Winding up business, what are the tax implications of liquidating Ireland Inc.?
 

David Fennell, Director

According to credit information group Experian there were 575 Irish liquidations in 2008, more than double the 273 liquidations in 2007. With no sign of the tide receding in 2009 this article highlights some taxation implications of liquidating Ireland Inc.

Overview
The most significant tax consequences of a winding up include:
(a) The commencement of the winding up is the end of an accounting period for corporation tax purposes. A new accounting period commences and does not end until 12 months has elapsed or the winding up is completed;
(b) As the company ceases to be the beneficial owner of its assets, a winding-up breaks any group relationship between the company and its subsidiaries. This will be relevant for group relief purposes and group payments but not for chargeable gains as specific provision is made for the retention of a capital gains tax group until the company is wound up;
(c) Distributions to shareholders will be liable to capital gains tax and not Dividend
Withholding Tax;
(d) The liquidator is subject to capital gains tax on disposals of assets during a winding up but the disposals are treated as disposals of the company;
(e) Where the company is insolvent and is a member of a VAT group, joint and several liability applies;
(f) Stamp duty and group relief clawback provisions need to be considered; and
(g) Capital distributions made by a liquidator are not regarded as distributions for the purpose of reducing the close company surcharge on undistributed investment income, estate income or income of service companies. The practical effect of this is if a surcharge on investment or estate income is to be avoided, it may be necessary to distribute the requisite amount prior to the commencement of the winding up.

The end of an accounting period has several tax implications.
(a) It establishes the due date for payment of preliminary corporation tax;
(b) It determines the due date for filing the company's corporation tax return;
(c) The ability to utilise trading losses under the loss carry-back, or group relief provisions are affected; and
(d) Capital losses on the disposal of assets can no longer shelter capital gains in the earlier period.

The preliminary tax requirement for short accounting periods is particularly inequitable. If a company goes into liquidation on say 31 March 2009, how could the company have foreseen that it was required to make a preliminary tax payment
by 21 February 2009?

A company is normally required to file its Form CT1 for an accounting period by the 21st day of the 9th month after the end of their accounting periods. However, special rules apply where the filing date for any pre-liquidation period would fall due more than 3 months after the commencement of the winding up.

Example
Bad Luck Builders Ltd prepared accounts for the year ended 31 December 2008. The winding up commenced on 25 March 2009. The CT1 return for this period is due on or before 21 June 2009 rather than 21 September 2009.

Short accounting periods complicate loss carryback claims. Careful planning may be required to unlock their potential especially in group situations where multiple effective tax rates can apply.

The appointment of a liquidator does not automatically mean that the company has ceased to trade. Whether or not a company has ceased to trade is a matter of fact with the principal issue being whether or not the liquidator is doing more than realising assets. If a trade has ceased then:
(a) Trading losses can no longer be carried forward (especially important where chargeable gains post-cessation might arise);
(b) Terminal loss relief claims may be available; and
(c) Balancing allowances and charges may be triggered.

A terminal loss arising in the final 12 months may be set off against trading income of the previous 3 years. Given the rapid deterioration in the economic climate, terminal losses are potentially very valuable at the current time but the timing of the cessation to trade is a critical consideration in extracting value from the relief.

Post cessation receipts are liable to corporation tax under Schedule D Case IV but certain losses and expenses may reduce the taxable sum.

Chargeable Gains
Any distribution in specie made by a liquidator in the course of a winding up is a capital distribution.
For capital gains tax purposes there is -
(a) a disposal by the liquidator of assets for their market values;
(b) an acquisition of those assets by the shareholders at those market values; and
(c) a disposal by each shareholder of shares for a sum that includes the market value of the assets received.
Where a liquidator makes more than one distribution to a shareholder each payment is a part disposal of the member's shares and the normal part disposal formula applies. Revenue guidance states that the residual value of shares at any particular distribution date is not generally queried-
"provided that:
(a) the valuation appears reasonable and
(b) the liquidation is expected to and is in fact completed within two years of the first distribution".

Liabilities in Liquidation
A company is chargeable to corporation tax on profits arising in a winding up.

