Changes to IR35 and the Impact on Personal Service Companies (PSCs)
How contractors pay tax through Personal Service Companies (PSCs) has been of concern to HM Revenue & Customs (HMRC) for some time. Intermediaries’ legislation and subsequent changes, most recently in April 2017, require contractors to consider whether to continue via a PSC. Clients are now being forced to consider moving to payroll without having time to plan an appropriate closure of their PSC, which may cause issues especially if the company has a significant outstanding or prospective 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 PSC need to cease trading.
What is IR35?
Actually called ‘Intermediaries legislation’, though commonly referred to as IR35, it was introduced in 1999 by the Inland Revenue budget press release number 35 and entitled IR35: Countering Avoidance in the Provision of Personal Services.
IR35 is a piece of anti-avoidance tax legislation, designed to tax ‘disguised employment’ at a rate similar to employment.
In this context ‘disguised employees’ means workers who receive payment through an intermediary, such as a PSC, but would be classed as employees if paid directly, as they provide the same services as someone directly employed.
April 2017 Changes to IR35
From 6 April 2017, HMRC made changes to the IR35 tax system which specifically affected public sector workers who provide services and are paid as contractors through their PSC.
Under the reforms, public sector organisations now 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 PSC. 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 have ended contracts and the option for contractors to work through their own PSC.
Contractors are now directly employed, or have joined an “umbrella scheme” company.
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 via a formal insolvency procedure.
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 with a marginal tax charge of 10%.
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 an expert team who have assisted many companies through the MVL process at a very competitive fee 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 or it cannot pay its debts as they fall due. Directors have a fiduciary duty to act in the best interests of the company and its creditors, and thus must take appropriate steps when they know or ought to know the company is insolvent.
It may well be that at the point when the contractor ceases to trade through a PSC, 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 (DLA) in anticipation of a future dividend being declared.
In this situation it is advisable to speak with an insolvency practitioner to assess what options are available to deal with the company as cost-effectively as possible. If there are substantial sums 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. Clients should be aware however that an overdrawn DLA remains repayable to the company in a liquidation.
Assessing the best course of action in situations such as those discussed above is not necessarily straight forward. Bridgewood is happy to work alongside accountants to provide clients with a clear understanding of the options available, and to assist them in finding the best outcome in the circumstances.