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Our client is a wholesale food company incorporated in 2015. It sold its customer list for £450,000 together with stock (£14,000) and fixed assets (£14,000) in May. Its activity has almost stopped since May except for final proceeds received in September.
The year-end December 2020 showed a reserve of £150,000 and no goodwill on the balance sheet. It is owned by a family of five shareholders with 20% of shares each, three of whom are directors. The parents own a warehouse jointly that the business used rent free and which they plan to sell in July 2022 to the same purchaser for an estimated gain of £230,000. The parents have annual rental income from residential properties of £13,000 each and no other income except a small salary of £8,000 and £4,000 dividend in 2021-22 and only rent income from 2022-23.
I have the following questions. First, can the final year end be extended to December 2021 to declare any dividend, salary or pension? Second, how can the reserve be extracted before winding up? (Maximum pension extract is limited due to relevant earning for pension.) Third, with estimated reserves in the final account over £600,000, would formal winding up with business asset disposal relief be a better option? Fourth, if so, can it be wound up over several years as long as it takes place within three years of cease of trade? Fifth, when is cessation of trade – is it May or September or December 2021? Sixth, can the sale of the warehouse be made over two tax years to exploit the capital gains tax annual exemption and business asset disposal relief?
Query 19,843 – Juggler.
The business sale is a cessation and ends a corporation tax period.
Juggler’s clients have the pleasant problem of how to spend their cash, Juggler has the less enviable task of making sure it’s done right because this is likely the make or break point for the family retirement plans.
The sale of the business in May is a cessation of trade and will end a corporation tax return period, the tax payment will be due nine months and a day after the sale date subject to the quarterly instalment payment (QIP) thresholds (which must be reduced pro rata for the short final trading period). It should be noted that post-cessation expenses cannot be carried back to the pre-sale period, so unless the expenses can be (and are) accrued (under normal generally accepted accounting principles (GAAP) to the profit and loss account for the pre-sale period (such as a bonus paid in respect of the sale) corporation tax relief is unlikely.
Companies House does not usually require the preparation of formal company accounts when the company will be closed down before the accounts are due for filing, so the question of whether they are run to the normal accounting period of December, extended or reduced is irrelevant.
Reserves extraction has two additional factors to consider beyond the usual: the first being the limited corporation tax relief for post-cessation expenses noted above and the second is the ability to obtain business asset disposal relief or investors' relief on dividends paid after the company is put into liquidation. The optimal tax approach will likely be some extraction by pensions, modest salary and then dividends to the higher rate threshold before entering liquidation with the rest by way of capital extraction through liquidation dividends, but it is unlikely that the tax position of all five shareholders will be the same, so some degree of compromise on the timing, amount and nature of the extractions is inevitable.
If a liquidator was appointed promptly, I would expect them to pay an interim (capital) dividend before 5 April 2022 and pay the final (capital) dividend shortly afterwards. Dragging out the liquidation by another year to try to obtain another round of annual exemptions for the shareholders would be a contrivance of little interest to the liquidator and their additional fees and the foregone use of the cash would mitigate the potential tax saving in any event.
HMRC generally accepts that an ‘associated disposal’ can take as long as three years after the disposal of the business as long as the asset continues to be used by the business (see HMRC's Capital Gains Manual at CG63998), so selling the warehouse in July 2022 should be acceptable as an associated disposal to the business sale in May 2021. Artificially delaying a stage of the sale by nine months or so to try save 10% of two annual exemptions would however incur significantly more commercial risk for minimal tax benefit. Indeed, I suspect that the extra peace of mind and earlier use of the cash would justify accelerating the sale into 2021-22 despite losing the 2022-23 annual capital gains tax exemptions if the buyer can be so persuaded. – Andy Tall.
A formal liquidation is likely to be the most suitable solution.
On extracting reserves before winding up, we must consider whether salary or pension payments would qualify for corporation tax relief. The company ceased to trade in May (because this is when it disposed of its entire trade and assets except cash) and therefore it is likely to be difficult to argue that a pension contribution or salary paid now would be to benefit the trade, particularly if there is no contractual obligation to pay them. HMRC's Business Income Manual at BIM38310 outlines this in more detail in relation to pension contributions stating: ‘Expenditure incurred for the purpose of going out of business, rather than for the purpose of carrying on the business, fails the statutory test.’
