Can contractors avoid IR35 investigation by closing down their limited company?

Can contractors avoid IR35 investigation by closing down their limited company?
Choose a Name: The name has to be unique, obviously, and not likely to be confused for someone else’s existing name. The best reference point is the Companies House website – www.companieshouse.gov.uk – which has a simple search facility so you can check your chosen version. Also, try to avoid names that are specifically related to your line of work, just in case you want to change careers later: imagine selling cars though a company called Al’s Bakery.
Decide on Share Ownership: Is this just you, or you and your spouse, or you and two or three other people? This is important, because it defines how to allocate the Ordinary Shares In the company. Dividends are paid in direct proportion to numbers of shares held. A husband and wife typically have 50% each, for example, but if one is already earning money, be aware of the impact of the share income on their tax position. Share allocation can be changed after the event. There are several variations on share management; but for anything other than a simple allocation of ordinary shares, get expert advice.
Register at Companies House: There is an online system you use to set up your company and pay the registration fee. It is fairly simple to use. One question it will ask is who the directors are. For a typical small contractor company you only need one but there’s no reason not to have more. Although not strictly necessary any more, it also helps to nominate a Company Secretary: this could be the same person, but it’s more sensible to have someone else, a partner or relative for example.
Register a Memorandum of Association: Something else to do while you are at Companies House. At its simplest this is a document describing what your company is for and how you wish to run it. You can do it yourself, but the document can have legal implications in a tax investigation so do some online research for a suitable template from sites such as www.simply-docs.co.uk or www.clickdocs.co.uk.
Set up a Bank Account: This has to be a business bank account. Banks are increasingly wary of new business accounts, so you will have to answer some detailed questions and it will help if you have some professional references and a signed contact to demonstrate you actually will have an income.
Register for VAT: You have to do this if your annual income is in excess of a set amount (currently £67,000 pa) but it Is advantageous to register anyway. VAT and the Flat Rate Scheme are discussed in more detail elsewhere.
And that’s it. It sounds complicated but is in fact quite straightforward. You can also take the easy way out; either use a company formation agent, or there are several accountants who specialise in contractors who will set up all if the above for you for a small fee, or even for free, as well as providing expert support. Finally keep track of all your various expenses setting the company up, since you can reclaim these once you start trading.

It is often heard that contractors routinely close down their companies in order to avoid IR35 investigations: the logic is that if the company no longer exists, it can’t be investigated. Sadly, perhaps, this is not actually the case.

Firstly, HMRC have the right to restore a closed (or dormant) company if they have reason to believe that the amount of tax owed makes it worthwhile doing so. Closing a company requires that you submit a final return and that can be investigated for PAYE compliance – which may easily turn into an IR35 case – up to 12 months after the actual closure date.

Secondly, should HMRC suspect incorrect information has been provided they have up to six years to investigate a company’s records If they suspect actual fraud or negligence, this extends to 20 years. So simply closing the company does not mean you won’t be investigated.

Although they have a fairly modest record of winning IR35 cases, should they succeed then a significant amount of money may need to be repaid. This will certainly be the unpaid taxes plus interest from the start of the investigated period. Under the provisions of Regulation 72, if HMRC conclude that you had deliberately misstated your PAYE position, as opposed to simply making a mistake over it, they can also impose penalties of up to 100% of the unpaid tax.

More importantly, Regulation 72 allows HMRC to pursue the director of the company personally for any outstanding debts provided they have firm evidence that said director was in a position to exercise some control over the affairs of the company. In other words, you are not protected from personally from having to pay the total debt.

But why would HMRC start such an investigation? To be fair, for most small freelance companies the effort is probably not worthwhile, but one trigger would be to notice that a director routinely closes and open companies in the same line of work for no obvious business reason. They may suspect “Phoenixing”, the practice of closing a company and opening a new one to avoid outstanding debts from the old company. Or the ex-Director may be the subject of an entirely separate investigation and HMRC decide to check his history.

The chances of a closed company being investigated may be small, but they are real. Closing the company does not offer any protection from IR35.

© 2009 All rights reserved. Reproduction in whole or in part without permission is prohibited.

Image: String telephone by dotbenjamin

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