A solvent liquidation is a liquidation where all creditors of a company will be paid their debts in full and then the surplus of company assets (after repaying those creditors) is returned to the shareholders. Solvent liquidations (otherwise known as members voluntary liquidations) are usually used to wind down the affairs of a company that is no longer is needed by the shareholders in a way that enables those shareholders to obtain a tax advantage utilising capital gains tax rates instead of income tax rates.
The length of the solvent liquidation process will vary depending on the size and complexity of the company’s affairs. In general, however, for straight forward cases the process will take approximately 6 to 8 weeks to complete. However, in other cases, perhaps if there are company assets to realise, (eg freehold properties), the process may take longer depending on how easy it is to sell those company assets.
The key benefit of a solvent liquidation is to wind down the affairs of a company in an orderly fashion to enable the shareholders of a company to have their investment in the company returned to them in a tax efficient manner.
The key risk of a solvent liquidation is that a creditor comes out of the woodwork that the directors had not foreseen or thought about which then has to be dealt with in some way. This may delay and reduce the amount of the return of the shareholder’s investment in the company. That creditor may be HMRC and thus it is important that the company’s tax affairs are fully brought up to date as part of the planning for a solvent liquidation.
The key procedural steps in a solvent liquidation are:-
- The directors and the company’s accountants or other advisors work with the insolvency practitioner to review the company’s affairs prior to the liquidation process commencing to ensure that all matters that need to be considered are considered. This is the time that the directors and their advisors should be looking at issues than might prejudice a smooth and efficient solvent liquidation process. Such issues might include unresolved legal claims against the company, the existence of warranties or indemnities previously given by the company or the existence of historic complex tax affairs of the company, eg disguised remuneration schemes.
- The directors will then swear a Declaration of Solvency confirming that the company has sufficient assets to enable it to repay all its creditors within a period not exceeding 12 months from the date the company enters into a solvent liquidation.
- The shareholders then resolve to place the company into solvent liquidation at which point the liquidator is appointed.
- The liquidator then ensures all creditors have been paid in full (plus statutory interest) and that HMRC tax clearance has been obtained. It should be noted that whilst obtaining HMRC tax clearance is not a legal requirement, failure to do so without giving HMRC an opportunity to claim in the liquidation, may invalidate distributions to shareholders. The need for the company’s tax affairs to be brought fully up to date as far as they can be prior to the liquidation process commencing is therefore very important.
- The liquidator then distributes the remaining surplus of company assets to the shareholders before ceasing to act. That distribution can be either of the assets themselves (known as distributions in specie) or by the cash proceeds of sale of those assets. In simple cases, distributions normally take place within 6-8 weeks of the liquidation commencing although part distributions can be made in certain cases immediately the company enters into solvent liquidation.
Solvent liquidations are where all the creditors of the company will be paid in full (plus statutory interest – currently at 8%). An insolvent liquidation is where all the creditors of the company will not be paid in full. The two procedures generally serve two different and distinct purposes. Insolvent liquidations are used when the directors of a company realise that the company cannot survive because it cannot pay its debts and thus needs to cease to trade, its employees dismissed and its assets used to repay creditors as far as possible. Solvent liquidations are used to formally wind down the affairs of a successful company when it has come to the end of its useful life and to facilitate the return of the capital and profits that the company has earned in its life to the shareholders in a tax efficient manner. Solvent liquidations are often used when business owners wish to retire and thus wind down their business activities. In such circumstances, the tax advantages of solvent liquidations can be significant, especially if Entrepreneur’s Relief is available to them.
A company is insolvent if either:-
- It is unable to pay its debts as and when they fall due (the cash flow test); or
- Its liabilities exceed its assets (the balance sheet test).
If a company can pay its debts as and when they fall due and its assets exceed its liabilities, it is solvent. This can be a difficult question to answer in certain cases. An experienced insolvency practitioner can help you to decide whether your company is solvent or insolvent and thus formulate a plan of action for the best way forward.
Advantages of a Solvent Liquidation as compared with a straight forward Striking Off of a company at the Register of Companies
Whilst the usual way to close down a solvent company is by way of a solvent liquidation process, if the company has no liabilities (because those that it had have all been paid and settled), the directors can apply to the Registrar of Companies to have the company simply struck off the Register of Companies. However, this procedure should not be used if the return of the investment to the shareholders is greater than £25,000 (due to the Bona Vacantia rules), but subject to that consideration, if there are no tax advantages to be obtained and all the creditors (including those that may not necessarily be readily identified) of the company have been paid in full, simply striking off the company at the Register of Companies can be a cost effective and simple way to bring the life of a solvent company to an end. However, solvent liquidations give directors and shareholders more piece of mind than a straight forward striking off process in that a solvent liquidation provides comfort to them that an independent professional has undertaken a formal managed shut down of the company’s affairs and concluded all outstanding matters and thus any application for the company’s affairs to be reopened once it has been formally dissolved is rarely going to be necessary.