the tell-tale signs a contractor may need to dissolve their limited company
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John Bell, Director and founder of licensed insolvency firm, Clarke Bell has kindly offered to provide some guidance on this sticky subject.
Dear Freelancer’s Couch,
I am weighing up the pros and cons as to whether I should close down my limited company. I am starting to think it is no longer cost-effective with off-payroll working/IR35 blanket bans if the majority of my work is going to be through an agency PAYE or umbrella company for the foreseeable future. I have so many questions…
What signs should I look for to gauge if it’s time for me to close down my limited company?
Factors (signs for cost comparison) that would determine if it is no longer financially viable to keep my limited company going
If you can’t pay your company’s bills (e.g. corporation tax, accountant’s fees) when they are due, this is a sign that your company is having cash flow problems.
A lot of freelancers have seen their income fall substantially due to the new IR35/Off-Payroll rules, as well as from the impact of COVID-19 and Brexit. For many of them, their outgoings have not changed – which means that they are now experiencing cash flow problems and have tax bills looming on the horizon.
In this case, you should take expert advice from your accountant and/or an insolvency practitioner.
Options on closing it down (e.g. company dissolution v. Members’ Voluntary Liquidation)
If a contractor is planning on moving into an employee/PAYE role, retiring or pursuing some other life or career plan then a Members’ Voluntary Liquidation (MVL) is likely to be the most tax-efficient way to close down their solvent company – particularly if the assets of a company are more than £25,000.
An MVL is an HMRC-approved process, and a licensed Insolvency Practitioner must be appointed for the liquidation. While it may have a negative-sounding ring to it – with terms like ‘liquidation’ and ‘Insolvency Practitioner’ – there is nothing negative about it. Quite the opposite, in fact. By placing a company into an MVL, it is a clear illustration that someone has been running a successful company.
An MVL allows a contractor to draw any remaining profit as a dividend, paying income tax on the dividend amount.
With the help of a licensed Insolvency Practitioner who will liquidate a company, the reserves can then be distributed as capital, which are then subject to capital gains tax (CGT) at either 18% or 28%.
Through an MVL, a contractor can also take advantage of Business Asset Disposal Relief (known as Entrepreneurs’ Relief before 6 April 2020). If someone qualifies for this relief, this can mean that CGT will be paid at a rate of 10% on qualifying assets, which can translate into considerable tax savings. Each shareholder of the limited company could also benefit from a tax-free allowance of £12,300, the Annual Exempt Amount. If there are multiple shareholders, this can be highly efficient.
To ascertain eligibility for Business Asset Disposal Relief / Entrepreneur’s Relief, contractors should speak to their Accountant and look at the Gov.uk website.
Dissolving your company is an alternative as long as your company meets the following criteria:
- It hasn’t changed its name for the last 3 months
- It hasn’t traded or sold off any stock for the last 3 months
- It hasn’t been threatened with liquidation and doesn’t have any other agreements in place with creditors like a Company Voluntary Arrangement (CVA)
Why would a company director choose to dissolve their company?
There are a variety of reasons why a company director might choose to dissolve their company.
They might be looking to:
- The business has fulfilled its purpose
- There is no need for it to stay open
However, it is important to be aware that the Insolvency Service has now gained the powers to investigate the directors of dissolved companies to make sure that the process is not being abused. (Previously, the Insolvency Service was only allowed to investigate directors of live companies or those going through an insolvency process.) This makes it more important than ever to only use this option when it is correct to do so.
What if my company has been affected by COVID?
In the aftermath of Covid-19, as well as the new IR35 rules, some limited company directors are struggling financially. If the company is insolvent (i.e. it can’t pay all its bills), the most common option is to place the company through the Creditors’ Voluntary Liquidation (CVL) process. Liquidating a company voluntarily via this method, rather than a compulsory liquidation, is an effective way of protecting the reputation of the directors and dealing with the company’s debts, while fulfilling all the directors’ legal obligations.
When a CVL is the best option, an Insolvency Practitioner will need to be appointed who will guide company directors through the process. They will work with the directors, and their accountant, to collect all the necessary information to proceed with the liquidation. As soon as the CVL process starts, the company will need to stop trading.
How much is it going to cost me to close down my business?
If you are closing your company with the liquidation process, you need to be aware that there is a wide range of fees charged by liquidators. Solvent liquidations (MVLs) start from around £1,000 – while insolvent liquidations (CVL) start from around £2,000.
Some Insolvency Practitioners are transparent regarding their fees and clearly show them on their website. This saves you the time and effort of having to contact the Insolvency Practitioner to find out what they are going to charge you.
For some directors, price isn’t really a factor in their decision-making process. They are happy to pay whatever they are charged to close their company.
However, a lot of directors don’t like to needlessly pay more than they have to. Consequently, the fee a liquidator charges will be a key factor in their decision as to who they will appoint. That said, as we all know, cheapest isn’t necessarily best.
Some people worry that a low price means they will get a poor service. However, when a liquidator has completed thousands of liquidations, they will have developed efficient processes which enables them to keep the price low.
When an Insolvency Practitioner is dealing with a large volume of liquidations, they are likely to have obtained a reduced price for the necessary disbursements. They should be charging the disbursements at cost, which will keep the overall cost of the liquidation down.
Also, when an Insolvency Practitioner has low overheads (e.g. not being based in the relatively expensive London area or having multiple offices), this should be reflected in their fees.
What tax liabilities will I have to pay if I close down my contractor business?
We would always recommend that you speak to your accountant regarding your taxes. This is a complicated aspect of any business, including when a company is closing down.
A key thing to ask them is whether you are eligible for and can benefit from Business Asset Disposal Relief.
Can I use any proceeds (if any left) of the business and place them in a tax-efficient source (pension contribution) or into a new investment venture?
If you have closed down your company with a Members’ Voluntary Liquidation, the shareholders will have the value of their company assets transferred to a personal bank account.
It is then up to you what you do with those funds – but, again, we would recommend you seek expert advice as to what to do with those funds, either from your accountant and or an Independent Financial Advisor.
I know this may sound a little self righteous, but when I first started contracting and had a “real” physical accountant, he gave me a pretty robust instruction in the legalities of a limited company. Key points were to never forget that although I might own the Company, it was legally a separate entity to me, and the need ensure its finances were “by the book”. In other words, funds to pay taxes, etc., have always been set aside at the time, ready for when they come due. Sadly, I have come across many over the years who treat their ltd company like an extra personal bank account with little regard to liabilities, hoping that their accountant can make sense of it for the annual accounts. I’ve seen several run into trouble as a result.
As for whether you should close down a ltd company, if you move to inside IR35 roles, there is no need to do so if you don’t want to. If all outgoings are dealt with, it can simply be made dormant for a time. If it doesn’t trade, the legal reporting requirements are minimal. There’s not even a need to retain accountant services. I did this myself for several years, when I had a consultancy role with a company as an employee.