How to pay the least tax closing a limited company
Following the closure of the cherished tax avoidance concession known as ESC C16, there has been concern among contractors about how to close down a limited company in as tax and cost-efficient a manner as possible, writes Martin McKechnie, a director at specialist accountancy firm the Low Tax Group.
Many are concerned about large tax bills and exuberant insolvency fees. While it is likely you will be paying more than you would have prior to March to close your limited company, the good news is that with the right tax planning you can minimise the cost of the new rules.
Previously, under ESC C16…
To recap, up until February 29th 2012, where a limited company business ceased to trade, it was possible for the assets (nearly always cash in the bank account), to be released to the shareholders and be taxed as a capital gain, rather than a dividend. The benefit being that there was a tax-free allowance of £10,600 per shareholder and the balance could be taxed at just 10%, instead of the effective dividend rate of 25%. Taxpayers needed HMRC’s permission to do this (rather than its forgiveness!) and, even though it was a concession, I never knew it to be refused.
The good news for contractors about the new rule (see Companies Act 2006, s1000 and s1003) is that because it is not a concession, you will no longer need prior HMRC approval. However, the amount that can be withdrawn in total will be limited to just £25,000.
So what is now the best way to shut down a limited company and withdraw funds in a tax efficient way?
Company holding less than £25k?
If you have less than £25,000 in the company on dissolution, there will be little change. You can still release the assets (cash) to shareholders and be taxed as a capital gain rather than as a dividend. The good news here is that you will no longer need permission from HMRC to do so.
If you want to distribute over £25k…
If you have more than £25,000 available you will have a choice:
- You could pay an insolvency practitioner (we have a supplier who can do this for £2,500 not the £7,500 HMRC suggests to pay) to formally wind the company up, and then have all the funds treated as a Capital Gain.
- Alternatively you can withdraw funds until there is £25,000 left in the company. You can then withdraw this balance of £25,000 as a Capital Gain.
There are still traditional methods to withdraw funds from your limited company, including:
- Most tax-efficient way to draw cash - The most tax-efficient way to draw the money out of your limited company is by way of dividends paid to a non higher-rate tax payer which for the current year means a person earning less than £42,475.
- Pay dividend to basic tax rate spouse - Notwithstanding HMRC’s dislike of ‘income shifting,’ it is still possible to pay a dividend to a shareholding family member, such as a spouse, to take advantage of their basic-rate tax band. These dividends could be taken out now or you could take advantage of a future year’s basic tax rate by withdrawing dividends over a period of time. For example, if you have £40,000 of surplus funds and your spouse earns £30,000 per annum, there is potential to withdraw £10,000 per annum over four years with no further tax liability.
- More ‘exotic’ methods of cash withdrawal - Meanwhile, and despite recent media and political criticism, there are still legal tax avoidance schemes available often utilising more ‘exotic’ instruments, such as trusts and tax havens. The entry level for these schemes varies but typically starts at around £60,000. With these schemes, you will pay fees as opposed to tax and you tend to get what you pay for, when considering rates of return.
- Take a loan, and the taxman takes - Finally, if you would rather seek HMRC’s forgiveness than their permission, it is also possible, if you need the money short term, to be able to take a loan for the money from the company. However HMRC will also ‘borrow’ from you 25% of the loan for a minimum of one year regardless of how quickly you repay the money.
Lastly, contractors should also be aware of the Phoenix clause:
- You will need prior written HMRC approval, but this can be rescinded with a so-called ‘phoenix clause’ if you go back into contracting. The effective tax rate for these withdrawals is 30%; comprising 20% company tax and 10% capital gains tax. It should be noted that all concessions including this one are being placed onto a statutory basis. HMRC are taking this opportunity to review the rules and it seems this route will only be applicable if the surplus funds are less than £4,000. If the funds are in excess of £4,000, you can achieve the same result with a formal liquidation of the company.
Each individual’s situation is different and so one or more of these solutions may be applicable. The most cost-efficient way to shut down your limited company will therefore be determined by analysing the resulting tax bill combined with the associated fees of each solution. We therefore recommend that you consult with a professional tax accountant to discuss your options further.
Editor's Note: Beacon LLP provide contractors with a specialist insolvency service. With Beacon LLP contractors can close down their limited company in as little as 24 hours with no upfront or hidden costs, for more information please click here.