Winding up a company tax-efficiently
Discussion
First time poster in this part of PH; hope I'm not duplicating a frequent question!
My wife's parents own a second property via a limited company, which they rent out. My wife and sister-in-law are minority shareholders in the company - about 17% each, and I believe my mother-in-law is the majority shareholder. The property is worth about £250k to £300k.
They have decided that it's no longer worth the effort of renting it out, and want to sell everything and distribute the proceeds to my wife and sister-in-law as an early inheritance, which is awesome news for us!
My father-in-law has been working out how to go about doing it, and what the tax implications are. His impression is that the company would pay 20% corporation tax on the proceeds of the house sale, then the remainder would be distributed to each party as a dividend, and we'd each end up paying 40% income tax on it. Once that has happened, my mother-in-law would gift us the remainder of her share, and the seven year rule will come into play for inheritance tax purposes.
That all sounds like a horrendous tax exposure, and I'm not sure that it's entirely correct. I'm going to suggest that he gets professional tax advice, but it would be nice to hear what people think.
From the reading I've done, I'm not convinced that we'd pay 40% on dividends - I've read that there's a slightly lower rate. Also, I'm reading that there are two ways of winding up a company, and my father-in-law is talking about the "informal" route in which the proceeds would indeed have to be treated as dividends. But AIUI if you do it "formally" and pay for a liquidator, the proceeds might be treated as capital and be subject to only 10% tax. I'm also not convinced that the whole of the sale proceeds would be subject to corporation tax in the first place.
I know very little about this, but am I on the right lines?
I suppose there are two parts of my question:
My wife's parents own a second property via a limited company, which they rent out. My wife and sister-in-law are minority shareholders in the company - about 17% each, and I believe my mother-in-law is the majority shareholder. The property is worth about £250k to £300k.
They have decided that it's no longer worth the effort of renting it out, and want to sell everything and distribute the proceeds to my wife and sister-in-law as an early inheritance, which is awesome news for us!
My father-in-law has been working out how to go about doing it, and what the tax implications are. His impression is that the company would pay 20% corporation tax on the proceeds of the house sale, then the remainder would be distributed to each party as a dividend, and we'd each end up paying 40% income tax on it. Once that has happened, my mother-in-law would gift us the remainder of her share, and the seven year rule will come into play for inheritance tax purposes.
That all sounds like a horrendous tax exposure, and I'm not sure that it's entirely correct. I'm going to suggest that he gets professional tax advice, but it would be nice to hear what people think.
From the reading I've done, I'm not convinced that we'd pay 40% on dividends - I've read that there's a slightly lower rate. Also, I'm reading that there are two ways of winding up a company, and my father-in-law is talking about the "informal" route in which the proceeds would indeed have to be treated as dividends. But AIUI if you do it "formally" and pay for a liquidator, the proceeds might be treated as capital and be subject to only 10% tax. I'm also not convinced that the whole of the sale proceeds would be subject to corporation tax in the first place.
I know very little about this, but am I on the right lines?
I suppose there are two parts of my question:
- Does the company have to pay corporation tax on the proceeds of the house sale?
- Is there a way of doing it so that we don't over-pay tax on the distributed proceeds, without going "Jimmy Carr" about it?
One of the difficulties of owning an investment property through a limited company is the likelihood of double taxation charges when the property is disposed of and/or the company itself disposed of.
If the property is sold by the company, then the company will probably have a Capital Gains Tax liability arising on the disposal gain. Company Capital Gains are taxed at Corporation Tax rates rather than the special CGT rates that now exist for individuals.
Companies do not get the CGT annual allowances either - but they may still be entitled to the old Indexation system for removing the inflationary aspect of the gain - which - if the property has been owned by the company for many years, may be quite a good relief.
Indexation was abolished for individuals in 1998 and replaced by Taper Relief. Taper Relief itself was abolished in 2008.
Once the property has been sold and any CGT/Corporation Tax paid by the company, the next problem is the individuals getting their hands on the sale proceeds siting in the company bank account.
They could take the money out at dividend levels set to keep them out of higher rate tax. Depending on the number of shareholders involved and the amount of cash, this could take a couple of years to extract in this manner.
Winding the company up and taking the cash out as a capital disposal could result in the individuals having to pay personal CGT on their share of the loot.
In some circumstances, the disposal of shares in a company can attract the lower Entrepeneurial Relief rates of CGT BUT these rates only apply when the company being disposed of relates to a business. Not all companies that received their income primarily through rental income are deemed to be trading businesses and therefore may not be eligible for Entrepeneurial Relief.
The company's accountant should be aware of all these issues and be able to advise the shareholders of the possibility of Entrepeneurial Relief being available or not for this particular company.
If the property is sold by the company, then the company will probably have a Capital Gains Tax liability arising on the disposal gain. Company Capital Gains are taxed at Corporation Tax rates rather than the special CGT rates that now exist for individuals.
