Sarah Bradford explores ways in which the family company may be shut down and the tax implications of each.
Many family businesses were left struggling as a result of the Coronavirus pandemic. A period of lockdown followed by the need to operate in a Covid-secure manner may mean that the business is no longer viable. Where this is the case, the decision may be made to stop trading and close the family company down.
There are various ways in which a company may be closed down. The options will depend on whether the company is solvent (i.e. able to pay its bills) or not. Alternatively, the company can be left to become dormant.
Closing a solvent company
Where the company is solvent and can pay its bills, it can be closed by applying to have the company struck of the Register of Companies or by going down the member’s voluntary liquidation (MVL) route.
The preferred option will depend on how much money there is to extract from the company and whether, from a tax perspective, it is preferable for the available funds to be taxed as dividends or capital.
Striking off
A limited company can be closed by being struck off. However, this option is only available where:
- the company has not traded or sold off any stock in the last three months;
- the company has not changed its name in the last three months;
- the company has not been threatened with liquidation; and
- it has no agreements with creditors (for example, a creditors voluntary arrangement (CVA)).
It should be noted that the directors can be held personally liable if they apply to strike off a company without paying off all the debts.
Income tax or CGT?
From a tax perspective, this can be attractive where the funds to extract are less than £25,000 and the company wishes them to be taxed as capital. For this treatment to apply, two conditions must be met.
- Condition A is that at the time that the distribution is made the company intends to secure or has secured the payment of any sums due to the company and it intends to satisfy or has satisfied any debts or liabilities of the company.
- Condition B is that the amount of the distribution (or where the company makes more than one distribution in anticipation of the striking off, the total of all such distributions) does not exceed £25,000.
If the retained profits are more than £25,000 and the company is struck off, the distributed profits will be taxed as a dividend. Where this is the case and it is beneficial for the final £25,000 to be taxed as capital, an interim dividend could potentially be made to reduce the retained profits to £25,000, before looking to strike off the company. However, care should be taken with this approach as HMRC may argue that the distribution was made in anticipation of the striking off and apply the income treatment to the full distribution (including the final £25,000).
It should also be noted that if the company has not been dissolved within two years of making the distribution, the capital treatment will not apply and the distribution will be treated as a normal dividend (rather than one made in anticipation of striking off). This provides options where the dividend route is more beneficial from a tax perspective and the retained profits are less than £25,000 – by making the distribution and waiting two years to dissolve the company, the distribution will be taxed under the dividend rules rather than as capital.
Where the distribution is not more than £25,000 and is treated as capital, the annual exempt amount (£12,300 for 2020/21) is set against the gains to the extent that is available. Spouses and civil partners have their own annual exempt amount and the ‘no gain/no loss’ rule can be used to transfer shares between spouses to maximise the use of available annual exempt amounts to shelter the gain. Capital distributions can, where possible, be spread over more than one tax year, to maximise the tax-free gains (but remember that the company must be dissolved within two years of making the last distribution for the capital treatment to apply).
Where the gain exceeds the annual exempt amount, business asset disposal relief (formerly known as entrepreneurs’ relief) can reduce the tax on the gain to 10% as long as the associated conditions are met, to the extent that the gains are covered by the available lifetime limit (set at £1,000,000 since 11 March 2020).
The ‘small print’
An application to strike off a company is made on form DS01, which must be sent to Companies House. The form should be signed by a majority of directors. Anyone who may be affected, such as employees, debtors etc, should be told within seven days.
A notice will be in the Gazette and if no one objects, the company will be struck off after two months have passed.
Members’ voluntary liquidation
A members’ voluntary liquidation (MVL) can be used where it is beneficial for capital treatment to apply and the retained profits exceed £25,000, such that under the striking off procedure, the dividend treatment would apply. Although this is more costly than a striking off, it may be worthwhile where the tax savings outweigh the liquidation costs.
Where the company is incorporated in England or Wales, the directors must make a declaration of solvency, stating that they have assessed the company any believe that it can pay its debts, along with interest at the official rate. The declaration should include the company name and address, the names and addresses of the company directors and the period in which the debts will be paid (which must be within 12 months of the date on which the company is liquidated).
After the declaration has been signed, a further five steps must be taken:
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The declaration must be signed by the majority of directors in front of a solicitor or a ‘notary public’.
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A general meeting with shareholders must be called within five weeks and resolution for voluntary winding up passed.
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An authorised insolvency practitioner must be appointed as liquidator at the meeting.
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Advertise the resolution in the Gazette within 14 days.
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Send the signed declaration to Companies House within 15 days of passing the resolution.
The liquidator takes control of winding up the company; the directors cease to have control and cannot act on behalf of the company.
Under an MVL the capital extracted from the company is treated as a capital distribution and is liable to CGT, rather than being taxed as a dividend, benefitting from the annual exempt amount where available. Where business asset disposal relief is in point, the rate of tax will only be 10%, assuming sufficient of the lifetime limit remains available (£1,000,000 from 11 March 2020).
Closing an insolvent company
If your family company is insolvent and cannot pay its bills, arrangements will need to be made to liquidate the company – striking off or entering into an MVL are not possible. In this situation, the interests of the creditors rank ahead of those of the directors and shareholders.
A director can propose that the company is wound up if it is insolvent and as long as 75% of shareholders (by value) agree to pass a winding-up resolution.
Once the resolution is made:
- an authorised insolvency practitioner must be appointed as liquidator to take charge of liquidating the company;
- the winding-up resolution must be sent to Companies House within 15 days; and
- the resolution must be advertised in the Gazette within 14 days.
The directors cease to have control over the company and anything that it owns once a liquidator is appointed. The company’s bank account is frozen when a winding-up petition is filed.
A company may be forced into compulsory liquidation if it cannot pay its debts if creditors apply to the Courts to get their money paid.
Other issues
On closing a company, there are various compliance obligations that must be met in relation to tax. These include filing final accounts and a tax return with HMRC, closing the PAYE scheme and cancelling the VAT registration. The directors must also meet any personal tax obligations.
Where losses are made in the final period, loss relief should be claimed.
Practical tip
The best route to closing a family company will depend on whether it is solvent, the retained profits to be extracted and whether it is better for these to be taxed as capital or income. Professional advice should be sought.
