Insights
Insights 07.10.19 Author: Toby Cooper

HM Revenue & Customs (HMRC) calling the shots

Insights 07.10.2019 Author: Toby Cooper

Paid your corporation tax on time? Think again.

Following decisions arising from Re Lehman Brothers International (Europe): Lomas v Burlington Loan Management Ltd [2015] EWHC 2269 (Ch)., HMRC have adapted their rules, resulting in statutory interest accruing on any pre-liquidation corporation tax paid subsequent to a company entering liquidation.

What does this mean?

For non-large companies, Corporation Tax (“CT”) is payable 9 months and 1 day following the end of the accounting period and, as such, historically, statutory interest on pre-liquidation tax liabilities was only accrued if payment was made after this due date, i.e. on late payments.

Now, however, companies placed into liquidation prior to settling their outstanding pre-liquidation CT liabilities, regardless of whether they are settled in advance of the tax due date, will be required to pay statutory interest, at 8% per annum, from the period the company entered liquidation to the date the tax liability is settled.

Illustration

Assume an accounting year end of 31 March 2018, with a CT due date of 1 January 2019.

The Shareholder(s) place the company into liquidation on 1 May 2018, with tax due on the final period up to the date of liquidation of £100,000. The Liquidator(s) settle the pre-liquidation tax liability on 31 July 2018, well in advance of HMRC’s deadline of 1 January 2019. Despite the tax being paid prior to the deadline, HMRC will now charge statutory interest, at 8%, on the full £100,000 for the period from 1 May 2018 (liquidation date) to 31 July 2018 (payment date), equating to an additional charge to the company of £1,995, for not having settled the liability prior to entering liquidation.

Retrospective Application

Going forward, this is a relatively simple issue to resolve. Provide the correct advice to directors / shareholders by advising them to settle their tax liabilities prior to winding up the company, thus avoiding any unnecessary statutory interest.

However, HMRC’s stance is to be applied retrospectively. Therefore, statutory interest will be applicable in respect of all existing / active Members’ Voluntary Liquidations, where the pre-liquidation tax liabilities were settled after the appointment of Liquidators.

In many instances, this can lead to significant, unexpected amounts of statutory interest being payable to HMRC, which will force Liquidators to abandon paying out capital distributions to shareholders and, in the worst scenarios, require them to call upon the indemnities provided by shareholders at the commencement of the liquidations, should one exist, to ensure that funds are available to settle the statutory interest without rendering the company insolvent.

What’s the message?

Ensuring that Directors are made aware of the importance of settling any outstanding liabilities, most crucially to HMRC, prior to placing their business into liquidation, can potentially save thousands in unnecessary additional charges.

All in all, managing the expectations of the shareholders will be the order of the day for many current Liquidators. But this will not be welcome news to company shareholders, where the capital distributions may be significantly diminished as a result of these decisions.

No Gain. More Pain.

In addition to HMRC’s policy change relating to statutory interest, HMRC has tightened up on the tax treatment on the repayment of overdrawn Director’s Loan Accounts (“DLA”), particularly relevant in owner-run businesses.

What’s going on?

Generically, companies are placed into Members’ Voluntary Liquidation (“Solvent Liquidation”) to enable shareholders to benefit from the lower tax rates afforded via capital distributions on the winding up of a company, i.e. Entrepreneur’s Relief (“ER”) at 10%, or Capital Gains Tax (“CGT”) at 20%, if ER is not applicable. This is in stark contrast to the 32.5% (higher rate) or 38.1% (additional rate) income tax which is payable on dividends declared prior to winding up in the ordinary course of business.

In many Solvent Liquidations, the assets remaining in the company are cash at bank and, quite commonly, an overdrawn DLA. Historically, the Joint Liquidators would distribute the beneficial interest in the DLA in specie (i.e. non-monetary distribution) to the shareholders of the company, which would have then been taxable as a capital distribution at 10% (or 20% if ER is not applicable).

However, HMRC has toughened its stance to say that, going forward, a distribution in specie of a DLA will be treated as income for tax purposes, taxable at 32.5% (higher rate) or 38.1% (additional rate).

What does this mean?

In order for shareholders to benefit from the tax advantages of placing their company into Solvent Liquidation, they will need to ensure that any overdrawn DLA’s are repaid, in full, prior to placing the company into liquidation. This way, the distribution of the cash at bank, via a Solvent Liquidation, will be treated as a capital distribution for tax purposes, representing a tax saving to the shareholders of up to 28.1%.

Illustration

ABC Limited has an overdrawn DLA of £100,000 and the shareholders wish to wind up the company and distribute the assets of the company in the most tax efficient way possible.

Scenario 1:

Place the company into Solvent Liquidation and distribute the beneficial interest in the overdrawn DLA in specie to the shareholders.

This distribution to the Shareholder will be treated as income for tax purposes and will attract tax payable at 32.5% (higher rate) or 38.1% (additional rate), dependent on the income levels of the Shareholder during the year.

As such, tax on the distribution will be payable of either £32,500 or £38,100.

Scenario 2:

Once the Director(s) have repaid their overdrawn DLA’s, place the company into Solvent Liquidation and distribute the cash at bank as a capital distribution.

In this scenario, the distribution of cash will be treated as a capital distribution and, as such, will attract tax payable at 10% (or 20% if ER is not applicable).

As such, tax on the distribution will be payable of either £10,000 or £20,000.

So, all in all, by settling the DLA prior to placing the company into Solvent Liquidation, the Shareholder(s) will receive a tax saving of between £22,500 and £28,100.

What’s the message?

Ensure that Directors are informed, particularly in circumstances of owner-run businesses, that they should seek to repay any overdrawn DLA prior to placing the company into Solvent Liquidation.

This may not be possible where the Director does not have the funds to make the repayment. However, even a repayment in part would lead to substantial tax savings at the end of the day.

Failing that, our advisors at CBW may be able to assist with introductions to funders, who may be willing to provide the necessary short-term access to funds.