In the first of a two-part article, Peter Rayney explores how to close down a ‘personal service’ company tax-efficiently.
There are a lot of personal service companies out there, and at some stage many of them simply come to the end of their working life. Given this, it is probably not surprising that advice is frequently sought about the most efficient way of closing down a personal service company. Tax is often a main consideration, since the owners will invariably seek to extract the residual reserves at the most beneficial tax rates. However, there will also be legal and commercial issues to factor into the planning.
Consider reinvestment within the company
This exercise is not always as straightforward as it seems. The natural instinct to dissolve or wind-up the company should always be questioned first.
Some owners may be looking to invest the company’s retained funds in buying a property or other form of investment. If this is the case, it makes little sense in triggering a tax charge on the extraction of the proceeds. The preferred option will often be for the existing company to reinvest the monies in buying the ‘new’ investments. The company could also become a tax-efficient family investment company with potential for future inheritance planning.
Extracting the reserves
On the other hand, if the owner wishes to take the money out for future private purposes, the most tax-efficient solution is likely to be ‘closing’ the company. Subsequently, after paying any remaining creditors, the owner-manager(s) can extract the company’s cash reserves (and any other assets) via a capital distribution.
Capital distributions paid after a company has been wound-up are treated as a disposal of an interest in shares (under TCGA 1992, s 122) and hence fall within the capital gains regime. Where a trade has recently been carried on, it may be also possible to obtain a 10% capital gains tax (CGT) entrepreneurs’ relief (ER) rate on the capital distribution.
Key anti-avoidance rules
The intended tax goal of obtaining capital gains treatment for the capital distribution is subject to a number of potential ‘anti-avoidance’ obstacles:
if the company has substantial reserves (i.e. more than £25,000), the temptation to simply dissolve the company must be resisted. Since 2013, HMRC no longer treat amounts distributed on the dissolution (‘striking-off’) of a company in the same way as liquidation distributions. Where the amount distributed on dissolution exceeds £25,000, the entire amount will be treated as an income distribution, which is likely to be taxed at the penal 32.5% and/or 38.1% distribution tax rates;
in such cases, the shareholder(s) must formally place the company into a member’s voluntary liquidation and incur some additional winding-up costs. This will enable the retained reserves and share capital to be extracted as a tax-efficient capital distribution;
however, the beneficial CGT treatment is unlikely to apply where the shareholder intends to carry on the same or similar trade/business in another company or in another business format. In essence, if the winding-up is mainly driven by the avoidance of income tax, the ‘anti-phoenix’ legislation (in ITTOIA 20005, s 396B) would apply to any liquidation distribution made within two years of the start of the same or similar trade/business. Consequently, the purported capital distribution would be taxed as an income dividend at the higher income tax rates (see my article in Tax Insider (November and December 2016) for detailed coverage of these rules).
Provided these obstacles can be surmounted, the owner-manager should be able to enjoy beneficial CGT rates on the amount distributed during the winding-up. In many cases, they should also be able to access the more favourable 10% ER rate for CGT purposes. The detailed CGT and ER considerations will be discussed in the second-part of this article.
Practical Tip:
Where the owner-manager wishes to extract significant (i.e. over £25,000) reserves following the closure of the trade, a liquidation will invariably be more tax-efficient than a dissolution, notwithstanding the additional legal costs of a formal winding-up.
