Closing your limited company: the tax implications
If you are considering closing a limited company, perhaps because you are returning to employed work or retiring, there are many issues to take into account, writes Cheryl Brown at Beacon Lip Limited.
If the limited company is no longer trading, you may owe income tax or capital gains tax (CGT.) This is the case if the value of the shares you hold has risen from when you originally acquired them.
Whether you pay either of these HMRC liabilities will depend on how the company is closed and the profit left.
Shareholder and director course of action: Informal (voluntary) strike-off
An informal (voluntary) strike-off can be achieved by submitting form DS01 and asking Companies House to strike your company off its register.
However, you cannot apply for this route if your company has traded or changed its name in the previous three months.
In addition, you cannot apply for strike-off, if your company is the subject of any insolvency proceedings or a section 895 scheme, which is an arrangement between the business and its creditors.
Fortunately, HMRC does understand that the business will have to continue to undertake certain activities in this three-month period, such as settling debts, disposing of assets, complying with statutory requirements and seeking professional advice on the striking off.
If the business’s retained profits exceed £25,000, all of the shareholders will need to pay income tax on it at their personal rate. In this case, it is prudent to speak to your accountant to see if there is a tax-efficient method by which to bring those profits down to the £25,000 threshold.
Bringing your profits down to this level enables you to take this as a capital distribution, and pay tax of just £1,270. This is achieved by subtracting your personal allowance of £12,300 from the £25,000, leaving £12,700 to be taxed at a rate of just 10% thanks to Business Asset Disposal Relief (BADR).
Members' Voluntary Liquidation (MVL)
If you cannot meet the above criteria for strike-off, MVL may be the answer.
This closing down of a solvent company sees its assets turned into cash and distributed to shareholders. An MVL must be undertaken by a licensed insolvency practitioner.
Here, the cash distributed to shareholders is taxed as a capital gain. This is usually the most tax-efficient way to close your company, if you can’t use informal strike-off, or if your retained profits are too high. As mentioned, this tax-efficiency is thanks to BADR (formerly known as ER, or Entrepreneurs’ Relief).
But you need to be clear that the above distributions will be subject to income tax; if the closing of the business seems to have been undertaken to reduce the tax bill, if the business has five or fewer shareholders, or if the owner begins trading in a similar way within two years.
Informal (voluntary) strike-off, or Members' Voluntary Liquidation?
The answer to this oft-asked question by contractors will therefore depend upon your personal situation and the company’s profit. You will almost certainly need professional advice to ensure that you are following the best (most advantageous) strategy.
For example, if you had a company with retained earnings of say £90,000, with an informal strike-off you could elect to take a dividend of £65,000 and use your annual exemptions. However you would have to pay tax on that dividend amounting to £20,475, as well as the CGT. In effect your total tax paid would amount to a hefty £21,745.
Using the same retained earnings figure of £90,000 but electing to pursue a Members' Voluntary Liquidation, the dividend would be minimal, leading to a much larger capital gain. However, the remaining cash the business would then be distributed to you via the liquidation meaning total tax would be £10,070, due to BADR.
As you can see, there is a significant difference in the result. Without doubt, the services of a professional adviser are eminently worthwhile, especially as there is peace of mind in knowing that their fee could be paid many times over thanks to your significantly more advantageous tax position!