Introduction
In the last two chapters, we have studied the computation of taxable total
profits and the corporation tax payable.
In this chapter, we look at some of the consequences of placing a company into
administration or liquidation.
We also consider the tax consequences which accrue when a company
purchases its own shares.
In the next chapters, we will consider further aspects of corporation tax,
starting with losses.
Study guide
| Intellectual level | ||
| 4 | Corporation tax liabilities in situations involving further overseas and group aspects and in relation to special types of company, and the application of additional exemptions and reliefs | |
| (b) | The scope of corporation tax: | 3 |
| (iii) | Identify and evaluate the significance of accounting periods on administration or winding up | |
| (iv) | Conclude on the tax treatment of returns to shareholders after winding up has commenced | |
| (v) | Advise on the tax implications of a purchase by a company of its own shares |
Exam guide
If the exam includes a question which includes the purchase by a company of its own shares you must be careful to consider whether the capital treatment will apply, and if so, whether it is beneficial. You must be prepared to advise whether any variation to a suggested purchase would be beneficial.
The topics in this chapter are new.
1 Winding up 12/12
FAST FORWARD
A new accounting period (AP) begins when a winding up commences. Thereafter APs are for 12 months until the winding up is complete. Distributions made during a winding up are capital. There are special rules in respect of accounting periods when companies go into administration.
1.1 Liquidation
A company in liquidation is chargeable to corporation tax on the profits arising during the winding up.
An accounting period ends and a new one begins when a winding up commences. Thereafter, accounting periods end only on each anniversary of the commencement of winding up, until the final period which ends when the winding up is completed. A cessation of trade after a winding up has commenced will not bring an accounting period to an end.
1.2 Example: accounting periods on a winding up
Totterdown Ltd, a company with a 31 December year end, ceased trading on 10 June 2014. The members passed a resolution to wind up the company on 12 September 2014 and the winding up was completed on 15 January 2016. From 1 January 2014 the accounting periods will be:
1.1.14 – 10.6.14 To the date trade ceased.
11.6.14 – 11.9.14 The commencement of a winding up brings an AP to an end.
12.9.14 – 11.9.15 Anniversary of commencement of winding up.
12.9.15 – 15.1.16 Final AP ends when winding up complete.
1.3 Administration
The Enterprise Act 2002 provides for companies to go from liquidation to administration and for assets to be distributed without a formal liquidation. In such cases, the following rules apply relating to when an accounting period will be deemed to end.
A new accounting period begins when a company goes into administration. An accounting period ends when a company ceases to be in administration and a new accounting period begins when a company moves out of liquidation into administration.
In contrast to the position in liquidation, where the corporation tax accounting periods are then annual from the date of appointment of the liquidator, there is no requirement to change the accounting reference date of the company. Therefore, future accounting periods in administration follow the original accounting dates.
1.4 Example: accounting periods in administration
Company A has a normal accounting date of 31 December annually. An administrator is appointed on
17 August 2015. As a result, for corporation tax purposes the company’s accounting periods will be 1 January to 16 August 2015 before administration and 17 August to 31 December 2015 after the appointment of the administrator. Accounting periods will then be 31 December annually while the company remains in administration.
When an administration ceases, a new accounting period must start for tax purposes, whether the company comes out of administration and recommences to trade normally or goes from administration into winding up.
1.5 Example: administration to liquidation
Company A remains in administration for 14 months and a liquidator is appointed on 10 October 2016.
The accounting period in administration will therefore be 1 January 2016 to 9 October 2016. The next accounting period will be the first liquidation accounting period, 10 October 2016 to 9 October 2017. Accounting periods will then be annually to 9 October until the company ceases to be in liquidation (either by striking off or returning to administration).
When a company comes out of liquidation into administration, a new accounting period must start. Again, this permits proper computation of the tax due as an expense of liquidation or administration.
1.6 Example: liquidation to administration
Following the above example, company A remains in liquidation for only three months, and a court order appointing a new administrator is granted on 14 January 2017.
The accounting periods are therefore 10 October 2016 to 13 January 2017 in liquidation, then 14 January to (presumably) 31 December 2017 in administration.
