The amount of tax contractors pay through their Personal Service Companies (PSCs) has been on the radar of HM Revenue & Customs (HMRC) for some time. Intermediaries’ legislation and subsequent changes, most recently this April, are requiring contractors to make decisions about whether or not to continue trading through a limited company. In some cases clients are now being forced to move onto payroll without having time to plan an appropriate closure of their limited company, which may cause issues especially if the company still has a significant tax liability.
Bridgewood has been advising contractors and working alongside accountants in this area for some time, and in this article we discuss the implications of IR35 and explore what options contractors have, should their company need to cease trading.
What is IR35?
IR35 refers to anti avoidance tax legislation, which is designed to tax ‘disguised employment’ at a rate similar to employment.
In this context ‘disguised employees’ means workers who receive payment through an intermediary, like their own limited company, but would be classed as ‘employees’ if paid directly, as they provide the same level of service as someone directly employed.
Properly known as the ‘Intermediaries legislation’, it is commonly referred to as IR35, as when introduced in 1999 by the Inland Revenue budget press release number 35 – it was titled IR35: Countering Avoidance in the Provision of Personal Services.
April 2017 changes to IR35
From 6 April 2017, HMRC made changes to the IR35 tax system which will specifically affect public sector workers who provide services and are paid as contractors through their limited company.
Under the reforms, public sector organisations have to deduct tax and national insurance contributions from contractors’ pay at source, rather than allowing workers to calculate their own tax contributions and pay them through their limited company. There are some suggestions that this could mean workers seeing as much as a 30% cut in their normal take home pay.
Many public sector organisations are already ending contracts, essentially ending the option for contractors to work through their own limited companies or personal service companies (PSCs).
Contractors are now being encouraged or required to become directly employed, or join an umbrella scheme.
In these situations, it is likely that the contractor’s limited company is no longer required and decisions will need to be taken about how to bring matters to close. If the limited company holds surplus funds, it will mean finding the best way to distribute funds to the shareholders – either through taking income distribution (dividends) over a period of time or a capital distribution through a Members’ Voluntary Liquidation (MVL).
However there may also be circumstances where funds in the limited company are depleted but the company still has liabilities to HMRC or other creditors. In this case, the company may well be insolvent and will need to be closed down accordingly.
How can a solvent members’ voluntary liquidation (MVL) help?
The main advantage of a Members’ Voluntary Liquidation (MVL) is that it can be a tax efficient way of extracting the remaining funds from the company. This is because distributions made out of an MVL are treated as capital receipts rather than income, and are therefore subject to capital gains tax rather than income tax. This is likely to be beneficial if Entrepreneurs’ Relief is available.
Shareholders should firstly seek advice from their accountant in calculating the likely tax benefit of an MVL, but typically it will be a benefit where the funds available for distribution are £25,000 or more. Even though the company is solvent, an MVL can only be completed by using a licensed Insolvency Practitioner. Bridgewood have assisted many contractors through the MVL process and work alongside accountants to provide extra support to their clients.
When might an insolvent creditors’ voluntary liquidation (CVL) be required?
A company is insolvent when its liabilities are greater than its assets and it is unable to trade out of its current position. Directors have a legal responsibility to act in the best interests of the company and its creditors.
It may well be that at the point when the contractor ceases to trade through the limited company, there are outstanding liabilities to HMRC, or other creditors, and no funds remaining in the company to pay them. This can often be the case where the contractor has built up an overdrawn director’s loan account in anticipation of a future dividend being called.
In this situation it would be advisable to speak with an insolvency specialist in order to assess what options are available to deal with the matter as cost-effectively as possible. If for example the amount of the overdrawn director’s loan account is less than the amount owed to HMRC and other creditors, then a Creditors’ Voluntary Liquidation (CVL) may be the best way of dealing with the issue and closing the company down.
Assessing the best course of action in situations such as those discussed is not necessarily straight forward. Bridgewood is happy to work alongside accountants to provide clients with a good understanding of the options available, and to assist them in delivering whichever course of action they choose to take.
If you would like more information, or have a client who may need our services, please don’t hesitate to contact me on 0115 871 2921 or by email email@example.com.
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