In the current economic crisis, an increasing number of companies are facing financial difficulties and potential insolvency. Unsurprisingly, at such times, tax issues can often be overlooked. This can lead to potential tax risks, lost opportunities and a failure to maximise assets. Correct planning can make a significant difference to the potential tax liabilities and maximisation of tax assets of a company or a group that is facing insolvency.
This article will provide a reminder of the insolvency procedures available and highlight some of the UK tax issues that arise when a company goes into liquidation, in particular focusing on the impact that a loss of beneficial ownership of assets in a liquidation could have on group members.
Types of insolvency proceedings
There are various types of insolvency proceedings that can be commenced by or against a company. The main ones are:
- Liquidation – this is the end of the line of the company concerned and will involve the cessation of any trade. The procedure can either be started by a winding up petition issued through the courts (a compulsory liquidation), usually by a creditor unable to recover money owing through other means or by a resolution passed by the company's shareholders recognising that it should no longer carry on in business. In this latter case, the liquidation is described as voluntary and may either be insolvent (a creditors' voluntary liquidation, where creditors have the ultimate say in the choice of the liquidator) or solvent (a member's voluntary liquidation, where the members' choice prevails). Crucially for tax purposes, on appointment of a liquidator a company loses beneficial ownership of its assets as the liquidator holds such assets for the benefit of its creditors generally (Ayest (Construction) Limited 50 TC 651).
- Administration – this is now the key procedure in the UK for insolvent companies. It is designed to maximise the chances of rescuing an insolvent company with viable prospects of being restructured, primarily through a protective moratorium designed to inhibit unilateral creditor action. If its rescue as a going concern is not achievable, there are subsidiary purposes, notably a better realisation of assets than would otherwise be likely in a liquidation. Administration may now be commenced out of court by the company itself, its directors or a qualifying floating charge holder (although other creditors still need to apply to court).
- Administrative receivership – this is the traditional procedure whereby a secured creditor, typically a bank, would recover monies owing through the realisation of assets covered by its security (commonly covering all of the assets and business undertaking of a company). As a result of changes effective in 2003, the ability to appoint an administrative receiver is declining with administration intended to be used instead.
- LPA Receivership (or fixed charge receivership) - this involves enforcement action in respect of one or more assets over which a creditor has a fixed charge. The 2003 changes did not restrict the ability to appoint such receivers.
- Company voluntary arrangement (CVA) - This procedure allows a financially troubled company to reach a binding contractual agreement with its creditors to pay all, or a set proportion of, the debts owing to all creditors over an agreed period of time. The incentive for creditors to agree to a CVA is the prospect of a better return than if the debtor company were to go into liquidation or administration. As a CVA does not of itself provide a moratorium against creditor action until it has been agreed, it may sometimes be combined with an administration. Once approved by over 75% in value of creditors voting on the proposal, it will be binding on all creditors who had notice of the meeting. A similar compromise arrangement (a scheme of arrangement) is available under the Companies Act 1985, although its main disadvantage compared with a CVA is that schemes require significant court involvement and are therefore typically much more expensive to implement.
Unlike a liquidation, there is no loss of beneficial ownership of assets by a company in administration, receivership or under a CVA.
Effect of loss of beneficial ownership of assets
Once a company goes into liquidation, beneficial ownership of its assets vests with the liquidator. This will adversely affect the majority of group relationships formed through the company in liquidation (as it will no longer beneficially own the shares in its subsidiaries) and could result in the loss of some important reliefs.
- It is no longer possible to group relieve trading and certain other losses between companies owned by the company in liquidation and other members of the group. Any losses arising after that time cannot be relieved against the profits arising elsewhere in the group. Therefore due consideration should be given to the need to eliminate profits via group relief claims before a company is put into liquidation.
- If a parent company of a group or a sub-holding company is facing liquidation and group relief is important, a pre-liquidation re-organisation could be undertaken. This could be achieved by interposing an intermediate holding company between the parent and its subsidiaries or by transferring the subsidiary companies to form a sub-group. Any trading losses could then be used between the companies in the new group.
- Where several reorganisations are planned to sell off viable trades, an alternative option would be for the company to enter administration first with liquidation following later. As entering administration does not cause a company to lose beneficial ownership of its assets it does not have the same adverse effect on group relief. Any gains realised on the sales during the administration process could then be relieved by post administration trading losses within the group.
- Stamp duty and SDLT group relief ceases to be available when transferring assets held by a company in liquidation (or where the group relationship is formed through such company). If an intra-group reorganisation is required then it is important that transfers requiring such group relief treatment take place prior to the appointment of a liquidator (eg during an administration period).
- Where it is planned to hive down the trade of a company as part of the liquidation process, the loss of beneficial ownership may prevent tax relief under section 343 of the Income and Corporation Taxes Act 1988 ("ICTA") from being granted. Under section 343, a transfer of trade will not be treated as a cessation followed by re-commencement where certain conditions are satisfied. The effect of the relief being available includes trading losses being carried forward into the successor company. As the relief relies upon common ownership, there is a potential problem for liquidations because a parent in liquidation does not have beneficial ownership of the shares in its subsidiary. As such, the timing of the liquidation becomes critical. If a hive-down under section 343 is to be carried out, it must be completed before liquidation commences (eg during a period of administration). Alternatively, so long as the trade has not ceased, a trade could be transferred during liquidation to a sister company under common ownership and still meet the section 343 requirements.
- Care should also be taken where a certain tax treatment depends on whether companies are “connected parties”. Such tests may use the definition of "control" in section 840 ICTA. A company in an insolvency procedure may not be under common control with its parent.
By contrast to the above, it is possible to transfer assets within a capital gains group free of corporation tax even where the group relationship is formed through a company in liquidation.
This note does not attempt to address all issues that may arise on a liquidation or other insolvency procedures. Other key areas to consider would include careful consideration of if, or when, there is a cessation of trade and the effect this could have. Also, there are strict rules for when accounting periods end in the insolvency context that could have significant tax implications. We should also not forget that HMRC will likely be a creditor in an insolvency and need to be dealt with appropriately.
What this note highlights is the significant effect an insolvency may have on the group’s tax position, and the lack of tax planning opportunities available once the liquidation process has begun. It is, therefore, essential to take appropriate steps in the pre-liquidation period to mitigate taxes. Managed properly, considerable tax savings can be attained and significant value can be added for creditors.