Close Company

A company resident in the UK that is under the control of five or fewer participators or any number of participators who are also directors.

Definition of “Close Company”

A Close Company is a company resident in the UK that is under the control of:

  1. Five or fewer participators, or
  2. Any number of participators who are also directors.

A close company is delineated by its structure of control, particularly concerning the distribution of control rights and benefits.

Alternative Asset-Based Test

Besides the control mechanism, there is an asset-based test to classify a company as a close company:

  • If five or fewer participators, or any number who are directors, would be entitled to more than 50% of the company’s assets upon winding up.

Principal Consequences

The primary consequences of being classified as a close company include tax implications by HM Revenue:

  1. Benefits in Kind: Certain benefits provided to shareholders can be treated as distributions.
  2. Loans or Quasi-Loans: Loans made to shareholders can be taxed as distributions.

Examples

  1. A small family-owned business controlled by three brothers and their father can be classified as a close company if they hold more than 50% of the shares.
  2. A technology startup where the four founding members, who are also directors, hold the majority of shares.
  3. A manufacturing firm consisting of five business partners, each holding equal shareholding, with four of them being directors.

Frequently Asked Questions (FAQs)

What is considered a participator?

A participator is an individual who has a financial interest in the company, such as shareholders and stakeholders with financial influence.

Are all small companies considered close companies?

No, not all small companies are close companies. The classification depends specifically on the control and distribution of shares among participants and directors.

How does being a close company affect taxation?

Close companies may face different tax treatments, particularly regards benefits given to shareholders and loans, which can be treated as company distributions by HM Revenue.

What is the difference between a close company and a closed company?

In the UK, the term “close company” is used, while in the USA, the American equivalent is termed “closed company.” Both refer to similar structures with limited and closely-held ownership control.

Can a close company avoid the classification?

To avoid being a close company, the company must change the structure of shareholding and director participation to exceed the thresholds defined by the asset-based test and control criteria.

Participator

A person or entity with a financial interest in a company, such as shareholders or key stakeholders.

Benefits in Kind

Non-cash benefits provided to employees or directors, which might include company cars, private medical insurance, and other perks.

Distribution

The payment of company profits to shareholders, which can include dividends, benefits in kind, or loans.

Close Investment Holding Company

A specific type of close company primarily set up to hold investments rather than conduct trade, often facing stricter tax rules.

Online Resources

HM Revenue & Customs (HMRC) Guidelines

GOV.UK Close Company Information

Suggested Books for Further Studies

  1. “Core UK Tax Principles” by Malcolm James

    • Provides an extensive understanding of UK tax principles, including classifications like close companies.
  2. “Taxation of Small Businesses” by Malcolm Finney

    • Delves into tax treatments and classifications for small businesses, particularly relevant for close companies.
  3. “Accounting in a Nutshell: Accounting for the Non-specialist” by Janet Walker

    • An accessible guide on various accounting principles that can shed light on the nuances of classifications like close companies.

Accounting Basics: “Close Company” Fundamentals Quiz

### How many participators, at a maximum, control a close company? - [ ] Ten or fewer - [x] Five or fewer - [ ] Seven or fewer - [ ] Four or fewer > **Explanation:** A close company is controlled by five or fewer participators. ### What alternative test applies to classify a close company? - [ ] Revenue-Based Test - [x] Asset-Based Test - [ ] Profit-Based Test - [ ] Share-Based Test > **Explanation:** An asset-based test applies if five or fewer participators or any number who are directors would be entitled to more than 50% of the company’s assets on winding up. ### Under which circumstances can benefits in kind be treated as a distribution by HM Revenue? - [x] Provided to shareholders in a close company - [ ] Provided to employees only - [ ] Provided to all directors regardless of participator status - [ ] Provided to external contractors > **Explanation:** Benefits in kind provided to shareholders in a close company can be treated as distributions. ### What is the equivalent term for close companies in the USA? - [ ] Public Companies - [ ] Open Companies - [x] Closed Companies - [ ] Family Companies > **Explanation:** In the USA, close companies are known as "closed companies". ### What happens when a close company provides loans to its shareholders? - [x] Loans can be treated as distributions by HM Revenue - [ ] Loans have no tax implications - [ ] Loans increase the company’s equity - [ ] Loans lead to immediate tax deductions > **Explanation:** When a close company provides loans or quasi-loans to shareholders, these can be treated as distributions by HM Revenue with potential tax implications. ### What denotes someone as a participator in a company? - [x] Having a financial interest in the company - [ ] Only holding a managerial position - [ ] Being an external auditor - [ ] Having an employee status > **Explanation:** A participator is someone with a financial interest in the company, such as a shareholder. ### How must a close company change to avoid the classification? - [ ] Increase dividends - [ ] Hire more directors - [x] Change the structure of its shareholding and directorship - [ ] Increase patent filings > **Explanation:** To avoid being classified as a close company, the company must restructure its shareholding and director participation to exceed the control thresholds. ### What falls under the classification of a distribution? - [x] Company profits paid to shareholders - [ ] Employee wages - [ ] Supplier payments - [ ] Insurance premiums > **Explanation:** Distributions refer to the company’s profits paid to shareholders, which can include dividends or benefits in kind. ### Which type of company is often taxed more stringently? - [ ] Sole proprietorship - [x] Close Investment Holding Company - [ ] Partnerships - [ ] Limited Liability Company (LLC) > **Explanation:** Close investment holding companies are often subject to stricter tax rules as they are set primarily to hold investments. ### What are some principal consequences of being a close company? - [ ] Increased funding opportunities - [ ] Higher dividend rates - [x] Certain benefits and loans treated as distributions by HM Revenue - [ ] More lenient tax regulations > **Explanation:** Being a close company means certain benefits and loans can be taxed as distributions by HM Revenue.

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Tuesday, August 6, 2024

Accounting Terms Lexicon

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