IN THE CURRENT economic climate, companies are sadly going bust. A frequently asked but often misunderstood so called tax planning idea doing the rounds involves paying £30K “tax-free” whilst the company undergoes voluntary liquidation.

At Shipeys Tax we consider the viability of this in the tax note below. Needless to say, never take tax advice from someone around a dinner table (unless of course he/she is an experienced tax adviser!).

Basics

Due to the unfortunate impact of COVID-19 and lack of demand, a sole director and shareholder of an hitherto successful company personal company has decided to put the company into voluntary liquidation. As part of the process the director decides to pay herself a redundancy or termination payment from the limited company as she has heard that such pay-outs are tax-free.

As part of the process the director decides to pay herself a redundancy or termination payment from the limited company as she has heard that such pay-outs are tax-free…

What is a redundancy/termination payment?

Broadly, this refers any payment to an employee for compensation for loss of employment that is not contractual, non-customary, related earnings or to the notice period. If it qualifies then the payment can potentially benefit from a statutory £30,000 exemption to tax and NIC. Nice.

Can a sole director shareholder receive a tax-free redundancy or termination payment from the company?

Generally speaking, in some circumstances it is possible for a director to receive termination payments that fall within the exemption. However, the old adage that the position should be reviewed on a case by case basis applies. Whilst the tax treatment of qualifying termination payments are quite well established, those involving sole director shareholders are somewhat trickier to navigate.

To employ or not to employ?

Firstly, it is important to identify whether the sole director is employed by the company. To receive a tax-free statutory redundancy payment, a worker must have an employment contract with their employer

Generally speaking, in some circumstances it is possible for a director to receive termination payments that fall within the exemption…

Evidence that could point the employment status includes the existence of an employment contract, payment of salary, duties etc which point towards employment.

The payment conundrum

Assuming the sole director is clearly employed by the company, it is then necessary to determine to what extent the payments relate to the termination of the client’s employment rather than their position as shareholder. Was the payment in actual fact compensation for loss of office or was it an extraction of “profits”, i.e. a dividend distribution? HMRC will obviously argue the latter, especially for one-man band companies where no other employees have been made redundant and paid termination payments. In other cases, payments to those close to retirement can be classed as part of the package an amount that arises from what is known as an employer-financed retirement benefits scheme (EFRB). Essentially, this is an unregistered pension scheme. If there is a payment that HMRC deems to be an EFRB, it will be fully taxable.

Self (de)termination

Secondly, even if a sole director satisfies the first condition and has clear evidence of  employment, there is another issue to consider: as the owner and director of the business making themselves redundant, they are effectively making the decision to cease trading and leave, and so fail the condition that they cannot resign or leave of their own volition.

Was the payment in actual fact compensation or loss of office or was it an extraction of profits, i.e. a dividend distribution? HMRC will most likely argue this route for one-man band companies where no other employees have been made redundant and paid termination payments…

An employee has to be made redundant by their “employer” – they have no choice in whether their role continues to exist.

In the case of a sole director/owner employee who is also a company director controlling the company, choosing to make themselves redundant is the same as choosing to end the employment. This will most likely nullify the redundancy argument. In addition, HMRC would also challenge a sole director company making a corporation tax deduction for their own redundancy in the company accounts, the nature of the payment not being deemed to be for the benefit of the trade.

An employee has to be made redundant by their “employer” – they have no choice in whether their role continues to exist…

Terminus

However, it is possible some termination payments may fall within the £30,000 exemption, provided they are not subject to tax under any other part of the legislation such as earning or benefits. The circumstances in which can occur are very few and far between and you would need specialist tax advice to help you navigate the tax traps. This is a fairly complex area as evidenced above and the facts of any case will need to be reviewed to determine whether any termination payments for the director would fall within the £30,000 exemption, but with the right set of circumstances some relief may be available.

At Shipleys Tax we have a team of experts who can advise on the above and whether a redundancy payment can be tax-free. Contact us on 0114 272 4984 or email info@shipleystax.com.