Slashing CGT’s tax-free allowance is another anti-PSC move contractors could do without

On top of a reduction in the dividend allowance that limited company contractors can receive, and a potential increase in corporation tax, the dawn of the new tax year on April 6th 2023 imposed another taxing slight on company owners – the slashing of the annual exempt CGT allowance from £12,300 to just £6,000, writes licensed insolvency practitioner Gareth Wilcox, partner at Opus Business Advisory Group.

Where does CGT tend to affect contractors?

Capital Gains Tax is ordinarily payable when an individual disposes of a chargeable asset, and in the context of my work, this is the tax payable when someone ‘disposes’ of their shares by placing the company into liquidation and receiving capital distributions from a liquidator.  Effectively, those receiving a distribution pay a tax on the difference between the money received from the shares, and the money which was originally paid for them. 

In most contractor cases, the monies paid for the shares when their companies are setup is minimal (usually £1 or £100), so most of the proceeds of liquidation represent a chargeable gain. Many contractors I speak to balk at the idea of this, since the monies being received represent profits that have already been the subject of corporation tax and only generated as a result of their individual efforts. But regardless of the balking – those are the rules.

Quite a kick

So, if you receive £100,000 from a liquidator on the closure of your limited company, and only paid for one £1 share on incorporation, the chargeable gain on which you are taxed is £99,999.  Until recently, the first £12,300 would be free, so you would only pay for tax arising on the remaining £87,699. Under the new rules, you would be taxed on £93,999 of it. Ouch.

It is worth remembering that the allowances apply to individuals rather than companies. As a result, if you have more than one shareholder, each shareholder is entitled to a tax-free proportion, which is partly why you will often see spouses taking shares in contractor companies. 

Company closure just got more taxing

The CGT allowance which has been more than halved is also annual, so liquidations have historically been timed to allow distributions to be made across two tax years, to maximise the potential use of allowances for all participating shareholders. Under the previous rules, this could potentially previously have enabled a couple owning a company 50/50 to receive £49,200 across two tax years tax-free, if they did not use their allowance elsewhere. This tax-free sum would now be slashed to £24,000.

While these monetary considerations are rarely the driving force behind a decision to close a company, the above example – which incidentally is entirely plausible – shows just how the new threshold of just £6,000 could now have a significant impact in company closure scenarios.

How does a lower CGT annual exempt amount interact with Business Asset Disposal Relief?

Somewhat starved of it of late, this is where the somewhat good news for contractors comes in.

Despite the cut in the annual exempt allowance, BADR (or Entrepreneurs’ Relief as it used to be known) still applies in full, meaning that for contractors who meet the criteria (as many do), the rate on which your gain is taxed can continue be reduced to as little as 10%.  The ‘relief’ under BADR is to the rate of Capital Gains Tax payable on the relevant gain. For example this would ordinarily be at 20% for higher rate taxpayers, and that’s the case for many contractors going into full-time roles.

As contractors obviously need to note, there are eligibility criteria required for BADR, such as the business trading for two years prior to disposal, as well as a limit of three years to qualify for the relief in the event of ceasing to trade. As such, consideration should be given at the outset as to what the exit plan is, and therefore who the owners and directors ought to be.

Where BADR does and doesn’t apply…

Where BADR applies, the effect of the reduction in the CGT annual exempt allowance is limited, since the additional amount payable will only be £630, i.e. the difference in paying 10% tax on the £6,300 which is no longer part of the allowance. This is per person, so be aware that the effect is multiplied by the number of shareholders there are.

Where BADR does not apply, the effect is more pronounced, for example where the ‘standard’ 20% is payable, the difference is obviously doubled to £1,260 per person.

What else has come with the new tax year?

On its own, the CGT annual exempt getting cut, even by this big amount, might not have caused too many contractors to have chancellor Jeremy Hunt, who announced it, on their office dartboard. But as has already been covered by ContractorUK, the rate of corporation tax has increased since last week too, and while most contractors in my experience will not be subject to the top headline rate, it is entirely foreseeable that contractor profits may exceed £50,000, and so CT bills will go up. This hike in CT (from 19% to 25%), on its own, led to a glut of liquidations late in the previous tax year, with shareholders keen to crystallise profits and gains before the new rules took effect.

Given the additional complexity with these new corporation tax rates, dividends not adding to take-home like they once used to, and much less CGT per year being tax-free, contractors probably haven’t had a better time to engage with their advisers – and to engage early to ensure they avoid unwelcome surprise come year-end.

Conclusion – not material, but certainly jarring

Based on the amounts usually involved in contractor liquidation closures, and the high proportion of those where BADR is claimed, the reduction in the CGT tax-free allowance is unlikely to have a material impact on the decision, or otherwise, to liquidate. Ordinarily the ‘tax free’ element is seen as something of a bonus, albeit one preceded by my initial comments on having already paid tax on the retained profits!

Yet the mood music is a bit jarring. This is just the latest incremental change ‘taking’ from contractors, particularly in the context of those running their own Personal Services Company (PSC). As always, forward-planning is key to ensure that all allowances and reliefs are available, though the margins thanks to these multiple squeezes are getting tighter.