The death of a company
When a solvent company comes to the end of its life, it can either be wound up or struck off. Winding up is the formal process, involving the appointment of a liquidator to sell assets and pay off debts, and distribute the remainder to shareholders. This surplus is then subject to capital gains tax. The disadvantage of liquidation is cost. According to HMRC, winding up “a small business with straightforward affairs” typically costs around £7,500.
The alternative is striking off. This is a simpler process, but has less attractive legal consequences. Distributions to shareholders are treated as dividends, with potentially disadvantageous tax implications. Historically, however, extra-statutory concession C16 has allowed distributions to be treated as capital in the hands of shareholders in the same way as a formal liquidation.
The death of a concession
Extra-statutory concessions (ESCs) are just what they sound like – concessions to the law made by HMRC. However, in 2005 the House of Lords ruled that HMRC should not be making new laws, but administering existing ones. Since then there has been a programme to abolish ESCs and where appropriate codify them in law.
On the 1st March 2012, ESC C16 succumbed to this fate. The old extra-statutory concession was enacted in law under The Enactment of Extra Statutory Concessions Order 2012, but not in its original form. Concerned with tax avoidance, the Government has put a £25,000 cap on distributions that are subject to capital gains tax. If distributions exceed this amount, all payments will be treated as dividends, not just the excess over £25,000.
Capital gains vs income tax
This creates a powerful incentive to conduct a formal winding up of a company if distributions will exceed £25,000. The tax treatment of capital gains is typically more favourable than dividends, with a maximum rate of 28% instead of 42.5% for dividends (dropping to 37.5% next year) and an annual tax-free allowance of £10,600 (2011/12). Distributions may even be subject to Entrepreneurs’ Relief, meaning a 10% rate of tax. However, for those with very little income the tax liability on dividends may be more favourable, so each case must be judged on its own merits.
Winding up vs striking off
If distributions are under £25,000 then striking off should be the cheaper option. For amounts over this, winding up is increasingly likely to be more favourable depending on commercial considerations, the tax position of the shareholders and the costs of liquidation.