Proper planning is essential to ensure you close your limited company in the most tax efficient way. We outline two main options below.
Important
A Targeted Anti Avoidance Rule (TAAR) was published in the Finance Act 2016 in order to prevent people from opening and closing a company to gain a tax advantage.
In order to combat phoenixing, a distribution from a winding-up will be taxed as if it were an income distribution, where the following four conditions are met:
- the company is a close company
- the individual holds are least a 5% share
- upon receiving a distribution, he continues to be involved directly or indirectly, with the carrying on of the same or a similar trade or activity to that of the wound up company, and
- the main purpose, or one of the main purposes, of the arrangements as a whole is to obtain a tax advantage
Brief Background
Clients who earn more than approximately £250-£300 per day for a full tax year often find when they come to close their company down there are retained earnings held in their ltd company bank account. This arises when they choose to keep their gross personal earnings below the basic rate limit of £50,270 (£12,570 + £37,700) each personal tax year – and so instead of paying out the maximum permissible amount from their company, they cap their earnings at the basic rate limit, allowing excess funds to be retained in their company bank account.
Option 1 – Dividend Payment
Once the company has paid all its creditors (usually only Corporation Tax/VAT), any remaining funds are paid out as a normal dividend payment. So long as the clients gross personal earnings for the current tax year does not exceed the basic rate limit, this is by far the best and easiest option.
This usually works if the client is closing down their company and leaving the UK, or else if the retained earnings is small. Note the basic rate limit is not reduced on a pro rata basis from the date of leaving the UK, so if you leave the UK at the end of November for example, you still have the entire tax year basic rate limit of £50,270 available to you.
Note that dividend payments you make to yourself once winding up proceedings have commenced will be taxed as a capital gain – please see below.
Option 2 – Capital Distribution
If your earnings for the current tax year will exceed the basic rate limit by an unacceptable amount (in terms of dividend top-up tax you will have to pay), then being taxed under the capital gains regime is a very tax efficient way of extracting any retained earnings from your company. The final distribution is taxed as a capital gain, rather than a normal dividend. There are a few points to note here;
- Up to a maximum of £25,000 paid after your company has commenced winding up proceedings (Closing accounts submitted and DS01 received by Companies House) will be taxed as a capital gain;
- The remainder of any dividends will have to be paid before the closing accounts are drawn up, and will be taxed as normal dividends;
- If you have more than approximately £36,000 in retained earnings and are eligible for entrepreneurs relief (see below), it will be more tax efficient for you to go through a formal company liquidation (called a Members Voluntary Liquidation – MVL). While this comes at a cost, it means the entire amount of retained earnings you have will be taxed as a capital gain, and if you have traded through your business for more than two years, this can generate a significant tax saving;
Business Asset Disposal Relief
Using BAD relief, any capital gain extracted from your company is treated in a very tax efficient way. To be eligible, broadly speaking you must have traded through your company for more than two years, whilst also being a Director, and at least a 5% Shareholder.
If you are not eligible and have a significant sum of retained earnings in your business, then any capital gains you extract may be taxed at a higher rate than dividends (Option 1 above). If this applies to you speak to your account manager to discuss the most tax efficient routes available to you.
Example:
Jen is a lawyer with her own limited company, Jen the Lawyer Limited. After contracting for 30 months she decides to take a permanent position in the UK. She has £20,000 in retained earnings in her company bank account, and her personal earnings for the current tax year sits at the basic rate limit (so Option 1 above will not work for her).
- Retained earnings: £20,000
- Maximum dividends of £1,000 already taken
- Tax band for Jen’s personal earnings in her permanent role: 40%
- £25,000 of distributions paid after winding up proceedings have commenced, are automatically taxed as a capital gain;
- So the final payment of £20,000 is taxed as a capital gain;
- Capital gains annual exempt amount 2023/24: £6,000
- Actual capital distribution subject to capital gains: £20,000 – £6,000 =14,000
- Capital gains tax at 10%: £14,000 x 10% = £1,400
- Overall tax on £20,000 payment: 1,400 / 20,000 = 7%
IMPORTANT
You need to be careful about taking any funds from your business bank account when approaching your end of trading. It may not be beneficial to have final payments taxed as a capital gain – please speak with your account manager about this.
Useful tip:
Get in touch with your bank, and get your daily transfer limit increased, this will be very handy when you need to pay your final Corporation Tax, and final distribution to the shareholders.
If you expect to have more than £36,000 in retained earnings, please let us know and we can help advise you on the Members Voluntary Liquidation route.