The tax effect on liquidating a company was probably not what Geoffrey Chaucer was contemplating when he created his famous quote. However the closure of a company has significant tax implications for many family owned businesses and many families in business.
This is especially so in the Perth business environment right now. Many good families with great businesses have experienced a large drop in income.
The liquidation of a company is a unique point in time for a company in that it is it the very last time the Australian Tax Office will extract taxation from a company. If a tax liability is not paid by a company that is liquidated then the tax liability will never be paid.
The tax consequences for a shareholder investor
If a family member has invested monies into a company that goes into liquidation the impact will be devastating. Sadly the liquidation is rarely quick. We typically see that they go on for many years – and while there are probably many good reasons for the lengthy delay it can be frustrating.
The event of a company entering into liquidation does not create any tax outcome for a shareholder. It is only when the liquidator announces that there is no reasonable likelihood of shareholders receiving no distributions or a return that a capital loss can be claimed. So if your liquidator is unsure of recovering; you will not be able to claim a tax capital loss until the liquidator has officially made the announcement in writing.
For example: Frank invested $2,500 into a new company. The company goes into liquidation in January 2016. Frank calls the liquidator and the liquidator verbally tells Frank that the company has no cash and liabilities in excess of $2m.
For whatever reason the liquidation carries on for a while and the official announcement that there is no reasonable expectation of return to shareholders until December 2017.
Frank is able to claim a tax capital loss in the 2018 tax year.
Another way to claim the capital tax loss is to sell the shares in the company. Typically the shares are worthless so selling the shares to a related party, provided the shares are sold at market value, is a viable strategy for bringing forward a tax capital loss.
The tax consequences for the liquidated company
If a company goes into liquidation it will still “do stuff”. It might sell some assets and make a tax profit on sale, it might still employ key staff to assist the liquidator do their job, and it might still sell stock and collect receivables from clients. All of these activities will create a tax outcome.
The upshot is that a company in liquidation will still lodge tax returns and pay tax like every other person.
Further, if a company in liquidation has old tax returns outstanding: these tax returns are still due. You cannot liquidate a company if the old tax returns are not lodged.
Admittedly most companies will have incurred substantial tax capital losses at this stage so income tax is not often paid: but the obligation to pay tax and prepare tax returns is still present.
If there is an unpaid tax debt to the Tax Office the Tax Office becomes an unsecured creditor of the liquidated company – so other creditors like staff and secured loans will rank ahead of the Tax Office.
However if a company has not paid its staff superannuation debts, or if a company has unpaid employee pay-as-you-go-withholding tax: then the Tax Office have the ability to pursue directors personally for those unpaid debts.
If a company has tax losses (which is normal): the tax losses are gone forever. You cannot transfer the tax losses from the company to the shareholders or a new company.
The tax consequences for employees
If your employer goes into liquidation your wages may not be paid. From a tax perspective you only will pay tax on wages paid to you when they are paid in cash.
If you have not been paid a wage you are not going to pay tax on the wage. You will however enjoy PAYG Withholding credits from your salaries even if they have not been paid to the ATO by your employer.
The tax consequences for suppliers
You can claim a tax deduction for debts of a client when the liquidator advises the amount they likely expect creditors to receive. This also applies to the GST – if you have paid an amount of GST to the Tax Office on sale you can request a refund of that GST.
As long as you have removed the debtor in your books and you have given up on any attempt to recover the debt you can claim a tax deduction for the sale.
Not all liquidations are insolvent
The closure of a company does not necessarily have to be in a financially distressed situation. Most of the liquidations that we see are liquidations of solvent privately held companies.
The benefit of liquidating a privately held company (as compared to simply deregistering it) are many.
The primary benefit of liquidating a private solvent company is that the gate for litigation claims is shut. Once the company is liquidated and finalised then creditors cannot start legal claims against the company. This brings certainty and closure for many family owned businesses who might have been operating a business or an investment in an area that is fraught with litigation concerns.
Further, the process of liquidating a company is one of the few ways that you can access tax free monies from within the company. So if the shares in a company are purchased pre CGT, or if the company has tax free elements from the small business CGT concessions, then the only way for many families in business to access and enjoy these tax benefits permanently is to liquidate their family company.
Not all liquidations are liquidations
A liquidation is indicative that the company is going to be shut. However this is not always the case. Often a director will identify the company cannot pay its debts as and when they fall due – which will make the company insolvent.
If a company is insolvent it might still have the ability to trade out of its financial stress, with the control of the liquidator (or administrator in this case) and continue on. When a company is in this situation the company is in receivership – not liquidation.
When an individual goes into liquidation they are referred to as becoming bankrupt. The trustee in bankruptcy, not a liquidator, will attend to the bankruptcy action. Liquidators are associated with companies.
A side benefit of liquidations
If you are in financial difficulty we understand that it is not a good spot to be. The process is of getting in financial distress often takes many years, it is not fun, always unplanned and it creates a terrible impact on a family and the family relationships. The pressure is devastating and can severely impact on your health.
A liquidation stops it all.
If you are in a bad spot talk to a liquidator. They are not monsters and they will give you clarity on your choices. Your family business accountant should also be strong enough to give you a tough answer and give you some insight – and make sure your family business accountants cover the tax, business and liability aspects of the liquidation.