Introduction
Recent tax rate changes have reduced the fiscal attraction of the small company. This has led some companies to consider disincorporation.
Disincorporation means transferring the company's trade and assets to the shareholder(s), who carry on the successor business as a sole trader or partnership, and winding up the company.
This is a brief guide to the mechanics of disincorporation.
Professional advice should always be taken based on specific circumstances.
10 Key Points
1. Legalities
Disincorporation may be effected by either a members' voluntary liquidation, or by simple dissolution.
Members' voluntary liquidation
This is the winding up of a solvent company, controlled by its members. For a disincorporation, the process includes the transfer of the business and assets to the new unincorporated business, owned by the shareholder(s). The directors must make a statutory declaration of solvency. This is followed by a members' resolution to wind up the company. The members must appoint a liquidator and the directors' powers cease on this date. The liquidator winds up the company. Winding up is the process of realising a company's assets to settle any debts. Any surplus is distributed to those entitled to it, i.e., creditors and shareholder(s). Then the company is dissolved and struck off the Register of Companies.
Dissolution under Companies Act 2006 s 1000
A solvent company can save the costs of a formal winding up. For a disincorporation, the company first transfers its trade and assets to an unincorporated business. Any minority shareholder or creditor who feels that this is prejudicial to their interests may challenge the transfer. The company may either settle liabilities or, subject to agreement from the creditors, may assign them to the successor business. The company then requests to be struck off under CA 2006 s 1003.
Technically a company may not distribute its share capital unless under a winding up. However, the Bona Vacantia guidance states the Treasury will not seek to collect any technically illegal distribution of less than £4,000 from the shareholders. Also, from 1 October 2008, CA 2006 allows private companies to reduce share capital by repaying it to shareholders.
2. Lack of tax reliefs
Despite continuity of ownership, disincorporation does not attract tax reliefs to mirror those available on incorporation. For example:
the company's accumulated trading losses cannot be transferred to the shareholder(s)
the company's assets must be transferred to the shareholder(s) to use in their unincorporated business; the company's disposal is at open market value for Capital Gains Tax (CGT)
any capital gain resulting may only be reduced by current, and not brought forward trading losses
any capital loss resulting may only be used against current accounting period gains; the shareholder(s) will also have acquired the asset at a reduced CGT base cost.
3. Cessation of trade
The company's trade is deemed to cease on transfer to the unincorporated business (CTA 2009 s 41). This causes one accounting period to end, and a new one to commence (CTA 2009 s 10(1)).
Unused trading losses cannot be carried forward beyond the deemed cessation of trade (ICTA 1988 s 393(1)). As they cannot be transferred to the new unincorporated business, they are lost. A current year trading loss in the accounting period to deemed cessation could be offset against other corporation tax profits, including chargeable gains, of the current and preceding 3 years (ICTA 1988 s 393A(1)).
The company's assets must be transferred into the shareholder's name. This requires the assets to be valued, and the shareholder(s) to pay for them. Assets may include property, goodwill, stock, and plant and machinery. The tax consequences for each are considered in the next few paragraphs.
4. Chargeable gains
Transfers of property may create substantial chargeable gains, on which the company will be chargeable to Corporation Tax. For CGT purposes, the transfer is deemed to be at market value (TCGA 1992 s17). No chargeable gain arises if the property is already owned by the shareholder(s). For a property owned by the company, SDLT could be avoided by distributing the property to the shareholder(s) in specie during winding up. However this would delay the company's chargeable gain from the accounting period of cessation, to a subsequent period; a company that makes a trading loss in the period to cessation may prefer to realise the chargeable gain in this period to enable it to be absorbed by the trading losses.
Any goodwill must be transferred, again deemed at market value, with the trade. The resulting capital gain will therefore depend on the market value agreed with HMRC. This value may be low for a very small company. For a business established after 31 March 2002, the gain is usually treated as a profit under the Corporate Intangibles regime (FA 2002 Sch 29).
5. Trading stock and work in progress
Transfers are deemed to be at market value, as the shareholder(s) are 'connected' with the company (CTA 2009 s 166). If market value is higher than both actual sale price and cost, the two parties may instead elect to use the higher of sale price and cost (s 167).
6. Capital allowances
Cessation causes a deemed disposal of plant and machinery. A balancing adjustment results, calculated on market value because the parties are connected. Instead the parties may jointly elect to transfer plant and machinery at tax written down value (CAA 2001 ss 266-267). However a company with unrelieved trading losses to absorb may prefer instead to realise a balancing charge on disposal at market value; the tax value of the plant will thus be increased for the successor business.
For buildings on which industrial buildings allowances were claimed, no balancing adjustment arises on disposal (Finance Bill 2007, applies to transactions from 21 March 2007). The shareholder(s) will continue to claim IBAs on the transitional basis until 31 March 2011.
7. VAT
The transfer of the company's business to be run by the sole trader or partnership is a transfer of a going concern. Subject to conditions, this is outside the scope of VAT, and no VAT charge arises. The new trader must register for VAT. Alternatively the company's VAT registration could be transferred to the trader.
8. Taxation of shareholder(s)
Although a strike-off under CA 2006 s 1000 is not a formal winding up, ESC C16 allows distributions to be treated as if made under a formal winding up, and therefore capital (rather than income) for the shareholder(s). Assurances must be given. The company must intend to cease trading permanently, pay off all creditors and distribute any remaining assets to its shareholder(s), and be struck off and dissolved. The company and shareholder(s) must agree to meet their tax liabilities. The concession is refused if HMRC suspects tax avoidance.
A capital distribution made after 5 April 2008, either during winding up or on striking off (provided capital treatment applies), may attract entrepreneurs' relief. This is because the capital distribution is treated as a disposal of an interest in shares (TCGA 1992 s 122). To qualify for entrepreneurs' relief the company must be the owner's 'personal company' and a trading company for at least the one year before it ceases to trade. The capital distribution must be made within three years after the trade ceases. (TCGA 1992 s 169I(7)).
9. Tax risks
Capital treatment risks challenge under the Transactions in Securities anti-avoidance legislation (ITA 2007 Part 13 Chapter 1). HMRC would challenge arrangements to achieve an 'income tax advantage' (ITA 2007, s 684). However transactions effected for genuine commercial reasons may be excepted (ITA 2007 s 685). Advance clearance on the tax treatment of the proposed capital distribution should be sought (s 701).
Capital distributions may arise from distribution of cash or assets to the shareholder(s) during a winding up. A 'double tax charge' is likely to arise: a capital gain on the company's disposal of chargeable assets, followed by shareholder's tax liability on the capital distribution - being a disposal in respect of the shareholder's shares.
If a company is struck off under CA 2006 s 1000, assets belonging to the company immediately before dissolution belong to the Crown. This could cause problems where the company has an outstanding loan to a participator (ICTA 1988 s 419). If the loan is repaid more than nine months after the accounting period in which it was made, s 419(4) relief is not given until nine months after the accounting period of the repayment (s 419(4A)). This will delay dissolution.
10. Practicalities
The company must make clear that it is no longer trading. The company bank account should be closed, and a new account opened for the successor business. Suppliers and customers should be asked to close accounts in the company name, and open new accounts in the new business name. The new business needs its own stationery, including invoices.
The trader must register with HMRC as self employed, within three months of commencing business, and must arrange payment of Class 2 NICs.
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