Closing your company over IR35 reform: six steps if you must shut
The IR35 reform of April 2017 is set to be extended to the private sector on April 6th 2021, so almost four years after it was introduced to the public sector.
Why? Well, the Treasury claims to have raised £550m in Income Tax and National Insurance Contributions (NIC) within the first 12 months of enforcing the measure, in a bid to actively tackle ‘disguised employment’ at taxpayer-funded bodies.
IR35: quick refresher
The private sector reform which (like its public predecessor) reassigns responsibility for determining IR35 status to the end-client, is going to apply only to a selected population.
From this coming April, it covers contracts in which the end-client is a medium or large company only, cushioning small businesses from the weight of the responsibility.
As many know, IR35, also known as the Intermediaries legislation, has been in force since April 2000. But it is the 2021 shift in responsibility that concerns contractors most, because it all but signals a rise in ‘blanket’ inside-IR35 decisions.
This status measure and the suspected way many clients will approach it throws into question whether operating through a limited company will continue to be lucrative. And it raises the question of whether it’s time to reshuffle the cards, writes Keith Tully, director of Real Business Rescue.
Working through a limited company post April 2021: your options
If caught by the measure, NIC and Income Tax will be automatically deducted from the contractor’s pay, resulting in a possible reduction in take-home pay.
You may consider renegotiating your rate of pay with your end-client to fill the payment gap. If successful, you may find continuing to work through a PSC (Personal Service Company) worthwhile, as the take-home pay should be similar, excluding the associated running costs. If you are unable to renegotiate your rate of pay, you may find that it’s more cost-effective to close your limited company and opt for an alternative operating structure.
Umbrella / PAYE
If you expect to work on more than one contract, one of which is caught by IR35 and one of which is outside IR35, you should consider switching between an umbrella company and your limited company, as this retains your right to a dividend allowance (currently £2,000 in the 2019/20 tax year).
Alternatively, if you’re on the client or end-user payroll, there will typically be no ongoing maintenance costs to fulfil. If the limited company is VAT registered, the agency will pay the invoiced amount including VAT for your company.
Parting with your PSC
Should you decide you must look at closing your limited company in preparation for the reform (or more likely, because of it), retain the following list because it contains six fundamental steps I recommend you take, largely in order. All six should both ensure tax-efficiency and compliance with HMRC.
- Final Dividends
Before striking off or liquidating your limited company, extract retained profits as a final dividend. The manner in which you take this will be determined by your exit route and how much profit is left in the business. A Members’ Voluntary Liquidation is typically the most tax-efficient method after taking into consideration the tax savings made from Entrepreneurs’ Relief.
- Administrative Duties
In the run-up to closing your limited company, you will have a stream of administrative duties to fulfil. Firstly and depending on the route you take (see step four and five), you will apply to strike off your business at Companies House through a DS01 form (application for striking off). Co-directors will also be required to sign the DS01 form.
Informing Interested Parties
Those associated with the company should be informed of your application for strike off, such as shareholders, creditors, traders, insurance company and your banking facility.
Ensure that you’re up-to-date with payment obligations to HMRC, such as Corporation Tax, VAT, National Insurance Contributions and, if applicable, PAYE. All financial paperwork to date should be submitted, such as your Company Tax Return and final Company Accounts. The paperwork should cover the time ranging from your last set of accounts to your final trading day.
- VAT Deregistration
If you decide to close your limited company, inform HMRC to cancel your VAT registration. It will typically take three weeks for your deregistration to be confirmed. Once the official date has been confirmed, this marks your final trading day. You must submit your final company tax return which covers the period from your last tax return to your final day of trading, taking into account VAT on stock and business assets.
- Informal Voluntary Strike Off
If you’re looking to close your business, you can apply for voluntary company strike off at Companies House. Yet a Members’ Voluntary Liquidation may be better suited.
Your strike off request may be rejected if your business is:
- involved in a liquidation process
- has creditor agreements in place, such as a Company Voluntary Agreement
- traded over the last three months
- changed names over the last three months
- Retained profits
If the retained profit in the company is below £25,000, shareholders will pay Capital Gains Tax on the distributions. When selling shares, the rate of Capital Gains Tax is 10% for a basic rate taxpayer or 20% for people paying higher than the basic rate of income tax. However, if you are eligible to apply for Entrepreneurs’ Relief, this would mean you’d pay a tax rate of 10% on the disposal, regardless of the rate of personal tax you pay.
If the retained profit in the company is greater than £25,000, the distributions will be treated as income and be subject to Income Tax. The income is typically extracted as a final dividend, rather than as salaried payment. This is because the tax rate for dividend income is lower than the tax rate applicable for salaries.
- Member’s Voluntary Liquidation
A Members’ Voluntary Liquidation (MVL) is a formal procedure used to liquidate a solvent limited company and is typically a solution for companies with retained profits exceeding £25,000. Following the appointment of a liquidator, business assets will be realised and the funds will be used to pay outstanding creditors and remaining funds distributed to shareholders.
An MVL is a tax-efficient way to liquidate your limited company as any extracted funds raised from the sale of shares will be treated as capital, not dividends. As a result, you may be able to claim Entrepreneurs’ Relief which poses a reduced tax rate of 10 per cent (and Capital Gains Tax will also be payable).
Life without ESC C16
Prior to March 1st 2012, a company could apply to HMRC under ESC C16 to request (subject to certain conditions), that distributions made from the company, prior to winding down, would be subject to (the more palatable) Capital Gains Tax regime.
This was a tax-efficient option available to companies which had reserves of retained profit exceeding £25,000 and were not looking to proceed with an MVL. In practice, ESC C16 meant that shareholders were not obliged to take a large dividend if the reserves exceeded £25,000 -- they had the option to treat the distribution as a capital gain (thus attracting a lower rate of tax).
However, as this ESC C16 is no longer available, if a limited company has reserves of over £25,000, it may be more tax-efficient to liquidate the company than to take a large final dividend and apply for strike off. If a liquidator is appointed on behalf of members, the distributions made by the liquidator to shareholders will be subject to Capital Gains Tax with no upper limit. These rules have not changed.
Where you are now
There’s no quick or easy, one-size-fits-all answer on whether to close your contracting company or not due to the projected impact of private sector IR35 reform. Hopefully, the six steps or areas above will make the process of parting ways with your company less painful.
The potentially irritating but hard to ignore backdrop to all this is that HMRC is being accused of failing to interpret its own status rules which it targets limited companies with, having lost five out of the last six IR35 cases! As the pressure on HMRC rises, the full effects of reforming IR35 are yet to be witnessed, even as the consequences of the original legislation continue to tumble in, including HMRC’s latest target – GlaxoSmithKline contractors. For many contractors, then, it’s clear who they probably view as the joker in the pack, but your focus should now be on playing the hand you’ve been dealt -- compliantly but tax-efficiently.
Editor’s Note: Related Reading –
The benefits of working inside IR35 via your limited company from April 2021
Contractors’ Questions: What should I do with my limited company once IR35 changes
Closing a company – due to IR35 or not