Closing, Liquidation & Demerger of Business
Closing of Business
The reasons to close a business often vary. Some entrepreneurs do it out of necessity, knowing that the business has simply run its course. Others may choose to close one business in order to start a new venture and to focus their attention on the new endeavour. Amid the Covid-19 pandemic, many small business owners made the decision to close.
Closing a storefront requires more than simply locking the doors and putting up an “out of business” sign on the door. It’s important to properly file a dissolution and dissolve the business with its state of incorporation.
A dissolution is a formal closure of a business with the state. Businesses may be voluntarily or involuntarily dissolved. A voluntary dissolution, for example, is one where a small business owner chooses to dissolve the business and file articles of dissolution to terminate it. Involuntary dissolutions, on the other hand, may occur to businesses in bad standing with the state. If these businesses do not take action to get back into compliance, the state may dissolve the business, and even decide to shutter it for good.
Pay off any outstanding debts
As your business reaches its final stages of dissolution, you must settle any remaining financial obligations associated with the business. This includes business debts as well as liquidating and distributing remaining business assets to members and shareholders.
Once you have completed each item on this list, your business will officially be dissolved. It’s a bittersweet moment, but also one where taking the proper steps helped your small business stay in compliance until the end of its lifespan. Onward to bigger and better startup ideas
File articles of dissolution
Once you have reached a majority vote to dissolve the business, it is time to complete the filing paperwork. If your business has incorporated as an LLC or corporation, you will need to file articles of dissolution. An application covers the following information:
· Name of the business
· Date dissolution will take effect
· Reason(s) for dissolving the business
· Information on any pending legal actions (if any)
· Is your business registered to do business in another state outside of its state of incorporation? If so, you must apply for an application or certificate of withdrawal in these states. This ensures that the business is not held liable for paying future annual reports and state fees.
File a final tax return
Your small business may be closing, but you are not exempt from tax responsibilities. You must file a final tax return and pay any taxes the small business currently owes.
Cancel your employer identification number (EIN)
An EIN is a tax ID that the IRS assigns to your business. It allows you to open a business bank account, hire employees, and legally identify the business on important paperwork.
The IRS recommends cancelling your EIN upon dissolving the business. This must be completed because the EIN is also linked to your IRS business account. Cancelling the EIN allows the IRS to close the account.
Additionally, the small business may need to cancel other items associated with the company. These include, but are not limited to, business licenses and permits and any “doing business as” names (DBAs) your business may have. Company purpose to start manufacturing of Yellow Fig which is falls in Division 15 of industrial activity. For the purpose of manufacturing, company purchase its raw
Liquidation of business
The liquidation of a company is when the company’s assets are sold and the company ceases operations and is deregistered. The assets are sold to pay back various claimants, such as creditors and shareholders. The liquidation process happens when a company is insolvent; it can no longer meet its financial obligations.
What is liquidation?
Liquidation involves winding up the financial affairs of a company as well as selling off the business’s assets to repay its debts. It includes dismantling the company’s structure in an orderly way. The liquidator is also tasked with investigating what might have gone wrong with the business if the company is liquidating due to financial issues.
Liquidation applies only to companies (businesses operating under the company structure). Bankruptcy – a different concept that’s sometimes confused with liquidation – only applies to individuals, including sole traders and partners in partnerships.
During liquidation, a liquidator is appointed to oversee the process and the liquidator has full control over the company’s operations, financial affairs and assets. The task of the liquidator is to wind up the affairs and cease trading as cost-effectively as possible.
Liquidation is different to selling a business, which only involves a change of ownership. Liquidation is the only way to wind up a company and terminate its existence. Once a company is liquidated, it is completely dissolved and permanently ceases operations.
The liquidation process
Liquidation may occur when a business is unable to pay its debts. This is called involuntary liquidation. Usually this involves a court order, made after an application by a creditor, though directors or a majority of shareholders can also apply to the court.
In addition, businesses might choose to liquidate if they want to stop operating for insolvency or other reasons. This is known as voluntary liquidation, and it’s decided by a members’ or creditors’ resolution. With voluntary liquidation, the company might have already gone through voluntary administration and/or a Deed of Company Arrangement (DOCA), and have since decided that the business is no longer viable and so chosen to wind it up.