The Irish Supreme Court held in Van Hool McArdle that in court liquidations, corporation tax was not a necessary disbursement of the liquidator, effectively making the tax uncollectable. This decision was reversed by Section 571 Taxes Consolidation Act 1997, which now imposes a liability on all 'accountable persons' such as liquidators to pay capital gains tax (or corporation tax on chargeable gains) on any chargeable gains accruing on disposals made by them. The tax is recoverable from the liquidator by way of an assessment to income tax under Case IV of Schedule D. This tax is treated as discharging a corresponding corporation tax liability of the company. A common problem in practice is the difficulty in ascertaining from the records the historical base cost of assets and any enhancement expenditure.

Section 571 only applies to chargeable gains. There is no statutory provision for the collection of corporation tax on deposit interest arising in the post liquidation period (in court liquidations). However, in members' or creditors' liquidations, tax on post liquidation income is not only subject to corporation tax but is also collectable.

Liquidators of groups often seek to rely on the capital gains exemption for disposals of certain shares and a careful review of the conditions for that relief is required. The exemption doesn't apply to all disposals of shares and the 'trading' requirement creates its own complexities in liquidation situations.

Priority in Liquidations
Liquidators are required to distribute available funds to creditors in a specific order. 'Superpreferential' status applies to employees PRSI deductions for all periods prior to liquidation. After the liquidator has discharged his costs and any necessary disbursements of the liquidation and paid the holders of fixed charges, preferential creditors including Revenue are next in line for payment.

Section 285 Companies Act 1963 lists preferential creditors in a winding up. The tax code applies Section 285 to more recent taxes such as relevant contracts tax (RCT) and VAT.

Revenue's preferential status, post Finance (No.2) Act 2008, now applies to:

• assessed taxes, i.e. including (but not limited to) corporation tax, income tax and capital gains tax assessed (or assessable) up to 5 April prior to the date of liquidation but not exceeding one year's assessment (plus interest). The Revenue will choose the year with the largest liability and can choose different years for different taxes;
• all VAT (including interest on that VAT) for which a company is liable for taxable periods ending within 12 months of the date of liquidation;
• all PAYE/PRSI amounts due for periods falling wholly or partly within the 12 months before the date of liquidation (plus interest on the PAYE element) irrespective of when the tax was due; and
• all RCT amounts in respect of deductions made (or which should have been made) on payments to sub-contractors in the 12 months prior to the date of liquidation.

Local authority rates for 12 months up to the date of liquidation are also preferred.

Special rules apply to companies authorised by the Collector General to remit PAYE/PRSI at intervals longer than one month. In such instances Revenue's preferential status also applies to amounts which would, in the absence of the
authorisation, have been due by the date of liquidation.

While the claims of foreign tax authorities are becoming increasingly enforceable by the Irish Revenue, especially in an EU context, it is worth noting that foreign Revenue debts are not preferred. Perhaps this is fortunate. There has not been a rush of foreign tax authorities to the High Court petitioning for the winding up of Irish companies as the UK Customs and Excise Commissioners did in the Cedarlease case.

Set-offs
Set-off is permitted where there is mutuality of debts, i.e. the debts must be owed to and owed by the same parties. The Revenue is empowered to set off any tax owing to a company in liquidation against tax due by the company. Thus, the amount recovered by way of set off does not rank with other creditors, whether preferential or not. However, pre-liquidation and post-liquidation debts are usually not offset against each other.

Any notices of attachment on debts of the company issued prior to the commencement of the winding up will be revoked but withholding taxes can be problematic. For example, is there an obligation imposed on third parties to deduct RCT or PSWT from payments to companies in liquidation? In my opinion any such deduction would unduly favour Revenue and Revenue should permit the payments to be made gross.

VAT
A liquidator has an obligation to register for VAT within 14 days of a disposal of goods owned by the company in liquidation and account for the VAT to the Revenue. Applications must be made in the name of the company with 'in liquidation' appended. Registration will be refused if the assets that will give rise to the liability have not yet passed into the control of the liquidator or there are no taxable assets for disposal.

The supply of freehold or freehold equivalent interests in 'new' properties is subject to VAT and a joint option to tax can be availed of where necessary. VAT should not be overlooked where property is to be transferred in specie to shareholders. In practice inadequate records is an increasing problem.

Claims for VAT deductions should be segregated between pre and post liquidation transactions. To maintain an input credit for VAT on the liquidator's fees the liquidator should not dispose of all the company's assets prior to issuing a final invoice.

Final Thought
Liquidations of insolvent companies will become more common especially in sectors beyond the construction and retail sectors which have suffered most to date. This increase in activity will raise new tax issues for liquidators and those dealing with companies in liquidation in the years to come.