Dividends on winding up
Where a company ceases to trade and is to be wound up, there will be a distribution of any remaining assets (once liabilities have been discharged) to the shareholders of the company. The tax treatment of such a distribution differs, depending on whether the company applies for a strike off from Companies House or is formally wound up by a liquidator.
In this insight, we consider the different tax treatments that may arise in differing circumstances, alongside the relevant anti-avoidance provisions to give thought to.
Companies Act strike off
The general rule is that distributions from a company to its individual shareholders are taxed as income distributions subject to income tax at the individual’s relevant dividend tax rate.
If a company is being struck off under the Companies Act 2006 dissolution procedure and if certain conditions are met, distributions may be treated as capital, subject to Capital Gains Tax (CGT) rather than income tax. In the majority of cases, paying CGT at rates of 20% or even 10% will be more favourable than income tax on distributions with rates of up to 39.35% depending on income levels.
The conditions for capital treatment on a strike off are set out in the Corporation Tax Acts, and broadly state that:
- the company has or intends to collect all debts owed to the company and satisfy all creditors of the company; and
- the total amount of distributions to all shareholders on a winding up do not exceed £25,000 in total.
Although the first condition may be relatively easy to meet, the second condition restricts capital treatment to companies with limited remaining assets. The £25,000 limit is an all or nothing condition so if the final distribution exceeds this figure, even by £1 only, none of the final distribution can be subject to CGT.
Business Asset Disposal Relief (BADR) may be available on the capital distribution to reduce CGT paid at 20% to 10%. BADR may be available to an individual shareholder on the gain from the capital distribution if, in the 24 months before cessation of the trade, the company was their ‘personal trading company’ and they were an employee or director of the company. The ‘personal trading company test’ is a complex test looking at the nature and size of an individual’s shareholding, together with voting and economic rights.
To be eligible for BADR the capital distribution must take place within three years from the date the trade ceased, and the individual must have sufficient BADR lifetime allowance remaining.
It is advised to seek professional advice before any BADR relief is claimed.
Shareholders may consider it desirable to declare a dividend immediately before the strike off procedure is commenced to reduce the final distribution to £25,000 or less. However, there are anti-avoidance rules which treat any distribution made in such circumstances as part of the £25,000 cap. Whether the rules affect a proposed distribution depends on timing and, in particular, whether the distribution is declared in anticipation of a strike off.
Formal winding up
Where an insolvency practitioner deals with the winding up, distributions to shareholders are capital distributions. Although there is a cost to instructing a liquidator which is not tax deductible for the company, the tax saving for individuals associated with a capital distribution may be greater than the fee charged by the insolvency practitioner. Unlike in the case of striking off, there is no limit on the amount of the final distribution eligible for capital treatment. BADR may also be available if the same conditions detailed in Companies Act striking off situations are met.
However, a distribution made to a shareholder on a formal winding up will nevertheless be taxed as an income dividend if:
- the shareholder holds at least a 5% interest in the company before the winding up;
- the company is, or was, at any time in the two years up to the winding up, a close company;
- within two years of receiving the distribution the individual shareholder carries on a trade or activity that is similar to the trade or activity of the wound-up company; and
- it is reasonable to assume that the main purpose or one of the main purposes of the winding up is to reduce the income tax liability of the individual.
Importantly here, the last point enables genuine commercial transactions to remain outside the anti-avoidance rules. If there is an intention to start a similar trade once a company is wound up, a review of the intentions and motivations behind any winding up should be undertaken to ensure that the anti-avoidance rules will not apply.
Gateley Plc is authorised and regulated by the SRA (Solicitors' Regulation Authority). Please visit the SRA website for details of the professional conduct rules which Gateley Legal must comply with.