Ken Moody considers possible ways of extracting cash reserves from personal services companies that may become redundant when the extension of the off-payroll rules is introduced.
Although the extension of the off-payroll working rules has been deferred for a year, some personal service companies (PSCs) may become redundant. No doubt in anticipation of the new rules applying from 6 April 2020, two of my PSC clients have been offered and accepted employment with one of their own clients.
Extraction methods
PSCs often have minimal assets apart from, perhaps, a cash surplus built up from trading profits. There are a number of ways of extracting:
- Top-up pension provision;
- Take out as dividend;
- Liquidate the company and receive capital distributions;
- Informal dissolution;
- Leave in the company and use as a ‘money box’.
A pension payment must be made while the company is still trading and is subject to the ‘wholly and exclusively’ rule having regard to the individual’s remuneration package as a whole. The £40,000 annual allowance could therefore be used to extract at least some of the cash, though advice from an independent financial adviser is recommended.
Dividends are, of course, income distributions. So option 2 may not be a popular choice unless as part of a strategy as described in relation to 5.
The first choice in most cases will be option 3 (i.e. to wind up the company). Distributions in a winding up are capital distributions, and in many cases capital gains tax business asset disposal relief (previously entrepreneur’s relief) will reduce the tax on the gain to only 10%. It was, of course, announced in the recent Budget that the lifetime ER limit is capped at its original level of £1 million for disposals on or after 11 March 2020. However, that might be sufficient in many cases.
Beware the ‘TAAR’
An issue of concern will be the targeted anti-avoidance rule (TAAR) aimed at ‘phoenixism’ (s 396B ITTOIA 2005), whereby capital distributions in winding up may be reclassified as income distributions if the individual is involved in a similar business within two years of receiving the distribution (within the terms of condition C, at s 396B(4)). Involvement may be as a sole trader, member of a partnership, company shareholder (holding 5% or more of the equity) or with a business carried on by a connected person. The latter would include services as an employee which are of a similar nature to the former business (see examples 1 and 2 in HMRC’s Company Taxation manual at CTM36330).
Where the owner-manager of a PSC takes employment with a former client, s 396B would not apply in most cases as it is unlikely that they will be connected with the client.
Condition D at s 396B(5) also requires that it is “reasonable to assume” that tax avoidance was the main purpose or one of the main purposes of the winding-up, which depends of course on the precise circumstances.
‘Safe’ distributions
Where a company is dissolved informally under CA 2006, s 1003, distributions “in anticipation” of striking off are treated as if they were capital distributions in winding-up up to £25,000 in total (s 1030A CTA 2010). In many cases, this amount will be too small to be of practical use.
Finally, the cash could simply be left in the company and used to provide an income for a period of years. For example, if two spouses or civil partners own the shares 50:50 they could each draw dividends of £50,000 in 2020/21 and pay income tax of just over £2,500 each (at the dividend 7.5% rate). If the couple had no other income, perhaps until retirement, or where business asset disposal relief (previously entrepreneurs’ relief) is not available, this strategy could prove attractive.
Practical tip
There is no clearance procedure under the TAAR at s 396B ITTOIA 2005. If winding-up is decided upon therefore, and for any reason the shareholder is or becomes involved with a similar business within two years of receiving the distribution the onus is upon the taxpayer and their advisers to consider whether condition D is met (see CTM34600). If it is considered that condition D is not met, disclosure of the circumstances and the view taken may be advisable.
