Contractors' guide to insolvency, Part One
Setting up and running a business on your own can be very rewarding but there are risks. Whether or not things turn out according to plan is an unknown.
In common though with other projects you take on as a contractor, you should begin with the end in mind and have some thoughts as to your eventual exit, writes Peter Windatt, chairman of the Insolvency Committee at the ACCA.
When the going is good
As the author of this two-part guide for ContractorUK, it is important to note that I am an Insolvency Practitioner (IP). Many would not assume that, as such, I might need to get involved with the closure of a company when things have gone well. However, for reasons of tax planning our profession is increasingly being required to help the directors and shareholders of solvent companies wind them up and, in doing so, ensure that their rewards are distributed as capital, and not income.
The Enactment of Extra-Statutory Concessions Order 2012 has been with us for some time now; the changes it introduced took effect from 1 March 2012.
The Order allows a company to make total distributions, not exceeding £25,000, as capital receipts for the purpose of calculating any chargeable gains for the shareholders. This is good news for investors in that they avoid the need for a formal insolvency and the distribution will be on the same basis as if a Members Voluntary Liquidation (MVL) has been carried out. However, if they exceed £25,000 they will be taxed as dividends. This can be avoided if the company is formally wound up through the use of a solvent MVL, the assumed costs of which are, according to HMRC in its work in considering the Order, £7.500. Clearly this is a significant proportion of the funds to be distributed if they are only just over the £25,000 threshold. There are internet-only providers offering headline rates of under £1,000 for those who have already crossed all the ‘Ts’ and dotted all the ‘Is’ and are happy with a ‘no frills’ service.
We would recommend avoiding the costs of an MVL entirely where possible. There are a few wrinkles that may be used to reduce funds held tax efficiently, but, if this can’t be done sufficiently to get the balance below the threshold, an MVL will be required. Good news for my profession at a time when the number of insolvent liquidations is in decline.
Recent contractor companies I’ve come across have been those in which earnings have been taken by way of a tax-efficient mix of PAYE earnings and dividends, possibly split between husband and wife, and have been kept below the higher rate thresholds. Cash has been built up within the company and the director now wants to extract that cash. A nice problem to have.
The questions then will include what is the best way to extract the cash and why is the cash wanted. If the money is wanted for pension provision then paying out to directors’ pensions directly from the company may be more appropriate and result in a corporation tax refund/reduction. If to buy some investment property, again perhaps considering this via a SIPP (Self-Invested Personal Pension) would be more efficient. The final balance is important too – can it be worked through to avoid my services being required? The whole process is largely tax-efficiently-driven, and proper consideration has to be given to each case on its own merits.
When the going gets tough
If business starts to go awry an optimist will often, Mr Micawber like, plough on hoping that “something will turn up”. While we no longer have debtors’ prisons, the direction of the pendulum, following the laissez faire approach following the Enterprise Act 2002 may now be starting to swing the other way. ‘Encouraging responsible risk taking’ and ‘giving entrepreneurs mechanisms which allow them to fail and start again’ is no longer so much in vogue. Making sure that allegedly rogue directors can’t just quit and start again, especially when it is at the creditors’ expense, is.
Accountability has become increasingly important. This is typified by the views of many commentators regarding administrations that allow companies to be ‘phoenixed’; they consider it to be legalised theft. The regulations to ensure a ‘pre-pack’ sale of a company’s assets back to the former directors, without affording other prospective interested parties a proper opportunity to consider acquisition, are tightening.
The first signs of trouble
When problems appear on the horizon, the earlier you speak to an insolvency or recovery expert the greater the number of options that are likely to be open to you. Correspondingly, as you continue down the road towards failure you will find the number of exit strategies falls.
It surprises many in difficulty that not all options require the formal involvement of an IP and many creditors, approached in the correct way, would rather you found a solution that avoided the costs involved with a formal insolvency solution. Provided you haven’t left a trail of broken promises, deals can, and often are, done. With a good accountant and IP you can properly consider your position; burying your head in the sand rarely helps.
The myths and legends surrounding insolvency are legion. However, when a director meets an IP for the first time they will always want to tell their tale – how they came to be in the situation they’re in. Generally directors are good at what they do, but, sadly, they are not always great at running a business. This is their undoing. They have worked hard trying to fill a perceived gap in the market place, but things have been slow to take off, the competition changed their strategy, a by-pass was built or clients have gone bust owing them money. Whatever the reason, they’re in trouble.
Directors fear being made bankrupt, divorce, losing their house and/or being disqualified from running a business again. And so the first job for an IP is to properly understand where the director is, where he is heading and, if things are going from bad to worse, stopping him. To quote Denis Healey, “when you’re in a hole, stop digging.”
Nine times out of ten the worst is not as bad as a director initially fears. Informed consideration of the alternatives gives a new purpose. It may be that the end is near, but with a little support there are alternatives available where the consequences – personal guarantees and penalty clauses, for example – may be avoided or mitigated. A good outcome may not be possible; the least bad one is then our goal.
This is part one of a two-part guide on insolvency, exclusive to ContractorUK, by Peter Windatt. He is an accountant and licensed insolvency practitioner with BRI (Business Recovery and Insolvency). He has previously chaired the Joint Insolvency Examinations Board (the exams that all IPs must take to qualify) and currently chairs the Insolvency Committee at the Association of Chartered Certified Accountants.
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