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Contractor tax: Hanging up your contractor’s hat (don’t forget about the tax!)
As a contractor/consultant starting out you may be far from thinking about an exit strategy when it comes to hanging up your hat and taking up retirement or even wearing a new cap as an employed worker. But daytime TV and watching over the grandkids could be laying in wait in the periphery– whether or not we like to accept it.
At first glance there might seem to be two main options to extract funds from a company which is no longer required when you hang up your contractor’s hat. First would be to make pension contributions and/or take additional directors remuneration to set you off in the right direction for your retirement.
The second option would be to leave the funds within the company and slowly extract them year by year to avoid paying the dreaded higher and additional rates of income tax. These options are efficient yet what if you’re in need of immediate funds to put a down payment on those 450 horses or that Ferrari?
The third way?
There is a third option that can provide just that…a Members Voluntary Liquidation.
A member’s voluntary liquidation (MVL) is the process of winding-up a solvent company and distributing its assets to its shareholders. This distribution is treated as a chargeable gain subject to the lower rates of capital gains tax (as opposed to income tax) and subject to certain conditions would qualify for entrepreneur’s relief. Entrepreneurs relief is given on disposal of a trading business to the shareholder in the form of a reduced 10% tax rate against the proceeds of the disposal (as opposed to the higher rates of capital gains tax). The benefits of this are clear and as such this became subject to abuse.
Broadly speaking, individuals would create a trading company and extract the funds via MVL only to create a new company (generally with a new contract) and repeat the process. HMRC have tackled this with the introduction of so-called ‘pheonixing’ provisions which came in to force in April 2016. Subject to certain conditions these would have the effect of treating the distribution as income rather than capital…
Ouch. So, where your company is not to be dissolved for genuine commercial reasons but rather to rise from the ashes in another guise, then your intended tax break will almost certainly be extinguished by HMRC’s water cannons.
However, HMRC take a different view of those who have genuine and honest intentions. In the case of winding up a company for the purposes of retirement and/or leaving behind a career in contracting to pursue employment, we are of the view that it is unlikely to be challenged providing certain conditions are met. This will be dependent on review of the circumstances of each individual case. If you are not within the scope of the broad pheonixing provisions you may be eligible to treat such a distribution as capital and be taxed on the chargeable gain with the ability to take advantage of entrepreneurs’ relief.
Clearly this is something to consider as you edge closer to retirement or the benefits of part-time or full-time employment. With the help of a competent tax adviser you may just end up with a sizeable tax efficient lump sum to ride off into the sunset with the power of numerous horses.