The tax refunds limited company contractors won't like
The brown envelope that landed on your doormat has told you in big bold letters: you’re due a tax refund from HMRC. Happy days, right? Maybe, but the truth is that a tax refund can be something of a mixed blessing, writes Chris Conway, managing director of Accounts & Legal, an accountancy firm specialising in contractors’ tax affairs.
Tax refund: why get one in the first place?
As the name suggests, a tax refund is the repayment of some of the tax that was previously paid to HMRC by a taxpayer. You get it either because the tax was overpaid, or because the tax bill was correct but subsequent business losses have been offset against the former tax liability.
It’s this second possibility that can give a tax refund a bit of a sour note, but let’s take a look at the other (better) one first.
The refund to rejoice at
There are a number of reasons why a contractor trading with their own PSC might have overpaid tax. It happens to permies too; an employee may have been assigned the wrong tax code, or may still be on an emergency tax code if they failed to give their new employer the P45 from their previous job.
For contractors, an overpayment of tax can occur if they have made advance payments to HMRC (known as Payments on Account) that turn out to be larger than their tax bill, or if they made Payments on Account but subsequently left contracting to take up a full-time salaried job.
In both cases, the overpayment of tax should result in a tax refund after the end of the tax year.
The not-so-good news
The other occasion is where a PSC, might be entitled to a tax refund when it may have paid the correct amount of tax in the past, but since then the business has suffered trading losses.
These losses can be carried forward to reduce future tax bills. Alternatively, losses can be carried back to be offset against previous tax bills. However, it is important to note that this tax refund is to their PSC for corporation tax. While it may not be a direct tax refund to the pocket of the contractor using a PSC, it is still a cash-flow to their company which they can benefit from if distributed as dividends. However, this will then be subject to dividend tax.
While the resulting tax refund from HMRC may taste sweet to a taxpayer, the sour note is due to the inescapable fact that the refund has arisen because their business has suffered a loss.
Are you like Sam?
Contractor Sam whose PSC has expenses that exceed his turnover (or sales) will have no corporation tax liability during that accounting period, since Sam’s company hasn’t turned a profit. If Sam’s company has been trading for a number of years and made a profit in previous years it can also choose to carry the remainder of the loss back to offset against prior years’ profits, resulting in a refund of some of the corporation tax paid in those years. It is important that a claim be made within two years of the accounting period the loss is made.
It’s always nice to receive a healthy chunk of money into your account, but it’s not so nice if the money comes because your business is struggling – for example, if turnover is in decline.
However, there’s one situation where a loss may be easier to stomach. Let’s say a business is not experiencing declining sales, but suffers a loss because it invests heavily in allowable expenses that will help fuel the growth of his business, then the resulting tax refund may not taste sour at all! In fact, to a PSC owner who has a fast-growing business and a strong pipeline of new contracts the refund from the taxman may taste particularly sweet!