Disincorporation

It used to be the case that it was more tax efficient to run a business through a limited company than to operate as a sole trader. However, increases in corporation tax rates, dividend tax rates and employer National Insurance contributions in recent years have swung the pendulum in the other direction. If profits are extracted in full for use outside the company, at all profit levels the total tax burden is less for an unincorporated business than for a limited company. Further, significant rises in Companies House filing fees have made operating as a company much more expensive.

There are, of course, some advantages to operating a business through a company, limited liability being the main one. Further, if profits do not need to be extracted, the tax burden can be less for a limited company than for a sole trader, as corporation tax rates are much lower than income tax rates (although the company does not benefit from a personal allowance).

However, if operating as a company no longer works for a client, which may well be the case for businesses at the smaller end of the scale, one option is to disincorporate and to transfer the business and it’s assets to the shareholders, who continue to run it as an unincorporated business. We take a look at what action is needed and the potential tax implications of disincorporation.

Closing the company

If the business is no longer able to be run as a company, the company can be closed, or kept and made dormant or used for other purposes. There are various ways in which a company can be closed, and the route taken will depend on whether the company is solvent or not. Where the company is solvent, the options are to apply to strike if off from the Companies Register or to use a member’s voluntary liquidation. If the company is insolvent, it can be put into administration, an application can be made to strike it off or a creditor’s voluntary liquidation can be arranged.

A company may be forced into compulsory liquidation if it is unable to pay it’s creditors.

Guidance on the various options for closing a company can be found on the Gov.uk website (www.gov.uk/closing-a-limited-company).

Corporation Tax

The company will need to meet it’s corporation tax obligations and pay any corporation tax that it owes. It will also need to ensure that all accounts have been filed at Companies House. These obligations will cease from the date the company is closed.

If the company is to be kept dormant, it will need to be registered as a dormant company with HMRC. While it will no longer need to file company tax returns, it will need to file dormant company accounts with Companies House.

Corporation Tax on Capital Gains

Where the company has assets, a capital gain may arise on the transfer of those assets on which corporation tax will be payable. Assets which may be transferred out of the company to the directors or shareholders may include land and buildings, stock, vehicles, goodwill and debtors. Assets may also be sold prior to closing the company if they are no longer needed in the business.

Where the assets are sold at arm’s length, the sale proceeds are used to work out the gain chargeable to corporation tax. However, where the business is to continue to be run as an unincorporated business, the assets will usually be transferred to the director/shareholder who is to continue to run the business. Where this is the case, the connected person rules apply and the gain on the asset will be calculated by reference to it’s market value at the date of transfer.

Where the assets have appreciated significantly, this may trigger a large corporation tax bill. This should be considered in advance when assessing whether disincorporation is worthwhile. Unlike incorporation, there is no relief when a company disincorporates.

Distribution of profits

If the company has profits, these will need to be distributed. The way in which these are taxed will depend on when and how they are distributed and whether the company is closed or kept dormant.

Where a company is wound up the tax treatment may be treated as a capital distribution if the total distributions since the company first intended to make a winding-up application do not exceed £25,000 and the company has secured payments due to it and paid it’s debts. Business asset disposal relief may be available the company must be dissolved within two years of the distribution for this treatment to apply.

In other cases, the distribution will be treated as a dividend and taxed at the dividend tax rates.

The preferred route will depend on personal circumstances; it is important to plan ahead to ensure that the desired outcome is obtained.

Trading Losses

If the company makes a terminal loss, relief for that loss may be available under the terminal loss provisions which allow a loss in the last 12 months of trading to be set against the profits of all or any of the preceding three years. Where a previous accounting period does not wholly fall within this period, the profits must be time apportioned. Claiming terminal loss relief may trigger a useful corporation tax repayment.

If the loss is not a terminal loss and the company has losses which have been carried forward from earlier accounting periods, these will be lost on disincorporation. The cost of the loss of relief should be taken into account when making a decision to disincorporate.

PAYE

If the company is registered for PAYE, the PAYE scheme will need to be closed, if the unincorporated business is to employ staff, a new PAYE scheme will have to be set up. Existing employees will need to be transferred to the new PAYE scheme. If the business is to be run as a sole trader without any employees, there will be no need to set up a new PAYE scheme. The sole trader is taxed on the profits of the business.

VAT

If the company is VAT registered and the business is to be transferred to a sole trader or partnership, the business can apply to transfer it’s VAT registration. Alternatively, the business can cancel it’s VAT registration and the unincorporated business can register for VAT when it needs to or wants to voluntarily.

No VAT is charged when a business is transferred as a going concern.

Operating as a Sole Trader

The sole trader’s taxable profits will be included in working out their tax liability for the tax year. Class 4 National Insurance will also be due where profits exceed the lower profits limit. Depending on their turnover, they may need to comply with MTD for ITSA.