For the vast majority of contractors, there comes the point where the decision to close their company must be taken. This could be for several reasons, including transitioning to a more profitable PAYE role, or to simply retire.
For PSCs, or personal service companies (most commonly used by contractors), closing is almost certainly going to happen at some point in the future. This is not due to some inherent issue with such a company, but rather that the contractor is the essence of the company itself, no contractor, no company. This makes the sale of PSCs a very rare sight indeed.
As closing down is typically the most appropriate option when a contractor stops contracting, it is important to know the process before taking action, especially if you have retained profits that you’d like to access tax efficiently.
If you have retained profits, you maybe be able to access them for just 10% tax
Of course, closing down an established company can be a complex task, and one that can be done in a number of ways. However, if your company has profits left in it when it’s closed, then you will need to distribute those funds to shareholders. Typically, that’s the owner/director/contractor. It’s important that you do this as tax-efficiently as possible so that when those funds hit your bank account, you retain as much of them as possible. If you want to access these funds at the lowest possible rate of tax, you could choose to close down with a Members’ Voluntary Liquidation (MVL), which is overseen by a licensed insolvency practitioner.
What are retained profits?
Before we explore the process of closing down a company with retained profits, we must first define the term.
Retained profits, or retained earnings, refer to the amount of money left after the company pays its dividends to shareholders. The money is kept within the company, often used to fund its growth, or as a financial airbag should things go wrong.
Often people like to keep a cushion in the company because if they were to transfer the funds to themselves, they would incur a tax charge on it. Unfortunately, when the company is closed, these funds will need to pass to the shareholders and will incur a tax charge. It’s therefore important you choose the most efficient way to close your company and reduce your tax bill. Often the extra cost of using a licensed insolvency practitioner will be repaid many times over by the tax savings accessed.
Closing a company with retained profits
When closing down a company, all assets owned by the company must be realised, and the creditors must be paid. After having done so, the company will be left with a detailed balance sheet. This balance sheet will reflect the company’s retained earnings and its share capital.
This capital can then be distributed as you please, either as a director’s salary or a dividend. This can be incredibly beneficial, as it makes use of income tax-free brackets. However, this does come with a considerable downside, that being shareholders will pay their highest marginal tax rate. In some cases, this could be as much as 45%.
Fortunately, the government has opened up some lower tax routes to taking money out of a business during closure, including through the use of Business Asset Disposal Relief (formerly Entrepreneurs’ Relief).
Closing a company via an MVL
Going down the Members’ Voluntary Liquidation route can be more appropriate for many companies. In doing so, a licensed insolvency practitioner will be involved, assisting with the process and handling the distribution of capital.
Distributing capital using this method will fall under Capital Gains Tax (CGT). Meaning it will be taxed at a rate of 20% as standard or 10% if you qualify for business asset disposal relief. There are annual tax-free allowances for CGT. Even when exceeded, CGT has a significantly lower tax rate than income tax. Meaning that an MVL is much more tax efficient.
What is Business Asset Disposal Relief?
Company directors can apply for Business Asset Disposal Relief, a relatively new name for Entrepreneurs’ Relief under certain circumstances. Assuming you are eligible, this will see your distribution taxed at only 10%. Provided you do not exceed the £1,000,000 lifetime limit.
This is a considerably lower rate than income tax, which charges 18% or 28% depending on the bracket relevant to your company. Ordinarily, qualifying for Business Asset Disposal Relief can be a challenge. For PSCs, however, most of the criteria are met by default. As such, this proves to be an excellent method of reducing tax expenses during company closure.
Fees associated with an MVL
Although closing down your business through the MVL process is undoubtedly the most cost-efficient, it does come with fees (fortunately, they are often more than recovered by the saving in tax). In exchange for MVL fees, you enlist the aid of a liquidator, more commonly known as an insolvency practitioner, to handle all the aspects of the closure from start to finish.
Closing via an MVL is a common option, one chosen by thousands of company directors each year. While the help is nice, the main reason is tax efficiency. An MVL saves companies a hefty sum that would otherwise be paid in taxes. Offsetting the cost of using an insolvency practitioner and then some. This makes the entire process easier and less costly. Allowing you to pursue retirement, a transition to a PAYE role, or to fund a new enterprise without extensive worry or issue.
Situations where an MVL is unsuitable
Closing a company through an MVL is generally the most cost-effective strategy. However, it is not suitable for every situation.
A company considering an MVL should hold a minimum value of £25,000. This includes assets, business accounts, and so on. If this minimum is not met, you should instead pursue removal from the Companies House Register. Advice on how to achieve this can be received from your accountant.
Another scenario unsuitable for an MVL is insolvency. Companies in this financial state cannot pursue either an MVL or removal from the Companies House Register. For example, while a company may have significant assets, its debts far outweigh these. So, during closure, the shareholders will not be entitled to any funds. Instead, a Creditors’ Voluntary Liquidation is much more suitable.
Clarke Bell can help
If you are considering closing down your company, don’t hesitate to contact Clarke Bell. We have 28 years of experience helping companies in your situation. Our experts will be happy to offer advice free of charge. We will assist you through the MVL process, or find an alternative route if an MVL is not suitable.