Reply to: Taking Dividends over future years from prior profits

[Waldorf]

That's a start for removing all the uncertainty surrounding this. But the difference between 10% and 28% or so Capitals Gain Tax is just too much for this "grey" area of tax planning when it comes to company closure.

Which is why we should just have a flat tax and do away with most, if not all, allowances and dodges that are out there.

If income tax and CGT was just a flat 30% say, it would be so much easier and probably raise more revenue, which at the end of the day, is what the government needs.

[sbakoola]

You can be confident if you meet all the criteria. At the moment you meet most...but your bank balance makes up >20% of your asset base, which possibly points towards investment.

You can typically ask for HMRC clearance (ie advanced confirmation that you will qualify) for certain things. See here...it suggests they won't give formal clearance, but will give an opinion. If you do go down this route, you need to be careful that you give them all the facts, and that none of those facts change between you asking their opinion and you going ahead.

That's a start for removing all the uncertainty surrounding this. But the difference between 10% and 28% or so Capitals Gain Tax is just too much for this "grey" area of tax planning when it comes to company closure.

[Maslins]

How do you know if you would qualify for ER? is it possible you could assume you will qualify, liquidate the company, appkly through SA for ER and then get rejected and face an exceedingly large tax bill?

Can this be premepted by checking first with HNRC?

You can be confident if you meet all the criteria. At the moment you meet most...but your bank balance makes up >20% of your asset base, which possibly points towards investment.

You can typically ask for HMRC clearance (ie advanced confirmation that you will qualify) for certain things. See here...it suggests they won't give formal clearance, but will give an opinion. If you do go down this route, you need to be careful that you give them all the facts, and that none of those facts change between you asking their opinion and you going ahead.

[SheLtd]

How do you know if you'd qualify for ER?

My opinion (and it is just that) would be that at the moment you'd have no problems getting entrepreneur's relief.

If you left it another year or two (with £25k trading income, £12k investment income) before liquidating I'd feel less comfortable claiming it.

...but the who knows what the tax laws will be like in two years.

I'd say if you want the cash out now, liquidate and complete your self assessment based on entrepreneur's relief. If you'd prefer income spread over quite a few years, then just take dividends appropriate to your personal tax situation/make pension contributions until it runs out.

How do you know if you would qualify for ER? is it possible you could assume you will qualify, liquidate the company, appkly through SA for ER and then get rejected and face an exceedingly large tax bill?

Can this be premepted by checking first with HNRC?

[Maslins]

The trading Income total over 4 years is approx £760k (or around £190kpa) all VAT, expenses & Corporation tax have been paid. Effectively the £400k is sitting in the company bank account accrued from retianed profits over 4 years. The comopany is now in irw 5th year of trading.

Of the £400k about £4k is derived from investments. However, I can foresee a time when trading income amounts to £25k and investment income about £12kpa. Probably not until after April 2013.

How does that additional info play-out?!

My opinion (and it is just that) would be that at the moment you'd have no problems getting entrepreneur's relief.

If you left it another year or two (with £25k trading income, £12k investment income) before liquidating I'd feel less comfortable claiming it.

...but the who knows what the tax laws will be like in two years.

I'd say if you want the cash out now, liquidate and complete your self assessment based on entrepreneur's relief. If you'd prefer income spread over quite a few years, then just take dividends appropriate to your personal tax situation/make pension contributions until it runs out.

[SheLtd]

Agree it's not black and white.

Ok, so re OP with £400k cash. Going forwards (if they continue to trade) will be £25k revenue, and (again based on 2% interest) £8k interest...so if they continue like that for a while they'd probably only pass 1 of the 3 tests should they liquidate at a later time...more of a risk.

But what has the OPs trading income been up to now? I can't see a figure in the thread, but am guessing it's much higher...to the point where probably the interest received is <20% of the trading income.Anyway, FWIW if these situations were my clients, I'd be more than happy to claim entrepreneurs relief under self assessment, and would be happy to argue it if HMRC challenged...though I appreciate that doesn't necessarily mean we'd win!

The trading Income total over 4 years is approx £760k (or around £190kpa) all VAT, expenses & Corporation tax have been paid. Effectively the £400k is sitting in the company bank account accrued from retianed profits over 4 years. The comopany is now in irw 5th year of trading.

Of the £400k about £4k is derived from investments. However, I can foresee a time when trading income amounts to £25k and investment income about £12kpa. Probably not until after April 2013.

How does that additional info play-out?!

[Maslins]

Agree it's not black and white.

Ok, so re OP with £400k cash. Going forwards (if they continue to trade) will be £25k revenue, and (again based on 2% interest) £8k interest...so if they continue like that for a while they'd probably only pass 1 of the 3 tests should they liquidate at a later time...more of a risk.

But what has the OPs trading income been up to now? I can't see a figure in the thread, but am guessing it's much higher...to the point where probably the interest received is <20% of the trading income.

Anyway, FWIW if these situations were my clients, I'd be more than happy to claim entrepreneurs relief under self assessment, and would be happy to argue it if HMRC challenged...though I appreciate that doesn't necessarily mean we'd win!

[Contreras]

Balance sheet
£200k Cash at bank
(£30k) VAT/CT etc
£170k Retained earnings

£100k Turnover
(£10k) Costs
£90k Trading profit
£4k Interest received (based on 2%, higher than most)
£94k Total profit before tax

Do you realistically think HMRC would be able to argue this was an investment company?

The scenario presented by the OP is that of £400k Retained earnings and £25k Annual revenue.

Just sayin' like.

As usual things are not always as black & white as one would like and it's really quite valuable to see the various points being discussed by the professionals here.

