ESC C16 and Entrepreneur's Relief when closing a limited company

Written by Sally Fletcher for planIT, November 12th 2010, updated August 17th 2011 

Company Closure

When a limited company is no longer needed and closes down, it usually makes an application on form DS01 to be struck-off the register at Companies House under Section 1003 of the Companies Act 2006 (formerly S652 of the Companies Act 1985).

Under the Act, the company has to meet the following conditions that it has not, in the last three months:

• Traded or otherwise carried on business
• Changed its name
• Disposed for value of property or rights immediately before ceasing to be in business or trade; or
• Engaged in any other activities except one necessary or expedient for the purpose of:

1. making an application for strike off or deciding whether to do so (for example, a company may  seek professional advice on the application and pay the costs of submitting the ‘striking off application by a company, form DS01'.
2. concluding the affairs of the company
3. complying with any statutory requirement

A company cannot apply to be struck off if it is the subject, or proposed subject, of:

• any insolvency proceeding (such as liquidation, including where a petition has been presented but has not yet been dealt with); or
• a section 895 scheme (that is a compromise or arrangement between a company and its creditors or members).

However, a company can apply for strike off if it has settled trading or business debts in the previous three months.

When a company is voluntarily applying to be struck off, all of the assets must be distributed, as any remaining, become the property of the Crown.

Assets (cash) would usually be distributed to the shareholders of the company by way of a dividend payment.  Dividends are classed as unearned income and are liable to personal income tax.

Extra Statutory Concession C16

Extra Statutory Concession C16  (ESC C16) is a process enabling assets to be distributed as a capital distribution when a company is being struck off the register.  This can have a tax advantage for the shareholder as the gain is outside the scope of personal tax and is subject to capital gains tax.

The lower rate of capital gains tax is 18%. The higher rate of capital gains tax for all capital gains over the threshold of £35,000 (2011/12) is 28%.  Each individual has an annual exempt allowance (AEA) of £10,600 (2011/12) in each tax year.

You should seek advice from us before making an application as your tax position needs careful consideration since the introduction of the higher capital gains tax rate.

An application to HMRC is made by the officers of the company and is subject to satisfying the application conditions.

Entrepreneur's Relief

Entrepreneur's Relief  was introduced in April 2008 and enables capital gains made by using ESC C16 when closing a company to be reduced and results in a tax effective rate of 10%.

Each individual has a life time allowance of £5,000,000 with effect from 23^rd June 2010 and £2,000,000 previously.

Prior to 23^rd June 2010 gains were reduced by 4/9 leaving the remaining 5/9 of the gain after AEA taxable at 18%.

With the introduction of the higher capital gains tax rate of 28% the above formulae is no longer used; instead, a 10% tax is charged on the gain after the AEA is deducted. 

Claims may be made in part or all on any number of occasions up to the life time limit if the qualifying conditions are met.

An individual who plans on using this route should seek our advice at least a year before making an application to ensure the qualifying rules are satisfied. Where large amounts of cash are held in the business, careful planning is required to ensure the ‘non-trading assets' rule is complied with.

Capital gains are declared by the individual on the self-assessment tax return in the January that is one year and 10 months following the end of tax year in which the disposal was made.

Example - Capital distribution V Cash distribution.

Jeremy has had a 100% shareholding in his personal company which has traded for 8 years.  He decides to retire and closes his company which has £72,000 of retained profit.  Assuming that the AEA and basic tax band have been used, the effective tax charge is as follows:

Dividend cash distribution

£72,000 x 25% equivalent net rate (22.5% x10/9) = £18,000

Capital distribution with ESC C16

£72,000 less capital gains allowance of £10,100 x 28% = £17,332

Capital distribution with ESC C16 and Entrepreneur's relief

£72,000 less capital gains allowance of £10,600 x 10% = £6,140

This brief is for guidance purposes only.  In all cases we would recommend that you discuss any queries with professional advisors.  planIT Services is a firm of Chartered Accountants regulated by the Institute of Chartered Accountants in England and Wales. Please feel free to contact us if you have any questions relating to this article or other accounting issues affecting contractors.