September 2021
In this month’s article in his ‘Keep it simple’ series, Neil Da Costa tackles a popular topic that features regularly in tax exams: winding down companies.
A company in financial difficulty can either choose a corporate voluntary agreement (CVA) or go down the administration/liquidation route.
The CVA option allows the company to reach a binding agreement with regard to paying off its debts and has no tax implications.
On the other hand, the appointment of an administrator means that the administrator becomes responsible for running the company with the intention of rescuing the company as a going concern. With regard to a liquidation, the liquidator takes control of the company with the intention of winding it up and is seen as the last resort where a buyer for the company cannot be found. Once the administrator or liquidator is appointed, the current accounting period ends and a new one starts.
Company implications
Usually, the company being wound up is loss making and it is important to realise gains before the cessation of trade so that the trading loss is offset against the gains. In addition, the loss for the last 12 months of trading is eligible for terminal loss relief and can be carried back 36 months on a LIFO basis against total profits to generate a tax refund.
Simple example: Gonedown Ltd
Gonedown Ltd operates a garage from its own site and has made trading losses of £1m. Before this, the company used to make profits of £100K a year. No buyers are available, so the owners have decided to wind down the company.
The site can be sold to a property developer and will realise a gain of £700K.
Should Gonedown Ltd sell the site to the property developer before or after the winding down?
Solution to Gonedown Ltd
Gonedown should sell the site before the winding down commences. This will mean that the capital gain of £700K falls in the current period and the trading loss can be offset against the gain.
The remaining loss of £300K can be carried back 36 months under terminal loss relief to yield a tax refund.
If the site is sold after winding down commences then the loss cannot be offset against the gain and £700K of the loss will be wasted.
Pre-liquidation distributions
Pre-liquidation distributions are treated as a dividend and must be paid out of commercially generated distributable profits. For individual shareholders, the dividend will be subject to income tax while the dividend will be exempt income for corporate shareholders.
Simple example: Distribution Ltd
Distribution Ltd pays out a distribution of £1m to its shareholders out of distributable profits before the liquidator is appointed. Distribution Ltd is a trading company.
The two equal shareholders are Rita who owns 50% OSC and is an additional rate taxpayer. Rita is a full-time director of Distribution Ltd and has owned the shares for 10 years.
Venture Ltd owns the remaining 50% OSC and has also owned the shares for 10 years.
Solution to Distribution Ltd
The distribution is paid before the liquidator is appointed and will be treated as a dividend.
Rita will receive a dividend of £500,000 and will have to pay income tax of £500,000 – £2,000 = £498,000 x 38.1% = £189,738.
Venture Ltd will receive a dividend of £500,000 which will be exempt income and not subject to corporation tax.
Post-liquidation distributions
Post-liquidation distributions are treated as a capital gain and a disposal of shares by the shareholder. This applies even if the distribution comes out of accumulated net profits. For individual shareholders, the capital gain is generally eligible for Business Asset Disposal Relief (BADR), while the gain will be eligible for the substantial shareholding exemption (SSE) for corporate shareholders.
Simple example: Distribution Ltd
Distribution Ltd pays out a distribution of £1m to its shareholders out of distributable profits after the liquidator is appointed. Distribution Ltd is a trading company.
The two equal shareholders are Rita who owns 50% OSC and is an additional rate taxpayer.
Rita is a full-time director of Distribution Ltd and has owned the shares for 10 years.
Venture Ltd owns the remaining 50% OSC and has also owned the shares for 10 years.
Assume the full £1m is a capital gain.
Solution to Distribution Ltd
The distribution is paid after the liquidator is appointed and will be treated as a dividend.
Rita will have a capital gain of £500,000 and would first offset her annual exemption of £12,300 to give a taxable gain of £487,700.
Rita has been employed by Distribution Ltd and owns at least 5% OSC for 24 months so the gain is eligible for BADR and the gain will be taxed at 10%.
Rita will have to pay CGT of £487,700 x 10% = £48,770.
Venture Ltd owns 10% OSC of a trading company for at least 12 months out of the previous 6 years so the gain is eligible for the SSE and no tax is payable.
Small distributions that do not exceed £25,000
To avoid the high liquidator costs, the company can voluntarily wind down and pay all its liabilities. If no liquidator is appointed, HMRC will allow distributions of not more than £25,000 to be treated as capital.
If the distribution is more than £25,000 then the full amount will be treated as a dividend.
• Neil Da Costa is a Senior Tax Lecturer with Kaplan in London. He is the author of Advanced Tax Condensed, which summarises the entire syllabus using memory joggers.
