Chapter 21 Companies – special situations Flashcards
1.1 Company purchase of own shares.
A company may buy its own shares back from a shareholder. The company must have sufficient distributable reserves to do this, if the company is public. A private company may still be able to buy back shares as long as the directors make a declaration of solvency. The extent the payment exceeds the available reserves is known as a permissible capital payment. When shares are repurchased, they are cancelled.
For a corporate shareholder, the capital route always applies. A gain/loss is calculated on disposal of the shares as usual, unless SSE applies.
For an individual either the capital or income route will apply. The capital route is a normal gains calculation. The income route is separated between a capital gain/loss using the original subscription price of the shares as proceeds . The income element is the difference between the proceeds and subscription price is taxable as a dividend.
If capital route conditions are met, then the capital route must be followed. The shareholder can plan to ensure the conditions are met if the capital route is preferable, similarly, the shareholder can plan to fail the conditions if the income route is preferable.
1.2 Purchase of own shares – capital route conditions
Capital route is compulsory if:
- The repurchase is in order to raise cash to pay IHT.
o The person selling the shares must use virtually all of the proceeds to pay an IHT liability arising on death.
o IHT could not otherwise be paid without causing hardship.
o The payment of tax must be within two years of death.
- The repurchase is for the benefit of the trade (all conditions must be met)
o Company must be an unquoted trading company or holding company of a trading group.
o Company must be able to demonstrate that the repurchase is for the benefit of the trade and not part of a scheme to avoid tax. Examples are buying out retiring directors, buying out dissident shareholders and shareholders has died, and beneficiaries do not want shares.
o The individual must be resident in the UK.
o Have owned the shares for five years prior to the repurchase (3 if inherited). The ownership of spouses can be added to determine if the period is met.
o Here must be a substantial reduction of the individual’s shareholding after the buyback. The shareholder must end up with no more than 30% of the shares in the company, and no more than 75% of the previous percentage holding.
2.1 Dividend stripping
Involves extracting profits from a company in the form of a dividend prior to the sale of shares in that company, to lower the gain when the company is sold. This is allowed as long as dividends are paid out of normal taxed profits (distributable reserves), otherwise HMRC may attack the dividend as a form of value shifting.
The individual shareholder is taxed on the dividend income using the dividend rates of 8.75%/33.75%/39.35%. The individual may prefer the gain however to utilise capital losses, AEA or 10%/20% CGT rate.
For the corporate shareholder, pre-sale dividends are likely tax free. The shares can be sold for a lower price resulting in a small gain. This would only be beneficial if the disposal did not qualify for SSE.
3.1 Tax implications of administration and liquidation
For an administrator a new accounting period begins on the date the administrator is appointed. Future accounting periods end on the normal accounting date and when the company ceases to be in administration.
The liquidator becomes responsible for the tax obligations for the company. The liquidator’s fees are not allowable costs when calculating taxable trading profits of the company. The costs of termination payments to employees made redundant are allowable, but payments in excess of statutory redundancy amount are only allowable deductions up to another three times this amount.
A new accounting period will start when the liquidator is appointed and will end on the earlier of 12 months or the end of the winding up process. Future distributions to shareholders will be capital.
If a parent company is in liquidation, then group relief stops (gains group still remains effective until date of the final distribution). In an insolvent liquidation the deductions allowance is increased by the net chargeable gains in the period. This means bf capital losses can be offset in full in a winding-up period. Gains transferred from another group company are not included in the net gains figure for this purpose.
3.2 Cessation of trade
This will end of AP unless the liquidator has been appointed. Balancing adjustments arise on disposal of plant and machinery that has attracted CA. trading losses need to be considered as carry forward under s45 is not an option. Options include current year, then carry back 12 months against total income and gains, group relief, then terminal loss relief (losses last 12 months carried back 36 months from start of AP of the loss, losses carried forward can also be carried back 36 months from the end of the AP of cessation).
On disposal of the company’s assets gains/losses will arise on chargeable assets disposed of and trading profits on IFAs held as trading assets. Company must deregister for VAT as they have ceased to make taxable supplies. If the company was a close company before the cessation of trade, it will become a close investment holding after. Participators can no longer claim income tax relief on loans taken out to purchase shares in that close company.
4.1 Tax planning on winding up a company.
If a company enters voluntary liquidation tax planning can be undertaken to sell assets to maximise use of losses and make distributions to shareholders in most tax efficient way. It is only possible to carry forward against total profits if the trade has not ceased or become small or negligible. Therefore, the company should sell assets prior to the appointment of liquidator to use any remaining trading losses.
Timing of distribution impacts how shareholders are taxed. Upon pre-appointment of liquidator, it is taxed as a dividend. After the appointment, it is treated as a capital distribution and a gain is calculated where proceeds equal the distribution.
4.2 Striking off.
This cannot be done until three months after the cessation of trade. No liquidator is appointed, in theory there is not an opportunity for distributions to be treated as capital. However, where the combined amount paid to shareholders is less than £25,000, the shareholders can elect to treat the amount received as capital rather than income.
Distributions from undistributable reserves (share capital and premium) are not permitted unless the company is undergoing a formal liquidation. Striking off should be considered as an alternative if distributable reserves are less than £25,000.
