What is a Declaration of Solvency?

October 28, 2021 / Business Insolvency

If you are entering your solvent limited company into a Members’ Voluntary Liquidation, you will need to be aware of the declaration of solvency which must legally be signed as part of the liquidation process.

To help directors find out more about the declaration of solvency and why this is part of the MVL process, Clarke Bell has put together this handy guide.

What is a declaration of solvency?

As we have mentioned, a declaration of solvency is a document that a director must sign before putting their solvent company into a Members’ Voluntary Liquidation (MVL).

As a Members’ Voluntary Liquidation is an option open only to solvent companies, the declaration of solvency document allows the company director to make a formal declaration stating that the company is able to settle any outstanding debts they have within the next 12 months.

Why is a declaration of solvency required?

The declaration of solvency is required before the Members’ Voluntary Liquidation is initiated to show that the company can pay back any debts within the next year.

If the company could not affirm its solvency, it would not be eligible for a Members’ Voluntary Liquidation.

Alongside the declaration of solvency, the company must also provide a statement of assets and liabilities.

The declaration of solvency has to be made in front of a solicitor or commissioner of oaths by the company directors and then filed at Companies House. There can be serious consequences if a false or negligible declaration is made.

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What is a Members’ Voluntary Liquidation?

As we have mentioned, a declaration of solvency has to be made before a company enters into a Members’ Voluntary Liquidation.

But what is an MVL?

A Members’ Voluntary Liquidation is a way for directors to close their solvent company in a tax-efficient manner.

This is a voluntary, legal process that formally winds up the solvent company, dealing with its assets and liabilities correctly, before it is dissolved and struck off the Companies House Register.

As a formal legal process, an Insolvency Practitioner must be appointed to carry out the MVL.

There are several benefits to closing a limited company through an MVL.

Firstly, this is a route that lets the director close their company in a quick way, meaning they can easily free up funds.

Another main advantage of an MVL is that it lets the director close the company in a tax-efficient way.

This is because funds taken out of the company through an MVL are subject to Capital Gains Tax rather than Income Tax which is set at just 10%, much lower than 18% at the basic income tax level or 28% at the higher level.

Furthermore, there are additional tax benefits to shareholders of the company if they qualify for Business Asset Disposal Relief.

Business Asset Disposal Relief lets a director sell all or part of the business and pay only 10% in Capital Gains Tax on the profits over the life span of the business. This is capped at £1 million.

Just as it sounds, this can save directors a significant amount on their tax bill.

To find out more about a Members’ Voluntary Liquidation and how to prepare for one, check out our handy guide.

What happens if you have signed a declaration of solvency and later discover the company is insolvent?

As we have mentioned, before the company can enter into a Members’ Voluntary Liquidation it is required to sign a declaration of solvency which promises that it has the assets to pay back any liabilities over the next 12 months.

However, what happens when a director signs a letter of solvency to later find out that the company is insolvent?

A director that wrongly signs a declaration of solvency, whether this is knowingly or not, faces a range of consequences.

After all, falsely signing a declaration of solvency is a criminal offence and therefore the director can face fines and disqualification from directorship in the future. In the most serious of cases, the director can even face a prison sentence.

If your company is insolvent, it is important that you do not sign a declaration of solvency and enter into an MVL. Instead, you will need to close your limited company through different means.

Closing an insolvent company

A company that is insolvent must be closed in a different way to a solvent company.

The first option is to close the company through a Creditors’ Voluntary Liquidation (CVL.)

As the name implies, this is a way for insolvent companies to voluntarily close whilst dealing with their debts and liabilities in the correct, legal manner as overseen by a licensed Insolvency Practitioner.

Putting your insolvent company into a CVL shows that you are meeting your obligations as a director towards creditors to which the company owes money. This helps to guard your reputation as a director, meaning you can open another company in the future should you wish to do so.

The other way an insolvent company can be closed is through compulsory liquidation.

Unlike a CVL, however, this is an involuntary process that is forced upon the company. As such, it is the most serious way a company can be closed and can have a wide range of negative consequences for the director.

Compulsory liquidation occurs when creditors issue a winding-up petition to the courts. Creditors can do this if they are owed a sum of £750 or more by the company and have had several repayment demands gone unfulfilled for 21 days or more.

If successful, the court will issue the company with a winding-up order and it will be forced to close.

Directors that let their companies fall into compulsory liquidation can face investigation for wrongful trading, disqualification from directorship and deteriorated relationships with professional bodies, customers and creditors.

Considering an MVL? Let Clarke Bell help 

If you are thinking about closing your solvent company through an MVL and are seeking advice on the declaration of solvency or indeed the entire process, Clarke Bell can help.

Our team of experts will work closely with your company to offer expert advice and get the best outcome for you. To find out more about how we can help get in touch today.