Contractors – how to close your company tax efficiently

With IR35 and many people now re-evaluating what they want from life, post pandemic, many contractors are closing their companies. If you’re a contractor that wants to close down their limited company, then it is worth seeking advice as to the most tax efficient way to do this. What you shouldn’t do is merely close your limited company or cease trading without thought as this will give you issues around tax and accessing your business bank account.

The two main ways to close a limited company are:

1. Members’ voluntary liquidation.
2. An informal or voluntary strike-off.

You could also consider making your limited company dormant if you think you may want to use it again in the future.

This blog covers options if you are running a solvent company. Find out which of these options is most tax-efficient and suitable for you and your company – and what the alternatives might be.

Reasons why contractors are closing limited companies

With IR35 changes and post pandemic changes, you may now be considering closing your limited company because:

• You are caught inside IR35, and contracting isn’t as lucrative.
• You are taking a permanent role as an employee.
• You have decided to retire.
• You have decided to change industries / roles.

With IR35 / Off-payroll reforms and clients employing contractors via umbrella companies, as a contractor, you may no longer need your own limited company.

Finding the most tax efficient options to close a limited company

When closing down a limited company, a contractor could take any remaining profit as a dividend. However, you will pay tax on the dividend amount at the normal rate.

If you decide to liquidate your company using a licenced insolvency practitioner then your remaining reserves will be distributed as capital and subject to Capital Gains Tax (CGT).

You could use and MVL and one of the benefits of using an Members Voluntary Liquidation (MVL) is that it utilises Entrepreneurs’ Relief that will potentially attract a lower rate of tax.

What is a MVL?

MVL stands for Members Voluntary Liquidation. A Members Voluntary Liquidation (MVL) is the formal process to wind up the affairs of a solvent company. A solvent company is one that has more assets than liabilities and can pay off all its debts.

If you’re looking to close your limited company and you have cash reserves over £35,000, you could extract the profits whilst paying tax at a rate of just 10%. This can be done using a Members’ Voluntary Liquidation (MVL). This allows you to close your limited company in the most tax efficient manner.

Benefits of a Members Voluntary Liquidation (MVL)

One of the big benefits of using an MVL is that it utilises Entrepreneurs’ Relief. Providing you qualify, this could mean you pay CGT at a rate of just 10% on qualifying assets.

As a shareholder you could also be entitled to a tax-free allowance of £12,300.

Qualifying criteria for Members Voluntary Liquidation

If you’re considering an MVL you need to meet the criteria below:

• After paying all liabilities, you have company reserves over £25,000 (although taking into account liquidators fees to undertake an MVL cash reserves over £35,000 is normally a good benchmark for it be most cost effective).
• The company has been trading for at least 12 months.
• You are at least a 5% shareholder and employee of the company.
• You aren’t intending on trading via a limited company for at least two years following the MVL (see tax avoidance section below).

Things to do before undertaking an MVL process

You must ensure the following:

• final accounts are up to the date the company ceased to trade are prepared.
• all creditors to be paid.
• any physical assets to be disposed of.
• any outstanding charges to be satisfied.
• the final VAT return and Corporation Tax Return to be submitted.
• if any liability is owed to HMRC after the submission of these forms, this will need to be paid.

MVLs should not be used for tax avoidance

MVLs should be used if you don’t intend to be trading via a limited company for a prolonged period of time. They are not to be used as a tax avoidance measure.

A Targeted Anti-Avoidance Rule (TAAR) prevents contractors from winding up companies to distribute profits before setting up new companies immediately afterwards.

Is an MVL right for you?

MVLs can give you financial benefits and can be very advantageous in the right circumstances. But you need to consider your profit, your personal circumstances and the liquidator’s fees.

Informal or voluntary strike off

An alternative to a MVL is an informal or voluntary strike off. You can apply to Companies House to have your company struck off the register. This is called an ‘informal strike-off’ or ’voluntary strike off’.

How to apply for voluntary strike-off

Prior to undertaking a voluntary strike-off, your company must have been inactive for at least three months. Although, can only carry out a limited range of activities such as settling debts, complying with statutory requirements, and disposing of certain business assets (excluding stock). To apply for your voluntary strike-off, you need to submit form DS01 to Companies House.

Taking profit from your company in a voluntary strike-off

If your company has any retained profits, you can take these as a dividend, and director’s salary. However, often this isn’t such a good tax efficient option as an MVL.

What tax do I pay in a voluntary strike-off?

The amount of tax you pay will depend on a number of things.

If the final profits are £25,000 or less,then you will pay Capital Gains Tax (CGT) on them. CGT is 10 per cent for a basic rate taxpayer and 20 per cent for a higher rate taxpayer; however, if you qualify for entrepreneurs’ relief it will be 10 per cent.

If the profits total more than £25,000 then they are subject to income tax. The rate of tax payable depends on your personal rate of tax and whether profits are taken as salary or dividends or a combination of the two.

Making your company dormant

If you’re struggling now, but you feel you may want to trade again under a limited company in the future, you can make your company dormant for now. This means it is no longer actively trading but continues to be listed at Companies House and can be used at a later date.

Contractors who operate as limited companies may want to make their companies dormant for a while if they return to full-time employment. You must also close your payroll and settle any debts.

What is the most tax efficient way to close your limited company?

With the contracting sector still reeling after IR35 reforms and contractors now considering their future, considering your tax options before you decide to close a limited company is crucial. In some circumstances, an MVL could offer tax savings. Seek professional advice before making a final decision.

Whatever the reason for considering closing your limited company, here at dns we have experts that will advise and help you to close your company as quickly and tax efficiently as possible.

We offer comprehensive advice and services to contractors who are looking to close their limited company. Speak to one of our experts. Simply, call us today on 03300 886 686, or you can also e-mail us at enquiry@dnsaccountants.co.uk.

About the author

Sumit Agarwal
Sumit Agarwal (ACMA ACA India), the Managing partner of dns accountants is a highly respected accountant with expertise in helping owner-managed businesses.