If the company had been in liquidation for some time, so that liquidation accounts had been prepared to 9 October for a number of years, the post-liquidation accounting periods would end on 9 October annually unless the administrator changed the accounting reference date.
1.7 Significance of accounting periods
The date on which an accounting period ends will affect the accounting periods into which income and capital profits and losses fall. This may prevent relief being obtained in the most beneficial way. For example trading losses of the current year or carried back can be set against other income or gains, whilst trading losses carried forward can only be set against trading profits. Capital gains may therefore be taxable if made after trade ceases even though there may be unrelieved trading losses.
1.8 Distributions
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1.8.1 Distributions during a liquidation
Distributions made after the liquidation has started are capital and treated as a part disposal of shares in the hands of the shareholder. This is the position even if the distributions include accumulated net profits of the company out of which dividends could be paid.
Where a company has distributable profits, it may be preferable to pay these out as a dividend before the liquidation starts. Any such distribution will be chargeable to income tax on a shareholder who is an individual.
Assets distributed in specie (ie in their existing form rather than sold and distributed as cash) by the liquidator are deemed to be disposed of at market value. Where the assets are chargeable assets, any chargeable gain arising is charged to corporation tax in accordance with the normal rules. Consequently there is double taxation on assets distributed to shareholders in the liquidation since the asset distribution will also be treated as a capital distribution in the hands of the shareholders. However, disincorporation relief may be available to avoid this double taxation (see earlier in this Text).
1.8.2 Distributions outside a formal winding up
Ordinarily, assets distributed outside a formal winding up represent an income distribution. This might occur prior to an application to strike the company off the Companies Register which is a cheaper way of ending a company’s existence than a formal liquidation.
However, under limited circumstances, distributions made in anticipation of such an application to strike off a company, are treated as capital receipts of the shareholders for the purpose of calculating any chargeable gains arising to them on the disposal of their shares. This may or may not be advantageous to the shareholders.
The conditions that have to be met for this treatment to apply are:
- at the time of the distribution, the company intends to secure (or has secured) payment of any sums due to it, and intends to satisfy (or has satisfied) any debts or liabilities of the company, and
- the amount of the distribution (or total amount of distributions if there is more than one) does not exceed £25,000.
If the company has not been dissolved two years after making the distribution, or has failed to secure payment of all sums due to it, or to satisfy all its debts and liabilities, then the capital treatment does not apply.
An alternative method for distributing assets outside a formal winding up is to use the provisions of Companies Act 2006 to reduce the capital of the company prior to striking off. A distribution made as a result of such a capital reduction will automatically be a capital distribution and so the above conditions for the capital treatment do not have to be met.
1.9 Other points
The appointment of a receiver, a manager or administrator has no tax consequences, apart from determining accounting periods as discussed above.
When a company is put into liquidation, it loses beneficial ownership of its assets. If the company to be liquidated is a parent company, it will therefore lose its group relationship with its former subsidiaries. No group relief (see later in this Text) will be available to any of the companies in the former group. By contrast, a group continues to exist for chargeable gains purposes (see later in this Text), notwithstanding the commencement of liquidation.
2 The purchase by a company of its own shares
12/10, 6/13
| A purchase of a company’s own shares may be taxable on the vendor shareholder as the receipt of an income distribution or (if certain conditions are satisfied) as capital proceeds. |
One of the competencies you require to fulfil Performance Objective 17 Tax planning and advice of the PER is to review the situation of an individual or entity advising on any potential tax risks and/or additional tax minimisation measures. You can apply the knowledge you obtain from this section of the text to help to demonstrate this competence.
2.1 Tax treatment for vendor shareholder
2.1.1 Income treatment
If a company buys its own shares for more than the amount originally subscribed, general tax rules state that there is an income distribution of the excess of the amount received over the subscription. This is called the income treatment.
Recipients of such distributions are treated in the same way as recipients of ordinary dividends. This means that basic rate taxpayers have no further tax to pay and higher rate and additional rate taxpayers must pay further tax.
