11 June 2020 | Taxation, Payroll
A termination payment to a director may become part of your tax planning in these difficult times, if your business has to close.
You may be aware that the most tax-efficient method of getting the money out of your company when it closes down is to wind it up and take its cash and other assets. That way the maximum rate of tax on what you receive is 10%, assuming that capital gains tax (CGT) entrepreneurs’ relief (ER) applies. This overlooks what you might be entitled to receive entirely tax free.
Entrepreneurs Relief has been renamed as business asset disposal relief or BADR.
As a director you may be entitled to statutory redundancy pay if you close your company. This can be complex, but essentially if you’ve worked in the company’s business, i.e. done more than just carry out your duties as a director required by company law. If you have an employment contract, then you have the same rights as any other employee. If you’re winding up your company you’ll get all its money and assets anyway. Or your share if there are other shareholders. You might think that giving yourself a redundancy pay off isn’t worth the effort. You’d be wrong.
Iain has owned all the shares in ABC Ltd for more than 20 years. If ABC permanently ceases to trade and Iain meets the conditions for redundancy pay, then ABC can pay him the maximum. For the purposes of this example we’ll say is £16,140. This payment reduces the lump sum ABC has to distribute when it’s wound up. ABC is also able to claim corporation tax relief for the payment. This increases its funds by £4,374 (£16,140 x 19%). This extra money goes to Iain on which he pays tax at 10% (the BADR rate). That makes him £3,937 better off. Because Iain doesn’t have to pay tax on the redundancy pay it saves him another £1,614 (£16,140 x 10%). Which is the CGT that would have paid on the £16,140, had the redundancy payment not been made.
If Iain’s employment contract had entitled him to additional termination payments then the tax savings would be greater. The rules allow a CT deduction for an additional payment of up to three times the statutory redundancy amount. However, if the total of statutory and non-statutory payments exceed £30,000 then they are less tax efficient than taking the money as proceeds from the winding up of the company.
You must be aware that a contractual termination payment for directors is often attacked by HMRC> They will argue that it doesn’t qualify for a CT deduction and that the payment is really for the director’s shares and so is liable to CGT. The longer an employment contract is in place the less likely it is that HMRC will attack the related redundancy payment.
Creating a last-minute contract of employment to secure entitlement to a redundancy payment is likely to be attacked by HMRC. Therefore, if you want to take advantage of the tax breaks that go with a termination payment then the best policy, especially for one-man companies, is to create an employment contract early in your company’s life.
For more information contact Angus Nicolson or Liam McCreath to talk through your options.
The information provided is for general information purposes only.
Legislation and details may have changed since this was written. The text may not include all matters that are relevant to your individual situation.
You should not make decisions, or refrain from making decisions, without taking further professional advice about your specific circumstances.
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