Q&A: When it’s time to wind up

Q. In the run up to the year’s end, I read various articles in the press about proposed changes to be made by HM Revenue & Customs to their tax treatment on the winding up of limited companies. As a director/shareholder of a private limited company I have considered winding up my business in the recent past. Could you please explain what changes are being proposed and the potential effect?

A. Following announcements made within the latest Pre Budget Report significant changes to company dissolutions are expected to come into effect from 1 March this year. The current treatment available under ‘extra statutory concession C16’ is to be formalised by legislation but changes being made to the concession while incorporating will mean that many individual shareholders will pay less tax if the company is dissolved under the current concessionary treatment in C16.

At the present time when a company reaches the end of its useful life, there are a number of ways for the shareholders to extract the company’s remaining assets. Through formal liquidation where assets are paid out to shareholders and are subject to capital gains tax (potentially at 10 per cent) rather than taxed as a dividend at higher income tax rates. You should be aware, however, that a formal liquidation is quite expensive, possibly around £4000 as a minimum, and needs to be undertaken by a qualified insolvency practitioner, by contrast an informal strike off costs £10.

Another alternative method of wrapping up the company is to have it struck off without the formalities of appointing a liquidator. However, in this case the distribution of proceeds without a formal liquidation cannot be treated as a capital distribution. However, the common route is for the officers of the company to ask the registrar of companies to strike the company off and take advantage of the tax treatment in C16. The major benefit of C16, providing certain conditions are met, is that distributions to shareholders are treated as if made in the course of a winding up. Importantly this means they are treated for tax purposes as capital rather than income distributions.

If the individual pays income tax at the higher or additional rates, capital receipts will be more tax efficient. Additionally capital receipts may benefit from entrepreneurs’ relief, meaning that the rate of tax is 10 per cent as opposed to 28 per cent. Under the current regime this concessionary treatment needs to be agreed in advance with the HMRC.

As you have read recently in the various articles from 1 March 2012, extra statutory concession C16 is expected to be replaced by legislation, but not on a like-for-like basis. Instead, if the legislation goes ahead as proposed, there will be a maximum of £25,000 in distributions that can be treated as capital instead of income. C16 did not impose any such limit.

Therefore, where total distributions on dissolution are likely to exceed £25,000, it may be well worth acting sooner rather than later as the additional tax liabilities can be quite high – even for a small business. You should note also that it will not be good enough merely to obtain C16 clearance before 1 March 2012, the distributions must be made before this date as well if the £25,000 limit is to be avoided.