Insights

It is becoming apparent that the COVID-19 crisis will result in many otherwise viable businesses being unable to survive. And businesses that do survive may need to consider restructuring. Reports are already indicating this, with 21,000 more companies being dissolved in March 2020 than in March 2019.

The shareholder directors of many smaller businesses currently operating as limited companies might be wondering what the future holds. If you have had to furlough your employees and completely scale back, you might be considering whether to expand again once this passes. Or whether to continue trading, but in a reduced capacity. Perhaps the idea of trading in future as a sole trader or even in partnership is appealing.

It’s a complex area and this article looks at the pros and cons of different business structures. There is a lot to consider if you are pondering disincorporation, as this example illustrates.

The future for Cakes Un-limited?

Jenny is the sole director and shareholder of a cake making business supplying events companies, which is incorporated as a limited company. The business launched in 2015 and has three employees, all of whom are currently furloughed. Jenny is currently wondering whether she will be able to keep them on the payroll after the government scheme ends, because business demand is likely to be badly affected in the medium term.

Given the anticipated reduction in trade, Jenny is also looking into different ways she can diversify, she believes she can start trading again, but on a much smaller scale and by supplying to different customers. She wants maximum flexibility, and consequently she is wondering whether she would be better trading as a sole trader by disincorporating her limited company. This is entirely possible, but there are many trade-offs to weigh up.

Issues relating to dissolving a limited company

If Jenny disincorporates her limited company, the company will need to transfer all its assets and liabilities (goodwill, property lease, plant and machinery, stock, debtors and creditors) as a going concern to the shareholder (Jenny) as a connected party, enabling her to then continue the business in an unincorporated form. This is transfer will be by way of a  distribution to the shareholder, which can take the form of either a formal or an informal winding up, or it can be completed as a ‘sale’ to the shareholders. Either way, there are a lot of tax and administrative considerations.

Winding up the company

Provided the company can still pay its creditors and retained profits are in excess of £25,000, Jenny will probably elect to undertake a members’ voluntary liquidation (MVL), which applies where the company being liquidated is solvent. She will need to appoint a liquidator who will complete the winding up process, including paying any outstanding creditors and transferring the company’s assets. Any remaining funds will be distributed to the shareholder (Jenny) by way of a capital distribution in exchange for her shares. As she is the sole shareholder and has operated the company for over 2 years, she will be eligible to claim Business Asset Disposal Relief, which means the gains arising on the capital distribution (up to a maximum of £1m) will be chargeable to capital gains tax at the rate of 10%. Business Asset Disposal Relief is the business tax relief previously known as Entrepreneur’s Relief before Budget 2020, when it was restricted from the original £10 million in lifetime gains to £1 million. We have written about this topic in a previous blog: Understanding Business Asset Disposal Relief.

By using a MVL to dissolve her company, Jenny will need to pay professional fees and should estimate between £2,000 and £10,000 plus VAT, depending on the complexity.

There are other aspects to winding up a company which will reduce the final amounts Jenny can receive, these are as follows:

Transfer of closing trading stock

Since Jenny is continuing in the cake making business but potentially as a sole trader, the transfer of the company’s stock – raw materials for baking and packaging items – will need to take place at the market value. In effect, Jenny will be buying the stock from her own company at standard market rates, which has a cost implication.

Capital allowances

The same applies to the transfer of plant and machinery, which Jenny will need to purchase from the company based on actual value. Adjustments will be required to allow for any capital allowances (AIA) tax relief granted to the company.

VAT

There may be a final VAT charge payable by Jenny for the transfer of goods held by the business. This would need to be reviewed by a VAT specialist to avoid any miscalculations. Using the current Time to Pay arrangements, it may be possible to negotiate a deferred payment with HMRC to reduce the short-term impact on cashflow.

Capital gains on transfer of chargeable assets

Capital gains may arise on the chargeable assets when they are transferred to the shareholder(s) at market value. In Jenny’s case, this includes an industrial kitchen facility she owned through the company, which now needs to be transferred into her own name.

Stamp duty land tax (SDLT)

Due to the property transfer, disincorporation of Jenny’s business also triggers stamp duty at the commercial rate. SDLT is chargeable at the full market value of the property, and the transfer of the property is taxable in Jenny’s hands as a distribution in specie, added to the value of the cash she has received when calculating her capital gains tax liability.

Intangible fixed assets

A corporation tax charge will apply to any gain arising on the transfer of business goodwill from the company into Jenny’s own name. Since the transaction is between connected parties - Jenny being the sole director and shareholder – the transfer will again take place at market value.

In Jenny’s case, because the goodwill will be deemed to be internally generated, the value of this can be nil and not liable to a tax charge. Any other intangible assets beyond goodwill, for example the customer database or any intellectual property, may trigger a tax change on disincorporation.

As this list illustrates, there is a lot to consider before going down the route of disincorporation and there will be many tax implications along the way. For instance, Jenny was taking the majority of her remuneration as dividends and paying the basic rate of tax personally, plus corporation tax on company profits. In the longer term, trading as a self-employed individual could result in a higher personal tax liability, especially if trade picks up again as Jenny hopes.

Other aspects to consider before going ahead with disincorporation include having to close the PAYE payroll scheme and all the legal implications of closing a company down. As the Chancellor hinted, there are also likely to be tax increases on the horizon, to help recoup the cost of the financial support provided by the government during the Coronavirus lockdown. We don’t yet have any evidence of this and cannot predict the future, but we can make a fair assumption that some tax increases are inevitable. In contrast, the government will most likely want to encourage as much business investment as possible, especially due to Brexit, so may be less likely to raise corporation taxes. Who can tell?

What next?

Clearly every business case is unique and needs to be evaluated. There may be instances where a sound case exists for a limited company emerging from the COVID crisis to pursue disincorporation. Clearly this is a complex matter and needs to be considered very carefully, with a professional tax adviser who can help you model the implications of the different options. RJP can identify how your tax bill will be affected and whether you can restructure your remuneration strategy.

If you would like to discuss the potential of disincorporating in more detail, contact us via partners@rjp.co.uk