The remainder of the proceeds (ie those not treated as income) will be a capital receipt. Thus there will also be a disposal of the shares by the vendor shareholder for capital gains tax. If the vendor shareholder originally subscribed for the shares, there will be no gain or loss, since the shareholder is merely getting back the subscription cost as the disposal proceeds. If, however, the vendor shareholder acquired the shares other than by subscription (for example by purchase), a gain or, more usually, a loss may arise. The proceeds for the disposal is equal to the original subscription cost, since this is the capital amount received by the shareholder on the purchase of the shares by the company.
2.1.2 Example
Jess bought 5,000 shares in Pink Ltd in July 2013 for £3 per share. The original subscription cost for these shares was £1 per share. Pink Ltd has agreed to repurchase these shares from Jess for £10 each in December 2015.
If the income treatment applies, Jess will receive a distribution from Pink Ltd as follows:
£
Cash received £10 5,000 50,000
Less subscription price (capital) £1 5,000 (5,000) Net distribution subject to income tax 45,000
Jess will also have a capital gains tax allowable loss on his disposal of Pink Ltd shares as follows:
£
Proceeds: return of subscription £1 5,000 5,000 Less cost of shares for Jess £3 5,000 (15,000) Allowable loss (10,000)
2.1.3 Capital treatment
When an unquoted trading company (or the unquoted parent of a trading group) buys back its own shares in order to benefit its trade, and certain other conditions are satisfied (see section 2.2), the capital treatment automatically applies. This means that the distribution is treated as a capital receipt for the disposal of the shares by the shareholder rather than as an income distribution.
Under the current CGT rules, the capital treatment may result in less tax being payable, particularly if the disposal qualifies for entrepreneurs’ relief, than if the income treatment applies.
Walter subscribed for 1,000 shares in BB Ltd, an unquoted trading company, at £1 per share. BB Ltd has agreed to repurchase Walter’s shares for £15 each in March 2016.
Walter has taxable income of £40,000 in 2015/16. He has made no other gains in 2015/16.
Show the tax payable by Walter if:
- The income treatment applies.
- The capital treatment applies and either:
- a claim is made for entrepreneurs’ relief; or
- a claim is not made for entrepreneurs’ relief.
(a) If the income treatment applies, Walter will have a net distribution as follows:
£
Cash received £15 1,000 15,000
Less subscription price (return of capital) £1 1,000 )
Distribution Income tax £14,000 25% (note) £3,500
Note: remember from earlier in the Text, only the extra tax needs to be calculated, not Walter’s full income tax liability.
For capital gains tax, there will be no gain or loss:
£
Proceeds: return of subscription £1 1,000 1,000
Less cost £1 1,000 (1,000) 0
(b) If the capital treatment applies, the gain will be as follows:
£
Cash received £15 1,000 15,000
Less cost £1 1,000 (1,000)
Gain 14,000
Less annual exempt amount (11,100)
Taxable gain 2,900
Capital gains tax
(i) If claim made for entrepreneurs’ relief £2,900 10% 290
2.2 Conditions for capital treatment to apply
The company purchasing its own shares must be an unquoted trading company (or the unquoted parent of a trading group). The trade must not consist of dealing in shares, securities, land or futures.
The ‘benefit to the trade’ test will be satisfied where:
- A dissident and disruptive shareholder is bought out
- The proprietor wishes to retire to make way for new management
- An outside investor who provided equity wishes to withdraw his investment A shareholder dies and his personal representatives do not wish to retain his shares.
The conditions to be satisfied by the vendor shareholder are as follows.
- The shareholder must be resident in the UK when the purchase is made
- The shares must have been owned by the vendor or his spouse/civil partner throughout the five years preceding the purchase. This is reduced to three years if the vendor is the personal representative or the heir of a deceased member and previous ownership by the deceased will count towards the qualifying period.
| The period of ownership will often be an essential point in an exam question. For example, you may be given a scenario where the purchase can be timed either before the five year deadline, or after it, and asked to show the taxation consequences in each case. |
Exam focus point
- The vendor and his associates must as a result of the purchase have their interest in the company’s share capital reduced to 75% or less of their interest before the disposal. Associates include spouses/civil partners, minor children, controlled companies, trustees and beneficiaries. Where a company is a member of a group the whole group is effectively considered as one for this test.
