Closing a company? End of ESC C16 could bring penalties

Time is of the essence for anyone seeking to extract funds from a company in the process of being struck off.

From 1 March 2012, new legislation may bring higher tax liabilities on any payments out of the business before it is dissolved.

What is the tax position when closing down a company?

Extracting funds from a company generally creates an income tax charge for the shareholder. However, certain payments made in the process of winding up of a company are an exception and may instead be subject to capital gains tax (CGT) – often a more tax-efficient option for the taxpayer.

Winding up a company can be a drawn-out process, and the formalities and appointment of an official liquidator expensive. The result is that many opt for the cheaper, more informal option of a ‘striking off’ procedure.

It is in these situations that the Extra Statutory Concession (ESC) C16 has been beneficial. Under this concession, HM Revenue & Customs (HMRC) has allowed certain payments to shareholders to be taxed as a capital gain rather than income, without the need to instigate formal winding up procedures.

What are the benefits of ESC C16?

Opting for a distribution of assets to be taxed as a capital gain will often provide taxpayers with a tax saving because CGT rates are generally lower than the equivalent charge to income tax for higher and additional rate taxpayers, especially where the CGT annual exemption (£10,600 in 2011/12) remains available.

ESC C16 also provides a certain degree of flexibility, letting you pick and choose which tax treatment would be the best for your particular circumstances.

What will the new measures entail?

From 1 March 2012, ESC C16 is being replaced by new statutory measures that remove a lot of the previous flexibility. The new rules are complex and contentious – particularly the introduction of a ‘cap’ that will significantly limit the availability of the beneficial capital treatment. Ultimately, this cap will mean that CGT treatment is no longer an option for any company distributing more than £25,000. Such businesses will need to consider their position carefully – and fast – before the legislation is introduced.

What does the end of ESC C16 mean for shareholders?

Shareholders may find themselves with additional or unexpected tax liabilities on any payments received in respect of their share capital. For example, additional rate taxpayers could be met with an income tax liability at an effective tax rate of 36.11%, compared with a CGT rate as low as 10% if entrepreneurs’ relief is available. (Read more in our previous post on entrepreneurs’ relief.) Any payments within an unused CGT annual exemption will be free of tax.

Is it too late to avoid being caught out? 

The deadline for making claims under ESC C16 is approaching fast but there remains a small window of opportunity to apply for the concession before the legislation is introduced on 1 March 2012.

Of course, there will also be wider, commercial implications to be considered and there are strict formalities that need to be adhered to under any such claim. Time is of the essence, therefore, if you are to take action before the new rules take effect.