Contractors can still close their contracting limited company tax efficiently using Extra Statutory Concession (ESC) C16 before new rules and a £25,000 cap on capital distribution come into force on 1 March 2012. Contractors failing to act in time will incur much higher tax liabilities on any distributed funds over the new £25,000 cap when they close their companies.
The current form of ESC C16 enables contractor shareholders to extract cash and liquidised assets from their contractor limited company as capital rather than as income, incurring a much lower rate of tax. But time is running out, and James Abbott, owner and head of tax at contractor accountant Abbott Moore, says: “Contractors who have already written to HMRC and been granted permission to apply ESC C16 but have yet to distribute capital should do so before 1 March.”
Funds must be distributed by 1 March
Abbott explains: “Under the current interpretation of the rules by HMRC, any distribution of funds that straddle the deadline will be considered by HMRC to contribute to the new £25,000 allowance, even if permission was received prior to 1 March and a portion of the funds have been distributed.”
So, if a contractor is unable to complete their capital distribution before 1 March because, for example, they are awaiting outstanding payment by a debtor, or have to sell an asset such as a company car, then Abbott suggests a distribution in specie.
“In specie means they can receive an asset in lieu of a cash distribution. So, for example, if a contractor, who had already deregistered for VAT, was planning to sell a server with a resale value of £1,000, but can’t close the sale before 1 March, they can accept the server in lieu of £1,000 cash.”
Whether amounts distributed under ESC C16 prior to 1 March 2012 mean that there is less of the £25,000 limit available for post 1 March 2012 distributions from the same company is still being hotly contested by major accountancy bodies, and Abbott says these rules may changes in coming weeks.
ESC C16 permission not yet granted by HMRC: a quandary
Contractors who have written to HMRC requesting permission to apply ESC C16 face a quandary, as Abbott explains: “It is possible for a contractor to proceed with winding up the company and dispersing funds prior to 1 March without permission from HMRC, on the assumption permission will be granted in early March.”
Contractors who have already written to HMRC and been granted permission to apply ESC C16 but have yet to distribute capital should do so before 1 March
James Abbott, Abbott Moore LLP
But there is a risk: “If permission is not later granted, and the contractor has distributed funds as capital, they may subsequently face a large tax bill for unpaid income tax, interest and penalties when HMRC catches up with them.”
The solution for contractors with a substantial amount of capital and assets to disperse may be to go down the route of formally liquidating their business. “A formal liquidation by a reputable practice can cost as little as £3,000, which is considerably less than potential income tax changes for a contractor with £100,000 in funds to distribute.
“And when a contractor uses a liquidator to formally liquidate their company, the total funds that can be distributed as capital, thus incurring lower tax changes, is unlimited”, adds Abbott. Contractors should consult their accountant to determine the most tax efficient option, and do so without delay as the deadline is rapidly approaching.