In the past, many shareholders in limited companies have benefitted from an HM Revenue and Customs (HMRC) concession called ESC C16.
The fundamental principle behind ESC C16 is that it provides a company with a mechanism for winding-up a company, without the need to incur the expense of a formal liquidation. Amounts distributed under ESC C16 are treated as a capital distribution in the same way as under a formal liquidation, whereas distributions from a company, other than in the course of a formal liquidation are treated as an income distribution and taxed in a similar way to dividends.
Obtaining capital treatment in respect of such a distribution will generally be preferable to income treatment due to the favourable capital gains tax regime that exists, particularly in view of the fact that a capital distribution under ESC C16 will be eligible for entrepreneurs’ relief, provided that the relevant criteria are met.
In a nutshell, ESC C16 provided a cost effective alternative to a formal liquidation, which might typically cost £5,000 – £7,500, while enabling the same tax treatment.
Provided certain conditions were met and assurances were given, HMRC have shown themselves willing to authorise this treatment.
However, changes are coming. On 6 December 2011 the government decided to legislate ESC C16 in the Enactment of Extra-Statutory Concessions Order 2012.
The effect of this is that the concession is it currently exists will change radically from 1 March 2012. With effect from this date, the limit for making distributions in an informal winding-up and achieving capital rather than income treatment thereof will be £25,000. Any distributions beyond that level will be treated as dividends in the hands of the shareholders, leading to an additional tax liability for higher-rate taxpayers. If a company enters into formal members’ voluntary liquidation, then no £25,000 limit applies and all distributions will be treated as capital gains. The proposed reforms will undoubtedly have a detrimental effect on the owners of SMEs, who are seeking to wind up their companies.
A business with distributable reserves in excess of £25,000 will now be faced with a choice of either:
- to accept ‘dividend’ treatment for tax purposes for distributions in excess of £25,000
- appoint a formal liquidator, with the additional costs that this will incur, in order to obtain capital treatment on the full distribution.
If you are likely to affected by this change, please contact us immediately for further advice.