01227 811745

The end to easy company closure?

From 1 March 2012, it will no longer be so straightforward to close a company and have the proceeds treated as a capital gain.

Before 1 March, using a special concession called ESC C16, a company could apply to HMRC for permission to treat distributions made on an informal winding up as capital. This would enable such distributions to be subjected to capital gains tax in the hands of the shareholders. Without this permission, the distribution of its reserves would be treated as dividends and taxed as income.

This distinction is important because many business owners are able to claim Entrepreneurs’ Relief. Using ESC C16, the applicable tax rate would reduce to 10% on distributions up to £5m, compared a tax rate if up to 50%, if ESC C16 is not used.

Historically, this has been an important part of tax planning over the life of an owner managed business. It has been common for business owners to set their annual remuneration at a level which minimises higher rate tax, leaving surplus profits to accumulate in the company, with the intention of withdrawing the accumulated reserves at an effective tax rate of 10% on company closure. The rules in ESC C16 also meant that the business owner could essentially manage the winding up of the business and could minimise external involvement.

This strategy is now no longer possible. However, some opportunities for sensible planning still remain.

The new rules will allow directors to treat distributions up to £25,000 as a capital gain. Whilst this will not be of use to many entrepreneurs, it will help the very smallest companies.

If a liquidator is appointed, then the distributions made by the liquidator to the shareholders will still be subject to capital gains tax in the hands of the shareholders with no upper limit. This situation has not changed. On the face of it, this suggests that in future it will be more beneficial to company shareholders to have a formal members’ voluntary liquidation, rather than to try and close the company informally, even though this would incur professional fees to do so.

A further possibility is to extract assets by arranging a company purchase of own shares. This route is likely to be more problematic, not least because HMRC clearance is invariably required for such transactions.

In summary, the withdrawal of ESC C16 will significantly affect the way in which business owner close their companies and is likely to increase the popularity of voluntary liquidation. However, options still remain and, as always, advisers will look for opportunities to maximise net returns to their clients and to protect their clients’ interests.