Capital distribution refers to the situation where a solvent company is closed and there are more assets than liabilities. Once any company debts have been paid and assets turned into capital (cash) the capital then gets distributed to shareholders.
There are potentially significant tax differences between voluntarily liquidating your company (the formal liquidation process) and dissolving your company (which is cheaper and faster to do).
There are often pros and cons in deciding how best to proceed weighing up the different potential methods of closing a solvent limited company weighed up against the tax position on the distribution of assets. We are highly experienced in advising companies on the best option in their circumstances. Please do call, email or use the live chat to find out how we can help you.
- What is a Capital Distribution From a Company?
- What are the Options Available to Shareholders and Directors who Want to Close a Company?
- How is a Capital Distribution Taxed?
- What Tax Benefits Could I see from Members Voluntary Liquidation?
- Can you get Entrepreneurs’ Relief on Liquidation?
- Are you Eligible for Entrepreneurs’ Relief?
- How Quickly are Shareholders Paid in a Members’ Voluntary Liquidation?
- Wind up Your Company in a Tax-Efficient way
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 company 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
What Tax Benefits Could I see from Members Voluntary Liquidation?
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 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.