An MVL (Members Voluntary Liquidation) sounds bad but is the sign of a successful company. In short, it’s a tax-efficient way for an owner to benefit from their previous hard work. An MVL is a simple and HMRC approved process that involves appointing an Insolvency Practitioner to efficiently close their company. The process of an MVL allows the contractor to draw on any profit within the company in the form of a dividend while just paying income tax on that dividend. The remaining reserves can then be distributed as capital under the Business Asset Disposal Relief scheme to reduce or eliminate any Capital Gains Tax. The only criterion for an MVL is that the company must have net assets of £25,000 or more.
IR35 has a long history and has been part of a contractor’s life for nearly 20 years. However, the biggest changes have come in the past 2 years and consequently, the MVL process is increasingly important to successful contractors.
Those providing what is seen as a genuine B2B service can pay tax more efficiently using low salary and dividend payments. However, following changes to IR35 legislation HMRC are keen to identify any worker who may be operating through their personal service company yet are effectively an employee. This is in order to reclaim the additional tax and national insurance which otherwise would be due.
The IR35 tax legislation forms part of the Income Tax (Earnings and Pensions) Act 2003 ('ITEPA'). It applies to workers of personal service companies (limited company contractors) who provide services to a client via their own limited company.
Recent IR35 changes mean HMRC will carry out an ‘IR35 enquiry’ if they suspect a contractor to be "caught" by the IR35 legislation. If HMRC determines the person is not a contractor but an employee, they calculate the individual's total income for the period in question as a salary and attempt to recoup the tax and national insurance contributions previously paid as dividends.
When explaining IR35, we often refer to these two terms regarding your status, but what is inside and outside IR35?
In short, they indicate your IR35 status as being a genuine contractor (outside) or a “disguised” employee for tax purposes (inside).
The terms reflect whether you are operating within the IR35’s legislation scope or not. Often choosing to work inside IR35 and putting your company into the MVL process simplifies your working relationship with your employer, HMRC and most importantly, provides you with a tax-efficient way to receive the capital and assets from your contract company.
To be ‘inside IR35’ means that you are considered, for tax purposes at least, an employee and therefore subject to PAYE.
While operating ‘inside IR35’, you still need to ensure that the appropriate taxes are being paid. This usually involves a ‘deemed payment’ of income tax being made at the end of the tax year (you should discuss this with your accountant). You should also reassess your IR35 status when your working practices change or when you begin a new contract.
If you’re working in the public sector or a medium/large private sector business, the fee-payer (usually a recruitment agency) will be required to deduct your income tax and national insurance at source. However, many agencies and clients are not set up to manage contractors through payroll, and therefore will only engage you via an ‘umbrella’ company. In this case the ‘umbrella’ company acts as your employer.
Should you be deemed ‘inside IR35’ following an IR35 enquiry, HMRC will raise a determination for the income tax, national insurance, as well as interest and potentially a penalty, based on what you should have paid. This can run into tens of thousands of pounds.
To be ‘outside IR35’ means that you are operating as a genuine business and therefore are outside of the IR35 rules.
If you are operating ‘outside IR35’, you can pay yourself a salary and draw the remainder of income as dividends. You are of course responsible for your taxes as usual.
If engaged in the public sector or a medium/large private sector business, your end-client is responsible for determining your status. But if they have deemed you as ‘outside IR35’, then you will be paid your fees and you will be responsible for managing your businesses taxes.
Even if you’re considered to be operating outside of the IR35 legislation, there remains the chance of an ‘IR35 enquiry’ from HMRC. It’s important therefore to evidence your working arrangement as seemingly clear-cut cases have resulted in HMRC deeming the contractor 'inside IR35'.
As of 6th April 2021, changes to the IR35 process have been implemented. This has increased the number of successful business owners using an MVL and benefitting from closing their current contractor company. The new legislation means that contractors now have their status determined by their engager (except for those working with a 'small' client in the private sector). As explained above, often the simplest solution for businesses is to encourage contractors to become employees.
There are three tests which are used to determine your IR35 status.
1 – Personal Service / Right of Substitution
The contract should not be based solely on you providing the work personally, but you can show you maintain “the power of delegation”. This means you can supply substitute workers to undertake part, or all of the work contracted while retaining responsibility for fulfilling the contract, substitute worker(s) and their payment.
2 – Control
This test assesses the ‘what’, ‘where’, ‘when’ and ‘how’ you carry out the contract. As a contract specialist, you should have a degree of control over these aspects where practical and which methods you use to complete the contract. For example, you wouldn’t tell a plumber or electrician how to do their job if they came to fix something in your home. To satisfy this test you’ll need to ensure the contract defines that you as the contractor are in control of how it is completed.
3 – Mutuality of Obligation
As a contractor there should be no expectations of further work and the client should not expect you to continue to provide further work once the contract is complete. The focus should be on non-mutuality of obligation, whereby the client or contractor can walk away from the contract. A clear start and end date, and determination of whether the contract will be renewed are essential. Without these clear definitive timescales, HMRC may take the stance that the contract is ongoing such as an employee would have.
Maintaining an unused or dormant company may not be the best use of the company’s assets or recompense you in the best way for your previous hard work.
More and more contractors with funds in their company are using MVLs in response to IR35 changes. Significantly it is now the responsibility of the employer to determine the contractor’s IR35 status. To avoid risking a fine for determining the status incorrectly, many employers choose not to engage contractors at all. This means that many contractors have a limited company that is lying dormant. In order to efficiently release all the funds and profits from their business, the company just needs to enter into the MVL process.
In an MVL a contractor, who is also an employee of the company, can also make use of Business Asset Disposal Relief. This means that the CGT can be paid at a lower rate of 10% rather than 18%/28%. Each shareholder (who holds at least a 5% shareholding) could also get a tax-free allowance of £12,300 which is the Annual Exempt Amount. This is only available through the MVL process.
The tax savings that are available through the MVL process would not be available in a strike off. The MVL ties up all loose ends and removes the opportunity for unforeseen creditors to make a claim once the Company is closed.
The whole process usually takes from 6 months to 1 year, but Interim distributions are made within this timeframe so you will not have to wait this long to get your funds out of the company. The remaining time is used for the statuary notification periods, communications with Companies House and HMRC, as well as tying up all the loose ends. In the meantime, none of this prevents you from working either as an employee or as a contractor in another Personal Service Company.
While you can't trade under your old business name, starting a new company is easy. You can register a new company for VAT and PAYE too. Choosing the MVL route now allows you to take advantage of your existing company without preventing you from any new working arrangements you need.
While we take care to ensure the information above is accurate, it is for general informational purposes only. The financial situation of you and your company is unique. You must therefore not construe the above as legal, tax, investment, financial, or other advice either explicitly or implied.
You should seek professional advice from Even Keel Solutions before proceeding with an MVL.