When a business closes, the final monies can be distributed as either an income distribution (a normal dividend) or a capital distribution. The distinction is very important - an income distribution will attract a further 33.75% burden for higher rate tax payers and 8.75% for basic rate tax payers.
If the distribution can be treated as capital, and if the individual has made no capital disposals in the same tax year, they can use their annual Capital Gains tax allowance (currently £3,000) to obtain the first £3,000 of distribution tax free. The balance of the distribution is taxed at 10% or 20% (higher rate taxpayer) or, if the gain qualifies for Business Disposal Relief the balance is taxed at just 10%.
Significant tax savings can be made by having the distribution treated as capital, however a capital distribution can only occur if the company is liquidated.
There is an exemption if reserves are less than £25,000 - no formal liquidation is then required. Care must be taken here however because HMRC can review any dividends that are paid in the last year of operation, and to the extent that they have reduced the final distribution to below the £25,000 limit, the balance may not then qualify as a capital distribution.
One way to guarantee capital status is to do a formal Members’ Voluntary Liquidation (MVL) of the company and thereby extract the whole amount as capital. MVL’s have become increasingly popular but they are costly given the amount of work involved in the process. An MVL costs between £2,000 - £2,500 in professional fees.
Important Note 1 - MVL rules state that where a distribution is made from a company, and within a period of two years after the distribution, the person receiving the distribution carries on a similar trade or activity, either through a company, as a sole trader or in partnership, then the distribution will be treated as income rather than capital. This also applies where the person receiving the distribution is involved with the carrying on of such a trade or activity with a connected person.
Important Note 2 – Changes announced in the Spring Budget 2020 now limit the lifetime allowance of Business Disposal Relief to £1 million of capital gains.
Summary
It is important for freelance contractors to take professional advice before they choose to close down their limited companies. The Champion business is perfectly positioned to help guide contractors through all of the options available to them and will fully outline potential tax liabilities and financial benefits.
Contact Us
For more information and advice simply request a call back or contact one of our advisors on 0161 703 2549. Alternatively please email us on info@championcontractors.co.uk.
Disclaimer: Please note, rules surrounding company closures are complicated and the correct course of any action will be dependent on the personal/bespoke needs of each individual. The above information does not constitute professional advice, only general information.