Lee Sharpe considers the main options when a company is ready for the chop – but is it always necessary?
There are currently numerous scenarios where it may be advantageous overall to operate a business outside of a company wrapper.
This article considers the tax aspects of ending a trading or property rental company from the perspective of an owner-managed business (OMB) or ‘family’ company. I shall assume that there is a standalone company which is solvent, with the prospect of a healthy cash surplus after settling all remaining liabilities, and that the shareholder-directors will have relatively significant capital gains implicit in their share interests.
Readers may note that the modest and short-lived ‘disincorporation relief’ that broadly mirrored the capital gains tax (CGT) postponement in incorporation relief was formally withdrawn from 31 March 2018.
Basic options
The director-shareholders of an OMB or family company typically have the following options:
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selling the company (or the business within it).
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dissolution by ‘striking-off’.
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liquidation or winding up.
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‘moneybox’ – liquidate all assets and hold the cash in the company; pay out dividends over years.
1. Selling the company
Probably the simplest option will be to sell the shares. The company will remain in existence, but under new ownership. The current shareholder-directors will no longer hold the shares, but should then have cash proceeds, which are subject to CGT. Possible complications include:
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Assuming that the company itself was a qualifying trading company, do the shareholder-directors qualify for business asset disposal relief (BADR, formerly entrepreneurs’ relief), such that the gain on share sale is taxable at only 10%, to the extent that the relief is available or applicable.
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While employment or directorships will typically cease on sale, the new owners may ask for the current director-shareholders to remain as employees for a transition period (for which appropriate remuneration will be expected).
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Where cash proceeds are payable in lumps over time, CGT will normally be calculated and payable on the basis that full proceeds have been received at the point of sale – even if future amounts depend on post-sale profits. Solutions may involve taking a combination of cash and securities, but this may risk a restriction of BADR.
The shareholder-directors may instead agree to sell the business out of the company, leaving the company holding substantial cash proceeds. The company itself will pay corporation tax on the capital gains arising on disposal of any chargeable business assets, which is entirely separate from any personal gains that might be eligible for BADR. The cash-rich company left over will then face options 2-4 below; see also the targeted anti-avoidance rule (TAAR) Spotlight below.
2. Dissolution by ‘striking-off’
After three months of inactivity, the directors can apply for the company to be removed from the Companies House register. The company should have sold all business assets, brought in all trade debts and settled its liabilities comfortably before being struck off. It follows there may be capital gains in the company to consider before any personal gains by shareholders on the company’s actual dissolution.
The company will cease to trade, which ends the company’s tax period (not necessarily the same date to which the company’s accounts are made up). Practically speaking, it is important in the pre-cessation accounts to provide for income and expenditure (e.g., potential bad debts or further recovery costs) to avoid, so far as possible, any post-cessation net expenses that are notoriously useless; likewise, that any trading or similar losses remain available to offset any late capital gains on the company’s disposal of business assets.
When the company is struck off, the shareholders will be deemed to have disposed of their shares in exchange for their proportion of the company’s residual assets. One might assume this would automatically be treated as a capital gain. But the default treatment of any distribution by a company in respect of its shares is that of income to the shareholder (i.e., taxed as a dividend CTA 2010, ss 1000, 1001; ITTOIA 2005, s 383).
Fortunately, there are numerous exceptions to this standard treatment. Veteran readers may recall happier times when Extra-Statutory Concession (ESC) C16 offered quite a generous scope to allow distributions on a striking-off to be treated as capital gains. Unfortunately, the statutory replacement introduced in 2012 capped the total distributions in anticipation of a striking-off at £25,000 (CTA 2010, s 1030A). Note that:
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There are other procedural conditions to meet for eligibility criteria for CTA 2010, s 1030A;
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the limit is £25,000 for the company, not per shareholder;
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HMRC has a habit of ‘starting the clock’ for the limit before the shareholders might have expected. For example, where the company has already distributed ordinary dividends but after the business has ceased, HMRC may argue these should be deducted from the already paltry £25,000 limit; and
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if that limit is ultimately found to have been exceeded, then all the distributions, so far as they exceed the return of share capital itself, will be deemed income; the limit effectively evaporates.
Owners of larger companies may have to look elsewhere, such as the formal winding-up procedure.
3. Formal dissolution or winding up
While no longer absolutely assured, the most certain route for shareholders to secure CGT treatment will be the more formal dissolution process (or ‘winding up’). The process is more involved and requires the appointment of a liquidator (so more substantial fees), but from then, distributions on a winding up should enjoy statutory exclusion from income categorisation, without a cap, enjoying CGT treatment (TCGA 1992, s 122).
While BADR should be welcome if available, CGT treatment for the shareholder should limit the effective tax rate to no more than 20%, while income tax on the dividend treatment in default would be either 33.75% or 39.35% – effectively double. Even without BADR, the tax saving from the CGT route may swiftly outstrip any extra costs.
Here again, the shareholder-directors will want to manage the business cessation process broadly in line with the striking-off procedure above (planning for accounting periods, point of cessation, utilisation of any tax losses and minimising post-cessation expenses where possible, etc.).
The company does not have to liquidate all assets unto cash beforehand; for example, it may well be possible to distribute a prized property asset to the shareholders in specie, but this will not circumvent any capital gains pending in the company on the disposal of that chargeable asset. Care should also be taken to avoid a possible SDLT trap for properties distributed out in specie.
A relatively new and potentially serious trap for distributions in a winding-up is the ‘anti-phoenixing’ targeted anti-avoidance rule (TAAR) (ITTOIA 2005, s 396B). HMRC hopes this will stop profitable ‘close’ (basically OMB) companies being wound up to extract accumulated profits as capital, then to repeat the process with a fresh company a few years later, etc.
The TAAR basically catches the individual shareholder who, having previously taken a hitherto capital-qualifying distribution from a 5%+ stake in a company being wound up, then becomes involved with a similar trade or business activity within two years (and avoiding income tax was one of the main purposes of the winding up). If caught, the individual must re-categorise their capital gain on that previous distribution as income – paying much higher rates, as above.
Conclusion: Is it worth it - or is there a fourth option?
Even relatively simple company terminations can involve a lot of steps, careful planning, and stress. One of the more bizarre announcements HMRC has published recently is Spotlight 47, suggesting a company sale could also be caught by the TAAR (that is based on legislation explicitly dependent on there being a formal winding up rather than a sale).
I might suggest that for many people who are approaching retirement, it may be better instead to consider using the company as a means of ‘topping up’ their pension, paying out dividends at relatively benign rates (0%/8.75%) over many years, and where the ongoing cost of running an otherwise ‘dormant’ company becomes relatively minor. It would still be feasible to wind up the company later on, with CGT on the remaining balance, with the caveat that BADR status, if any, would be forfeit once three years had elapsed since the company ceased its qualifying trade (TCGA 1992, s 169I(4)).
