Simon Hewes writes (in April 1999) "Entrepreneurial Activity or Tax Avoidance?
Whilst it would be a disaster if the government prevented individuals from exploiting the legal benefits of operating through the medium of a limited company, I would not be disappointed if a casualty of the present proposals were the "Composite" company.
What is an Composite company?
There is no technical definition. However, broadly it is a company through which a number of otherwise unrelated individuals operate as a business organisation. They operate under the "umbrella" of the company: they are its employees and shareholders and, perhaps, directors.
The company then contracts with other organisations, the income is received by the company which then distributes it to its shareholders and employees as dividends and salary. The dividend element does not attract NI and therefore a saving is made.
What is the problem with composite companies?
Would you go into business with complete strangers? I would imagine that the answer would be "no". That is precisely what contractors who operate through an composite company are doing. Here are some problems which we have identified:
The income of a contractor is at risk. Strictly, a contractor does not have a right to income. The income belongs to the company-the contractor has a right against the company for salary and dividends. If there is any default by a contractor, then the company (and therefore anyone else operating through it) will suffer by any non payment. This can be covered by an indemnity from the person in default or withholding by the company, but what if the contractor in default simply disappears-does a runner-and the withholding is insufficient? A bit of paper-the indemnity -is hardly to be of any use. The employer could sue the composite company for breach of contract. The assets of the other contractors-the income attributable to "their" activities-would then be at risk.
Where are the complex rights enshrined? In our experience the economic effects and sharing of income is contained on a spreadsheet and can be worked out-assuming 100% compliance-mathematically, but the legal provisions (share rights in articles of association, employment agreements, etc) have not been put together to match these economic effects. In my opinion this is because it is probably impossible to do so. Operating through an composite company is a great act of faith.
Who are the directors of the Company? Rather you than me. Companies can only distribute profit (a dividend is a distribution of profit) if the directors are satisfied that the company has profits available for distribution. The only failsafe way of achieving this is by reference to the annual audited accounts of a company, but with an composite company dividends are declared weekly! But on the other hand wouldn't you want to be a director to ensure that "your" money was being properly looked after?
Should not the directors make a provision against possible liabilities? If they are distributing all the company's assets then it would give the directors some comfort if they held something back but how much and would this then make the composite company less attractive?
I could go on but I think that I have made the most important points. Who am I? Simon Hewes, a partner in the corporate division of Bond Pearce. We are a substantial commercial law firm with offices in Southampton, Bristol, Plymouth and Exeter. We have over 400 staff.
We have carried out extensive research in respect of composite companies. We came to the conclusion that with regard to the legal issues we must have done more work than anyone else, because there appeared to be so many fundamental shortcomings that we felt that no one who researched the issues fully could possibly recommend that a person should trade through an composite company. My hunch is that these schemes are being put forward on the basis of the potential tax savings without any thought or warning being given to the fundamental legal problems.
I would hasten to add that these issues should not be a concern in respect of a single person company.
Simon Hewes
Partner, Bond Pearce
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