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What Is A Close Company?

What Is A Close Company

In the UK, a close company is defined as a limited company with five or fewer participants, or a limited company where all the participants are also directors. For most small limited companies, ‘participators’ will just mean shareholders. However, if the company has issued debt finance called debentures, then the holders of the debentures will also be considered participants.

Characteristics of a Close Company

One of the unique characteristics of a closed company is that its stock is not available for public sale or traded on a national securities exchange. This means that the general public cannot readily invest in them, and the shares are often held by the owners or managers of the business and sometimes even their families.

Close companies have more flexibility compared to publicly traded companies as they are free from most reporting requirements and shareholder pressure. This added level of secrecy can prevent competitors from learning about a company’s plans and give close corporations greater flexibility in how they operate.

However, with fewer shareholders involved and shares not publicly traded, liquidity can be an issue for close corporations. When a shareholder dies or has a desire to liquidate their position, the business or remaining shareholders will buy back the shares.

Examples of Close Companies

There are closed corporations all over the world. They are involved in a wide variety of business pursuits, from retail and manufacturing to business services and financial services. Some examples of well-known closed corporations include:

  • Cargill
  • Ernst & Young
  • PricewaterhouseCoopers
  • SC Johnson
  • Hearst Corporation
  • Chick-Fil-A
  • Hobby Lobby (U.S.)
  • IKEA
  • ALDI
  • Bosch
  • LEGO (Europe)

Tax Implications for Close Companies

If a close company makes a loan to a participant that isn’t repaid within nine months and one day of the company’s year-end, the company will have extra tax to pay. The tax effects of dissolving a business depend largely on the type of organisation you are closing.

A closed company may elect to pay dividends to its shareholders. But, because issuing dividends may result in double taxation, most closely held corporations opt to not pay dividends.

Seeking professional tax planning advice can help close companies minimise their tax liability when operating and especially when dissolving the business.

Key Features of Close Companies

  • Shareholders – A close company must have 1-50 shareholders. The shareholders often include the directors and founding members who manage the company.
  • Share transfers – Shares in a close company cannot be freely transferred like with a PLC. Transfers require the agreement of all shareholders.
  • Reporting – Close companies have more flexible reporting requirements and do not need to publish accounts and reports like PLCs.
  • Directorships – Close companies can have a single director while public limited companies require at least two.
  • Share types – Close companies can only issue ordinary shares while PLCs can also issue preference shares.
  • Company suffix – Close companies must use ‘Limited’ or ‘Ltd’ in their name while PLCs use ‘Public Limited Company’ or ‘plc’.

Reasons for Establishing a Close Company

There are several advantages to the close company structure that make it appealing for many small and medium enterprises (SMEs) in the UK:

  • Privacy – Close companies have fewer reporting requirements and can keep financial information private. This can help maintain competitiveness.
  • Flexibility – Close companies have fewer regulations to comply with and can operate more flexibly. Decision-making may be easier with a small group of shareholders.
  • Tax efficiency – Close companies can manage taxes efficiently by retaining profits within the company. They can pay corporation tax at a lower small profits rate.
  • Capital raising – Close companies can raise investment capital by issuing shares but in a more private manner than PLCs.
  • Ownership control – Founders can retain greater ownership control in a close company with no pressure from outside shareholders.

Close Company Taxation

Close companies in the UK have some specific tax considerations:

  • Corporation tax – Close companies pay corporation tax on profits. The small profits rate is 19% for profits up to £300,000. The main rate is 30% above £300,000.
  • Income tax – Close company shareholders pay income tax on salaries and dividends received from the company. Dividends are taxed at dividend tax rates.
  • Capital gains tax – Shareholders may need to pay capital gains tax when selling shares at a profit. Entrepreneurs’ relief can reduce CGT liability in some cases.
  • Inheritance tax – Shares passed on during inheritance may be liable for inheritance tax. Business relief can reduce this if shares are held for 2 years.
  • Loans to shareholders – Close company loans to shareholders over £15,000 may incur a tax charge for the company. Interest is also taxable.
  • Losses – Tax relief options may be limited for shareholder directors’ loan interest and capital losses in close companies.

Professional tax planning is advisable for close companies to fully utilise allowances and minimise their tax liability.

Close Company Reporting Requirements

Close Company Reporting Requirements

Close companies have fewer reporting requirements than public limited companies in the UK. However, they still need to prepare and file certain accounts and reports:

  • Annual accounts – Close companies must prepare annual statutory accounts and directors’ reports to be filed with Companies House and HMRC.
  • Abbreviated accounts – Small companies can file abbreviated accounts with fewer disclosures if they meet certain criteria.
  • Company tax return – A corporation tax self-assessment return must be completed annually by closed companies.
  • Confirmation statement – A confirmation statement (previously annual return) must be filed each year to confirm company details.
  • Shareholder registers – Close companies must maintain up-to-date registers of shareholders and charges over their assets.
  • Audit – Small close companies are exempt from audit requirements unless shareholders holding at least 10% request one.
  • Penalties – Late filing of accounts and tax returns will incur financial penalties. Persistent breaches can lead to disqualification of directors.

