A look at ESC C16 as things currently stand, together with a look at the new proposals
There has been widespread confusion regarding Extra-Statutory Concession C16 (ESC C16), 'has it been abolished?' and 'is it limited to £4,000?' being common questions.
The topic of ESC C16 seems to be hitting the accountancy press on a regular basis and there have been further developments this month, so this article aims to clarify the position as it stands at the moment.
The fundamental principle behind ESC C16 is that it provides a company with a mechanism for winding-up a company, without the need to incur the expense of a formal liquidation. Amounts distributed under ESC C16 are treated as a capital distribution in the same way as under a formal liquidation, whereas distributions from a company, other than in the course of a formal liquidation are treated as an income distribution and taxed in a similar way to dividends.
Obtaining capital treatment in respect of such a distribution will generally be preferable to income treatment due to the favourable capital gains tax regime that exists, particularly in view of the fact that a capital distribution under ESC C16 will be eligible for entrepreneurs’ relief, provided that the relevant criteria are met.
In a nutshell, ESC C16 provides a cost effective alternative to a formal liquidation, which would typically cost £5,000-£7,500, while enabling the same tax treatment.
An application must be made to HMRC for capital treatment under ESC C16 to apply.
The text of ESC C16 stipulates that the following conditions must be met in order for the concession to apply:
(a) they will supply such information as is necessary to determine, and will pay, any corporation tax liability on income and capital gains; and
(b) the shareholders will pay any capital gains tax liability (or corporation tax in the case of a corporate shareholder) in respect of any amount distributed to them in cash or otherwise as if the distributions had been made during a winding-up.
HMRC also stipulate three additional conditions in their manuals at CTM36220:
(a) the liquidation of the company whose assets etc have been acquired, or
(b) the sale of shares in either company.
Many practitioners would have been using ESC C16 without having been aware of what “bona vacantia” is and the recent coverage regarding this has added a layer of confusion.
Bona vacantia means “ownerless goods”. In the context of ESC C16, bona vacantia refers to the undistributable reserves of the company; typically, its share capital. The Treasury Solicitor’s Department has a Bona Vacantia division which is responsible for dealing with ownerless assets and passing them to HM Treasury.
Prior to Companies Act 2006, the Bona Vacantia department agreed that non-distributable reserves, of up to £4,000, could be extracted from the company, without them seeking to claim possession of these assets, provided that the persons extracting the cash had permission under ESC C16.
The Companies Act 2006 introduced new provisions that enabled the directors of a company, that on a declaration of solvency by the directors the company could turn its non-distributable reserves into distributable reserves. It is now therefore much easier to reduce a companies’ share capital under Companies Act 2006 than was hitherto the case under Companies Act 1985. Consequently, the £4,000 concession that had applied prior to the Companies Act 2006 became redundant.
On 14 October 2011, the Treasury Solicitor advised that the £4,000 de minimis limit for recovering unlawful capital distributions on dissolution of a company would be scrapped and they would no longer pursue recovery of any such distribution. This is an entirely separate matter from the proposed legislation of ESC C16, which merely deals with the tax aspects of a distribution.
The publicity surrounding bona vacantia caused confusion, with many believing that only £4,000 could be distributed under ESC C16 and/or that ESC C16 had been withdrawn; neither of which are true. So for now, Bona Vacantia semantics aside, things are more or less as they were. There is still, in theory, no limit to the amount that can be distributed under ESC C16, although HMRC, as with all extra statutory concessions, have the right to deny its application if they feel that the main purpose is for the avoidance of tax.
There are, however, proposed changes afoot.
On 6 December 2011 the Government decided to legislate ESC C16 in the Enactment of Extra-Statutory Concessions Order 2012.
The effect of this is that the concession is it currently exists will change radically as from 1 March 2012. With effect from this date, the limit for making distributions in an informal winding-up and achieving capital rather than income treatment thereof will be £25,000. Any distributions beyond that level will be treated as dividends in the hands of the shareholders, leading to an additional tax liability for higher-rate taxpayers. If a company enters into formal Members' Voluntary Liquidation, then no £25,000 limit applies, all distributions will be treated as capital.
The proposed reforms will undoubtedly have a detrimental effect on the owners of SMEs, who are seeking to wind up their companies. If the proposals go ahead, business with distributable reserve in excess of £25,000 will now be faced with a choice of either:
(a) to accept “dividend” treatment for tax purposes for distributions in excess of £25,000, or
(b) appoint a formal liquidator, with the additional costs that this will incur, in order to obtain capital treatment on the full distribution.