Iain Rankin looks at some options potentially available to business owners contemplating the cessation of their businesses.
The Coronavirus pandemic is encouraging some entrepreneurs to bring forward their retirement plans. Business owners should carefully consider a number of potential tax strategies.
Tax efficient treatment of a company’s retained reserves
In most cases, when owner-directors wish to close their company, they will find that it is more tax-efficient to extract the company’s reserves via a formal member’s winding-up.Such distributions are normally treated as capital and taxed under the capital gains tax (CGT)regime (TCGA 1992, s 122(5)(b)), at more favourable rates.
However, a word of caution; this beneficial CGT treatment may be denied if the shareholder intends to carry on the same or a similar trade or business in another company within the next two years i.e. if the winding-up is driven mainly by the avoidance of income tax, the‘anti-phoenix’ legislation (in ITTOIA 2005, s 396B) applies to any liquidation distribution.
If the company has reserves exceeding £25,000, the temptation to simply dissolve the company must be resisted. Since 2013, HMRC no longer treats amounts distributed via a voluntary strike-off in the same way as a liquidation. If the amount distributed on a dissolution exceeds £25,000, the entire amount will be treated as an income distribution, which is likely to be taxed on the director at 32.5%, or even 38.1%. Therefore, a member’s voluntary liquidation is normally more tax-efficient than a dissolution, notwithstanding the additional legal costs involved.
Keeping the company
However, owner-managers with no other major source of income should instead consider keeping the company, even for several years, and instead pay the distributable reserves as annual dividends within the shareholder’s basic rate band, thus benefiting from a much lower 7.5% tax charge.
Potential business asset disposal relief
For those owner-directors of trading companies able to sell their business, it should be possible to secure the beneficial 10% CGT rate on the capital distribution gain under the business asset disposal relief (BADR) provisions; BADR is the new name for entrepreneurs’ relief (i.e. since 6 April 2020).
Assuming an owner-director is entitled to the full BADR lifetime gains allowance, the first £1million of gains (after deducting the annual CGT exemption) would be taxed at 10%, with any excess gains being taxed at 20%.
The BADR legislation contains special rules for capital distributions, all of which must applyfor at least two years ending with the date of disposal:
- The company must be a trading company;
- The shareholder must have held at least 5% of the company’s ordinary share capital, voting rights and economic rights (as defined in TCGA 1992, s 169S(3)); and
- The recipient shareholder must have been an employee or director of the company
The capital distribution must further take place within three years of the cessation of trade.
Family investment companies
Some owners may be looking to invest retained funds by (for example) buying a property oranother form of investment. In such cases, it would be more tax-efficient to reinvest thanextract funds from the company. This can often be best achieved using a family investment company, created by amending a company’s articles of association, SIC code and drawing up a new shareholders’ agreement.
Family investment companies have several tax advantages. For one, they can receive dividends from other companies without any further tax charge. For another, the familyshareholders can undertake tax-efficient dividend extraction strategies.
There is the added tax advantage that they are a useful vehicle for estate and inheritance tax planning. Family investment companies work best if the majority of the investment income is retained by the company over a longer period, rather than being paid outimmediately to the shareholders. Owner-managers can then consider suitable transfers of shares to children, using annual allowances and perhaps considering a discretionary trust.
Practical tip
Faced with great future uncertainty and the prospect of significant losses, the obvious course of action for many directors will be liquidation. However, it is always important toconsider other options. As long as the company remains solvent, the owner-manager can control the process of winding up to their tax advantage.
