Distributions on company cessations
When a director winds up a company it is often the case that money has accumulated in the business which is rightfully owed to the company’s shareholders. This money needs to be distributed effectively prior to closure of the company.
In certain situations dividends paid to shareholders may have run down the distributable reserves to their legal limit (dividends are not allowed to create negative distributable reserves). However there may still be money left to distribute as a result of the cessation.
It is important to note whether the company is being ‘struck off’ or whether it is being placed into liquidation as this will affect the tax treatment of any withdrawals.
‘Striking off’
‘Striking off’ is not a formal winding up procedure despite it being a statutory process. Any surplus assets (including the repayment of share capital represented by these assets) are distributed as an income distribution (similar to a dividend).
A caveat to this approach is where certain conditions are met which allow the distribution to be treated as capital This means a taxpayer will pay tax at Capital Gains Tax rates rather than at income tax rates.
It is more tax efficient to distribute assets as a capital distribution where:
- At the time of distribution, the company has collected, or intends to collect, its debts and has paid off its creditors
- The amount withdrawn is less than £25,000 (whether as a dingle distribution or as separate amounts)
Where a company has applied to be ‘struck off’ but within two years of making a distribution it has not been wound up, or it has failed to collect all its debts or pay all its creditors, then the distribution if automatically treated as an income dividend.
Distributions which exceed the £25,000 limit are taxed in full similar to a dividend at the individuals dividend rate of tax, unless the company goes down the route of a formal liquidation (see below).
As a capital distribution the taxpayer may qualify for “Business Asset Disposal Relief” (a 10% rate of Capital Gains tax restricted to the ‘lifetime allowance’ of £1m). In addition, as a capital distribution the annual exempt amount would be available (£12,300 for 2021/22).
Liquidations
The key difference between ‘striking off’ a company and a formal liquidation is that all distributions made during the winding up process are treated as capital distributions (and subject to Capital Gains tax).
Any company making a distribution of more than £25,000 will effectively be forced down the formal liquidation route if they want to access the capital distribution rules. It is important to note that appointing a liquidator will lead to additional costs being incurred as a result of the liquidation (additional costs are normally in the region of £2,000 – £3,000 for a small unincorporated company).
Where the distribution is of assets other than cash it is important to consider the value of those assets when considering whether the £25,000 threshold is breached.
As with ‘striking off’ it may be possible to access the benefits of ‘Business Asset Disposal Relief’, in addition, if the distribution is timed correctly it may be possible to access two years’ worth of Capital Gains Tax allowances.
Often a liquidator distributes 75% of the amount as soon as funds are received, retaining the excess as a ‘buffer’ payable once HMRC clearance has been obtained and the period for any creditors to object has passed.
From a planning point of view it is advantageous to make any payments on either side of the 5 April tax year end and make a claim for two years’ worth of CGT allowances.
Another tax planning possibility may be available if it is expected that shareholders will be higher rate taxpayers on withdrawals as dividends under the ‘striking off rules’. In this case shareholders withdrawing less than £25,000 limit could take advantage of placing the company into liquidation if the shareholders CGT tax rate would be lower than the marginal dividend tax rate (and / or ‘Business Asset Disposal Relief’ is available). However, this route should only be embarked upon if tax savings exceed the costs of liquidation.