Contractor Doctor: Can I receive a tax-free redundancy payment from my ltd company?

Dear Contractor Doctor

I have built up quite a large cash balance in my company bank account, and work has dried up in my field. So, I’m thinking of closing the company and going travelling for a couple of years. I’ve read online that if there’s no job for you with your employer, you can get tax-free redundancy payouts of up to £30,000.

Can I receive a tax-free redundancy or termination payment from my limited company?

Thanks

Tyler

Contractor Doctor says:

“The short answer is no; the shareholder directors of limited companies cannot receive tax-free statutory redundancy payments, and nor can the company claim corporation tax relief for any payouts,” explains James Abbott, owner and head of tax at contractor accountant Abbott Moore.

“To receive a tax-free statutory redundancy payment, a worker must have an employment contract with their employer, and they cannot resign or leave of their own volition.

“Even if a contractor satisfies the first condition and has an employment contract, 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 second condition.”

Why contractors don’t have employment contracts

According to Abbott, few contractors have employment contracts with their limited company, and as they are company directors they are also office holders

There is good reason for this: “If a contractor has an employment contract with their limited company, then they must pay themselves a salary at the national minimum wage.

“When most contractors add up the number of hours they actually work, including both time spent with clients and time spent on winning new work and administering their business, even at £6.19 per hour it adds up to a hefty salary.”

When most contractors add up the number of hours they actually work, including both time spent with clients and time spent on winning new work and administering their business, even at £6.19 per hour it adds up to a hefty salary

James Abbott, Abbott Moore

This may mean the contractor pays considerably more income tax and National Insurance Contributions (NICs) than if they had the flexibility of paying themselves a low salary and topping up their remuneration with dividends.

Employees can’t resign and still get tax-free redundancy

“A contractor may decide that they do want to pay themselves a higher salary than they would normally need to and so have an employment contract with their company which satisfied minimum wage requirements,” continues Abbott. “However, they still have to overcome the second condition of qualifying for tax-free redundancy, which is that they cannot choose to leave or resign.”

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 limited company contractor employee who is also a company director controlling the company, choosing to make themselves redundant is the same as choosing to end the employment. They won’t qualify for redundancy.

“HMRC would challenge a contractor making a corporation tax-relief claim for their own redundancy in the company accounts,” warns Abbott. “It would ask questions about the nature of such a payment made to a sole director, and would recognise that the controlling director and the employee are one and the same.”

Termination, or ex gratia, payments

Abbott confirms that termination, or ex gratia, payments, which also qualify for tax-relief within the £30,000 redundancy payment allowance, would be similarly barred for limited company contractors. And anyway, termination payments are not tax deductible for a company that is ceasing to trade.

A termination payment is an additional payment made by an employer to an employee that the employer is not obliged to make, nor is it customary to make. The employer cannot be contractually bound to make the payment, otherwise the payment would be taxable.

Abbott sums up: “The controlling aspect of a contractor-director prevents the contractor-employee from benefitting from tax-free payouts.”

Published: Thursday, August 15, 2013

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