[Maslins]

Hi Alan, yes, it was your post that prompted mine.

Useful link. It seems to suggest three tests, and in virtually every case for contractors:

- asset base - will mostly be cash. Whether this in itself is a trading or investment asset is questionnable, though I'd agree a typical contractor holding £200k+ would struggle to argue they needed that for the trade.

- income - whilst they're still contracting, it'll only be a tiny minority who have interest received making up >20% of income.

- expenses/time - again, for most the expenses relating to investment activities will be £nil, and time spent will be negligible.

So virtually every contractor will pass 2/3 of the tests with flying colours.

I can't see where in the link it mentions large cash balances specifically- it talks about investment properties a couple of times...but that's it.

Another link which I think is relevant is here. Ok so the main topic of the page is transfering a trade out prior to liquidation (which I think contractors do need to be careful about - ensure if starting up a new contractor Co straight away that it has new client, new assets, new trading name etc). Anyway, the bit I feel is relevant here is the example which talks about a company with "£1m cash representing its undistributed profits". Ok so for all we know possibly the company also has other assets totalling £5m...but there's no mention of that much cash causing an issue in terms of tax treatment on drawing out, just that the trade and assets were transfered.

I think it'd take an extremely aggressive inspector to attempt to argue your typical contractor Co with cash was an investment company...and I can't see them succeeding even if they did.

[Nixon Williams]

Assuming that you are referring to my post, I certainly do not wish to scare people. I have always been happy to give my take on an issue and let people make their own mind up.

As is so often the case there are no simple answers and it comes down to a matter of opinion and an individuals attitude to risk.

Taking our own clients as a sample, we have very few that have substantial cash deposits that would be a concern when it comes down to the closure process.

This guidance from HMRC - CG64090 - Entrepreneurs? Relief: trading company and holding company of a trading group - the meaning of "substantial" clearly indicates that the cash pile is an area they may look at, as such it is something clients should be aware of.


Alan

[Maslins]

Whilst I'm not directly disagreeing with you, I do think you're perhaps unnecessarily scaring people. Let's put some numbers to a simplified hypothetical example contractor company with cash (probably fairly similar to most of the ones asking questions here).

Balance sheet
£200k Cash at bank
(£30k) VAT/CT etc
£170k Retained earnings

£100k Turnover
(£10k) Costs
£90k Trading profit
£4k Interest received (based on 2%, higher than most)
£94k Total profit before tax

Do you realistically think HMRC would be able to argue this was an investment company?

Ok so cash at bank makes up way more than 20% of assets...even if they just kept enough to cover their company taxes it would nearly always do that. That wouldn't change even if their clients took ages to pay hence trade debtors. Contractors have negligible need in terms of assets. They have their beloved macbook and iphone...and that's it.

Assuming the cash is simply sitting in a deposit account and the company owner isn't doing any dabbling in the stock market/property etc, it'd need to be a massive balance to be earning >20% of the company's income, and I'd be extremely surprised if choosing which deposit account took up more than 1% of the owner's working time.

[Nixon Williams]

Entrepreneurs Relief guidance does not refer to any level of cash reserves being acceptable because in my opinion it is of no consequence what form those business assets take. In ER we are looking at the disposal of the shares in the company, therefore my opinion is whether it is a large cash reserve or a factory purchased by a company giving the value of the shares is of no matter.

For Capital Gains purposes, a trading company is defined in TCGA 1192, s165A(3) as 'a company carrying on trading activities whose activities do not include, to a substantial extent, activities other than trading activities'.

HMRC will generally regard any activity as not being substantial if it comprises less than 20% of the company's activities. Therefore attention needs to be paid to aspects such as the level of assets, turnover, profit etc in trading and non-trading activities.

Problems may arise where it is perceived that the company may have cash in excess of its current trading requirements.

Some have suggested that one way around this is for the director(s) to minute that they are retaining the cash for future purposes, as such there should be no issue with obtaining ER on disposal assuming that the cash has been generated from trading activities.

I would caution that it would be difficult for most consultancy businesses to argue that they need a substantial cash pile for future trading use.

As the tax difference could be quite large, I would advise clients to be careful if they have large cash balances and chat to their accountant about the right approach.

Alan

[ClearSky Accounting Dan]

If we look back to the reasons for Entrepreneurs Relief being introduced it was to encourage investment and entrepreneurs in the SME industry. This is why I believe the level of cash reserves to be irrelevant in determining whether ER is available. If a company's purpose is to maximise shareholder wealth then this is exactly what has been achieved, whether that be in the form of building up a large cash reserve or investment property portfolio, they are all business assets.

Entrepreneurs Relief guidance does not refer to any level of cash reserves being acceptable because in my opinion it is of no consequence what form those business assets take. In ER we are looking at the disposal of the shares in the company, therefore my opinion is whether it is a large cash reserve or a factory purchased by a company giving the value of the shares is of no matter.

[sbakoola]

yet another example of tax uncertainty in this country .. do we pay 10% tax or 28% tax after limited company closure depending on whether HMRC classify a certain amount of money in a business account as either 'investment' or 'trading' money according to a few 'rules of thumb' that HMRC use.

Its pathetic.

[ASB]

I always thought money in the company was a business asset, how could it be called/classified if there are other possibilities?

I don't I phrased it particularly well. It is a business asset in the sense that it belongs to the business.

However the question is one of whether the asset is used in the course of the business. As has been pointed out there is a possibility that HMRC might view a large wad as not used in the business and then it is not eligible for ER.

An extreme example might be that you bought a painting to make your office wall look pretty. i.e. replace the cash asset with something clearly not used for the benefit of the business.