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Contractor Doctor: Can I pay back an HMRC tax refund in instalments?

Dear Contractor Doctor,

I am the sole director and shareholder of my contractor limited company and received two cheques totalling £19,000 from HMRC for corporation tax and VAT overpayment. I cashed the cheques into the business bank account, transferred the money into my personal account and used it as a deposit on a house.

My accountant has just told me that the money was not owed to me and I will have to pay it back out of the company’s retained earnings of £32,000, but I need this cash to live on as my contract ends very shortly and I don’t know when I’ll be working again. I am also planning to leave the UK to return home and close my limited company.

Do I have to pay this money back and if so can I pay it back in instalments when I have another contract?

Thanks

Sally

Contractor Doctor says:

“The contractor’s limited company has received money owed by HMRC and the contractor has then paid this money to themselves personally,” explains Phil Richards of contractor accountant BFCA Chartered Accountants. “The contractor has therefore extracted £19,000 out of their company and this should be accounted for as a director’s loan, a dividend, by salary and expenses or possibly a combination of these.”

And according to Richards, whichever way the contractor has chosen to pay themselves, they will have incurred a liability to their company and possibly to HMRC: “The key point is that the contractor’s limited company and the contractor are two separate legal entities.

“When the contractor’s limited company received the money from HMRC it was for a reason, or an error, but that is a matter between the company and HMRC,” he continues. “When the contractor then extracted the money out of the company, it is an issue between the contractor and their company.”

Tax liabilities

When the funds were transferred to the contractor’s personal account, depending on how the payment was classified, the contractor would potentially become liable for:

  • If the £19000 is accounted for as a directors loan, then potential S419 tax liabilities arise if this loan is not repaid within 9 months of the year end. The S419 tax would be charged at the year end, and would amount to 25% of the £19,000. There may also be Benefit In Kind charges on the interest rate that the contractor may not have paid to the company.
  • If the £19,000 is taken as a dividend, then higher rate tax may become payable at 25% of the net dividend payment and this depends on the contractors earnings in the tax year.
  • If the £19,000 is taken as a salary, then employers National Insurance Contributions (NICs) of 12.8% would be payable in addition to the gross amount paid, employees’ NICs of 1% and PAYE income tax at the highest band rate for the contractor would be payable.

The contractor has extracted £19,000 out of their company and this should be accounted for as a director's loan, a dividend, by salary and expenses or possibly a combination of these

Phil Richards, BFCA Chartered Accountants

“Even if HMRC paid the tax refund to the contractor’s limited company in error, the company would still be liable to return the money in full,” says Richards. “The refund from HMRC is a matter between the company and HMRC, and the fact that the contractor has extracted the money is a matter between the contractor and their limited company.”

HMRC won’t allow company closure

As Richards explains, winding up the limited company is not an option, as HMRC won’t allow it: “If there is a company debt to HMRC, they won’t allow the contractor to close the company until the debt has been paid.”

And leaving the country won’t clear the debt either, as it does not reduce the contractor’s liabilities as a UK taxpayer and director. “The UK tax authorities will pursue the contractor overseas,” says Richards, “and HMRC has agreements with other tax authorities for this purpose.”

However, HMRC may be sympathetic to the contractor paying any tax liabilities in instalments, as its Business Payment Support Service, introduced following the onset of the credit crunch and recession, will negotiate affordable payment plans with companies and individual taxpayers.

Contractors are ultimately responsible

“A contractor’s accountant is responsible for calculating how much tax a contractor and their limited company have to pay,” explains Richards. “But the contractor is responsible for actually paying the tax. So, in this case, the contractor may have paid corporation tax on account before the company tax return had been completed, hence the overpayment. In fact, the contractor’s accountant did well to reclaim the overpayment!”

But even if HMRC paid the contractor’s company a tax refund in error, the contractor’s limited company is still liable to return the money in full. HMRC will not allow the contractor to close the company until the debt has been repaid, and a contractor can’t escape by going abroad, because of the bilateral tax agreements most countries have with the UK.

“If it looks too good to be true, it probably is, and contractors should resist the temptation to take the money and run,” concludes Richards. “If in doubt about whether repayments can be paid to a contractor personally, it is wise to confirm with an accountant what can be paid, plus how and when.”

Good luck with your contracting!

Contractor Doctor

Published: 30 September 2009

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