Tax Doctor:
Mark McLaughlin
ATII ATT TEP

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December 2004

Q:

I have just joined a business as a director, and all the staff etc have also transferred from my previous trading company. However, my previous company, in which I owned a 75% shareholding, still has approximately £40,000 in it. What is the most tax-efficient method of withdrawing this cash for myself? I don't think we can close the company, since we are waiting to see if one of our clients who owes £50,000 and is currently in administration, will be able to pay us the money owed.

A:

The two main ways of extracting income from the company are salary/bonus or dividends. You state that you are a 75% shareholder of the company. Who owns the other 25%? Paying a dividend usually means that the other shareholder becomes entitled to some of the company's surplus funds. Is this acceptable? In addition, company law broadly requires that dividends are paid out of profits available for distribution. The company's balance sheet will indicate the level of dividends which can lawfully be paid.

If dividends are acceptable, the tax liability on your dividend is 25%, assuming that you are a higher rate taxpayer. This compares favourably with a 40% tax rate on a salary/bonus, as well as National Insurance contributions for you and the company.

Another option is to liquidate the company. Payments to shareholders during liquidation in respect of their shares are treated as capital, not income. Capital payments to shareholders are normally liable to capital gains tax (CGT), not income tax. This means that CGT taper relief may be available to reduce any capital gain arising, depending broadly on how long the shares have been held and the period over which the company was a trading company. The annual CGT exemption (£8,200 for 2004/05) may further reduce (or possibly eliminate) any remaining gain, assuming that the exemption has not already been used elsewhere.

An alternative to liquidation is to informally wind up the company. For tax purposes, strictly speaking payments to shareholders during the winding up of a company are income distributions, like dividends. However, by concession the Inland Revenue will treat distributions to shareholders during an informal winding up as capital payments, if certain conditions are satisfied and assurances given. An application for this concession to apply must be made to the Inspector of Taxes who deals with the company's tax affairs.

As mentioned, distributions of capital (as opposed to dividends) mean that CGT taper relief is potentially available. The amount of taper relief will depend on how long you have held the shares since 6 April 1998, and whether the shares are a 'business asset' or a 'non-business asset'. Shares in a company that is not trading are normally a non-business asset. Presumably, the company is no longer trading. The date when trading ceased is potentially important. Assuming that the Inspector applies the concession and treats distributions to shareholders during the winding up of the company as capital payments, any significant non-trading periods may dilute the taper relief available, unless the company was inactive.

There are special rules for 'inactive' companies that are close companies. A 'close' company is a company under the control of five or fewer 'participators' (broadly shareholders, although the definition is wider), or under the control of its directors.

For CGT taper relief purposes, a company is active (i.e. not 'inactive') if it is being wound up after its business has ceased. However, a company is not regarded as active if, for example, all it does is hold money. The Inland Revenue's own Capital Gains Manual states that a company will be active if its post-cessation business affairs are being dealt with while the company remains in being. However, it also states that '…a company that is in liquidation and where there are no business activities, and there are no other activities, is unlikely to be active'. In the case of your company, if it is otherwise dormant apart from holding funds on deposit, the Inspector of Taxes will hopefully agree that it is inactive, and that any later receipt of funds from the customer in administration does not of make the company active.

Mark McLaughlin

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