1. Tax Journal
The non-taxing weekly for top practitioners
Tax Journal, Issue 1133, 24
27 July 2012
Analysis - Back to basics: Tax on the winding up of a company
Paul Howard
is a Director at Gabelle LLP, providing independent tax support for accountants and other professionals. Paul
advises on direct tax issues affecting owner managed businesses. Email: paul.howard@gabelletax.com; tel:
0845 490 0509.
Priya Dutta
is a Senior Consultant at Gabelle LLP, providing independent tax support for accountants and other
professionals. Priya advises on personal tax and trusts and has recently been involved in a number of cases
involving disguised remuneration. Email: priya.dutta@gabelletax.com; tel 0845 490 0509.
© Reed Elsevier (UK) Ltd 2012
Speed Read: A company is a separate legal entity, so when it is no longer required it has to be
wound up, otherwise the company will remain in existence as a dormant company. There are tax
issues that need to be considered both for the company and for the shareholders. When a company
is wound up it will dispose of all its assets, either by way of sale or by way of distribution in specie to
the shareholders. Any losses incurred by the company up to cessation of trade can be carried back
three years. The timing of expenses up to cessation of trade should be considered, so as to ensure
that corporation tax relief is obtained. The shareholders will need to consider their CGT position, and
may also need to bear in mind any income tax implications. There are implications for the availability
of loan interest relief, and also in connection with dealing with directors loans when a company is
wound up.
A company is a separate legal entity and has a life independent of its shareholders and directors. Just
because a company ceases to trade, runs out of money, or becomes insolvent it will continue to exist until it
is liquidated, wound up informally and struck off the register at Companies House, or simply struck off as a
result of non-compliance.
In this article we will consider some of the tax issues that the company and its shareholders/ directors need
to consider, focusing on owner-managed businesses (OMBs), when, for whatever reason, the company is no
longer required or is forced to cease trading.
From the company perspective the first issue to bear in mind is that if a company is wound up or liquidated it
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2. either has to dispose of its assets, realise its debts and pay off its creditors, or distribute its assets in specie
to its shareholders. In either event this can give rise to corporation tax as well as personal tax liabilities.
Disposal of assets by the company
Where a company disposes of its chargeable assets, for example freehold or leasehold property or pre-2002
goodwill, a chargeable gain or capital loss will arise. If those assets are sold to a third party it can usually be
taken that this is on an arm's-length basis, so that the consideration received for those assets will be taken
as proceeds for CGT purposes. However, where assets are transferred to the shareholders as part of the
proceeds of liquidation or winding up the market value of those assets will need to be considered and a
capital gain computed accordingly. This will form part of the company's profits or give rise to a capital loss for
corporation tax purposes.
If the company's trade started on or after 1 April 2002, any goodwill would be dealt with under the intangible
assets rules in CTA 2009 Part 8. Transactions between related parties will be treated as having been
effected at market value, which could give rise to a profit for corporation tax purposes where a business is
transferred to the shareholders.
Disposal of stock, plant and equipment
The disposal of stock will give rise to a trading profit or loss for corporation tax purposes. The market value of
that stock will need to be considered if it is transferred to the shareholders, but if they are going to take over
the stock and carry on a trade themselves it may be appropriate to make an election under CTA 2000 s 167
so that the stock is transferred at original cost. In order to do this the parties must enter into a joint election,
within two years of the end of the accounting period in which the trade discontinued. This election is not
available to large companies.
The disposal of plant and machinery will give rise to a balancing allowance or balancing charge, although if
the shareholders take over the trade it would be possible to elect for the assets to be transferred at tax
written-down value under CAA 2001 s 266.
Terminal losses
If in the period to cessation the company makes a trading loss for corporation tax purposes, that loss can be
carried back three years. A practical point to bear in mind is that insolvent companies that are in formal
administration are exempted from online filing, and it is often possible to agree losses with HMRC without the
need for formal accounts, although the loss claim should usually be made in a return so a CT600 may be
required.
