The Income tax Act 2007 allows a company to make a tax free distribution of capital gains “on liquidation”.
The IRD issued publication QB20/03 on 11 December 2020. The publication discusses the first step legally necessary to achieve “liquidation” in both the short form (s318(1)(d) Companies Act 1993) and long-form liquidation (s241(2)(a) Companies Act 1993).
IRD have confirmed when “liquidation” occurs under each process. It reinforces BR Pub 14/09 that a short form liquidation commences (for tax purposes) when a valid resolution is passed, when the directors (and/or shareholders depending on the constitution) make the decision to wind up the business, pay all creditors, distribute surplus assets and request removal from the register of companies, and then carry out the short from liquidation process. It also confirms that the first step legally necessary to achieve a long form liquidation is not the same. A long form liquidation commences when the shareholders pass a resolution to appoint a named liquidator.
The commentary talks of the trigger for losing the “on liquidation” status under the short form method. Quite simply, if the company continues to trade after the winding up resolutions under the short form process or before the formal liquidation, there is a risk a capital distribution in that period is taxable. Also, if a company commences a short form process then there is a significant delay or does not complete the formal strike off, earlier capital distributions may be held taxable.
Directors need to be wary that when they decide to wind up their company and opt for the shortform method that they cannot be held to have traded in the winding up process and they cannot incur significant delay without reason. Refer IRD’s example 3 below. The short form liquidation process must lead to the company strike off.
Example 1 below shows it can take time to achieve a winding up, even years.
Changing processes from short to long form is less clear. The article suggests “unforeseen processes” as a legitimate reason. It does not specify the common position where companies resolve to wind up their businesses, start to carry out that process and then appoint a liquidator to complete the process down the track. Liquidation for tax purposes starts on the winding up resolution and then the formal long form liquidation starts from the shareholder resolution appointing the liquidators by name later. It seems so long as there is a clear intention and reason to change process that this is acceptable.
These are the key clauses relating to the change of process, from my perspective are at 12 and 13 of QB20/03 :
12. Changing Processes “Sometimes, a company that has embarked on a short-form liquidation may find it necessary due to unforeseen circumstances to appoint a liquidator. This could occur, for example, where a dispute arises in the course of winding-up the business that would be better to have a third-party liquidator resolve. The Commissioner considers that the period known as “on liquidation” began when a valid resolution was passed commencing the short-form liquidation process.”
13. Time Delays “In some cases, there may be an extended period between the first step legally necessary to achieve liquidation and the removal of the company from the register. The period may even span different tax years, so that a distribution is made in a period preceding the removal of the company from the register. The Commissioner will assume that any distributions are made pursuant to a genuine intention to liquidate. However, if the liquidation is not completed or, in the case of a short-form liquidation, the company does not cease to trade after a resolution to cease to trade is passed, then such a distribution will not have occurred “on liquidation” and the distributions will be taxable.”
This suggests that a company may change processes so long as there is a genuine intention to liquidate from the outset and “on liquidation” occurs from the initial resolution (so long as further trading does not disrupt that).
The key message is, so long as your client can clearly show there was no trading after the winding up resolution then there should be no issue with advancing a short form method. For certainty advancing a formal long form solvent liquidation is recommended – particularly for companies with large capital distributions. It removes the risk.
For advice on solvent or shortform liquidations contact our team.
Related Article: Ceasing to Trade a Company in New Zealand