- The vendor must not be connected with the company or any company in the same 51% group after the transaction. A person is connected with a company if he can control more than 30% of the ordinary share capital, the issued share capital and loan capital or the voting rights in the company.
Henry holds 300 of H Ltd’s 1,000 issued ordinary shares.
Will the capital treatment apply if the company buys 80 shares back from him?
Total shares Held by Henry
Initially 1,000 300
Less repurchased (and cancelled) (80) ( 80)
920 220
Henry originally had a 30% interest. This is reduced to 220/920 = 23.9%, a reduction to 23.9/30 = 79.7% of his original interest. For a capital gain to arise, he must sell at least 97 shares back to H Ltd, thus reducing his percentage holding below 30% 75% = 22.5%.
2.3 Other points
The capital gains treatment is not given if a main objective is tax avoidance.
As seen in the above example, any shares repurchased by the company must usually be cancelled. They cannot be re-issued.
The capital treatment is also available where a company purchases shares to enable the vendor to pay any inheritance tax arising on a death (the ‘benefit to the trade’ test and the other conditions in section 2.2 do not then apply).
Companies considering the purchase of their own shares may seek HMRC clearance to ensure that the capital treatment applies.
If there is a repurchase by an employer company of employee shareholder shares (see earlier in this Text) and the capital treatment applies, the usual exemption applies for gains on the first £50,000worth of such shares. If there is a repurchase by an employer company of employee shareholder shares and the capital treatment does not apply, there would usually be a charge on the distribution under the income treatment described above. However, there is no charge to income tax on such a distribution in relation to the employee shareholder shares if a gain on them would have been exempt had the capital treatment applied, provided that the shareholder is not an employee or office holder of the company at the time of the disposal. In simple terms, the capital gains exemption is transferred to the income distribution.
Chapter roundup
| | A new accounting period (AP) begins when a winding up commences. Thereafter APs are for 12 months until the winding up is complete. Distributions made during a winding up are capital. There are special rules in respect of accounting periods when companies go into administration. |
| | A purchase of a company’s own shares may be taxable on the vendor shareholder as the receipt of an income distribution or (if certain conditions are satisfied) as capital proceeds. |
Quick quiz
- Inca Ltd makes up accounts to 31 March. The company goes into liquidation on 1 November 2015 and cease to trade on 31 December 2015. The company is finally wound up on 31 July 2016. What are the accounting periods from 1 April 2014?
- Does the appointment of an administrator affect a company’s accounting periods?
- What is the impact (if any) on a company accounting period when a company moves out of liquidation into administration?
- Are distributions made during a liquidation treated as capital or income distributions?
- A company is about to make an application to be struck off the Companies Register. It has secured payments of sums due to it and satisfied its debts and liabilities. The company has surplus cash of £20,000 to distribute to its shareholders. How will the distribution be treated for tax purposes in relation to the shareholders?
- When a company buys its own shares, what potential tax consequences may occur for the shareholder whose shares are being bought?
Answers to quick quiz
- 1 April 2014 – 31 March 2015
1 April 2015 – 31 October 2015
1 November 2015 – 31 July 2016
- A new accounting period begins when a company goes into administration. An accounting period ends when a company ceases to be in administration.
- A new accounting period begins when a company moves status from liquidation into administration.
- Distributions are capital distributions and are treated as a part disposal of the shares in the hands of the shareholder.
- The distribution will be treated as a capital receipt for the shareholders as the conditions for payments and debts have been satisfied and the amount of the distribution does not exceed £25,000.
- If a company buys its own shares from a shareholder and pays more than the amount originally subscribed, the general tax rules treat the excess amount paid as a distribution (taxed in the same way as an ordinary dividend) made by the company to the shareholder. Income tax applies to the shareholder recipient of the distribution. There will also be a disposal of the shares for capital gains tax purposes: the proceeds will be the original subscription for the shares.
If certain conditions are met, however, the full amount paid by the company for a purchase of own shares will be treated as capital proceeds for the shareholder and capital gains tax will be due on the gain. A claim may be made for entrepreneurs’ relief on the disposal.
| Number | Level | Marks | Time |
| Q26 | Introductory | 10 | 19 mins |
