Whilst the work of many licensed insolvency practitioners tends to focus upon insolvent situations, the provisions of the Insolvency Act 1986 mean that where company assets exceed £25,000, a formal solvent liquidation process is required if shareholders wish to close a company and withdraw the assets, normally cash, whilst benefitting from the capital gains tax regime. Without a formal liquidation process, monies paid from a company to shareholders are by way of dividend which are taxed at income tax rates : the highest one being 45% ( 46% if you are taxed in Scotland ). Thus, if one can benefit from the maximum capital gains tax rate of 20%, or even the Entrepreneurs’ Rate of 10% should special circumstances apply, the benefits of liquidation are clear.
There have been a large number of solvent liquidations of personal service companies “PSC” in the last four or five years e.g. when individuals working in the oil and gas industry have left the area and no longer have a reason to maintain a limited liability company, or there is no particular benefit in having a company because a staff position has been obtained. The proliferation of PSCs in the North East has resulted in many PSC shareholders receiving a substantial tax benefit when the monies are withdrawn from the company at closure.
The rules for obtaining capital gains tax relief tightened on 6 April 2019 because it was deemed somewhat unfair that a person could invoice through a PSC for several years, build up a large amount of cash in a tax-friendly company environment, and then liquidate the company with a 10% tax charge on the monies withdrawn. This has been seen as far more tax advantageous compared with earning the same amount, say £130,000 annually, and paying a higher rate of income tax. HMRC have sought to make it harder to act in this manner by, for example, changing the period of share ownership and disallowing capital gains tax treatment if the individual returns to the same industry in certain circumstances : designed to ensure that income tax applies rather than capital gains tax.
The tax landscape is changing again on 6 April 2020 because HMRC propose that PSCs operating in the private sector ( not just oil and gas ) are treated in the same way as those PSCs who have been operating in the public sector since April 2017 i.e. income tax and national insurance deducted at source from every payment to a PSC if the receiver of the service considers that the basis of engagement is broadly similar to that of an employee. This topic is commonly referred to as IR35 and HMRC are already issuing letters to PSCs in the oil and gas sector suggesting that if the service provision is similar to that of an employee, the large oil service companies who engage PSCs in the North East might start deducting PAYE and NIC from the monthly invoice next April. The current HMRC consultation period expired at the end of May and further pronouncements are expected shortly.
Anecdotal comment suggests that the large oil and gas companies might operate a consistent interpretation of the tax treatment of a PSC e.g. if one considers issues such as control, right of substitution and mutuality of obligation, one must ask who really decides what work is undertaken, when, and under whose control. One might expect the large companies to be conservative in their outlook because, if they have any concern that they may become liable for payroll deductions following an HMRC audit, yet have paid a PSC gross, their finance departments will not be a happy place when HMRC deliver a huge PAYE and NIC demand covering all PSCs.
This may force many PSCs to consider that there is a significant tax disadvantage to operating through a limited liability company i.e. a levelling of the tax playing field could mean that there is little purpose in operating a PSC in the oil and gas industry.
HMRC have created a website www.gov.uk/guidance/ir35-find-out-if-it-applies that asks various questions in order to help determine whether or not a PSC might be treated as an employee and hence, subject to tax deductions at source. The website has been prepared by HMRC and perhaps unsurprisingly, tends to favour treating a standard PSC as an employee. It will not be surprising to see numerous challenges to the HMRC assessment process in the months ahead.
What seems clear is that the general direction of travel is against a PSC that receives the vast proportion, if not all, of income from one source on a regular basis. A natural development of this could well be that many PSCs will decide that it is not cost effective to maintain a limited liability company and seek to pursue a solvent liquidation closure for the company before any further change in the tax rules that make it even more difficult to enjoy the benefit of Entrepreneurs’ Relief.
The insolvency team in Meston Reid & Co have handled a large number of solvent liquidations in the last year or so and this is unlikely to abate in the near future.
The views in this article are those of Michael J M Reid, licensed insolvency practitioner and partner of Meston Reid & Co, chartered accountants, Aberdeen. They do not purport to represent those of the firm in general.