The shareholders' position
Looking at the shareholders, proceeds and extraction of funds from the company will be taxed either as a
distribution or under CGT principles. Particularly where entrepreneurs' relief is not available on a disposal of
shares in the company the shareholders should consider paying a dividend of a part or the whole of the net
assets of the company. This may be appropriate where the shareholders are basic rate taxpayers so that
dividends can be paid without incurring an income tax liability.
Tax Journal, Issue 1133, 24 at 25
Once any dividend payments have been dealt with, the company can be put into liquidation (through a
members' voluntary liquidation) or wound up informally prior to striking off. Where the company is liquidated
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3. through a members' voluntary liquidation, distributions by the company to a shareholder will be treated as
proceeds for CGT purposes. Where there are several distributions each will be treated as a part disposal,
which means that a liquidation can span more than one tax year, with the result that the shareholders could
make use of more than one annual exemption. Where distributions take the form of assets, the value of
those assets will be used for CGT purposes -- it does not matter whether those assets are themselves
chargeable assets.
Informal winding up followed by striking off at Companies House used to be dealt with under ESC C16,
which gave capital gains tax treatment for any distributions by a company in the course of winding up once
clearance had been sought under the concession. ESC C16 has now been enacted as an amendment to
CTA 2010 s 1030A which affords capital gains tax treatment only where total distributions from the company
are less than £25,000. This means that, except for the smallest of companies, a formal members' voluntary
liquidation would have to be used if capital gains tax treatment is required.
If the company has significant issued share capital it may be appropriate to carry out a capital reduction to
return share capital to the shareholders. If as a result less than £25,000 remains in the company, the balance
could be distributed in the course of an informal winding up.
Phoenix arrangements
A simple liquidation or winding up is not caught by the transactions in securities legislation, following the
case of CIR v Joiner [1975] 3 All ER 1050. However, where a company is wound up, and the trade is
transferred to a new company under the control of the same persons as the old company, transactions in
securities would be in point. This means that HMRC would issue a counteraction notice, as a result of which
the proceeds on liquidation of the old company would be treated in whole or in part as if the company had
paid a dividend. However, if the trade is transferred from the company and carried on in an unincorporated
form these anti-avoidance provisions are unlikely to apply.
Entrepreneurs' relief
Where entrepreneurs' relief (ER) is available the gains arising on the disposal of shares will be charged to
tax at 10%. The ER rules are quite generous where a company has ceased to trade. The disposal of shares
(or a distribution on dissolution) will qualify under the rule that the company has within three years
immediately preceding the disposal ceased to be a trading company. Therefore where a company is wound
up ER should be available if the following ER tests are met throughout the last 12 months before the disposal
or cessation of trade if earlier:
· the individual holds at least 5% of the shares and voting rights;
· the company is a trading company; and
· the individual is an officer or employee of the company.
* * * * * *
Checklist of issues to consider
Company Shareholder
Terminal losses Entrepreneurs' relief
Disposal of assets/stock Distributions
Expenses Striking off
Overdrawn loan account Transactions in securities
Pension/termination payments Loss on disposal of shares
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4. Close investment holding companyLoan interest relief
* * * * * *
Under current proposals, from 6 April 2013, if shares are acquired under an EMI share option scheme, the
5% test does not need to be met, but they still need to have been held for a year up to cessation of trade or
sale of the shares. Nevertheless, where an individual has options over shares he would need to consider
whether to exercise those options if the company is going to cease trade and be wound up.
So long as the winding up is completed within three years of the cessation of trade ER would continue to be
available to the shareholders.
Income tax relief for losses on shares
The distributions made on liquidation will be in satisfaction of the individual's shares. As such where the total
distributions amount to less than the base cost paid for the shares, the individual may be able to claim for
income tax relief up to the value of the loss under ITA 2007 s 131 provided the shares are qualifying shares.
Qualifying shares are those which have EIS relief or those in a qualifying trading company which were
subscribed for by the individual.
