Liquidating a company – Is it a capital gain?

One of the anti-avoidance measures introduced by the latest Finance Act changes the way that certain payments to shareholders will be taxed. This may result in payments following some company liquidations being taxed as dividends instead of capital gains.

The Government is concerned that the new higher rates of income tax that have applied to dividends since 6 April 2016 may tempt some shareholders/directors to extract value built up within their companies in a capital form, rather than paying out the retained profits as dividends. This is because capital gains are generally taxed at a lower rate than income, possibly as low as 10% where Entrepreneurs’ Relief is available.

For example, a shareholder who pays higher rate tax receiving £100,000 on the liquidation of his company would pay income tax of £32,500 (32.5%) if the anti-avoidance applies, whereas Capital Gains Tax would be just £10,000 (10%) if Entrepreneurs’ Relief is available. Consequently, new stricter rules now apply to transactions dated on or after 6 April 2016.

When is a liquidation taxed as income?

For the new anti-avoidance rules to apply the company being wound up must firstly be a close company and the individual must have held at least a 5% interest in the company (ordinary share capital and voting rights).

A further condition is that the individual (or connected person) continues to carry on the same or a similar trade or activity to that carried on by the wound-up company within the two years following the distribution.

It must also be reasonable to assume having regard to all of the circumstances, that the arrangements appear to have a tax advantage as one of the main purposes.

Can we obtain advance clearance prior to the liquidation?

Accountants and tax advisers requested that the new anti-avoidance rules should provide a formal clearance procedure prior to the transaction, thus providing certainty as to whether or not the payment would be taxed as income or capital. Unfortunately, there is no formal clearance procedure. Nonetheless HMRC have received a number of clearance requests from taxpayers. Their standard reply states that it is not their general practice to offer tax clearance on recently introduced legislation. However their letter includes a small number of examples along with their view of the correct tax treatment of each transaction. In the meantime we understand that they are working on more detailed guidance, which should be published before the end of this year.

This is a very complex area and we suggest that you contact us before you consider liquidating your company. We have a wealth of experience of advising businesses on liquidations. You can contact Angie Harvey on 0131 317 7377 who will ensure you are put in touch with an appropriate member of staff.