Understanding Capital Distributions
In this article, we address the question, ‘What are capital distributions?’ and talk through how to wind up your company in the most efficient way possible.
What is the Members Voluntary Liquidation tax benefit?
The main benefit of distributing the company’s assets through members voluntary liquidation is that any funds are paid as a capital distribution, as opposed to income. As a result, any dividends will attract capital gains tax. This is opposed to income tax or dividend tax, based on your income tax band. Accordingly, where shareholders are mostly individuals and there are over £25,000 of assets to distribute, it is generally worth proceeding.
In addition to the above, it is also generally possible to claim entrepreneur’s relief on liquidation. This further reduces the tax rates you would be required to pay on the capital distribution. This relief is available to any shareholders at the time of the company liquidation, who hold in excess of 5% of the voting rights in the company.
The table below shows how much you could save based on a salary of £25,000, with net assets of £100,000, to distribute in a single member company.
|Members Voluntary Liquidation
|Dividends Prior to Dissolution
Dividends as Income
|Tax payable||Tax payable|
|Net proceeds after tax||Net proceeds after tax|
|Possible savings through MVL = £19,675|
What is the HM Revenue & Customs stance?
While the tax benefits may seems too good to be true, HM Revenue & Customs does not view member’s voluntary liquidation as a tax avoidance scheme. Historically, there has been a position whereby the process has been abused. For example, a contractor has set up a new company for each contract and, rather than drawing salary, has simply waited till the end of the contract and liquidated the company, before starting a new contract under a new company.
From April 2016, new changes have come into effect to clamp down on this behaviour. As a result, even if you make a capital distribution through solvent winding up, HM Revenue and Customs may reclassify this as income if you meet all three of the below conditions:
- You are a shareholder eligible for entrepreneur’s relief.
- The main intention was to obtain a tax advantage.
- You have been involved in a similar business within 2 years after the solvent winding up.
This means that it is not wrong to seek the tax advantages of a members voluntary liquidation, but it must be done for the reasons the legislation was originally introduced for. A more in depth look into this can be found here, along with some case studies.
HM Revenue and Customs have also brought forward some other policy changes and other future issues, which you should be aware of in preparing to enter the solvent winding up process.
How does the Members Voluntary Liquidation process work?
In order to claim the members voluntary liquidation tax benefits, you will require the assistance of a licensed insolvency practitioner. Your IP will oversee the process and assist you in the preparation of a Declaration of Solvency. In order to reduce costs, we generally recommend finalising the affairs of the company before commencing the solvent winding up process.
For more information, see our step-by-step guide to the MVL process. Once the company is in liquidation and you have received your distribution, you’ll need to make your application for entrepreneur’s relief on the capital distribution. If you require assistance, this is something your accountant should be able to help with.
Where you meet the eligibility criteria, making capital distributions when winding up your solvent company can make significant savings. However, you should make sure you don’t fall foul of HMRC’s rules and get caught out. If you are unsure if you can benefit, contact our business rescue experts, and seek independent tax advice from your accountant, particularly in seeking entrepreneurs relief on liquidation.