Dear Contractor Doctor
I am a financial IT contractor and due to the downturn in the financial sector, I spent much of the last 18 months on the bench without a contract.
As a result, I was forced to use all my savings and most of the cash I had put by to pay the previous financial year’s corporation tax bill just to pay the bills. My corporation tax is overdue and HMRC has written to me several times demanding that I pay up. Now I’m being threatened with debt recovery proceedings.
I can’t pay my tax bill to HMRC. What are my options?
Contractor Doctor says:
“A contractor limited company that is unable to meet its tax liabilities when they become due is technically insolvent,” explains Mike Simister, licensed insolvency practitioner and director at specialist contractor licensed insolvency practitioners Lines Henry.
“Often the only solution open to a contractor who has spent the money put aside to meet their limited company’s corporation tax and who does not have access to alternative sources of personal or other finance is to liquidate the company.”
The closest HMRC comes to negotiating is by allowing a Time To Pay arrangement. However, if the debt cannot be paid off in one year, or if the contractor has had a Time To Pay agreement previously, then HMRC will not negotiate and the debt must be paid in full.
Why normally cash-rich contractors can go bust
In Simister’s experience, contractors typically find themselves unable to pay their tax bills for three reasons: “A limited company contractor, like Toby, might have an extended period of time between contracts. With no income and the same outgoings, they choose to dip into their limited company’s corporation tax fund to continue paying themselves a salary.
“In doing so they create either an overdrawn loan account or an unlawful dividend. In either case they are repayable to the company by the contractor.
“In some cases, tragedy may have struck the contractor’s household and either they are too sick to work, or they are nursing a spouse or relative. Without an alternative source of income, they keep their household going, again using company money originally set aside for tax.”
The final class of contractors Simister dubs the ‘ostriches’, because they often choose to ignore the situation: “Some contractors claim they are no good at paperwork, or even ignore their accountant’s advice to set money aside for tax and spend all of their income to sustain their lifestyle.”
Simister often finds that ‘ostrich’ contractors don’t understand that the company is a separate legal entity from them, and treat the cash in the business like their own personal piggy bank, including money that should be saved for tax payments.
Often the only solution open to a contractor who has spent the money put aside to meet their limited company's corporation tax and who does not have access to alternative sources of personal or other finance is to liquidate the company
Mike Simister, Lines Henry
For the ‘ostriches’, Simister highlights that it is the knock on the door by the bailiff that may finally spur them into action: “The bailiffs may visit when the contractor is at work, so it is their partner or spouse, or even their children who answer the door. And it may also be the first time anyone else in the family becomes aware that there is a problem.”
HMRC’s process when it does not receive monies due
According to Simister, the bailiff’s visit is quite a way down the line, after HMRC has worked through a set process: “A contractor whose limited company’s financial year ends on 31 March must pay any corporation tax by 1 January the following year.
“But HMRC might not realise that they have not received any tax due until three months later, when the corporation tax return must be submitted. Within a few weeks, it will start sending letters.
“We understand from our clients and accountants that HMRC will attempt to secure any monies owed from the contractor director personally, suggesting the bill is paid using personal funds or a credit card.”
Debt recovery and distraint
HMRC has the powers to send in its tax officers to seize the assets of a business owing tax and auction those assets to pay all or part of the arrears. But most contractor limited companies have few or no assets.
Simister explains: “If an HMRC collections officer turns up at a contractor’s home demanding to enter and seize the company’s assets, the contractor can refuse them entry and show them a copy of the accounts, which will confirm there are no assets beyond perhaps a laptop and printer to seize.”
However, Simister warns that HMRC is increasingly outsourcing its debt recovery to private companies that are paid by results and which adopt a range of tactics, including sending in the bailiffs, to recover unpaid tax.
“Private sector bailiffs are used to dealing with personal debt and entering a home to remove televisions and other high value items belonging to the home owner. They can’t do this to a limited company contractor, as the company and contractor are separate legal entities; the bailiff cannot seize personal assets to pay company debts.”
Winding-up orders and compulsory liquidation
Eventually, if HMRC has not been paid, it will apply to the High Court for a compulsory winding-up order and force the company into liquidation. This, says Simister, is not a good outcome for a contractor.
“If a contractor ignores HMRC and does not speak to a licensed insolvency practitioner, then HMRC will liquidate the company. The local official receiver will hand the file to the next insolvency practitioner on the rota to collect in monies owed to the company by the contractor. If the contractor has no income, the insolvency practitioner can make them bankrupt and seize personal assets like their house.”
Simister has heard from clients’ accountants that the actions taken by official receivers and local insolvency practitioners are highly variable. Some contractors ‘get away with it’ and walk away from the liquidated company; others risk losing their homes.
Voluntary actions before HMRC takes the ‘nuclear option’
Simister recommends that the most effective action for companies with tax arrears and unable to pay their bills is to be proactive, and avoid the random outcomes of the official receiver and court-appointed insolvency practitioners.
“It may be possible to negotiate a Time To Pay agreement with HMRC if the debt can be repaid within 12 months,” he says. “But the contractor’s earnings may not be sufficient to make that possible.”
“A company voluntary arrangement (CVA) is an unlikely option because it requires the agreement of the creditors, and for most limited company contractors the only major creditor is HMRC, which is unlikely to negotiate.”
Simister says that the trigger point for insolvency is when the contractor’s limited company cannot realistically repay the debt within 12 months. If this is the case, the solution for most contractors is to undergo a voluntary liquidation. This would involve them agreeing an affordable payment plan to clear their debt to the company, using a licensed insolvency practitioner who the contractor has chosen.
The contractor can usually then start a new limited company and get on with their contracting career.
‘D reports’ on the conduct of contractor directors
But it may not be quite as simple as starting a new company and moving on, as Simister explains: “Insolvency practitioners are required to submit a ‘D report’ on the conduct of the directors which resulted in the insolvency.
“If the insolvency arose because the contractor spent the money owed to HMRC, then they would almost certainly fall into the category of an adverse report. The Insolvency Service may then take action that could result in the contractor being disqualified from being a director. In cases when there was genuine hardship, such as a family illness, this will be taken into account as a mitigating factor.
“Many banks are less keen to provide a bank account to a company where one of its directors has been involved in insolvency,” Simister adds.
This in itself is a problem, because if a contractor cannot trade via a limited company and has to use an umbrella company, their net income will fall by an average of 15%, assuming they were previously outside IR35. This in turn may mean the contractor cannot afford the repayment plan they have agreed.
Simister concludes that ideally contractors should act as soon as there is any chance of them getting into tax arrears: “Although circumstances may force insolvency on some contractors, many could avoid getting into tax arrears by recognising that their company is a separate legal entity. Being a director comes with responsibilities, which includes making provision for the company’s debts, including its tax liabilities.”