Since the withdrawal of Entrepreneurs Relief on the sale of a business to a company and the sale of a personal service company (PSC), taxpayers and their accountants have been looking at ways to create gains that will be eligible for entrepreneurs’ relief (ER) and so will be taxed at 10%.
Not surprisingly, HMRC is alert to any transactions that fall under their definition of a tax scheme and has recently warned taxpayers against using a new scheme it has uncovered to reduce tax payable on earnings to 10%.
- A taxpayer who owns a personal service company (PSC) in the UK sells that company to an organisation based in Cyprus. This sale is correctly taxed as a capital gain. If the taxpayer has owned at least 5% of the PSC for a year or more, the gain will be eligible for entrepreneurs’ relief (ER), so will be taxed at 10%
- The
taxpayer continues to be a director of the PSC after its sale to the Cyprus entity, and continues to work through that PSC in the UK
- The scheme providers claim that the monthly payments the taxpayer receives in return for his work through the PSC are capital payments subject to ER, and thus taxed at 10%
HMRC clearly believes
that this tax scheme doesn’t work, although it doesn’t specify why. It is probably connected with the valuation of the disposal of the PSC and the timing of receipts.
When the PSC is sold in stage one, its value at that point is subject to CGT (assuming small or nil base cost), so ER can be claimed on that gain. The owner may also be paid an “earn-out”, which is an amount based on value the PSC will generate in
the future– i.e. the earnings created at stage three.
The earn-out must be taxed at the same date as the proceeds from the PSC sale to qualify for ER. For that to happen the value of the earn-out must be determined at the time of the sale of the PSC. If the earn-out is based on the earnings at stage three it is difficult to see how it can be determined accurately at stage
one.
Where the value earn-out can’t be determined until stage three it becomes a separate right. That right is subject to CGT, but when the cash is received, not at stage one. The disposal of the right is not eligible for ER, as it is not a disposal of shares or of a business, so CGT is due at 20% (or the rate applicable when the right is disposed of).
HMRC warns that it will investigate anyone found to be using this scheme, before the taxpayer has even submitted their tax return.
When the tax return is submitted including a claim for ER, that claim will be challenged and CGT will be demanded at the full rate, plus
interest and penalties on any underpaid tax.
If you run a PSC and this scheme is suggested to you then beware!
Noel Guilford