10 April 2020 - Article
Many companies, which have ceased business and paid off all their creditors, wish to avoid the expense of appointing a licensed insolvency practitioner as a liquidator and going through a formal winding up procedure to distribute surplus funds to the shareholders. It is common practice to take advantage of the informal dissolution procedure set out in s1003 Companies Act 2006. A company following this procedure simply distributes its remaining assets to its shareholders and then applies to the Registrar of Companies to be dissolved.
Existing tax position
Sums distributed to shareholders on a formal liquidation are treated as capital payments and so, where received by individuals or trustees, would fall within the scope of capital gains tax. Any other distribution is treated as income in the hands of individual or trustee shareholders. Given the difference in rates between capital gains tax (a maximum of 28%) and income tax (a maximum effective rate of 36.1% in relation to company distributions) and the greater range of reliefs available against capital gains, capital treatment is generally preferable.
HMRC has long recognised that unfairness can result from a strict application of the legislation. For this reason, there is an HMRC ‘extra statutory concession’ (‘ESC C16’), which HMRC follows in order to permit most distributions in the context of an informal dissolution to be treated as if they were made under a formal winding up.
Proposed tax change
HMRC is currently undergoing a process of incorporating their extra statutory concessions into the applicable legislation itself. On 13 December 2010 it published a consultation document which included a proposal to amend the legislation governing distributions in respect of share capital prior to the dissolution of a company in order to give effect to ESC C16. However, the proposed draft legislation includes an additional condition that must be satisfied before capital treatment applies. The additional condition is that the total amount distributed to shareholders must not exceed £4,000.
If the legislation is amended as set out in the consultation document, there will be many instances of simple, privately held companies that wish to be wound up informally but which will now need to be subject to a formal liquidation in order to ensure capital treatment for their shareholders.
The £4,000 figure has been chosen by HMRC because it regards this as being broadly equivalent to the cost of winding up a small company (ie recognising that it is uneconomic to engage a liquidator if his fees would equal or exceed the sum to be distributed). This view is consistent with that taken by the Treasury Solicitor. In many cases, sums distributed to shareholders on an informal dissolution do not comply with the strict Companies Act requirements for making dividends or other distribution. Any amount unlawfully distributed technically belongs to the Crown. It is the Treasury Solicitor who acts on behalf of the Crown to recover these sums but it has made clear that it will not pursue distributions of less than £4,000.
Whilst the HMRC and Treasury Solicitor positions may appear consistent, changes introduced by Companies Act 2006 now enable companies to distribute to their shareholders sums which it would previously have been unlawful for them to distribute (unless on a formal winding up or a court approved reduction in capital), such as amounts standing to the credit of a company’s share capital or share premium account. So, in practice, companies have been able to avoid formal liquidations even if the sums to be distributed exceed £4,000. The proposed changes to the tax treatment of these distributions may now make this uneconomic. We have written to HMRC to ask them to reconsider the £4,000 ceiling on distributions.