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When a company comes to the end of its useful life - a standalone project completed, the owner retiring - it may be closed down. Where the company still has assets these need to be transferred out to the shareholders. This can be done by voting dividends or winding the company up as a voluntary liquidation. In the former the shareholders will pay income tax on receipts, in the latter Capital Gains Tax (CGT). For a trading company, the CGT route is often more tax efficient thanks to reliefs such as Entrepreneurs’ Relief.
Big changes are coming to the tax treatment of dividends in April 2016 and many company owners who extract profits via dividends will have larger tax bills. The Government is concerned people will be encouraged to leave profits in the company and extract it later as capital on a winding up.
New anti-avoidance legislation has been proposed to take effect from 6 April 2016. The intention is to tighten up when this capital treatment is available. The proposals are proving controversial as they are drafted so widely that many advisors are concerned straight forward commercial transactions could be impacted. The proposals also introduce yet more uncertainty into the tax system.
If all the following criteria are met when winding up, distributions will be reclassified as dividends and subjected to income tax, not CGT.
The conditions are:
Test 1 - Most family companies will be ‘close’.
Test 2 - There are lots of circumstances where people may close down their company as it is no longer required but continue to be involved in the same line of business. For example on retirement, an engineer may do the occasional consultancy work, or a hairdresser retains a few favoured clients with home visits. A property company owner may still have a let property personally.
It may also catch people who sell the trade from their company and then are employed by the new owner. Individuals using ‘special purpose vehicles’ – keeping separate projects in separate companies for commercial purposes or to control risk – could also meet this test.
Test 3 - This is the crucial element. When will HMRC consider a tax advantage has been obtained? For a retiree doing ad hoc work and taxed directly there is no future income tax benefit. However, what about past benefits? The shareholders may not have drawn all the cash out of the company via dividends they could, or chosen to build up reserves over time for contingencies. The concern is if HMRC feels that more money was left in the company that was needed for usual working capital they could argue there has been an income tax benefit and apply the rules. In effect HMRC would be deciding what they thought was a reasonable company dividend policy.
So if an individual is not intending to have a clean break after shutting the company there may be uncertainty over how HMRC will tax the distributions.
If you are looking to wind down in the coming years and then have a clean break then, as they stand, the proposals should not affect you. If you are looking to retire but still do some activities similar to what your company did, then we won’t know the precise position for some time. The legislation is only in draft form as at February 2016 and could yet change before 6 April 2016. Until enacted, and we see how HMRC uses the legislation, or what guidance they offer over when a benefit arises, it leaves those looking to exit in an uncertain position.
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