We all know that the pressures of running a contracting company can be massive at the best of times, but in the current climate of IR35 uncertainty, it is becoming, for many, unbearable. We’re finding, rather than put up with this uncertainty, many contractors are taking the view to close down their company and accept a staff role. Read on to find out how to do this in the most tax efficient manner, which might just soften the blow a little.
What are the options available?
It’s worth noting that the options available require that the company in question is capable of paying all it’s debts. In a simple contracting company, these debts are unlikely to be anything other than corporation tax, VAT, and maybe a bit of PAYE. If we assume that all these are paid up to date (or at least provided for) and there’s still a chunk of cash in the company’s coffers then, if the company is no longer required, how do we get our hands on that cash with minimal exposure to tax?
As with most tax questions, the answer is “it depends.” This time it depends on two things: 1) how much money is in the reserves, and 2) if you’re willing to make pension contributions.
Generally speaking, if a company has less than £25,000 in reserves, then a formal liquidation process is not required and therefore an informal dissolution can be undertaken. If the reserves exceed £25,000, then a liquidator needs to be appointed and the company should go through the Members’ Voluntary Liquidation (MVL) process.
Both of these processes attempt to move the distribution of the funds out of “income” – dividends for example, and into “capital” which, in general terms us more tax efficient.
So, two (maybe three) options then:
If the company’s assets/reserves do not exceed £25,000 the most straightforward process is likely to be an informal dissolution by way of a simple filing at Companies House. However, don’t be fooled into thinking that this is easy. It may be simple but an experienced and expert eye is required to ensure there are no mistakes made.
The process is basically this:
- Settle the debts of the company – including VAT and Corporation Tax up to the cessation of trading activities (note: this may mean paying tax earlier than it would normally be due)
- Withdraw funds from company in the correct proportion according to the shareholding – in general terms a 50% shareholder gets 50% of the funds.
- Close the company
Members’ Voluntary Liquidation
If the reserves of the company are more than £25,000, and all other tax planning routes have been exhausted, then the MVL route is likely to be the only option available. While there are costs associated with this, typically an MVL will cost around £2,500 the tax benefits are likely to significantly outweigh these.
Of course, there are drawbacks to an MVL: control of the assets of the company will be required to be handed to the liquidator and the time for the whole process is subject to HMRC clearance but it is generally accepted that this process works well enough.
Using either the Simple Procedure or the MVL means that funds which would ordinarily be treated as a dividend, and therefore taxed at 7,5%, 32.5% or 38.1% depending on whether the recipient is a basic rate, higher rate or additional rate taxpayer, can be taxed at just 10% provided the distribution qualifies for Entreprenuer’s Relief. In addition, because the distribution is reclassified as capital, the first £12,000 of income for each shareholder is exempt from tax. You can see therefore that very quickly there are significant tax savings available. Here’s a quick worked example:
SIngle shareholder (higher rate taxpayer) with £100,000 reserves
|Company retained earnings||£100,000||£100,000|
|Available to distribute||£0||£97,500|
|Annual CGT exemption||£0||£12,000|
|Liable to CGT||£0||£85,500|
|CGT payable (assuming ER)||£0||£8,550|
|Income tax payable 32.5%||£32,500||£0|
|Net amount received by director||£67,500||£88,950|
Clearly therefore there are significant tax savings available if you are closing your company but it is important that great care is taken and the appropriate level of planning is carried out between you and your advisers to ensure the correct method is chosen and the correct process is followed.
What’s this third way you mentioned?
It’s not really a third way, as such, but it’s perhaps an additional process you need to consider before getting involved in either of the above options, and this is to consider whether your company can make contributions to the director’s pension scheme. This is, of course, likely to be more appealing to the older contractor due to the lock-up of the funds but managed properly, the above tax liabilities could be removed altogether by making appropriate pension contributions. But again, proper planning and advice is essential.
So, the key here is “planning.” It’s essential that you get out in front of this. If you think that the Off-Payroll rollout is going to mean you’ll be quitting contracting, now is the time to start thinking about your exit: between now and next April, there could be potential to defer some of your proposed dividends and distribute this as capital instead, or you could start the pension contribution process bot of which could potentially save you thousands.
Of course, no two sets of circumstances are the same, so we’d urge you to contact your Acumenica accountant or adviser to discuss a plan.
(This article is for general guidance only and is not intended to be relied upon as advice. Acumenica Group Ltd accepts no responsibility for any loss, financial or otherwise, incurred as a result of action, or inaction, taken cased on the information contained herein.)