An update
We have posted a couple of items about the evolving position which have proved popular with readers.
The most recent posting, on 7 November, was subsequently annotated to reflect later developments but it now seems sensible to publish a new posting as we know what the statutory replacement for ESC C16 is likely to look like.
The current posting explains the recent developments and highlights the issues readers need to get their heads round before the statutory replacement for ESC C16 is in place for distributions made on or after 1 March 2012.
The new rule
The statutory replacement will be introduced by Statutory Instrument placed before Parliament, possibly in January, and it will apply to any payments made on or after 1 March 2012 in anticipation of a dissolution.
Payments up to £25,000 will be subject to capital gains tax but if total payments, per company, exceed that amount then all of those payments will be subject to income tax.
The company law problem
There was a problem with share capital paid out prior to a dissolution as this does not comply with Companies Act 2006 and so is an unlawful distribution. The payment is potentially recoverable from the shareholders. This is no longer a problem.
The Treasury Solicitor’s Office has confirmed that it will not take action to recover such distributions.
Tax payable
Taxpayers and tax advisers will have to consider how much tax will be payable under the various scenarios and determine their course of action accordingly.
For payments prior to 1 March 2012, made in accordance with ESC C16, only capital gains tax is payable.
For payments made on or after 1 March 2012, even if ESC C16 has been ‘granted’ in anticipation of the payment, capital gains tax will only apply if the total payments are less than £25,000. If payments exceed that amount then all the payments are subject to income tax.
If the income tax liability is going to significantly exceed the capital gains tax liability then you should consider a formal liquidation which will ensure that capital gains tax is payable on the amount paid out.
You should also bear in mind that entrepreneurs’ relief may also be available which would reduce the capital gains tax liability to 10% of the gain and would make the capital gains tax ‘option’ much more attractive.
When a dividend is paid to a basic rate taxpayer there is no further tax to pay. A basic rate taxpayer who is liable to capital gains tax will have 18% capital gains tax to pay on any gain subject to the first £10,600 of gains being tax free – the annual exemption. So being liable to income tax may be beneficial for those shareholders who are basic rate taxpayers.
If the shareholders are higher rate taxpayers then you need to compare the 25% income tax that is paid on the dividend with the 28% capital gains tax that may be payable if the distribution is liable to capital gains tax instead.
If the shareholder pays tax at the additional, 50%, rate then the capital gains tax rate is also 28% but if the dividend is liable to income tax the tax payable on the dividend is 36.11%.
For a higher rate taxpayer capital gains tax is greater but income tax is higher for a taxpayer liable at the additional rate. If the shareholder is eligible for entrepreneurs’ relief then capital gains tax may be favourable in almost all situations.
What should you do now?
There are now just over two months before ESC C16 is likely to come to an end and the statutory provisions come into force.
Tax advisers should consider clients that have companies that are no longer trading and which have significant reserves. If it is going to be cheaper to pay capital gains tax rather than income tax on a dissolution and you want to avoid the cost of a formal liquidation then it will be to your advantage to apply for the concession and make sure the payments are made before the end of February.
You need of course to consider whether it might not be more appropriate to go for a formal liquidation for other, non-tax, reasons.
The calculations can get quite complicated and if there are several shareholders then they may face different tax situations and you will need to consider the different potential tax bills before deciding the best course of action.