Companies do not get the CGT annual allowances either - but they may still be entitled to the old Indexation system for removing the inflationary aspect of the gain - which - if the property has been owned by the company for many years, may be quite a good relief.
Indexation was abolished for individuals in 1998 and replaced by Taper Relief. Taper Relief itself was abolished in 2008.
Once the property has been sold and any CGT/Corporation Tax paid by the company, the next problem is the individuals getting their hands on the sale proceeds siting in the company bank account.
They could take the money out at dividend levels set to keep them out of higher rate tax. Depending on the number of shareholders involved and the amount of cash, this could take a couple of years to extract in this manner.
Winding the company up and taking the cash out as a capital disposal could result in the individuals having to pay personal CGT on their share of the loot.
In some circumstances, the disposal of shares in a company can attract the lower Entrepeneurial Relief rates of CGT BUT these rates only apply when the company being disposed of relates to a business. Not all companies that received their income primarily through rental income are deemed to be trading businesses and therefore may not be eligible for Entrepeneurial Relief.
The company's accountant should be aware of all these issues and be able to advise the shareholders of the possibility of Entrepeneurial Relief being available or not for this particular company.
Thanks Eric, that's been very helpful - particularly your reference to the indexation allowance, which I was unaware of.
I've done some further research, and you're absolutely right that indexation does still apply to companies. I found a useful page that shows you how to calculate the chargeable gain. This could make a huge difference to the amount of corporation tax applicable, because the house has been owned by the company for several decades.
However, I've read somewhere on the HMRC site that Entrepreneurial Relief (sounds rude!) is not applicable to a company whose sole purpose is to let a property.
I've done some rough sums, and the tax is starting to look slightly less horrendous.
I've done some further research, and you're absolutely right that indexation does still apply to companies. I found a useful page that shows you how to calculate the chargeable gain. This could make a huge difference to the amount of corporation tax applicable, because the house has been owned by the company for several decades.
However, I've read somewhere on the HMRC site that Entrepreneurial Relief (sounds rude!) is not applicable to a company whose sole purpose is to let a property.
I've done some rough sums, and the tax is starting to look slightly less horrendous.
Edited by Dr Mike Oxgreen on Monday 29th April 13:31
The CGT is based on any "profit" made on the property after the costs (inc enhancements made during ownership) have been augmented by the indexation factor.
One potential issue is that the calculation of "original cost" is normally rebased to the open market value on 31 March 1982 - if the property was bought before this then you can opt to use cost if higher. You would need to ask several decent estate agents if they would provide a March 1982 valuation and I normally use the middle value - keep any valuations as evidence.
Dependent on the amount of distributable reserves that can be paid out as dividends and what each shareholders tax position is will vary what best advice is about extraction and winding-up.
Entrepreuners relief will not apply as the company's activity is excluded.
Do you have an Accountant as you all should be discussing the various options and how they effect ypur tax liabilities.
David
One potential issue is that the calculation of "original cost" is normally rebased to the open market value on 31 March 1982 - if the property was bought before this then you can opt to use cost if higher. You would need to ask several decent estate agents if they would provide a March 1982 valuation and I normally use the middle value - keep any valuations as evidence.
Dependent on the amount of distributable reserves that can be paid out as dividends and what each shareholders tax position is will vary what best advice is about extraction and winding-up.
Entrepreuners relief will not apply as the company's activity is excluded.
Do you have an Accountant as you all should be discussing the various options and how they effect ypur tax liabilities.
David
Could perhaps be some mileage in your wife transferring some shares to you - no point for example in her paying tax at the higher 32.5% if you haven't even used up your lower rate bracket.
If dividends are paid to you as a basic rate tax payer then there is no further tax liability from you.
If dividends are paid to you as a basic rate tax payer then there is no further tax liability from you.
I've now found out that the house was purchased in 1983, so we don't need to get a special valuation done.
I'm a higher rate taxpayer, and my wife is on the cusp of the higher rate. So I don't think there's anything we can do between us to reduce the tax - it might as well go to my wife and she'll get a grand or two at the basic rate before the higher rate kicks in. I suspect my wife's sister is probably a basic rate taxpayer, so it might be worth her while taking her 17% share in one tax year and the rest in the next year to make maximum use of her basic rate allowance. She'll still end up paying higher rate tax both years, though.
I have also suggested to my parents-in-law that they might want to consider splitting the dividend into two tax years. My mother-in-law has little or no income herself, but a single dividend of the whole amount would take her through the higher rate band and well into the top rate band (>£150k) for that year. If it were split then she could avoid the top rate band.
Can I check my understanding of the inheritance tax that could apply?
