Although it is seldom the most tax efficient way to dispose of a company, this route is often forced on the vendor because the purchaser refuses to buy the shares instead, for the reasons already explained earlier in this section.
Once the assets of the business have been sold by the company, and it has paid the resulting corporation tax on its gains, we are left with what is sometimes known as a “cash-box” company – that is, a company whose only asset is a large bank balance. Unless the company plans to use this cash to start a new business venture, of course, the question is how to get the cash out.
What happens next?
If the company pays the cash out to its shareholders as a dividend, they will suffer income tax at 25% on that dividend (assuming they are higher rate taxpayers).
The alternative is to wind up the company and distribute its assets to its members.
This will be treated as a disposal of their shares for CGT purposes, and so they will pay CGT based on the cost of their shares, and how long they have owned them.
GOLDEN RULE: Do not assume that liquidation will always be better than a dividend.
Consider the following case study:
Propco Ltd is a property investment company, set up two years ago by Steve, who is the sole shareholder. His 100 shares cost him £100. He pays income tax at 40% as he has a well paid job. He is married to Jane, who has no income.
After selling all its properties and paying all its tax, Propco is left with £700,000 in the bank, and no other assets or liabilities. Steve and Jane decide to get the cash out of the company.
Assuming in either case that Steve gives half his shares to Jane before anything else is done, we need to compare the tax effect of the company paying a dividend of £350,000 to each of them, or of liquidating the company and paying CGT on a gain of £350,000 each.
Looking at a dividend first, then at liquidation:
It would have been all too easy to rush into a liquidation that would have cost them nearly £100,000 in tax. Notice also that the saving does not entirely depend on using Jane’s lower rates and exemptions – Steve, who pays higher rate tax on all his gains and income, saves £48,980 by taking a dividend.
Essentially, it all depends on the rate of CGT that the shareholders will pay on their gains if the company is liquidated.
In some cases, a combination of a dividend first, and then a liquidation, will produce the best result.
There are two ways a company can be liquidated – the formal and the informal way.
A formal liquidation must be done by a specialised accountant called a “licensed insolvency practitioner”.
It tends to be expensive (not least because in some circumstances a licensed insolvency practitioner can become personally liable to the company’s creditors if he gets things wrong!), but it is sometimes necessary due to the nature of the company’s business – ask your accountant to advise you.
This form of liquidation is also known as “striking-off”, or “an ESC C16”. This is by far the commonest form of liquidation, and it goes like this:
· The company pays all its debts and collects everything owed to it.
· It then approaches the inspector of taxes and asks him to confirm that Extra Statutory Concession C 16 will apply – without this assurance, when the company pays out its cash, this would be treated as a dividend for tax purposes, but under ESC C16 HMRC agree to treat it as giving rise to a capital gain as with a formal liquidation.
· Having got the inspector’s confirmation that ESC C16 will be applied, the company pays out all its cash to its shareholders (it is also possible for the company to transfer any assets it may have such as a property, though this is a little more complicated to arrange). The shareholders are treated as if they had sold their shares for the amount of cash or other assets they receive.
· Finally, the company applies to the Registrar of Companies to be “struck off” the Register of Companies. Once the Registrar has done this the company is dead – though, like Dracula, it can sometimes be revived if unforseen liabilities appear.