There are times where business owners, whether voluntarily or involuntarily, may need to wind up their business.

It is generally less complicated to wind up the business of a sole trader (who has declared “bankruptcy”) than to wind up a business run through other structures. For companies, the terms typically used would be to “go into administration” or “liquidation”. More on this below.

A sole trader is less complicated to wind up because the principal of the business is also personally responsible for all debts and liabilities accrued by that business.

Dealing with a company wind up

To wind up a business in a company, a trustee may be appointed (either by yourself or by your creditors) to conclude all current contracts, sell remaining stock and other assets, pay outstanding debts and creditors, and notify all concerned (the bank, customers, suppliers).

What happens under a voluntary administration?
Voluntary administration is where a company’s directors hand over the business to a professional administrator to decide on the best plan of action.

If your company can’t pay its debts and is insolvent, voluntary administration and liquidation are two of the key options. The definition of insolvent is when liabilities total more than the value of assets, and debts cannot be paid. Insolvent trading is where a business continues to incur debts even though the owner or directors are aware, or should be, that the business cannot pay them. A business’s principals in these cases can be held personally liable, and even face jail time in the most extreme cases.

Voluntary administration can be a way for businesses in financial distress to get some wriggle room from creditors. Going into administration could stave off having to go into liquidation if the business is administered in such a way to maximise the chances of it continuing in business (or if that’s impossible, then to at least get a better result for creditors and shareholders upon the inevitable liquidation).

The first step is a meeting of directors and appointment of an administrator, who will try to salvage the business’s financial standing.

Apart from a director voluntary administration (where the directors opt to place the business in an external administrator’s hands), a firm going into administration may also be initiated by a secured creditor or the company’s shareholders. The company may also be put into receivership, which is where an external receiver takes over the company’s assets and sells them to pay off secured debt.

What happens under a liquidation?
If going into administration or receivership does not lead to a viable arrangement, then liquidation is the alternative. Liquidation is the formal process for winding up a company’s financial affairs to settle debts with the proceeds of the sales of its assets. A search of ASIC’s website will yield some useful information.

A vote of creditors or a court order can put a business into liquidation, or the business can do so voluntarily. The appointed liquidator will prioritise creditors, with secured creditors first (those whose claims against the company are protected by a charge over a specific asset or group of assets – like a bank that issues a mortgage), then unsecured creditors (with contractual rights to receive a set amount of money but not backed by a charge over a specific asset) and lastly shareholders.

Generally, the claims of one priority class must be fully satisfied before those of the next priority level down get to see a cent. There may be pro-rata payments among claimants at the same priority level if not enough funds can be cobbled together.

The liquidator’s job is to get the best result for creditors and shareholders, and part of this can be collecting, valuing and selling all assets. If any insolvent trading is uncovered, company directors can also be sued by creditors to recoup funds.

But if continuing trading is in everyone’s best interests, then the liquidator can also go down that path. Usually however, another outcome of this is to be able to sell the business as a going concern, as well as perhaps to finish and sell work in progress. The aim is to wind up the company, but to do it in a commercially practical way.

Beware of the tax implications

Some general tax implications to consider when winding up your business include the following.

Asset sale
Of course, as with every other stage of the business life cycle, you will have to factor in the tax consequences of dealing with the business’s financial woes.

If assets are sold to pay debts, the proceeds would still be subject to tax as ordinary income or as a capital gain. Just be aware that if the business has to sell its trading stock or other assets at bargain prices (below market value), in certain instances tax law may nevertheless treat the sale as having been made at market value, regardless of how much was actually received.

If you are a sole trader winding up your business or if you own shares in a company being wound up, and you sell the assets of the business or the shares in the company to a “white knight”, you will still be subject to tax on the sale.

Where the sale is taxed under the CGT rules (for example, real property or goodwill), you could be entitled to various tax exemptions and concessions under the small business CGT concession rules. In this situation’s best-case scenario, 100% of a capital gain could be tax-free.

Debt forgiveness

If a creditor or a lender decides to forgive part or all of a debt or a loan (that is, releases the business from the obligation of paying the amount back), the amount may fall under the “commercial debt forgiveness” rules.

In essence, the business may have to reduce, among other things, the value of any carry forward tax losses (which could be the case if the business has been in strife for a few years), and perhaps capital losses, by the amount forgiven. However the forgiven amount would generally not be assessable income, and sometimes there would be no tax consequences at all.

On a related note, if you (or your company) cancel contracts in the course of winding up, there may be capital gains or losses as a result – intangibles such as contractual rights come within the CGT regime.

Getting any money out of the company

If you are a shareholder of a company being liquidated, any distribution you receive from the liquidator should be tax-free to the extent that it is a return of your original investment amount; anything above that amount is most likely to be taxed as a dividend.

The tax law in relation to voluntary administration and liquidation is very complex, so good advice is always preferable. See this office for guidance.

Tip! Don’t forget to cancel your ABN

For any business with an ABN, the ATO also says you need to notify it that you have ceased trading within 28 days of doing so, and also to cancel registration for GST, if applicable, within 21 days of cessation of trading.

You can keep and re-activate the ABN if things pick up for you in the future (remember, even Donald Trump was bankrupt in 1992!). However as long as you keep the ABN active, you will still be expected to lodge activity statements.