Once the company is in liquidation, unsecured creditors cannot continue or start legal action unless they have permission from a court. Directors no longer have authority, and the company’s bank accounts are frozen. Any trading that continues is at the discretion of the liquidator. Liquidation can last as long as necessary, but the process has to conform to strict rules and procedures depending on the type of liquidation it is.
Why choose liquidation?
Liquidation is the only way to wind down operations and shut down a business in an orderly way. It ensures assets are distributed among creditors, and helps minimise the impact of insolvent trading. It also gives shareholders, creditors and directors the opportunity to have an independent expert investigate and manage the liquidation. So the top reasons include control, lower costs, and freedom from the stress of insolvent trading.
Liquidation vs. voluntary administration
Voluntary administration is very different from liquidation. Though liquidation is a possible outcome, voluntary administration won’t necessarily result in business liquidation. It’s a chance for directors to appoint an external administrator to possibly help overcome the business’s financial problems and return to normal trading. The business could enter a DOCA, return to the directors’ control, or be liquidated. In contrast, liquidation means the company will soon cease to exist with no chance of returning to trading.
While both processes involve bringing in an expert to manage the business, voluntary administration opens the door to a wider range of possibilities than liquidation, which always results in the company shutting down.
Outcomes of liquidation for employees
Once the liquidator is appointed, the company’s directors lose all legal authority and the liquidator could decide to terminate all employees. However, if the liquidator believes temporarily continuing trading is the best course of action, employees could continue in their roles or be rehired. This typically happens if the liquidator intends to sell the business.
Employees are likely to lose their jobs in the event of liquidation. Additionally, they could also lose out on entitlements if there are insufficient assets to cover the cost of the entitlements. However, employees could recover some of this through the Fair Entitlements Guarantee (FEG). The FEG is a government scheme that lets liquidation-affected employees claim up to 13 weeks of unpaid entitlements like wages, annual leave, redundancy pay, long service leave, and payment in lieu of notice
Why would a successful business liquidate?
Liquidation is sometimes voluntarily entered into by profitable businesses as it’s the only way to shut down operations, and if the owner does not or cannot sell the business.
For example, if a business has been built based on the services of a single person, then the stepping down of that person may require the business to be liquidated even though the business is currently viable. Another scenario may be if there has been an attempted ‘hostile takeover’ of a successful business, then in order to prevent the business from being taken away from them then the owners may choose to liquidate.
Demerger of Business
A demerger is a form of corporate restructuring in which the entity’s business operations are segregated into one or more components. It is the converse of a merger or acquisition.
A demerger can take place through a spin-off by distributed or transferring the shares in a subsidiary holding the business to company shareholders carrying out the demerger. The demerger can also occur by transferring the relevant business to a new company or business to which then that company’s shareholders are issued shares of. In contrast, divestment can also “undo” a merger or acquisition, but the assets are sold off rather than retained under a renamed corporate entity.
The expression ‘Demerger’ is not expressly defined in the Companies Act, 1956. However, it is covered under the expression arrangement, as defined in clause (b) of Section 390 of Companies Act.
Division of a company takes place when
1. Part of its undertaking is transferred to a newly formed company or an existing company and the remainder of the first company’s division/undertaking continues to be vested in it; and
2. Shares are allotted to certain of the first company’s shareholders.
A demerger is a form of restructure in which owners of interests in the head entity (for example, shareholders or unit-holders) gain direct ownership in an entity that they formerly owned indirectly (the ‘demerged entity’). Underlying ownership of the companies and/or trusts that formed part of the group does not change. The company or trust that ceases to own the entity is known as the ‘demerging entity’.
Definition of demerger U/s Section 2(19AA) of the Income Tax Act
The definition of ‘demerger’ as given under Section 2(19AA) of the Income Tax Act is unduly restrictive, and subject to various conditions. Some of the conditions mentioned are:
1. The first condition is that all the property of the undertaking should become the property of the resulting company.
2.Conditions of Sec 391 to Sec.394 should be satisfied.
3.Similarly, all the liabilities relating to the undertaking immediately before the demerger should become the liabilities of the resulting company.
4.Explanation 2 provides that not only identified liabilities should be transferred to the resulting company, but also general borrowings in the ratio of the value of the assets transferred to the total value of the assets of the demerged company.
5.Assets and liabilities have to be transferred at book value.