Rumours about the future of Capital Gains Tax and Entrepreneurs’ Relief mean that any limited company contractor that will be affected by IR35 rule changes in April should strongly consider closing their limited company as soon as possible.
The Chancellor is set to lay out his latest Budget on 3 March 2021. Rishi Sunak has previously signaled that tax increases will be needed to mitigate the impact of the coronavirus pandemic on the public purse.
There are strong rumours that a Capital Gains Tax increase could be on the cards in this year’s budget statement. Capital Gains Tax is the tax on the profit when you sell something that has increased in value. Increasing the rate of Capital Gains Tax would not violate the Government’s triple tax lock promise.
It’s also rumoured that Entrepreneurs’ Relief, which limited company owners can use to reduce the rate of Capital Gains Tax they pay when selling (or disposing of) a business, could be reduced or eliminated in 2021. This comes after the scope of Entrepreneurs’ Relief was watered down at Budget 2020.
What are the new IR35 rules?
The IR35 rules will hit private sector businesses from April 2021. The planned rollout was deferred from April 2020 due to the COVID-19 crisis. These new rules mean that clients (not contractors themselves) will be responsible for determining the employment status of contractors.
It is designed to identify contractors and businesses which are avoiding paying the appropriate tax by working as ‘disguised’ employees, or are engaging workers on a self-employed basis to ‘disguise’ their true employment status
Why should contractors care?
Any contractor that trades through a limited company could be affected by new IR35 rules in the private sector from April 2021. For most contractors that are caught out by the rule change, it will make sense to close down their limited company and move to an alternative arrangement, like an umbrella company.
In most cases, the most tax-efficient way of shutting down a limited company will be through a Member’s Voluntary Liquidation (MVL). Using an MVL means that you can withdraw any cash tied up in the business quickly and easily, while also benefiting from Entrepreneurs’ Relief.
Pursuing an MVL may become more expensive, however, if Capital Gains Tax increases or Entrepreneurs’ Relief is reduced or eliminated.
Tom Fox, Licensed Insolvency Practitioner at Umbrella Insolvency said: “We’re likely to see many contractors pursuing an MVL this year, but the difference between starting the process now versus in a few weeks time could be thousands or even tens-of-thousands of pounds.
“Even if the rules on Capital Gains Tax and Entrepreneurs’ Relief don’t change in March, starting an MVL now could save you from a big administrative headache in April.”
John, an IT contractor, had been trading for the past 5 years via his limited company. He was recently notified by his client, however, that due to being caught inside IR35, the end client was no longer able to pass work to him via his limited company. John was able to continue working with the client, however, on the basis that he was paid each week via an umbrella company.
John no longer had any need for his limited company which had reserves of around £100,000.
If John, a higher rate tax payer, had decided to close down the company himself and draw these funds as dividends then his personal tax bill would have been over £30,000.
John, however, decided to close down the company using a Members Voluntary Liquidation (MVL) process.
Because John was paid the company reserves from the Liquidator, he will be able to benefit from Entrepreneurs’ Relief which will result in a lower personal tax rate of 10%. This will bring his personal tax bill to below £10,000.