Along with the changes to contractor dividend tax rules, that come into force from April 2016, the government are making plans to restrict any loopholes that could be used to avoid this extra tax, by targeting Member’s Voluntary Liquidations (MVL’s). Contractors need to be aware of the new rules to MVL’s and there’s a small window of opportunity to act before April 2016.
An MVL is used to wind-up a contractor limited company, and at present it’s a tax-efficient way to extract the remainder of cash reserves held in a company bank account.
Don’t miss the boat
In December 2015, HMRC announced a new Targeted Anti-Avoidance Rule (TAAR) to prevent contractors from closing a limited company, extracting the cash reserves using a MVL, and then setting up a new limited company soon after.
The exact details of this new TAAR are yet to be determined, however it is expected to be introduced in line with changes to dividend tax, in April 2016. It pays to investigate your options now to avoid missing the boat.
When a contractor limited company is closed using an MVL, cash held in the bank account can be transferred as capital, rather than income, and, taxed accordingly.
Capital gains tax is currently 28%, however, with Entrepreneurs Relief (ER), this can be reduced to as low as 10%.
Compared to the higher income tax rates of 40% and 45% this is naturally very attractive for contractors, and in light of the new rules to dividend tax, adding an extra 7.5% to each tax-band, HMRC fear that the MVL system will be a means for tax avoidance on what would normally be regular dividend draw-down.
To qualify for ER, the following applies:
- Your company must have traded for more than 12 months
- You, as a shareholder, need to have been an employee for more than 12 months
- You must also hold a minimum of 5% shares
What happens after April 2016?
Contractors wind-up their companies for many reasons, such as returning to permanent roles, opting to trade under an umbrella company, or retirement.
HMRC however, want to ensure that an MVL can not be used simply for tax avoidance, by closing down a limited company to then continue exactly the same business in another, after extracting all their cash reserves from the original company at a much lower tax rate.
After April 2016, withdrawal of funds from a limited company will be automatically considered as income, and subject to income tax if all three of these criteria are met:
- A distribution is made by the company to a shareholder as part of the company winding-up
- Winding-up the company has a purpose of obtaining a tax advantage
- Continuation of a similar trade activity in a new company, within a period of two years
Rules one and two are already going to affect virtually all contractors, automatically. Whilst it can be argued tax isn’t the main purpose in closing a limited company, there is going to be some element of tax within the decision. How clearly defined the rules are when they are published will depend on any leverage.
The third rule is controllable though, however it is restrictive. It would result in not being able to trade using a limited company for two years following the MVL, which won’t suit all contractors.
Window of opportunity is narrowing
Those with large cash reserves sitting in a company bank account may find soon that they are unable to wind-up their company and extract their funds, tax efficiently, until retirement, or, they will be forced to trade in a way that doesn’t involve a limited company, which continues to be the most tax advantageous way to trade for the large majority of UK contractors.
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An MVL is best executed by a licensed insolvency practitioner, for which there will be a fee to pay for their assistance, however, it isn’t a straightforward transaction to do alone.
This process can take several months from start to finish, due to the administrative procedures.
As there is a 21 day notice period, it is essential to act promptly as the window of opportunity is closing.
Also, it has not been confirmed whether those MVL’s that are “in progress” when the rules change in April 2016, will be allowable or not – any delays with MVL’s are typically through HMRC
Talk to your contractor accountants if:
- You have large cash reserves in your company bank account
- Taking into account the admin fees, above £50,000 would be worth exploring
- Your accounts and record-keeping are (more or less) up-to-date