A contractor’s guide to closing a company with retained profits

At some point in every contractor’s life, they will reach the point when they want to close down their limited company – either to retire or take up a PAYE role.

This closing of a company is the likely fate of PSCs, as a contractor effectively is the company so it’s very rare that they are able to sell the company when they want to move on.

First and foremost, your limited company's financial health

But it is the financial state of the company that determines the way in which it can be closed. And of course, the different states a company is in range from very profitable to insolvent.

In this article exclusively for ContractorUK, John Bell, director and founder of licensed insolvency practitioners Clarke Bell, considers how a director can close down their company when it has retained profits.

What are retained profits?

The first thing to clarify is what do we mean by ‘retained profits’

Retained profits (also referred to as ‘retained earnings’) are the amount of profits which are kept by the company, rather than paid out to shareholders as dividends.

What process closes a company with retained profits?

To get a company closed down, all of its assets need to be realised and all of the company’s creditors paid. 

This leaves a balance sheet which should show that the cash in the contractor’s bank account as being equal in value to the company’s share capital including the retained earnings.

This cash balance can then be distributed by way of director salary or dividend, while the company is still active.

This will utilise the income tax-free bands. The problem with this is that the shareholders will pay tax at their highest marginal rate. This could be 45%!

Instead, the MVL route…

The alternative is that the company is placed into Members’ Voluntary Liquidation (MVL). Then, the distribution is made by the liquidator / insolvency practitioner.

This distribution counts as Capital Gains Tax (CGT) and so will be taxed at 20% - much lower than income tax. There are CGT tax-free annual allowances as well.

For contractors, the optimum strategy is normally considered to be to distribute the income tax allowance by dividend -- and then place the company into MVL.

Then, if the company directors qualify for Business Asset Disposal Relief (previously known as Entrepreneurs’ Relief), the distribution is taxed at 10%, subject to the £1m lifetime limit.

It is generally accepted that £25,000 is the amount it is considered to be a minimum to make the MVL route, the better route.

If the company has an Overdrawn Directors Loan Account (‘ODLA’), this can be distributed ‘in specie.’ Interested? Contractors should ask their accountant or insolvency practitioner about how this process works.

Formality, freeing up assets and fees

The MVL process is a formal way to close down your solvent company in the most tax-efficient way.

Whether you’re looking to retire, free up assets to fund a new venture or take up a PAYE role (potentially due to the IR35 reforms), an MVL is a very tax-efficient way to close down a solvent company.

You will need to appoint a liquidator (also known as an insolvency practitioner) to place your company into liquidation, for which they will charge you a fee. However, the tax savings available with an MVL do make it a very attractive option for thousands of company directors every year.

Other situations

If the value of the assets of the company is less than £25,000, it may be better to strike off your company from the Companies House Register. Your accountant will be able to advise you how to do that.

If your company is insolvent (i.e. it cannot pay its bills), then you will not be able to use the MVL process or to strike your company off. It is likely that a Creditors’ Voluntary Liquidation will be your best option. Consult your accountant and / or an insolvency practitioner if this applies to you.

Free advice

To find out if an MVL is right for your company, call an insolvency practitioner who specialises in MVLs. They should give you that advice free of charge, so you have nothing to lose, or ask your accountant instead, if they won’t. In our experience, contractors are more often than not pleasantly surprised by the amount of tax savings that are available through the MVL process. And it is a process that is recognised by HMRC, so there should be no nasty surprises from the taxman either!