earnings generated from trading activities may amount to an investment activity. The first point to consider is whether or not there is any identifiable activity distinct from the trading activity”.
However, it seems clear that in most cases the mere retention of cash surpluses on deposit account does not amount to an activity at all for the purposes of TCGA 1992, s 165A(3), and I have had informal clearances from HMRC in such circumstances confirming the company’s trading status.
If the funds were invested in stocks and shares or actively managed, that might be different (but don’t forget that TCGA 1992, s 169I(6) and (7) only require the relevant conditions to be met for one year ending with the disposal of the shares or cessation of the trade).
