Dear Contractor Doctor
I am an IT contractor and started out in the industry straight after college without going to university. However, I’ve always wanted to go to university to take a degree in software engineering.
Now, after a decade of successful contracting, I’ve built up a substantial cash pile in my contractor limited company and am contemplating using it to fund me through a three-year degree course.
Can I take a three-year break to take a degree and fund the course using my company’s money?
Contractor Doctor says:
“A contractor may be able to use their limited company’s cash to provide an income during a three-year career break, but HMRC is unlikely to allow the cost of the university course fees as a deductible expense,” explains James Abbott of contractor accountant Abbott Moore.
“However, contractors considering a shorter course that will directly benefit the contractor’s business, such as a master’s degree or Master of Business Administration (MBA), may have a stronger case to make to HMRC for legitimately using company money to pay course fees,” he adds.
Either way, he says the key points for contractors contemplating a multi-year break for study are to consider what happens to their company, and what happens to the money in it.
“Assuming there are sufficient funds, a contractor can use their contractor limited company to pay an income via dividends indefinitely, even if it is not trading,” continues Abbott. “A contractor may simply be required to adopt Close Investment Company (CIC) rules when they are not earning contracting income.
What happens to the company?
As Abbott explains, just because a contractor has decided to take three years or more to study does not necessarily mean their limited company has ceased trading: “Ideally, contractors in this situation should continue to complete small projects whilst studying, or accepting longer contracts between academic terms during vacations, if that’s practical.”
The limited company would have a significantly reduced income, but would continue to operate as normal in every other respect. This includes running legitimate expenses through the business and drawing an income via dividends.
A contractor may be able to use their limited company's cash to provide an income during a three-year career break, but HMRC is unlikely to allow the cost of the university course fees as a deductible expense
James Abbott, Abbott Moore
“However, if the contractor intends to devote the entire three years to study and is not intending to trade and generate fee income, then if there is a substantial cash balance in an interest-bearing account, this will generate investment income. The gap between close investment company rates and small company corporation tax has closed substantially, currently 4% and forecast to be a difference of only 2% by 2014.
As a CIC the company must still file accounts and complete a corporation tax return, as there will be a corporation tax liability on the investment income. And the only expenses a contractor can claim are ‘management charges’, which are highly prescribed by HMRC.
Entrepreneurs relief versus dividends
“Because of the costs associated with running an investment company, I would always ask a contractor whether it is worth them keeping the company,” says Abbott, “because it is possible to extract the cash via entrepreneur’s relief paying only 10% tax on the capital.”
When a company ceases to exist, its liabilities also tend to die with the business, assuming the contractor has fulfilled all of their director’s duties compliantly and paid outstanding debts.
Equally, as Abbott highlights, drawing an income via dividends can also be highly tax efficient, as corporation tax has already been paid on cash reserves: “Assuming there is sufficient cash in the company, a contractor on study leave can draw dividends up to the higher rate tax limit throughout their degree and pay no income tax.”
Each contractor’s circumstances are different, and Abbott urges any contractor considering such a long break to discuss the options with their accountant, particularly if they have substantial cash on deposit.
HMRC’s rules on training and development
Abbott notes that HMRC’s rules on training and incidental expenses are actually quite generous and, as long as a contractor can justify the direct benefit to the business arising from the training, then the associated costs and expenses will qualify for a corporation tax deduction.
“Unfortunately, HMRC’s operational policy shows that the university fees for a three-year degree course would not qualify for tax relief,” he says. “And if a contractor tried to fund the university fees of their child through their company as a ‘scholarship’, HMRC has specific legislation to prevent this.”
A highly specific master’s degree course, or an MBA, on the other hand, may have considerable commercial benefit for the company, so a case could be made for charging the fees and associated expenses to a contractor’s company.
Abbott concludes: “As with any major decision regarding the future of a contractor’s business, an early conversation with their accountant will identify what options are available and their implications.”