How to manage the cost of closing down a business
Insolvency practitioner John Dickinson looks at the most tax-efficient way to shut a business following HMRC changes
When a company stops doing business, the legal entity continues to exist and may still hold cash or assets. What is the best way to carry out a controlled wind-down of a company and extract any remaining value? Recently the rules changed making closing down potentially more costly and worrisome than before.
Reading the HMRC release reveals there is some confusion about how best to close down a business. Essentially there are three main options which we'll explore below:
1. Extra Statutory Concession 16 2. Liquidation 3. And extracting the remaining value of the company as a dividend, which is then taxed as income.
Extra Statutory Concession 16
Previously, directors could close down a company by distributing the assets to the shareholders and taking advantage of the Extra Statutory Concession 16 (ESC), whereby HMRC would treat this distribution of the remaining value as a return on capital and tax it as such, which was usually advantageous. Thereafter the directors would file for the company to be struck from the register.
HMRC has now imposed a limit on the value of the distributable assets of £25,000 for ESC 16, restricting its use (previously there was no limit and HMRC made concessions on a discretionary basis). On the plus side for business owners, the Treasury Solicitor (the government's in-house legal organisation), which previously would only allow share capital of £4,000 or under in total to be distributed to shareholders, has now removed this concession and will no longer intervene.
Prior to the removal of this concession, if a company had issued 10,000 shares of £1 each, only 4,000 of these could have been redeemed and the Treasury Solicitor could have taken all the share capital in excess of the £4,000 limit. To reduce share capital used to require a court order, but the law has now changed to make it much easier. As a result the Treasury Solicitor has withdrawn the restriction which is now largely redundant.
ESC 16 has always been a cost-effective way for small businesses to close, but leaving aside the costs issue there is always a risk in this process, as any creditor or potential creditor could make an application for the company to be restored and pursue their claim, with some likelihood that the directors' may well be held personally liable for the debts.
Liquidation and extracting cash as a dividend
Other options for winding-up a business include liquidation, but it can be an expensive process. For smaller companies with cash-only businesses and a few shareholders this could cost £5,000-15,000. For more complicated businesses the costs could be far higher. Another option is to extract all the value in the company as a dividend, but you will have to pay income tax rather than capital gains tax on the dividend.
If tax is the only factor and there are a small number of shareholders then the decision could be an easy one. Where individuals have total income below £150,000 but are not basic rate tax payers then dividends will be taxed at 25% and capital distributions taxed at 28%. Additional rate tax payers are taxed at an effective rate of 36.1%
Therefore where a single shareholder has income of £90,000 and the reserves in the company are £200,000 it would make sense to pay £60,000 as a dividend and consider liquidating the company and receiving the remaining £140,000 as capital. Assuming there were no other capital gains in the year the tax saving to the shareholder would be £14,308.
However, this is a very simple example. The position is invariably complicated by each individual shareholder's position. The tax they are required to pay will depend on whether or not they are basic rate tax payers, whether entrepreneurs' relief applies and the timing of the distributions, amongst other things. One benefit of a formal liquidation is that the liquidator will advertise for creditor claims and once complete will call a final meeting of the company and the company will be struck off by the registrar, drawing a line under the company and its directors' liabilities.
Liquidation remains the least risky and most flexible method of distributing assets. For instance, a liquidator can, where appropriate, distribute a company's assets in specie i.e., directly to the shareholder without realising them for cash therefore assets such as property can be transferred directly to the shareholder. This can in certain instances save on Stamp Duty where the assets are property or shares.
In other more complex situations the company can take advantage of Section 110 of the Insolvency Act 1986 and fundamentally restructure the business. This option is more common with family businesses, companies where the owner is retiring, and those with more complicated shareholder structures. It's often less complex in such cases to start a new company and avoids capital gains tax.
Usually this means splitting a business up or moving property or investments out of the company. The company is effectively wound-up and its assets distributed to new companies. As consideration, the shareholders are given shares in the new companies. This can prove to be an excellent and tax efficient method of reorganising a company using the solvent liquidation as the main plank.
In addition many large corporates liquidate their dormant subsidiaries rather than choose the striking off route mainly for reasons of corporate governance as well as efficiency. There are economies of scale and often the cost of winding the company up is less than the cost of keeping it going. Usually, there are no assets in the companies but there may be historical charges etc. that relate to debts long since paid. Liquidation deals with these issues properly and incisively.
For many companies there is little to choose between the high liquidation costs which give rise to a smaller capital gains tax, drawing a dividend with a high income tax payment, or risking an ESC 16. Where once ESC 16 would have been the most attractive option for smaller companies with limited assets they now face an insidious choice.