- Wednesday, 12 March 2014 08:44
- Written by Andy Vessey
Planning for CGT mitigation when the company closes down
For the vast majority of contractors, their companies will have a limited shelf life, ie equivalent to the length of time they spend contracting through a PSC. There will be very few that will be carried on by the children or some other relative. So when the company has served its purpose and the time comes to dispense with it, it is important to ensure that final taxes are mitigated as far as possible within the acceptable parameters of tax planning.
It is likely that upon winding up their company there will be final assets to be distributed, mainly cash. In the normal course of trading, company profits are likely to be extracted by way of salary or dividends.
When the company is dissolved there are three options available to the contractor as to the manner in which they may claim the final fruits of their labour:
- Dividends subject to income tax.
- Disposal of shares subject to capital gains tax (CGT).
- A combination of (1) and (2).
As long as the contractor is not liable to higher rate tax on the final dividend income then the issue is straightforward. For the current tax year, total taxable income (including the dividend) would have to fall below £41,450 (basic rate band £32,010 + £9,440 personal allowance). For 2014/15 this only slightly increases to £41,865 (basic rate band £31,865 + £10,000 personal allowance). Where this is the case then no additional tax arises on the dividend.
The effective higher rate tax on dividends is 22.5% (32.5% less 10% tax credit) where taxable income falls between £32,010 - £150,000 and 32.5% (42.5% less 10% tax credit) where taxable income exceeds £150,000.
Where final distributions are no greater than £25,000 then this can be done as part of an informal winding up. For distributions in excess of £25,000 however a contractor will have to go down the route of a formal winding up if they want to secure capital gains treatment.
Not only can a contractor make use of an annual exemption (a tax free amount) of £10,900 but any remaining gain can be taxed at the rate of 10% where the share disposal qualifies for Entrepreneurs Relief, rather than the normal 18% or 28%
Entrepreneurs Relief is available on gains of up to £10 million and operates as a lifetime limit.
There are broadly three types of disposal that qualifies for Entrepreneurs Relief but the one that will mainly be applicable to contractors is a 'material disposal of business assets' which will be the shares held in their company. To qualify as 'material' however, throughout the year ending with the disposal:
- the company must be the individual's personal company;
- the company must be a trading company; and
- the individual must be an officer or employee of the company.
For a company to be a personal company an individual must hold more than 5% of the ordinary share capital and voting rights in the company. It is not possible to aggregate shareholdings of connected parties, e.g. husband and wife.
Whilst a company must be a trading company it can be involved with activities that are non-trading activities provided these are not substantial so as to affect the trading status of the company. Substantial in this context means more than 20% and HMRC use a number of indicators to evaluate this. One of those indicators is the asset base of the company. If the value of a company's non-trading assets is substantial in comparison with its total assets then this could point towards it not being a trading company.
So how would this affect a company that carries excess cash balances? HMRC usually accept that cash arising out of trading activities should not prejudice a company's trading status. To be considered a non-trading or investment activity the cash would have to be managed. However where cash is not required by the company for its current or future needs consideration may need to be given as to whether it should be extracted if the winding up of the company is on the horizon, so as not to scupper entitlement to Entrepreneurs Relief.Comments