Concerns have been raised by the anticipated change in legislation which will affect entrepreneurs’ relief. For contractors (and their advisors) closing down a company has been an approach used to protect contractors against IR35, although in this day and age of ‘the brand’, it is difficult to argue a commercial rationale for doing so.
Technically, this approach has never been ‘fool-proof’, although having spoken to our tax advice line colleagues, we are only aware of one occasion in the last dozen years where HMRC have challenged a claim for Entrepreneurs’ Relief where a company had been closed and the business restarted under a different legal entity – and that wasn’t even a contractor.
We have recently had a number of queries prompted by the change in entrepreneurs’ relief expected to come into force on the 6th April 2016 and currently laid out as draft legislation to be inserted into Chapter 3 of Part 4 of ITTOIA 2005 at 396B (Distributions in a winding up). The amendments would deny entrepreneurs’ relief where a shareholder in a close company receives a capital distribution from a company in liquidation after 5 April 2016 and the individual carries on a trade or activity which is the same as, or similar to, that carried on by a company within a period of two years beginning with the date on which the distribution is made.
We suspect that the reason for this amendment is that previously, despite anti-avoidance legislation being in place, HMRC had to become aware of the ‘phoenixism’ and undertake a counteraction.
Under the new legislation, the taxpayer will know that if the trade is continued within two years, HMRC will expect to have seen an income distribution and that the correct amount of income tax has been paid on those dividends. If that is not the case, i.e. it has been treated as a capital distribution and entrepreneurs’ relief has been claimed, then an incorrect return will have been submitted with all the ramifications that would follow if that return were to be subsequently selected for enquiry.
However, if a contractor is closing a company down and restarting under another guise, and this follows an income distribution upon which the full and correct amount of income tax has been paid, then this should not be an issue for HMRC and for the reasons stated below, it might still be an effective counter-measure against IR35, albeit the commercial rationale is hard to justify.
Turning to the scenario where the contractor closes down ABC Ltd and restarts the contract with XYZ Ltd – always assuming that the agency or end client contract allows the contractor to do this, or at worst, requires the contractor to pay an admin charge for the ‘name change’. If HMRC undertake an enquiry in to the current engagement now being undertaken through XYZ Ltd, and they are successful in arguing that IR35 applies, they will come to that decision not only by looking at the contract terms and the working practices, but also by speaking to the end client.
In the discussions with the end client, it may then become apparent that the contractor has worked at the end client for a number of years, albeit it through ABC Ltd in the earlier part of the engagement. Whilst HMRC cannot simply assume that the earlier engagement was ‘caught’ by IR35 just because the most recent period is (see, for example, the ‘split decision’ in JLJ Services Ltd v Revenue & Customs  UKFTT 766), HMRC may nevertheless wish to undertake the same exercise, and, of course, if the contracts and the working practices are the same, they are likely to be successful in arguing that IR35 applies to the earlier periods as well.
At this point, HMRC could raise assessments against ABC Ltd, but because the Company is no longer in existence, if they wanted to recover the tax and NIC, they would need to seek to use the transfer of debt provisions to make the contractor personally responsible for the debt.
Whilst HMRC could ask what commercial reason the contractor had for closing ABC Ltd and incorporating XYZ Ltd, it is not illegal to do so. However, the key question would probably be: did the contractor close ABC Ltd because he/she knew that the deemed calculation applied (i.e. was the contractor seeking to avoid tax and NIC due under IR35)? The reason for HMRC asking this question would be to argue that the contractor had acted carelessly or negligently whilst as a director of the ABC Ltd. If this could be proved, then it would enable HMRC to transfer the debt and make the contractor personally liable.
However, if the contractor can demonstrate that he/she did what might be expected of a reasonable person and approached an independent organisation for an opinion on the IR35 status of their engagement(s) and that independent opinion was ‘not caught’ by IR35, we believe that the contractor could demonstrate that they had acted reasonably. We therefore believe it would be difficult to make any charge of carelessness/negligence stick.
In summary, HMRC have quite a few hoops to jump through before they could successfully argue that IR35 applied to those earlier contracts; we are not sure that they have the enthusiasm to do so. Whether that justifies phoenixing – either commercially or from a tax perspective – is a different question altogether.
Author: Paul Mason, National Contractor Manager
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