Many a contractor will be aware of the (high) possibility of HMRC forcing workers onto payroll moving them over to the unregulated Umbrella Company marketplace and the horror stories emerging there; but that’s for another time.
Of course until any announcements are made in the Autumn Statement the contractor industry is in a state of flux. However that doesn’t mean that you should sit on your laurels and do nothing.
Now is exactly the time to be doing some planning to make sure that if you do have to close down your limited company this is done via the most tax efficient method available which, for many, could be a ….
Members Voluntary Liquidation
Known as an MVL this isn’t as dramatic as the title leads us to believe.
An MVL is very different to a company strike off which is a straightforward process often used when there are little funds remaining in the limited company.
An MVL may sound like a lot of work and red tape but its worth it for the financial benefits that can accrue by going down this route.
Just to say that this is a perfectly legal route for exiting your limited company. An MVL is not a tax avoidance scheme. It merely uses tax legislation put in place for the benefit of entrepreneurs who have set up their own business. The tax advantages reward the entrepreneur for their hard work, the risks they have taken and the stress they may have suffered in setting up and running their own business.
The MVL is undertaken via a formal process requiring the appointment of a Liquidator. It kicks off with the company issuing a statement of solvency meaning that it can meet its debts i.e. it isn’t bankrupt (so there’s no impact whatsoever on personal credit ratings). The Liquidator takes over the company collecting any outstanding debts, paying any liabilities and making the formal returns necessary. It needs up to date accounts to do this which will usually be prepared by the accountant. As part of this process the Liquidator establishes how much can be paid out to the shareholders of the company; known as the Capital Distribution.
Importantly the Capital Distribution (subject to certain rules being met) should qualify for Entrepreneur’s Relief meaning that it is taxed at 10%.
Why should you consider this route to company exit
The benefits of an MVL are best shown by a simple example.
Let’s take a Contractor who has £100,000 of retained profits in the limited company after settling taxes and any creditors (see note below about changing Dividends to Director’s Loan).
The contractor is a higher rate tax payer.
Closing Company by Strike Off
If the company is closed by the Strike Off process then the company can distribute £25,000 as a capital distribution. The rest would be paid to the shareholders by way of an income distribution i.e. dividends. The income distribution would happen before the capital distribution.
So the tax liability would be made up of Capital Gains Tax and Income Tax.
After setting aside the capital distribution of £25,000 to be paid later after the income distribution, there would be £75,000 to pay out by way of dividends.
A canny accountant would plan this income distribution to occur so as not to push the taxpayer over £100,000 (the amount where the personal allowance starts to reduce by £1 for every £2 of income). This could mean paying out the dividend over a couple of tax years, before the close down process starts and the capital distribution made.
Assuming this to be the case then the Dividends of £75,000 would attract Dividend Tax at the rate of 32.5% (assuming there is other income taking the tax payer up to this higher rate but below £100,000. The tax due could be higher if the tax payer is pushed over the £100,000 and more still if over £150,000 when the additional rate of 38.1% could apply. Suffice to say this needs careful tax planning!).
In the example there would be Income Tax to pay of £24,375.
Capital Gains Tax
The liability here would be calculated at the current rate of Capital Gains Tax (2019 / 2020) for higher rate tax payers which is 20% on your gains from other chargeable assets (not residential property). However this is reduced to 10% if Entrepreneur’s Relief is available.
The first £12,000 of the £25,000 gain is exempt from Capital Gains Tax (Capital Gains tax-free allowance).
This leaves an amount of (£25,000 – £12,000) £13,000 subject to Capital Gains Tax at 10% (the Entrepreneur’s Relief rate).
Therefore Capital Gains Tax at 10% would be £1,300 on the £25,000 capital distribution.
This gives a total tax bill on the £100,000 available to distribute of £25,675.
Exiting via an MVL
If the company was closed by way of an MVL then the £100,000 would be paid out as a capital distribution qualifying for Entrepreneur’s Relief, subject to conditions being met.
This gives a reduced tax bill as follows:
(£100,000 – £12,000) £88,000 subject to Capital Gains Tax at 10% being the tax rate for Entrepreneur’s Relief.
Therefore Capital Gains Tax at 20% would be £8,800 on the distribution of £100,000.
That’s a tax saving of a staggering £16,875!
This is a significant saving to closing down a company through a strike off (although there will be a Liquidator’s fee to pay of course – see below).
For more on how to calculate capital gains tax including how to calculate it for lower rate tax payers see https://www.gov.uk/capital-gains-tax/rates
What should you do now?
If you are thinking of closing your limited company in the foreseeable future then there are things to do in preparation for your exit.
In discussions with your accountant (yes you will need an accountant in place for this to make sure that the necessary planning is done and the process is followed. If your accountant doesn’t know how to do an MVL then find an accountant that does; dare I say like us at CheapAccounting.co.uk!) agree an Exit Plan and a Revised Profit Extraction Strategy based upon taking a salary, minimum dividends and the rest as a director’s loan.
The loan will be paid back as part of the MVL process. So if, for example, you would usually extract £75,000 in dividends then you can take an amount as a Director’s Loan instead. This increases your retained profits available for distribution. When the company is liquidated the loan would be repaid, as part of the process, from your capital distribution which has been taxed at 10%.
In effect you are extracting money at 10% tax rather than 32.5% or 38.1% dividend tax.
Of course there are many things to note as part of this methodology; importantly the company could be liable for extra Corporation Tax on the Director’s Loan (known as S455 tax), there could be a benefit in kind, the loan has to be declared in the accounts, you can’t do an MVL and then start up a new limited company straight away (known as phoenixing) etc. Your accountant will discuss all of this with you; it sounds complex – it isn’t if your accountant knows what they are doing and again it can’t be stressed enough that this is all legal and above board.
Here to help
At CheapAccounting.co.uk we work with our Partner, Opus Restructuring LLP, to bring a combination of accountant and liquidator skills that’s essential to make sure that the MVL is as painless and seamless as possible.
Yes of course there are costs involved (our fees for preparing the accounts necessary are on our web site and you should budget about £3,000 to £3,500 for the Liquidator fees plus disbursements). However, as illustrated above the financial benefits make the MVL worthy of consideration as a route to exit your company.
Contact us if you’d like a free no obligation chat about this. We’re here to help.
Message to Sole Practitioner Accountants
If you’re unfamiliar with this process or it’s not something you’d like to do yourself we can work with you, your clients and our Liquidator Partner, Opus Restructuring, to guide you and your client through the MVL doing as much or as little as you’d like us to do.
We promise not to poach clients – we’re professional accountants who are here to help!
Please note that any figures quoted above are examples only for illustration.
The exact figures need to be worked through by your accountant if you decide to go down this exit route.
No responsibility can be accepted for reliance placed on the above. Seek advice SPECIFIC to your circumstances.