Tax Efficient Way to Dissolve a Business Partnership

When considering ending a business partnership, there are two distinct types of dissolution depending on whether one partner wants to carry on trading, or if the entire operation will cease to exist.

• Technical: when one partner leaves and another joins – the business carries on trading.
• General: the partnership is wound up, the business ceases to exist, and partners take funds from the organisation, assuming it is solvent.

The Partnership Act 1890 regulates this type of action and describes the reasons why business partners might want to dissolve their agreement. But, assuming that a general dissolution is taking place – maybe the partners are retiring – a Members’ Voluntary Liquidation may offer more benefits in terms of tax efficiency.

What is a Members’ Voluntary Liquidation (MVL)?

The main eligibility requirement for entering a Members’ Voluntary Liquidation is the solvency of the business. All directors are required to sign a declaration to this effect, stating that the business can pay its debts, including interest, within a period of 12 months, although it is often the case that a solvent partnership is dissolved well within this timescale.

Tax treatment of capital following a Members’ Voluntary Liquidation

Entering into a Members’ Voluntary Liquidation offers huge benefits as far as the tax treatment of capital is concerned. Funds released from the business will be treated as capital rather than income meaning it will attract Capital Gains Tax (CGT) rather than income tax; this often results in a vast reduction in the amount of tax individuals are liable to pay.

The current rates of Capital Gains Tax are 20% for higher rate taxpayers (28% for gains on residential property) as opposed to the 40% income tax rate. You will also be able to take advantage of your Annual Exempt Amount (AEA) for CGT which means the first £12,000 of gains will not be subject to tax. As an added bonus, directors may also be able to take advantage of Business Asset Disposal Relief (BADR), formerly known as Entrepreneurs’ Relief prior to April 2020, which was introduced to encourage people into business by providing tax relief on dissolution.

Business Asset Disposal Relief/Entrepreneurs’ Relief

In order to be eligible for Business Asset Disposal Relief (BADR), formerly 'Entrepreneurs’ Relief', you must have owned the business for at least two years before liquidation. Qualifying assets will see the effective rate of CGT halve to just 10% up to a lifetime limit of £1 million. If shares are being sold you must hold a minimum 5% of ordinary shares and voting rights.

If you deduct your AEA from your gain on disposal, you will owe 10% on the remaining assets that qualify for Business Asset Disposal Relief.

The process of entering into a Members’ Voluntary Liquidation

As previously mentioned, the business must be in a solvent position in order to be eligible for Members’ Voluntary Liquidation. This is why it is vital to ensure you have accurately valued your business assets and calculated your liabilities to ensure that the Declaration of Solvency is valid.

Begbies Traynor has licensed insolvency practitioners across the UK who can guide you through a Members’ Voluntary Liquidation. We offer a free initial consultation at your local Begbies Traynor office – just contact a member of our expert team to discuss your circumstances.