Shares are subscribed for by the individual if they are issued to the individual by the company in exchange
for money or money's worth. Therefore, second-hand shares will never qualify for relief unless they were
transferred from a spouse (or civil partner) and the spouse (or civil partner) had originally subscribed for the
shares.
Relief under ITA 2007 s 131 may be capped to the greater of 25% of the individual's income and £50,000
from 6 April 2013 following recent government proposals.
Overdrawn directors' loan account
Where there are overdrawn directors' loan accounts, these need to be dealt with. Where the company is
solvent, these are usually cleared by
Tax Journal, Issue 1133, 24 at 26
a credit which is treated as a distribution on the winding-up. However, if this does not happen, it may simply
mean that the loan is written off. Where any part of a loan from a company to a director/shareholder is not
repaid the director is assessed on it under ITTOIA 2005 s 415 (as if the amount were a net dividend)
provided they liquidate or formally write off the unpaid balance. To do this, the liquidator must take an active
decision either not to chase the debt or to write it off.
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Loan interest relief
An individual may have borrowed money to buy shares in or to lend money to the company, and claimed
loan interest relief against total income for income tax purposes. Relief would cease to apply if the loan
remains outstanding after the company has ceased to trade, at which point it may become a close
investment holding company.
If possible, therefore, the proceeds from winding up the company should be used to repay the loan.
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5. However, where a loan has been made to a trading company, and the loan becomes irrecoverable, a capital
loss would be available so long as the provisions of TCGA 1992 s 253 are met.
Close investment holding company
On ceasing to carry on a trade, the company may become a close investment holding company. This means
that it will pay 24% tax on all its post-cessation income and gains. A company which was trading in the
period ending with the date of cessation will not be treated as close investment holding company in its
following accounting period, for that year only.
Pension and termination payments
It may be tempting, on cessation of a company's trade, to make a large pension contribution in relation to a
retiring director. A contribution following the cessation of trade may result in the company being denied a
corporation tax deduction. In order to get a CT deduction the pension contribution must be made wholly and
exclusively for the purposes of the company's trade. Whether a deduction is available will depend on the
facts. A deduction will be denied where the contribution is made in connection with the cessation of a
company's trade. So for example, where a large discretionary pension contribution is made to a retiring
director and similar contributions are not made in relation to other unconnected company employees it is
likely that a CT deduction will be denied. Where a pension contribution is made as part of the director's
remuneration package, it will be a business cost that crystallises on cessation and will therefore attract a CT
deduction.
The same principle applies to termination payments. The case of CIR v Anglo-Brewing Co Ltd (1925) 12 TC
803 held that where a termination payment or pension contribution is made for the purposes of winding up a
company and not for the purpose of a trade the company will not be entitled to a CT deduction. However,
where payments are made to employees under a pre-existing contractual or statutory obligations (for
example, statutory redundancy payments), they will be deductible for CT purposes.
When does a company cease trading?
The date a company ceases to trade is important because it may affect:
· the date the accounting period ends -- which may result in excess losses which cannot be
carried back;
· whether pension or termination payments are deductible expenses; and
· whether shares have been held for one year in order to qualify for entrepreneurs' relief.
Exactly when a company ceases trading is a question of fact. Records should be kept to evidence the date of
cessation, such as letters to customers and public notices.
Stamp duty and SDLT
Usually there are no liabilities to stamp duty or SDLT when a company is wound up. However, care needs to
be taken where a company transfers realty to the shareholders and there is a loan secured on the property
that is to be taken over by the shareholders. In this case an SDLT liability could arise on the value of the
loan, which may be treated as consideration for the acquisition of the property.
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6. Conclusion
When a company ceases to trade the shareholders need to consider what to do with the company. Usually
they would want to dissolve the company and extract the assets to which they are entitled as shareholders.
However, there are a number of potential tax liabilities that should be considered so as to ensure that the
winding up is achieved in the most tax-efficient manner.
There are tax liabilities both at the corporate and shareholder levels, and implications that cross over,
especially where assets are transferred in specie to the shareholders.
For further tax guidance, see www.taxjournal.com.
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