AIUI, my mother-in-law has a £325k tax-free IHT allowance, and so does my father-in-law. In the event of one of them dying, their allowance passes to the survivor who ends up with a £650k allowance. BUT... if my mother-in-law gives us this early inheritance and then dies within seven years, am I right in thinking that there's no tax to pay at that point because it's below £325k - but my mother-in-law has effectively used up that portion of her allowance and my father-in-law will end up with a reduced allowance? Is that how it works? Also, I'm assuming that if she survives seven years (which of course we hope she will) that she would keep her £325k allowance intact - is that right?
I'm a higher rate taxpayer, and my wife is on the cusp of the higher rate. So I don't think there's anything we can do between us to reduce the tax - it might as well go to my wife and she'll get a grand or two at the basic rate before the higher rate kicks in. I suspect my wife's sister is probably a basic rate taxpayer, so it might be worth her while taking her 17% share in one tax year and the rest in the next year to make maximum use of her basic rate allowance. She'll still end up paying higher rate tax both years, though.
I have also suggested to my parents-in-law that they might want to consider splitting the dividend into two tax years. My mother-in-law has little or no income herself, but a single dividend of the whole amount would take her through the higher rate band and well into the top rate band (>£150k) for that year. If it were split then she could avoid the top rate band.
Can I check my understanding of the inheritance tax that could apply?
AIUI, my mother-in-law has a £325k tax-free IHT allowance, and so does my father-in-law. In the event of one of them dying, their allowance passes to the survivor who ends up with a £650k allowance. BUT... if my mother-in-law gives us this early inheritance and then dies within seven years, am I right in thinking that there's no tax to pay at that point because it's below £325k - but my mother-in-law has effectively used up that portion of her allowance and my father-in-law will end up with a reduced allowance? Is that how it works? Also, I'm assuming that if she survives seven years (which of course we hope she will) that she would keep her £325k allowance intact - is that right?
Can you elaborate on the £11k exemption? That's not something I've heard of.
So far, I understand that going down the liquidation route means that we could use "entrepreneurial relief" (which still makes me chuckle). However, this company existed solely for the purpose of letting the house, so that relief is not available AIUI.
Is the £11k exemption you mentioned something else?
So far, I understand that going down the liquidation route means that we could use "entrepreneurial relief" (which still makes me chuckle). However, this company existed solely for the purpose of letting the house, so that relief is not available AIUI.
Is the £11k exemption you mentioned something else?
It is the personal Annual Capital Gains exemption that every individual gets each year. For tax year 2013/14, this annual allowance is £10,900 per person.
So, if an individual makes a capital gain of £100,000, they will pay Capital Gains Tax on a gain of £89,100 (£100,000 less the £10,900).
If, however, an asset owned by THREE individuals makes a gain of £100,000, the gain is divided up three ways - each individual having a gain of £33,333 against which they can each offset their personal allowance of £10,900 - leaving £22,433 taxable for each person.
This means that overall, of the gain of £100,000, only £67,300 will be subject to CGT.
So, if an individual makes a capital gain of £100,000, they will pay Capital Gains Tax on a gain of £89,100 (£100,000 less the £10,900).
If, however, an asset owned by THREE individuals makes a gain of £100,000, the gain is divided up three ways - each individual having a gain of £33,333 against which they can each offset their personal allowance of £10,900 - leaving £22,433 taxable for each person.
This means that overall, of the gain of £100,000, only £67,300 will be subject to CGT.
Eric I notice you mentioned that you could choose to take money out of a company as dividends and do this over an extended period to avoid paying tax at the higher rate. I'm not an accountant but I thought this wasn't allowed, i.e. if the company is not earning any money or trading for a period of 6 months or more then you can't just keep drawing dividends indefinitely without incurring the wrath of HMRC, is that not right?
Correct - dividends cannot exceed distributable profits IIRC. Pretty sure retained profits form part of this distribution.
Btw the last time we did something similar to a company was through the liquidation / capital gains route in 2005. I think the sum involved was £125k and we were able to bridge 2 tax years for 2 sets of allowances (be careful) based on good advice from the liquidator and our Accountant.
The tax bill was zero and we may have kept some records somewhere
Btw the last time we did something similar to a company was through the liquidation / capital gains route in 2005. I think the sum involved was £125k and we were able to bridge 2 tax years for 2 sets of allowances (be careful) based on good advice from the liquidator and our Accountant.
The tax bill was zero and we may have kept some records somewhere
Dr Mike Oxgreen said:
Wow! As I mentioned, I will strongly encourage my parents-in-law to take professional tax advice, and that right there is compelling evidence that good advice can save a lot of money!
Remember, David, your asset is 2x the one we liquidated, but your indexation will be considerably more as your wife has held the asset for a fair bit longer.I recall one of the techniques we used was to bring other family members into the shareholding to optimise CGT relief, though only spouses benefited further from any indexation in this scenario
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