Although the question refers to relevant earnings for pension purposes, this is only a factor for personal pension contributions and not employer contributions. Therefore, it is likely that the company paying dividends instead of salary or pension contributions will be more tax efficient. This would also mean that there would be no benefit to extending the year end.
CTA 2010, s 1030A provides for distributions up to £25,000 (in total not per shareholder) to be made as a capital distribution on winding up. However, s 1030A(2) allows HMRC to consider dividends made in anticipation of winding up to be included within that limit; as such there would be a strong case for the department to argue that all dividends would be subject to income tax.
While the parents will have a significant amount of their basic rate band available to receive dividends at rates of 8.75% (with the recently announced healthcare levy) this may not be as beneficial for the other three family members who may incur higher tax rates making this route inefficient for them.
Further, to ensure only basic rate income tax is paid, the dividends would have to be paid over several tax years which (a) the other shareholders may not agree to and (b) would mean the winding up is likely to occur after July 2022 meaning no capital disposal of the shares will have been made for the purposes of the business asset disposal relief (BADR) associated disposal rules on the property.
A formal liquidation is therefore likely to be the most suitable solution for all shareholders who will each receive a capital distribution of £120,000.
TCGA 1992, s 169I(7) states that, as long as the company has been trading for at least two years up to the date of cessation of trade and the disposal is made within a three year period, BADR will be available.
Given the question refers to BADR on the disposal of the warehouse, it is assumed that the parents are directors meaning the two non-director shareholders will not qualify for BADR unless they are either employees or a company secretary.
It is also assumed that each shareholder has at least £107,700 of their total £1,000,000 lifetime allowance for BADR purposes, as well as their annual exemption of £12,300.
The warehouse has been used by the company rent free and, assuming it has also been used for business purposes throughout the period of ownership, should qualify for BADR on disposal by the parents under the associated disposal rules at TCGA 1992, s 169K(1B).
TCGA 1992, s 122 states that if a person receives a capital distribution in respect of their shares they are to be treated as if they have disposed of an interest in their shares. Further, s 169K(1C) confirms that disposals in a winding up are not prevented from being eligible disposals for the purposes of the associated disposal rules. Thus, it may be possible to split the capital distributions during winding up over several tax years and still benefit from BADR on the property (which will qualify as a result of the first cash distribution in liquidation).
It should, however, be noted that the shareholder must dispose of at least 5% of the company’s (not their own individual) shares. Thus, at least 25% of the cash must be distributed (representing 5% of each shareholder’s holding) by the liquidator before disposing of the warehouse.
Commercially, it may be difficult to split the disposal of the warehouse over two tax years to benefit from two annual exemptions and it is likely to be preferable for the liquidator to split the distribution of cash over more than one tax year instead as this will also benefit the other shareholders, ensuring that all distributions are made before May 2024 for BADR purposes.
Although the position of each shareholder would need to be considered individually, a formal liquidation is likely to provide the greatest overall tax saving, particularly given the level of gain arising on the property. – Nick Wright @ Jerroms.
The tax position of each shareholder will need to be considered separately.
Statutory accounts for the company can be prepared to any date. For corporation tax purposes an accounting period ends on cessation of trade irrespective of the date to which accounts are prepared (CTA 2009, s 10(1)(d)). If the company’s trade ends on 31 May 2021 and the accounts are prepared to 31 December 2021, then it will be necessary to file two tax returns, one for the period from 1 January to 31 May 2021 and the other for the period from 1 June to 31 December 2021.
When the company ceases to trade is a question of fact. Juggler should refer to the guidance in HMRC’s Business Income Manual at BIM80565 et seq. In particular, note that a trade may cease before trade debts are collected (see Tryka v Newall [1963] 41 TC 146 and BIM80575). In this case this may mean that the company’s trade ceased in May, but Juggler needs to confirm this. Any receipts after the cessation of trade are taxed in accordance with CTA 2009, Pt 3 ch 15, although it is possible to make an election for receipts to be taxed on the date the trade ceases.
From the shareholders’ perspective, Juggler needs to consider the position of each shareholder in turn. The query states that pension contributions are limited due to relevant earnings, but if the shareholders are directors and/or employees then a pension contribution of £40,000 each tax year can be made. It may be desirable to pay dividends if the shareholders can use their dividend allowance and basic rate band.
If the company is liquidated, business asset disposal relief should be available. It appears advisable to liquidate the company in the 2021/22 tax year before the warehouse sale takes place in 2022-23, so that the capital gains tax annual exemption can be used in both years. – ANA.
