What Are The Tax Implications of Closing Your Limited Company?
Are you planning to close down your limited company? Maybe you want to go back to your full-time job or you simply want to retire. If you want to close down your limited company because it is not trading anymore, then you might need to pay Capital Gains Tax or Income Tax. However, this will only be done if you have already gained some profit on the prior cost of the shares you want to dispose of.
The Income Tax and Capital Gains Tax that you will be paying will depend on how you close your business as well as the amount of profit that remained inside the business.
What Are The Options Available To The Shareholders And Directors?
Generally, directors and shareholders have two options when it comes to closing down their limited company. Provided that the company is still capable of paying any debts, they can either choose Member’s Voluntary Liquidation (MVL) or Informal Strike-Off. Here, we will be discussing these two options as well as the details of their tax implications.
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Close Your Company Down With An Informal Strike-Off
An informal liquidation is the simplest way of closing down your company. All you have to do is inform the Companies House that you want to strike off your company from their list. This can be accomplished by filling out the form “DS01” then submit this to Companies House. However, companies are not allowed to make an application for voluntary strike-off if, during the last three months, the company has carried on with the business or has done some trading or perhaps changed its name.
HMRC understands that even if you are thinking of a voluntary strike-off within the three-month period, there are still some activities that the business must undertake. Some samples of activities that the business can do during the three-month period include disposing of assets with the objective of disposal just like the normal way of trading or carrying on with the business, accomplishing any statutory requirement, resolving the concerns of the company, such as paying business or trading debts, applying for strike-off, paying the fee for the strike-off application, or seeking professional advice on the strike-off application.
In other words, a company who is selling apples must not continue selling apples within the three-month period. Nevertheless, they could sell the truck that was used for delivering the apples or perhaps the warehouse where they kept the apples.
A company is not allowed to apply for a strike-off in case it is a proposed subject or the subject of section 895 scheme wherein an arrangement or a compromise is created between the company and its members or creditors. Or perhaps there is a liquidation proceeding wherein the petition has been introduced but has not yet been handled with. Take note that any business who violates these restrictions could be fined.
What Tax Do I Pay With An Informal Strike-Off?
In case your company obtained retained profits of more than £25,000, then all shareholders are required to pay income tax on the profits that they have gained based on their personal rate. However, if the retained profits that you have gained is more than this figure, then you should seek some advice from your accountant in order to find the most tax-efficient way of lessening your retained profits to £25,000.
Typically, these retained profits are shared as a final dividend, hence, the tax rates that will be used to a strike-off could either be 7.5%, 32.5% or 38.1%. This will be based on the marginal rate of personal tax.
Most often, this option is not generally recommended since the whole amount including the £25,000 will be taxed as a dividend. It will not matter what your marginal rate is, it is much better if you can bring down your retained profits to £25,000 and consider this as a capital distribution upon closing down your company and pay a tax amounting to £1,270.
This amount was computed by deducting £12,300 capital gains allowance for 2020/21 from the £25,000 profits. The remaining amount was £12,700 and this will be taxed at 10% Entrepreneurs Relief when applicable.
In case some of the retained profits are spent on the salary of the director, instead of a dividend, then the tax amount that will be paid will depend on the director’s personal rate, most often this is higher compared to the dividend tax rate.
In case the profits are lower than £25,000, then all shareholders are required to pay Capital Gains Tax. In the event that the company is selling its shares, then the normal rate of Capital Gains Tax is set at 10% for a basic rate taxpayer, however, for those who are paying more than the basic rate of income tax, the rate is 20%.
On the other hand, if you are qualified to apply for Entrepreneurs’ Relief then you only need to pay a tax rate of 10% on the disposal without considering the rate of your personal tax.
In case your company fails to meet these conditions, or unable to pay its debts, then you are not legible to apply for a voluntary strike-off and you may be required to liquidate your company.
Closing Your Company Using A Members’ Voluntary Liquidation (MVL)
The Members’ Voluntary Liquidation (MVL) is a method that is used for closing down a solvent company. The assets of the company will be converted into cash, afterwards, it will be shared with the shareholders. An MVL should only be done by a licensed insolvency practitioner.
When using an MVL, all the distributions that will be given to the shareholders will be taxed as a capital gain. In case you are not capable of using the informal strike-off method which we discussed above or you have a large amount of retained profits, this is generally the most tax-efficient choice after you have considered the Entrepreneurs’ Relief. If you need some advice on your personal situation, then you should talk to an accountant.
Nevertheless, you also need to consider that the distributions from a company which resulted from voluntary liquidation might be subject to income tax based on certain circumstances. For instance, the winding-up of the company is done in order to lessen tax. Or within the period of two years after the owner received a distribution, he is engaged with the same trade or activity. Or when the company is considered as a “Close Company” wherein its shareholders are only five or less.
Which One To Choose – An Informal Strike-Off Or A Members’ Voluntary Liquidation?
Before making a decision on which option to take, it is important that you have to seek expert advice. It is important that your advisor must take into account your personal tax situation as well as the amount of profit that will be distributed to your shareholders.
Here, we will provide you with a sample to help you in choosing which option is best for you.
For instance, a single shareholder who is also the director of his company wants to close down his business on April 30, 2020. Assuming that his retained profits are £90,000, then the informal strike-off will try to lessen it to £25,000 by distributing £65,000 as dividends.
In the 2020/21 tax year to date, no dividend has been distributed. Its director has not taken any salary. Also, there are PAYE earnings of £60,000 from the director obtained from other employment, hence the dividend tax must be paid at the higher rate of 32.5%.
Furthermore, in the 2020/21 tax year, the director did not obtain any other income. During that year, the director has not obtained any sales from his personal assets and has never utilised any capital gain allowances as well. For the 2020/21 tax year, £2,000 is used as the dividend tax-free allowance.
Informal Strike-Off Vs MVL
For the Informal Strike-Off, a dividend of £65,000 from the company will be deducted from its retained earnings of £90,000, hence the amount left will be £25,000. This amount will be deducted by the Individual capital allowance in 2020/21 tax year which is £12,300, also considered as the annual capital exemption. So, the amount of Capital Gain will be £12,700. 10% Entrepreneurs Relief or Capital Gains Tax in 2020/21 tax year is equivalent to £1,270. The Dividend Tax Payable is set at 32.5% which is equivalent to £20,475. £65,000 dividend is deducted by £2,000, which is the tax-free dividend allowance, the result is £63,000 multiplied by 32.5%, the result is £20,475. Hence, the total tax and fees for the Informal Strike-Off will be £21,745 which is the sum of £1,270 + £20,475.
When it comes to MVL, an amount of dividend worth £2,000 will be deducted from the retained earnings of £90,000. There is no other dividend issued aside from £2,000, which is the tax-free dividend allowance. Hence, the retained earnings after dividend will be £88,000. The same annual capital exemption will be used which is £12,300. This is the Individual capital allowance in 2020/21 tax year. So, the Amount of Capital Gain will be £75,700. Using the Entrepreneurs Relief rate of 10%, the amount of Capital Gains Tax payable will be £7,570. There is no Dividend Tax Payable for this method, however, there will be an MVL advisor fee which is estimated at £2,500. Therefore, the total tax and fees for the MVL will be £10,0707, which is the total of £7,570 + £2,500.