For many, the word ‘liquidation’ is often associated with business failure in some way. However, not all liquidations are conducive to failure. A solvent liquidation can be used as a tax-efficient way for shareholders of successful businesses to extract capital as part of a wider exit strategy.
What is a Members’ Voluntary Liquidation?
Members’ voluntary liquidations (MVLs) involve the liquidation of a solvent company. A members’ voluntary liquidation can be an attractive mechanism to crystalise the value of a company’s asset position and can be a tax-efficient route to realise that value.
The members’ voluntary liquidation process is relatively simple, with shareholders signing a declaration of solvency, guaranteeing that the company can fulfil their debts within the next 12 months and the passing of a special resolution, allowing the members’ voluntary liquidation process to go ahead, along with the appointment of the liquidator.
Creditors are entitled to receive statutory interest at a rate of 8% above base from when the company is placed into members’ voluntary liquidation until the liquidator satisfies the debts. It is usually advised that the company pays off their creditors before the appointment of the liquidator to save the cost of interest.
Immediately upon appointment, the liquidator will advertise for additional claims, allowing a minimum of 21 days for creditors to provide relevant details. Once this time has elapsed, a distribution can be made to the shareholders, and the company will be wound up.
Why is the timing of a member’s voluntary liquidation important?
The timing will come down to personal circumstances and the primary motivation for instigating the members’ voluntary liquidation. For example, when dealing with a group structure, consideration of the wider operation of the subsidiaries and any contingent liabilities will need to be considered to ensure that a trading entity can meet any liabilities that may arise in the future.
If dealing with one company, the shareholders may have different personal tax circumstances in different years, making planning the members’ voluntary liquidation to make receiving the distribution in a certain tax year more advantageous for the individual shareholders.
Presently shareholders receiving a distribution from a members’ voluntary liquidation will be obligated to pay capital gains tax on any distribution they receive, but this is often preferable to paying dividend taxation rates.
Dividend tax rates for 2023/24 are 8.75% if your income is taxed at the basic rate, 33.7% for the higher rate and 39.35% at the additional rate. In contrast, the capital gains tax rate is 10%, where the total taxable gains and income is less than £37,700, with any excess taxed at 20%. Where business asset disposal relief applies, the rate of tax on the whole gain is 10%, subject to the lifetime allowance of £1m.
It has yet to be determined whether the current tax rates will change for 24/25; however, once the economy stabilises, the government will likely look for new ways to increase revenue. Given that tax increases are never popular with voters, capital gains tax is a prime target for an increase as the burden does not fall on the majority of UK citizens.
The pitfalls
Whilst members’ voluntary liquidations offer the benefit of tax efficiency, anti-avoidance rules preclude shareholders from beneficial tax treatment if tax is the primary motivation for liquidation. That is not to say that tax has no role in choosing a members’ voluntary liquidation, but rather tax efficiency must be incidental to the overall reasoning behind liquidating an otherwise healthy business.
The shareholders will also need to carefully consider any contingent liabilities that may crystallise after the liquidator has been appointed to ensure they can provide the required indemnities and repay any distribution received to meet the costs of that liability.
Consideration must also be given to the mechanisms for receiving the benefit of any assets in specie, such as the assignment of any loan repayments or deferred consideration post-disposition to ensure that the shareholders are entitled to receive the benefit of those assets after liquidation.
Failure to make the above considerations will result in disappointed shareholders and could negate the tax advantages of a members’ voluntary liquidation.
Our restructuring and insolvency lawyers offer bespoke advice to business owners wishing to realise the capital value of their business.
We also advise group companies on using members’ voluntary liquidations to simplify and streamline group structures and work closely with and can introduce our clients to our network of insolvency practitioners contacts to assist with appointing a liquidator.
