Disincorporation: Key Considerations for Business Owners. Part 2

Understanding the Tax Implications

No Disincorporation Relief: What This Means for You

Unlike incorporation, which allows certain tax reliefs (such as TCGA 1992, s 162, permitting gains on qualifying business assets to be rolled into shares), there is no equivalent relief for disincorporation. A temporary disincorporation relief was introduced in April 2013 under George Osborne’s government, allowing land, buildings, and goodwill to be transferred to shareholders at the company’s base cost — avoiding a corporation tax charge on gains. However, this relief was limited to assets worth £100,000, saw minimal uptake, and was abolished in March 2018.

As a result, when disincorporating, any company assets transferred to shareholders are subject to capital gains tax (CGT) and potential income tax implications. The absence of tax relief means planning the transition carefully is crucial.

Example:

A limited company owns a business property worth £500,000, originally purchased for £300,000. If this property is transferred to the owner during disincorporation, the company faces a capital gain of £200,000, taxed at the corporation tax rate (currently 25%). The owner may also face stamp duty land tax (SDLT) if taking the property personally. These costs must be factored into the decision.

How to Close a Limited Company

Option 1: Striking Off the Company (Dissolution)

For small companies that meet specific conditions (e.g., have not traded for three months and do not have significant liabilities), the easiest and cheapest way to close a business is by applying for voluntary dissolution. The steps include:

• Completing Form DS01 and submitting it to Companies House.
• Paying a £33 fee for an online application.
• Ensuring all liabilities (e.g., tax, debts) are settled beforehand.

Tax Considerations:

• Any assets distributed before striking off are treated as income distributions.
• If total distributions are under £25,000, they may be treated as capital rather than income, potentially qualifying for Business Asset Disposal Relief (BADR) (previously Entrepreneurs’ Relief), which reduces the CGT rate to 10%.

Option 2: Members’ Voluntary Liquidation (MVL)

For companies with larger reserves, a Members’ Voluntary Liquidation (MVL) is often preferable because:

• Distributions are automatically treated as capital, not income.
• BADR may apply, reducing CGT to 10%.
• The process provides a legally clear and structured closure.

However, MVLs are more expensive,often costing several thousand pounds in liquidator fees. If the company has significant retained earnings (e.g., over £50,000), the tax savings may justify the cost.

Example:

If a company distributes £200,000 via a striking-off process, it may be taxed as a dividend at up to 39.35% (if a higher-rate taxpayer). If the same amount is distributed via an MVL, it could qualify for BADR and be taxed at just 10% — a substantial saving.

Beware of Anti-Phoenixing Rules

HMRC enforces anti-avoidance rules to prevent individuals from closing one company and starting another similar business purely to avoid tax (known as ‘phoenixing’). To discourage this, anti-phoenixing rules apply if:

1. The individual had at least a 5% interest in the company.
2. The company was a close company (i.e., controlled by five or fewer shareholders).
3. Within two years, the individual (or their connected persons) starts a similar trade.
4. HMRC deems that one of the main purposes of the winding-up was to reduce income tax.

If all four conditions are met, distributions from the liquidation may be taxed as income rather than capital, removing the benefit of BADR.

Example:

John runs a successful marketing agency as a limited company and decides to close it down, taking £100,000 in retained earnings. A few months later, he starts a sole trader marketing business. If HMRC believes the main reason for closing the company was to avoid income tax, the £100,000 could be taxed as an income distribution rather than capital.

VAT Considerations When Disincorporating

If the company is VAT-registered, it has two main options:

1. Transfer the VAT registration to the new business entity (sole trader or partnership). This can be complex and may involve long processing delays with HMRC.
2. De-register and apply for a new VAT number as a sole trader or partnership. This is often faster and cleaner but may involve reclaiming VAT on some assets.

Tip: If you aretransferring significant assets, be mindful of VAT clawback rules — especially for capital goods over £250,000, which may require an adjustment period underthe Capital Goods Scheme.

Final Practical Tip: Seek Advance Clearance

Before winding up the company, itis highly recommended to apply for clearance under Transactions in Securities Rules (ITA 2007, s 701). If granted, this provides assurance that HMRC is unlikely to challenge the tax treatment of distributions.

Conclusion: Is Disincorporation Right for You?

Disincorporation can be an attractive option for businesses facing increased compliance costs, changing tax regimes, or a desire for simpler operations. However, the process comes with significant tax considerations, especially around capital gains, VAT, and anti-avoidance rules. If you’re considering disincorporation, seek expert advice to navigate the financial and legal complexities effectively.

At Zeus Accountants, we specialize in business restructuring and tax planning. Contact us today to discuss the best approach for your business transition.