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What are the tax implications of closing your limited company?

Posted on Feb 4th, 2019 | Tax

What are the tax implications of closing your limited company?, image of two pensioners at a laptop

Thinking about closing your limited company? Perhaps you’re retiring or going back into full-time work?

If you want to close a limited company which is no longer trading, you may have to pay Capital Gains Tax or income tax, depending on how the company is closed and how much profit is available to distribute to shareholders and directors.

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What are the options available to the business?

There are generally two options available to shareholders and directors when closing their company – informal strike off or a members’ voluntary liquidation (MVL).

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An ‘informal’ liquidation or ‘winding up’ can be made by simply apply to Companies House to strike your company off the register. An application for a voluntary strike off can only be made on the company’s behalf by its directors or a majority of them. The application is made by submitting certain paperwork to Companies House (known as ‘Form DS01’).

The company may not make an application for voluntary strike off if, at any time in the last three months, it has:

  • traded or otherwise carried on business
  • changed its name.

HMRC recognises that even when considering a voluntary strike-off over the three-month period, a business will still need to undertake certain activities. HMRC provides examples of activities a business can undertake in the three-month period as:

  • making an application for strike off or deciding whether to do so (for example, seeking professional advice on the application or paying the filing fee for the strike off application)
  • concluding the affairs of the company, such as settling trading or business debts
  • complying with any statutory requirement
  • disposing of assets held for the purpose of disposal in the normal course of trading or otherwise carrying on business.

In practice, this means a company in business to sell apples could not continue selling apples during that three-month period but it could sell the truck it once used to deliver the apples or the warehouse where they were stored.

A company cannot apply to be struck off if it is the subject, or a proposed subject, of:

  • any insolvency proceedings such as liquidation, including where a petition has been presented but has not yet been dealt with
  • a section 895 scheme (that is a compromise or arrangement between a company and its creditors or members).

You will commit an offence if you breach these restrictions, and are liable for a fine on conviction.

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If your company’s retained profits are more than £25,000, all shareholders have to pay income tax at their personal rate. The retained profits are usually distributed as a final dividend, so the tax rates that apply to a strike off after 6 April 2016 are either 7.5%, 32.5% or 38.1%, depending on your marginal rate of personal tax. Our article “Tax rates, thresholds, and allowances” has more information.

If some of the retained profits are paid as salary to a director (rather than as a dividend) then the amount of tax paid depends on the director’s personal rate, which is usually higher than the dividend tax rate.

Where profits are below £25,000, all shareholders pay Capital Gains Tax. When selling shares, the regular rate of Capital Gains Tax is 10% for a basic rate taxpayer, or 20% for people paying more than the basic rate of income tax. However, applying for Entrepreneurs’ Relief means you pay a tax rate of 10% on the disposal, regardless of the rate of personal tax you pay.

If your company doesn’t meet these conditions, or cannot pay its debts, you cannot apply for a voluntary strike off and you may have t liquidate your company.

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Members’ Voluntary Liquidation is a process used to close down a solvent company. The company’s assets are turned into cash and then distributed to shareholders. An MVL is carried out by a licensed insolvency practitioner.

With an MVL, all distributions to shareholders are taxed as a capital gain. If your profit is more than £25,000, this is usually the most tax efficient option after you take into account Entrepreneurs’ Relief.

However, you need to be aware that distributions from the voluntary liquidation of a company may be subject to income tax under the following circumstances:

  • The company is a ‘Close Company’ (i.e. has five or fewer shareholders)
  • Within two years after receiving a distribution the owner is involved with a similar trade or activity
  • The winding up of the company appears to be to reduce tax.

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You need to take specialist advice before deciding which option to take. Your advisor will need to consider your personal tax circumstances and the amount of profit available to distribute to shareholders.

The following example may assist you in deciding on which option is best for you.

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A single director/shareholder wishes to close their company on 30th April 2018. We’ll assume the following:

  • Retained profits are £90,000 – the informal strike off seeks to reduce this to £25,000 by paying dividends of £65,000
  • No dividend has been taken in 2018/19 tax year to date
  • No salary was taken from the company by the director
  • The director has PAYE earnings of £60,000 from other employment – dividend tax must therefore be paid at the higher rate of 32.5%
  • The director has no other income in the 2018/19 tax year
  • The director did not sell any personal assets in the year and has not used any capital gain allowances
  • The 2018/19 tax year dividend tax-free allowance is £2,000.

 

Informal strike off MVL
Retained earnings £90,000 £90,000
Dividend to be taken from the company before 30th April 2018 (£65,000) (£2,000) 1

 

Retained earnings after dividend paid £25,000 £88,000
Annual capital exemption used 2 (£11,700) (£11,700)
Amount of Capital Gain £13,300 £76,300
Capital Gains Tax Payable 3 £1,330 £7,630
Dividend Tax Payable at 32.5% £20,475 4 None
MVL advisor fee (estimated) None £2,500
Total tax and fees for comparison 5 £21,805 6 £10,130 7

1 To utilise tax-free dividend allowance. No other dividend issued

2 Individual capital allowance in 2018/19 tax year is £11,700

3 Entrepreneurs Relief rate of Capital Gains Tax is 10% in 2018/19 tax year

4 £65,000 dividend paid Less £2,000 tax free dividend allowance = £63,000 @32.5%

5 May be reduced with personal tax planning

6 £1,330 + £20,475

7 £7,630 + £2,500

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You can find out more about MVLs and whether it’s right for you in our article “What is a Members’ Voluntary Liquidation?”.

We also have a Crunch Partner who can offer you a great MVL service if this is what you decide is right for you.

This is only general information, so for bespoke advice please speak with your accountant.

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Written by Jake Smith

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