In this guide, we’ll explain what the capital distribution on winding up a company is, how it is taxed and how Entrepreneurs’ Relief can be used to reduce the tax payable on a disposal of qualifying business assets.
What is a Capital Distribution From a Company?
A capital distribution from a company is any money that’s paid from the company to its shareholders that is subject to capital gains tax and is not treated as income for income tax purposes.
The majority of distributions made by a company are in the form of income distributions, such as dividend payments, and will be subject to income tax. However, when winding up a limited company, it is possible to close it in such a way that the retained profits and any funds raised from the sale of company assets are paid as a capital distribution.
What are the Options Available to Shareholders and Directors who Want to Close a Company?
Generally speaking, there are two options available to company directors and shareholders who want to close a solvent (i.e. it can pay any outstanding debts) limited company. They can either opt for an informal strike-off (also known as a company dissolution) or they can use a member’s voluntary liquidation (MVL). One of the main differences between these two procedures is how the distributions from the company are taxed.
How is a Capital Distribution Taxed?
- Informal strike-off
In the case of an informal strike-off, the maximum value of share capital and company assets that can be distributed as capital on strike-off is £25,000. Any profits over that amount will be subject to income tax. All shareholders will have to pay income tax on the distributions they receive at their personal income tax rate.
Any retained profits above £25,000 are usually distributed among the company’s shareholders in the form of a final dividend. The tax rates that apply to those dividends are 7.5 percent, 32.5 percent or 38.1 percent, depending on each shareholder’s personal rate of income tax.
When striking off a limited company with profits below £25,000, all the shareholders pay capital gains tax at either 10 percent for basic rate income tax payers or 20 percent for higher rate income tax payers. However, if you’re eligible for Entrepreneurs’ Relief, you will pay a capital gains tax of 10 percent regardless of the income tax you pay. We’ll discuss that in more detail later on.
- Members’ voluntary liquidation (MVL)
A members’ voluntary liquidation is a formal procedure governed by the Insolvency Act 1986 to close down a solvent company. Before the company is closed, its physical assets will be valued, sold and turned into cash by a licensed insolvency practitioner. That cash will then be distributed among the company’s shareholders.
If you want to close a limited company with share capital and company assets that exceed £25,000, a members’ voluntary liquidation is likely to be more tax-efficient if you’re a higher rate income tax payer. With an MVL, all distributions to shareholders are subject to capital gains tax, which is likely to make this best option if there are high levels of retained profits in the company. Entrepreneurs’ Relief is also available to eligible shareholders in an MVL.
That said, it is worth factoring in the upfront costs of an MVL, which for a small or medium-sized company with cash in the bank but no physical assets to realise, will start at around £2,000 plus VAT. There are also some circumstances where the distributions from a company undergoing a members’ voluntary liquidation may be subject to income tax. That includes:
- If a shareholder/director who receives a distribution is involved in a similar trade or activity within two years
- The main intention of the MVL was to obtain a tax advantage rather than a genuine desire to close the company
How Much tax will I pay if I Liquidate my Company?
The following simplified example is based on a sole director and shareholder of a company with retained profits of £100,000 and a salary of £25,000
|CAPITAL DISTRIBUTION VIA AN MVL||DIVIDEND DISTRIBUTION VIA AN INFORMAL STRIKE-OFF|
|Net Proceeds After Tax||£88,800||£69,125|
|Possible Saving||£19,675 via an MVL|
Can you get Entrepreneurs’ Relief on Liquidation?
Entrepreneurs’ Relief allows qualifying shareholders to pay capital gains tax at a reduced rate of 10 percent, rather than 20 percent, on the gains of all qualifying assets that are sold via a members’ voluntary liquidation. Entrepreneurs’ Relief is also available on a capital distribution following the strike-off procedure on retained profits up to a maximum of £25,000.
Are you Eligible for Entrepreneurs’ Relief?
You must meet at least one of the following criteria to qualify for Entrepreneurs’ Relief:
- You possess at least 5 percent of the shares, securities or voting rights in the company that’s being wound up. You will also be eligible if you have had the chance to buy 5 percent of the shares at least one year before the company’s closure, as long as you have been an employee for at least one year and the company focuses on trading (e.g. rather than investment).
- You are disposing of all or part of the business as a sole trader or a business trader. However, you must have owned the business for more than one year before you sell it and the assets must be sold within three years.
- You lent an asset to the business that is being closed. This only applies if the asset was used for a year before the business was closed or you have already sold at least 5 percent of your stake in the business.
There’s no limit to the number of businesses you can sell or close during your career under the scheme. However, there is a lifetime limit on capital gains which is set at £1million, after which point, Entrepreneurs’ Relief will not be available.
How do you Calculate Entrepreneurs’ Relief?
As we have discussed, Entrepreneurs’ Relief works by reducing the capital gains tax payable on the profits gained when disposing of company assets. To calculate the Entrepreneurs’ Relief on a capital distribution, simply:
- Calculate your taxable gain by adding together your capital gains minus any losses (such as the cost of the MVL)
- Subtract your tax-free capital gains allowance (£12,300 for individuals in 2020/21)
- You’ll pay capital gains tax of 10 percent on the remaining figure – and the rest is yours to keep
How to Claim Entrepreneurs’ Relief on Liquidation
Entrepreneurs’ Relief is commonly claimed when completing your self-assessment tax return. However, you can also submit a claim by submitting Section A of the Entrepreneurs’ Relief Help Sheet here or by submitting a claim in writing to HMRC.
The deadline for claiming Entrepreneurs’ relief is the 31st January of the year following the tax year when the disposal was made.
How to Commence a Members’ Voluntary Liquidation
If you want to wind up a limited company and benefit from the reduced tax payable on a capital distribution, you will require the assistance of a licensed insolvency practitioner. The process is as follows:
- Signing the Declaration of Solvency
Company directors will be required to sign a sworn ‘declaration of solvency’ to confirm that the company can settle all of its liabilities in full within 12 months. A general meeting of shareholders will be held and, if 75 percent of shareholders agree to the MVL, the insolvency practitioner will take control of the company’s affairs.
- The liquidation process begins
The insolvency practitioner will notify Companies House and HMRC of the liquidation and submit the relevant documents. The MVL will be advertised in the Gazette and any outstanding creditors will be invited to make claims for the monies that are owed.
- Capital distributions are made
Any physical assets the company owns will be valued and sold by the liquidator. Once HMRC has confirmed that there are no outstanding liabilities and all other creditors have been paid, the company’s cash in the bank and the funds raised through the sale of assets will be distributed among the company’s shareholders according to their shareholding. The company will be dissolved and removed from the Companies House register after three months.
How Quickly are Shareholders Paid in a Members’ Voluntary Liquidation?
In simple cases where there are no outstanding liabilities, the liquidation can be completed and the company dissolved within six months. However, it’s not unusual for a capital distribution to be made to shareholders before this time.
This will be done using a signed indemnity, which provides protection if creditor claims are made after the distributions have been paid. The result is that the majority of the funds can be paid to the shareholders very quickly. A small amount will be held back until the company has been officially closed to cover the cost of disbursements and the liquidator’s fee. Any remaining funds will then be distributed among the shareholders.
Wind up Your Company in a Tax-Efficient way
If you are considering closing your solvent company via a members’ voluntary liquidation or want advice on the most suitable way to wind up your business, we can help. Just get in touch for free, confidential advice from a licensed insolvency practitioner.