Why the perfect contractor storm would be Entrepreneurs’ Relief changing with IR35
It doesn’t take a contractor market specialist like us to be aware that there are currently a great number of contactors considering their options due to upcoming changes with IR35 and feared changes to Entrepreneurs’ Relief – both of which we’ve assessed for ContractorUK readers before, but new practical guidance is now necessary, writes Gareth Wilcox, partner at Opus Restructuring & Insolvency.
Let's start with what’s scheduled. The April 6th IR35 changes mean that there are a great many engagers who are terminating their contractor workforce now, and bringing roles ‘in house’ or on payroll. The result of this is that there will be many contractors with straightforward Personal Service Companies that are no longer trading, some of which may have substantial cash reserves.
Relevant winding-up considerations for limited company or PSC contractors in this unenviable position have been outlined by us already. But, broadly speaking, where a company is being closed by a contractor who is not considering restarting trade, many would qualify for Entrepreneurs’ Relief and therefore a 10% Capital Gains tax rate on the surplus reserves available (following payment of liabilities).
Promised reform to Entrepreneurs’ Relief
The reform to IR35, though, may have come at a particularly unfortunate time for contractors. In fact, taken with Whitehall’s groans about ER (explored below), it all sounds rather like a perfect storm could be brewing.
In particular, while there has been a certain level of relaxation among the business community since the General Election, the government confirmed in its manifesto that it is proposing to review and reform Entrepreneurs’ Relief. Although it is far from clear exactly what this review may entail, a recent Times article indicated that the Treasury wants to remove the relief entirely, owing to the significant amount of tax it considers is lost due to the relief.
To the extent that Entrepreneurs’ Relief is reformed (or removed) it is also unclear at this time when it will take effect from, i.e.:
- With immediate effect from the date of Budget 2020 on March 11th;
- With effect from the new tax year on April 6th 2020; or
- With effect from some time in the future (perhaps the tax year commencing April 6th 2021).
Timing (could hardly be worse)
Clearly, if Entrepreneurs’ Relief is reformed at the Budget with either immediate or new tax year effect, there is little time for contractors to act. Where a Members Voluntary Liquidation (MVL) is required, distributions of capital can only be carried out once a liquidator is appointed, which is not an immediate process.
There are many engagers who are keeping their contractor workforce on until the end of March 2020, so if reform is to take place in either scenario 1 or 2 above, it is likely that it will be too late for those contractors affected to benefit from Entrepreneurs’ Relief.
Clearly if option 3 is followed, then contractors will at least have some time to consider and deal with their affairs before the changes take effect. If this is the case, however, it would still be prudent for options to be considered at an early stage following cessation, to ensure that no reliefs are lost.
What if I’ve already ceased trading via my contractor limited company due to IR35 reform?
For those contractors whose companies have already ceased trading, clearly there is an incentive to act now. Presuming your affairs are in order and the process is appropriate, it is still possible to get a company into MVL and a distribution made prior to Budget day on March 11th 2020. This will not be the case for much longer, however, and you should consider taking professional, independent and tailored advice now.
In short, you should strongly look at engaging an Insolvency Practitioner (IP) with expertise with engagements of this type. The one you want will recognise that contractors tend to operate using a very straightforward model where there are typically only one or two directors or shareholders, minimal (if any) physical assets and ordinarily no creditors other than HMRC and an accountant.
These IPs will be well-placed to offer guidance and assist you efficiently – knowing the contractor set-up is half the battle here, if a swift execution of matters is your goal. And being swift should be, with the clock running down.
What if I am not ready?
It should be borne in mind that decisions regarding liquidation or business disposal ought not to be taken lightly, and there are clearly many contactors who are not yet able to close. With many engagers only bringing roles ‘in house’ with effect from the new tax year, any distributions made will be subject to the new rules on ER, if they take effect in either scenario 1 or 2 above.
As I’ve made clear previously, even if Entrepreneurs’ Relief is abolished, it will still often be more tax-efficient for closures and distributions to be carried out through an MVL process (at the standard Capital Gains Tax rate of 20%), rather than income dividends being extracted at the prevailing rate. Clearly though, this may amount to double the tax which a contractor was previously banking on paying on exit.
What if I have a director’s loan?
Recent HMRC guidance has been issued, confirming the availability of ‘set-off’ in liquidation scenarios. This being the case, even if a business owner has already extracted cash from a company by way of a director’s loan, it may be possible for this to be treated as a capital distribution as part of the liquidation. Such cases ought to be treated with urgency since Corporation Tax is payable where director’s loans are left outstanding for a prolonged period, and this applies equally to companies in liquidation.
With the above in mind, and time running out before substantial changes may be made, it is recommended that contractors engage with their professional advisers at an early stage, to ensure that the best possible outcome can be obtained.
What steps are YOU taking?
Recognising the current climate, we have already been gearing up for a potential influx of contractor MVLs and have streamlined our processes to deal with their unique requirements. These matters are not to be entered into lightly, even if we get what I’d call ‘scenario 4’ – a consultation on ER reform promised at some point in the near future. With IR35 already closing the contractor limited company walls in for some, perhaps such a vague commitment on Budget day would be a case of the chancellor giveth.