Contractors can only lose under the new ESC C16
It is with regret that the demise of a much-liked and cherished tax avoidance concession, known as ESC C16, is upon us, writes Richard Bayliss, managing director of the Low Tax Group. HM Revenue & Customs has been forced by European law to remove concessions and put tax law on a fixed statutory footing. While this may seem a great idea to remove uncertainty and reduce the ability of HMRC to move the goalposts, the tax authority has used the opportunity to move the goalposts at the same time as ‘clarifying’ the rules.
Why contractors like ESC C16 as it is today
Up until February 29th 2012, where a limited company business ceases to trade, it is possible for the assets (-nearly always cash in the bank account), to be released to the shareholders and be taxed as a capital gain, rather than a dividend. The benefit of this is that there is a tax-free allowance of £10,600 per shareholder and the balance can be taxed at just 10%, instead of the effective dividend rate of 25%. Taxpayers need HMRC’s permission to do this (rather than its forgiveness!) and, even though it was a concession, I have never known it to be refused.
ESC C16 enters legislation with £25K cap
The good news for contractors about the new rule (see Companies Act 2006, s1000 and s1003) is that because it is not a concession, you will no longer need prior HMRC approval. However, the amount that can be withdrawn in total will be limited to just £25,000.
Reading the policy notes, I take the HMRC-authored spin that this move represents an ‘increase’ on the £4,000 they originally proposed with a pinch of salt. Unfortunately, this is another example of HMRC proposing a scary option, then trying to be seen as the good guys by only implementing a slightly less draconian alternative.
From March 2012, if you want to distribute over £25k…
If you have more than £25,000 available you will have a choice:
- Withdraw funds as a dividend until there is £25,000 left in the company. You can then withdraw this balance of £25,000 as a Capital Gain.
- Alternatively, you could pay an insolvency practitioner about £5,000 (not the £7,500 HMRC suggests to pay) to formally wind the company up, and then have all the funds treated as a Capital Gain.
Contractors will be up to £5k worse off
The end result if you have less than £25,000 in the company on dissolution is that there will be no change. But if you have between £25,000 and about £60,000, you will end up paying more tax than at present; the exact amount increasing from £1 up to about £5,000 depending upon exact circumstances. Once you have above £60,000, you might as well pay the insolvency practitioner the £5,000, but the tax will be the same.
Contractors are the losers here
Whichever way you look at it, either HMRC or insolvency practitioners are going to be better off, no contractor will. I would like to think that in a competitive market the insolvency fees might drop, maybe closer to £2,000, but it seems that the price of statutory certainty is, for now, being paid by the hard-pressed contractor.
Editor's Note: Further Reading - Changes to ESC C16 run contrary to state policy