Maintaining accurate records and seeking professional accounting assistance can help close company directors fulfil their reporting duties and avoid penalties.

Becoming a Close Company

There are a few ways that a new business can adopt the closed company structure in the UK:

  • Incorporation – A close company can be established by registering with Companies House as a private limited company. The required documents must be filed.
  • Convert existing business – An existing business such as a sole trader or partnership can incorporate to become a close company limited by shares.
  • Change from PLC – A public limited company can re-register as a private company by passing a special resolution and informing Companies House.

The company name must include ‘limited’ or ‘ltd’ and articles of association are required on the formation of a close company. Company formation agents can assist with the registration process for a fee.

It is also possible to convert an existing close company into a PLC by re-registering. However, this requires adhering to the greater reporting and regulatory requirements of a public company.

Pros and Cons of a Close Company

Close companies have some advantages but there are also potential disadvantages to consider:

Pros of a Close Company

  • Fewer reporting requirements and regulations
  • Privacy over financial and operating information
  • Tax efficiency for retained profits
  • Direct control by founders over strategy
  • Easier decision making
  • Flexibility to operate and make changes

Cons of a Close Company

  • Limited ability to raise external investment capital
  • Lack of market valuation through share trading
  • Inheritance tax on shares if not properly planned
  • Minority shareholders have limited powers
  • Higher audit costs if shareholders demand it
  • Directors have extensive legal responsibilities

Seeking professional legal and financial advice can help establish the right company structure and maximise the benefits.

Converting a Sole Trader or Partnership into a Close Company

Many small businesses begin as sole traders or partnerships. At some stage, the owner(s) may consider converting into a close company to enjoy the benefits like limited liability. Here is an overview of the conversion process:

  • The partners or sole traders should take professional advice from legal and accounting advisers before proceeding. Tax planning implications need consideration.
  • A company name must be chosen and checked for availability with Companies House.
  • The company constitution is drafted covering shares, director appointments and articles of association. Share types and director roles are agreed upon.
  • The company is incorporated with Companies House and issued a certificate of incorporation. A bank account should be opened.
  • Assets like property and equipment are transferred from the old business to the new company, often at market value. Legal transfers will be required.
  • The old business is closed – contracts are novated, suppliers are notified, and stationery and branding are changed to the new entity.
  • Trading commences as a new close company. Accounting systems are updated and reporting obligations begin. Staff contracts may need to change.

Overall, converting an existing business into a closed company requires careful planning but can put the business on a growth footing and provide long-term benefits.

Close Company FAQs

Can I turn my sole trader business into a close company?

Absolutely – it’s quite straightforward to convert your unincorporated sole trader business into a closed private limited company. This gives your business a separate legal status and also limits your liability. Just be sure to get professional advice on the process.

What are the main downsides of a close company?

Some of the key disadvantages are having limited options for raising investment capital externally, potentially attracting inheritance tax if shares are passed on, and taking on extensive financial reporting duties as directors. Minority shareholders also don’t have much power in closed companies.

How is a close company different from a regular private limited company?

A private limited company is simply a company that can’t sell shares to the public – it covers both close companies and other small private companies. Close companies specifically have a small number of shareholders, typically less than 50, who are often directors or family of the directors.

Can my child be a shareholder in my close company?

Yes, there’s no minimum age for being a shareholder in a close company. But children can’t be appointed as directors, so you would need to make arrangements for adults to represent the child’s interests until they turn 18.

What type of shares do close companies issue?

Close companies are limited by shares, so the company is owned by shareholders rather than the directors themselves. But close companies are restricted to only issuing ordinary shares, whereas public limited companies can also issue preference shares.

How many directors must a close company have?

One of the flexible features of close companies is that they can be run by a single director. This compares to public limited companies which are required to have at least two directors. It’s often wise to have more than one in case of emergencies though.

What’s the maximum number of shareholders allowed?

To be classified as a close company in the UK, the company needs to have no more than 50 shareholders. Going above this number would mean becoming a public limited company and complying with more stringent regulations. Most close companies have far fewer than 50 shareholders.

What reporting does a close company need to do?

Close companies have to comply with filing annual accounts, company tax returns and confirmation statements each year. They also need to maintain official registers of shareholders and directors. Small close companies can qualify for audit exemptions.

If I die, can my kids inherit my shares easily?

Yes, your shares in a close company can be passed on to your children or other beneficiaries through your will after you pass away. They become the new shareholders, but can’t be directors until turning 18. Some inheritance tax planning may be helpful though.

Conclusion

In summary, a close company is a type of business entity characterised by a small number of shareholders who are typically involved in managing the business.

Close companies offer benefits like operational flexibility, confidentiality, and tax efficiency compared to public companies. However, they also come with downsides such as limited financing options, liquidity constraints, and extensive legal responsibilities for directors. Careful planning and advice are required to successfully run a close company in the UK.

The close company structure can allow founders to maintain control and grow their business steadily if utilised properly. With professional guidance, close companies provide an attractive model for many small and medium enterprises.

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