This two-part article looks at some important considerations for company owners when disincorporating their business. Part one looks at tax implications for the company.
These are difficult and worrying times, including for business owners. It was reported in the Financial Times last week that an extra 21,000 companies were dissolved in March 2020, compared to March 2019.
Sadly, the Covid-19 pandemic will cause the failure of many businesses. Some companies will cease trading, never to recommence. However, other companies will survive, although their owners may be forced to operate on a much smaller scale.
Crumbs Ltd and Bill
By way of illustration, Bill is the sole director and shareholder of Crumbs Ltd, a small catering business, which has traded in London since 2016. COVID-19 has forced the company to release its only two employees. Bill is hopeful he can still earn a living for himself but would prefer the simplicity of owning and running the business personally.
This article looks at some important tax implications for Bill’s accountant to consider when advising him on disincorporating the company and operating the business as a sole trader.
Dispensing with the company
Disincorporation generally involves the transfer of the assets and liabilities of a business (i.e. including any goodwill, property, plant and machinery, stock and creditors) as a going concern to the shareholder(s), who then continue the business in an unincorporated form. A distribution may arise through a formal or informal winding up, or it can be made by way of a ‘normal’ sale or distribution to the shareholders.
A members’ voluntary liquidation (MVL) is common in practice. An MVL is largely controlled by the company’s shareholders and can be used only where the company being liquidated is solvent (Insolvency Act 1986, Pt IV). An MVL broadly involves the liquidator winding up the company, which (under a disincorporation) would entail the transfer of the business and assets to the shareholder(s), after paying off creditors. In our illustration, Bill decides that the company should be wound up.
Tax issues for the company
Until recently, a temporary disincorporation relief was available for small companies. The effect of this relief was that when a qualifying business disincorporated and its assets were transferred to individual company owners, there was no immediate corporation tax on chargeable gains that arose (on qualifying assets) within the company. However, for businesses to qualify the transfer had to take place between 1 April 2013 and 31 March 2018 inclusive.
The potential tax issues of disincorporation for Bill’s company include those outlined below.
- Transfer of closing trading stock
As Crumbs Ltd is ‘connected’ with Bill (see CTA 2009, s 168), and Bill will continue to carry on the trade, the deemed ‘market value’ rule (in CTA 2009, s 166) will apply to the transfer of closing stock. However, in Bill’s case, it should be possible for the parties to make a joint election (under CTA 2009, s 167) to transfer the stock at its actual transfer value (or, if higher, the book value).
- Capital allowances
No writing down allowances are given on plant and machinery in the final basis period, and a balancing adjustment is calculated. This is generally computed by reference to the actual transfer value of the plant and machinery, but market value is applied where the parties are ‘connected’, as in Bill’s case (CAA 2001, s 575). However, Crumbs Ltd and Bill may make an election (under CAA 2001, s 266) for the plant to be transferred at its tax written-down value instead (CAA 2001, s 267).
The industrial unit is being distributed to Bill in specie as part of the winding up. In the case of fixtures, as no consideration is given (see CAA 2001, s 196, table item 3), the ‘disposal value statement’ requirement would need to be satisfied. A ‘pooling’ requirement also applies in relation to fixtures, whereby the availability of capital allowances to a purchaser of fixtures is generally conditional on the pooling of relevant expenditure prior to transfer. Otherwise, Bill’s qualifying expenditure for the fixtures would be deemed to be nil (CAA 2001, ss 187A–187B).
A joint election under CAA 2001, s 198 (‘Election to apportion sale price on sale of qualifying interest’) would neither be possible nor necessary for the fixtures, because it is not a sale (at or above market value), nor the permanent discontinuance of the qualifying activity followed by a sale (CAA 2001, s 198(1)).
As a general rule, where a trade ceases the VAT-registered person is deemed to make a taxable supply of all the goods then held by the business. However, since the business of Crumbs Ltd will be transferred to Bill who will continue to carry it on as a sole trader, there should be no VAT on the transfer by virtue of the ‘transfer of going concern’ provisions (SI 1995/1268, art 5).
However, where land or buildings are being transferred in respect of which the transferor has made an election to waive exemption (ie has exercised the option to tax), the transferor is required to charge VAT at the standard rate unless the transferee has made a valid option to tax the relevant property before the transfer takes place.
To avoid any delays obtaining a new VAT registration, consideration could be given to electing to continue using the business’s existing VAT registration number (on form VAT 68), as the history of the business will be well known to Bill.
- Capital gains on transfer of chargeable assets
Capital gains can arise when chargeable assets are transferred to the shareholder(s). The chargeable assets of the company are deemed to be disposed of at market value for tax purposes (TCGA 1992, s 17). Crumbs Ltd owned a small industrial unit. The property might be distributed to Bill in specie during the winding-up to avoid SDLT (see below). This would still trigger a chargeable gain, by reference to the property’s market value.
- Stamp duty land tax
An SDLT charge may arise on Bill when the industrial unit is transferred to him on disincorporation. SDLT is generally charged on the consideration provided for the transfer; so if Bill bought the property from Crumbs Ltd, SDLT would be chargeable on the purchase price paid. However, consideration could be given to ‘distributing’ the property to the shareholder (Bill) in specie during the winding-up. This will normally avoid any SDLT charge (see FA 2003, Sch 3, para 1), and generally ranks as a capital distribution in the shareholder’s hands. However, the assumption of any property loan/mortgage by Bill would represent ‘consideration’ for the transfer with a consequent SDLT charge, unless the debt is owed to Bill (see SDLTM04042). If the property is situated in Scotland or Wales, the equivalent taxes will need to be considered.
- Intangible fixed assets
A corporation tax charge will apply to any gain arising on the transfer of business goodwill, on the chargeable gain arising on the disposal of any pre-1 April 2002 goodwill and on the profit (or ‘credit’) arising in relation to any post-31 March 2002 goodwill. However, in our example the goodwill of Crumbs Ltd was internally generated post-31 March 2002 and does not feature on the company’s balance sheet.
The profit arising on the disposal of post-31 March 2002 goodwill is generally calculated as the excess of the disposal proceeds over the tax written down value (if any) of the goodwill. Disincorporation will normally result in a transfer of assets between ‘related parties’ (within CTA 2009, s 835), which is deemed to take place at market value for the purposes of the intangible fixed assets regime (CTA 2009, s 845). However, in the case of Crumbs Ltd, the value of goodwill to be deducted from the deemed proceeds for the purposes of calculating the profit on disposal is nil, as the goodwill was internally generated and was not shown in a company’s balance sheet (CTA 2009, s 738).
Intangible assets other than goodwill (eg copyright and customer lists) also falling within the regime could give rise to a tax charge on disincorporation.
…and there’s more
The above list of tax implications is not exhaustive; there are other possible issues to address (e.g. closure of PAYE scheme). Each case needs to be considered on its particular facts. Of course, the non-tax legal and other considerations of disincorporation (e.g. company and commercial law) will also need to be scrutinised.
Part two of this article will look at tax implications of disincorporation for individual shareholders.
The above article was first published by AccountingWeb on 1 May 2020: www.accountingweb.co.uk/tax/business-tax/disincorporation-and-downsizing-get-the-details-right