Many family companies have been impacted by the Coronavirus pandemic with demand for their services reducing substantially. These companies may have a healthy bank balance representing accumulated profits although there may be a fear that, if the recovery is long and drawn out, these reserves will be depleted.
What would the tax position be if the company was to be liquidated now, but with the possibility of restarting the businesses using a new company at a later date, should the business climate improve?
There is likely to be an expectation from the shareholders that tax will be payable on the cash received via the liquidation at the applicable lower rate of capital gains tax, 10% or 20%, as opposed to income tax rates of up to 38.1%.
This may be achievable, but care should be taken to ensure that the anti-avoidance rules do not apply to the liquidation.
Anti-avoidance rules when capital distributions would be treated as liable to income tax
Whilst the Government has introduced a number of Coronavirus support packages for businesses, employees and the self-employed, the existing tax rules largely continue to apply. These include certain anti-avoidance rules which have the effect of treating capital distributions, in a liquidation, as income distributions chargeable to income tax.
As the company in this example is in a position where it can pay its shareholders dividends out of company reserves, and hence the shareholders pay income tax on those dividends, HMRC will need to be convinced there is a genuine reason why the company needed to be liquidated only to restart again later. HMRC’s views on whether the anti-avoidance rules apply may be swayed by genuine difficulties created by Coronavirus, but each case will be dependent on its own facts and no guidance has been issued on this point.
If HMRC was to successfully argue that the anti-avoidance legislation did apply, then they could treat all of the proceeds of the liquidation as income tax, giving rise to significantly higher tax liabilities. For example, a liquidation of a company with reserves of £500,000 would give rise to a capital gains tax liability of £50,000 (assuming Entrepreneurs’ Relief was available), but if this was charged to income tax, the liability would be nearer £190,000.
Importance of a statutory clearance application
We would recommend that any company seeking a voluntary liquidation submit a statutory clearance application to HMRC. It is important that a full disclosure of all relevant facts is made, as any change of facts, compared with those disclosed may result in the clearance being withdrawn.
The other anti-avoidance rule that should be considered is the so-called “anti-phoenixing” rule. Broadly, if a company is liquidated and the business is then restarted within 2 years of receiving a liquidation distribution, HMRC are able to consider whether the main purpose, or one of the main purposes of the liquidation, was to avoid or reduce a charge to income tax. Again, this could mean that the proceeds of the liquidation would be subject to income tax and not capital gains tax, giving rise to significantly higher tax liabilities.
Aside from the tax considerations, businesses thinking of taking these steps should make sure that they have carefully evaluated how liquidating the company (even with the intention to start to trade under a new company at a later date), could impact on other aspects of their business, such as Intellectual Property held by the current company and other contractual rights and obligations with stakeholders, such as employees, customers, suppliers and landlords.
Additional advice and assistance
If you are considering liquidating your company, please do contact us to discuss the options and where applicable we can assist with the drafting of HMRC clearances and related matters: firstname.lastname@example.org.