What to do if you need to wind up a company? ESC C16 rules explained

In last month’s Livewire newsletter, we reported a change to the ruling that shareholders informally winding up their companies can distribute any remaining funds as capital and depending on the circumstances, can also benefit from entrepreneurs’ relief. With effect from 1^st March, if the company concerned has distributable funds in excess of £25,000 all funds distributed will be treated as dividends and subjected to income tax in the usual way. This means tax will be payable at rates from 25% to 36% depending on the individual circumstances, rather than potentially at a rate of 10% if distributed as capital. The news of this change inevitably created something of a rush as companies tried to benefit from a last minute tax planning opportunity. Whilst it is now too late to make a new application for this facility and benefit from the old rules, there are still options to consider going forward. We therefore thought it useful to explain what the rules are on the informal closure of a limited company, where this is undertaken under HMRC extra statutory concession 16 (ESC C16), and provide you with some advice on what to do in the future should the need to dissolve a company arise. Usually when a company is dissolved any remaining assets, once all monies have been collected and all debts paid,  are distributed to shareholders and a professional liquidator – an insolvency practitioner – will be responsible for presiding over the process.  Because of the costs involved, which can amount to between 6 and 8 thousand pounds, many business owners have historically preferred to take advantage of ESC C16 which permits the informal closure of a company instead. Once confirmation is received from HMRC that ESC C16 can apply, and once certain undertakings are provided by the shareholders, any money remaining in the company can be distributed to shareholders in proportion to their shareholdings and can be treated as capital distributions in exchange for their shares. Hence the proceeds will be treated as capital, subject to capital gains tax rather than income tax, and with the potential to claim entrepreneurs’ relief. Following the conversion of ESC C16 into legislation with effect from 1^st March, and the curbing of the level of funds which can be distributed in this way, the situation will be slightly different.  If a company has distributable reserves of £25,000 or less, it may proceed as previously with a capital distribution following agreement from HMRC. However if the funds exceed this amount, the entire distribution will be subjected to income tax. If funds exceed £25,000, they can still be extracted as capital if the company enters into a formal liquidation. There are of course liquidator’s fees involved in this route, and if the funds are significant, they may warrant paying these fees.  In such cases, there will be no issue relating to any remaining funds being treated as capital and the existing rules can be applied as appropriate, regardless of how much is left in the company. The tax payable in this case by the individual shareholders may be as low as 10% if the capital gains qualify for entrepreneurs’ relief. If however the funds are not significant enough to warrant the payment of liquidator’s fees, a better alternative may be for the company to pay a dividend, reducing the available funds to £25,000 and then pursue an informal winding up. Care needs to be taken with this approach to ensure the dividend does not fall foul of HMRC’s anti avoidance measures. For instance the dividend paid needs to be regarded as a proper dividend, which is declared according to the correct procedures. The level of the dividend also needs to be covered by the company’s available reserves. For these reasons, it is wise to seek professional advice to ensure all aspects have been considered and addressed.  HMRC has indicated that in instances where it believes a company has not followed correct procedure with a pre-liquidation dividend, the full level of income tax will be payable. If you are in this situation and may need to discuss the best way to wind up a company containing funds, please contact Lesley Stalker or Paul Webb by emailing las@rjp.co.uk or pw@rjp.co.uk.