What is a Close Company?

In Short

• A close company is usually one controlled by five or fewer participators (shareholders or similar) who can vote or receive most dividends.
• Close companies face extra tax rules, including on loans to participators, distributions, and certain financial transactions.
• Companies can stop being close if ownership broadens or they become part of a non-close company.

Tips for Businesses

Check whether your company qualifies as a close company, as this affects tax obligations and restrictions on loans, dividends, and distributions. Keep clear records of participators, ownership, and transactions, and seek professional legal and tax advice before making loans or other benefit payments to shareholders to avoid unexpected tax liabilities

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Table of Contents

• What is a Close Company?
• Practical Considerations 
• Key Takeaways
• Frequently Asked Questions

As a business owner, you may have encountered the phrase “close company” when working out your company’s tax liability. 

This article will explain which kinds of companies are close companies for tax purposes. It will also look at the restrictions the law imposes on close companies as part of the government’s anti-tax avoidance laws.

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What is a Close Company?

For the purposes of anti-tax avoidance, the law considers any company to be a close company if it is “under the control” of:

• five or fewer “participators” (usually shareholders); or any number of participators who are also directors; or 
• five or fewer participators (or participators who are directors) possess or are entitled to acquire either:
  • such rights as would entitle them to a greater part of the company’s assets that are available for distribution among its participators in a distribution on a winding up; or
  • such rights as would give rise to this entitlement, disregarding any rights held as a loan creditor.

What Does “Under the Control” Mean?

A company is controlled if five or fewer participators: 

• can exercise their voting rights as shareholders; 
• are entitled to more than 50% of any dividends the company issues; or
• are entitled to more than 50% of the company’s assets if it is wound up.

What is a Participator?

In practice, most participators are company shareholders entitled to dividends or the company’s capital upon its winding-up. 

Another example might apply to a director without any shares in the company. The director would be a participator if they enter into an agreement with the company entitling them to dividend payments as if they were a shareholder. 

Exceptions 

Certain companies are not capable of being close companies, even where the criteria outlined above apply. 

These kinds of companies include:

• non-uk resident companies; 
• registered societies and building societies; 
• companies quoted on a stock exchange; or 
• companies controlled by at least one non-close company.

This means that if a company is a wholly owned subsidiary of a non-close company, the subsidiary company is not a close company. 

Practical Considerations 

In most cases, it is usually quite obvious if your company is a close company. The most straightforward example is any company owned by five or fewer people who all hold ordinary shares in the company. 

However, individuals looking to avoid their tax liability often enter into unusual arrangements with their company that hide the fact that they ultimately control the company. The greater the number of shareholders (or individuals with shareholder-like powers), the less likely it is that all of them are engaging in tax avoidance. Therefore, the law widely defines “participators in control” to apply to any company that the participators could potentially use to facilitate tax avoidance. 

We will now look at some of the law’s most common restrictions on close companies.

Loans to Participators 

If a loan is made to a participator of a company, the company must pay corporation tax on the amount of the loan. In addition, the company must pay Her Majesty’s Revenue and Customs (HMRC) within nine months and one day from the end of the accounting period which the company issued the loan. 

For example, if your company loans you £20,000, it must pay tax on this to HMRC. If you pay the loan back, the company gets this tax back. If not, the loan is treated like a dividend, and you may have to pay tax on it personally. You should also ensure you seek taxation and legal advice before proceeding to do this. 

Distributions

For tax purposes, ‘distributions’ refers to dividend payments or the distribution of the company’s assets upon a wind-up. For close companies, certain other transactions qualify as a distribution. These include:

• company cars; 
• accommodation; and 
• other benefits in kind.

Such distributions can attract additional tax liability. 

Transactions in Securities Rules 

Certain tax laws regulate how companies and individuals are entitled to transform an income receipt into a capital receipt. 

Were your company not a close company, this would be far more tax-efficient. However, because it is a close company, there are securities rules that ensure you do not benefit from any tax advantage.

Key Takeaways

For most practical purposes, close companies are fairly easy to identify. They include companies with five or fewer shareholders that can vote on shareholder meetings and receive more than half of any dividends the company pays out. If your company is a close company, there are additional laws that restrict your company’s ability to take advantage of tax-favourable transactions, such as issuing loans to shareholders. 

If you need help with your business, our experienced business lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.

Frequently Asked Questions