Summary of Ltd tax benefits over Self-Empl?
Discussion
I've read all the relevant topics back to the March budget, but I dont have a specific resolution to my query. Why do people set up Ltd companies and pay themselves dividends? Is it because tax on dividends (after corp tax) are lower than the higher rate tax band of 40%? Wouldnt CT mean that tax on divs would need to be less than 40%-CT% to benefit?
Lets assume that I earn a round £100,000pa gross. How do the figures work out?
Cheers
Lets assume that I earn a round £100,000pa gross. How do the figures work out?
Cheers
Significant tax savings are available.
The nil rate band is now gone, so all small companies pay CT at 19%, when the profit is taken out as a dividend there is no extra tax to pay until the income exceeds the basic rate band.(assuming one sole director/shareholder)
If the individual were self employed they would be paying tax & national insurance of 33%.
A clear tax saving; what complicates the calculation however is the extra administrative & accounting burden on Ltd companies and other matters such as Company cars.
If the profit were 100K, the calculation would be even more complex. Because the company would pay 19%, and then the sole director/shareholder would pay an additional tax on all dividends over the basic rate band, at an effective rate of 32.5%.
The nil rate band is now gone, so all small companies pay CT at 19%, when the profit is taken out as a dividend there is no extra tax to pay until the income exceeds the basic rate band.(assuming one sole director/shareholder)
If the individual were self employed they would be paying tax & national insurance of 33%.
A clear tax saving; what complicates the calculation however is the extra administrative & accounting burden on Ltd companies and other matters such as Company cars.
If the profit were 100K, the calculation would be even more complex. Because the company would pay 19%, and then the sole director/shareholder would pay an additional tax on all dividends over the basic rate band, at an effective rate of 32.5%.
But does that mean that on the £60k earnings over the upper limit (which is currently approx £40k) they would pay 19% CT then 32.5% extra dividend tax.
Therefore paying £11400 CT (60k*19%) and £15795 dividend tax (60*(1-19%)*32.5%) totalling £27,195 which is 45.3% aggregate tax. This is worse than the standard upper 40% employee tax. What did I d wrong?
Therefore paying £11400 CT (60k*19%) and £15795 dividend tax (60*(1-19%)*32.5%) totalling £27,195 which is 45.3% aggregate tax. This is worse than the standard upper 40% employee tax. What did I d wrong?
kryten22uk said:
But does that mean that on the £60k earnings over the upper limit (which is currently approx £40k) they would pay 19% CT then 32.5% extra dividend tax.
Therefore paying £11400 CT (60k*19%) and £15795 dividend tax (60*(1-19%)*32.5%) totalling £27,195 which is 45.3% aggregate tax. This is worse than the standard upper 40% employee tax. What did I d wrong?
I think your dividend tax is wrong.
Assume that director/shareholder is higher rate taxpayer.
60K profit (or additional profit) CT of 11,400. £48,600 is distributed as a dividend taxed at 32.5%, but with a 10% tax credit available.
Kryten - don't mix up the company's Corporation Tax liability with your personal Income Tax and NI liabilities. They are distinct and separate.
If you personally took NOTHING from the company for yourself, you would have NO personal tax or NI liability whatsoever. Obviously, the company would still have its Corporation Tax liability to pay based on its trading profits.
The trick with managing tax liabilities for small owner managed companies is not tailoring the company's economic activity to optimise its own Corporation Tax liability, but exercising care in deciding how the directors/shareholders extract money for themselves in the most tax effective manner.
>> Edited by Eric Mc on Tuesday 30th May 13:58
If you personally took NOTHING from the company for yourself, you would have NO personal tax or NI liability whatsoever. Obviously, the company would still have its Corporation Tax liability to pay based on its trading profits.
The trick with managing tax liabilities for small owner managed companies is not tailoring the company's economic activity to optimise its own Corporation Tax liability, but exercising care in deciding how the directors/shareholders extract money for themselves in the most tax effective manner.
>> Edited by Eric Mc on Tuesday 30th May 13:58
Eric Mc said:
The trick with managing tax liabilities for small owner managed companies is not tailoring the company's economic activity to optimise its own Corporation Tax liability, but exercising care in deciding how the directors/shareholders extract money for themselves in the most tax effective manner.
Quite. So how would someone do it who earns way over the normal 40% income tax limit. ie how would you orchestrate it for £100k profits? Ignoring unnecessary intricacies of course.
kryten - flinging numbers at us is meaningless. We are only accountants, not mathematicians.
I will probably only confuse you even more by telling you that the 10% tax on the dividend doesn't really exist.
jaglover - agreed.
Kryten - just seen your follow up. If you have £100,000 profits in your company available to be distributed to the shareolder/directors then you are in a very good position.
First of all, how many shareolders are there? Can you safely distribute dividends to all of them (keeping in mind the Revenue's attack in the Arctic Sytems case).
Second, have you paid salaries to the directors?
If so, have you maximised your tax free allowances through salaries?
Is the Minimum Wage an issue you need to address?
Do you need to consider Net Relevant Earnings levels for pension contributions?
Have you extracted any NI free benefits from the company?
What is the situation with your loan accounts with the company? Could loan repayments be used to pay yourseles tax free?
>> Edited by Eric Mc on Tuesday 30th May 14:17
I will probably only confuse you even more by telling you that the 10% tax on the dividend doesn't really exist.
jaglover - agreed.
Kryten - just seen your follow up. If you have £100,000 profits in your company available to be distributed to the shareolder/directors then you are in a very good position.
First of all, how many shareolders are there? Can you safely distribute dividends to all of them (keeping in mind the Revenue's attack in the Arctic Sytems case).
Second, have you paid salaries to the directors?
If so, have you maximised your tax free allowances through salaries?
Is the Minimum Wage an issue you need to address?
Do you need to consider Net Relevant Earnings levels for pension contributions?
Have you extracted any NI free benefits from the company?
What is the situation with your loan accounts with the company? Could loan repayments be used to pay yourseles tax free?
>> Edited by Eric Mc on Tuesday 30th May 14:17
Eric Mc said:
kryten - flinging numbers at us is meaningless. We are only accountants, not mathematicians.
Sorry, i'm just quite confused about where the tax savings are coming from. I'm considering going from a salaried job into contracting, and hence was interested in the best route and the possible tax savings.
Assume you own a ltd company with 100% of the shares. Assume 100k net profit before tax. Corp tax will be £19,000 for 2006-07.
Assume you took the balance of £81k as a dividend, with normal tax allowance you would expect to pay income tax at 40% on anything over £40,485. That means a tax bill of just under £16,200. This does assume that you have no other income than the dividend payment.
If your net profit from self employment was 81k then you would pay more personal tax and NIC. On top of the £16,200 at 40% you'd pay a further £7,541 in tax for 10% and 22% bands. You would also have to pay Class 4 NIC on your net profit of around £2,700.
Assume you are ltd with 100% of shares, your actual income after tax would be £64,800 from £81k. If you were self employed your income would be £73,450. The company has to pay the £19k CT, not you personally.
Or at least that's my simplistic view, is it right Eric? I'm no accountant.
>> Edited by mike_e on Tuesday 30th May 15:35
Assume you took the balance of £81k as a dividend, with normal tax allowance you would expect to pay income tax at 40% on anything over £40,485. That means a tax bill of just under £16,200. This does assume that you have no other income than the dividend payment.
If your net profit from self employment was 81k then you would pay more personal tax and NIC. On top of the £16,200 at 40% you'd pay a further £7,541 in tax for 10% and 22% bands. You would also have to pay Class 4 NIC on your net profit of around £2,700.
Assume you are ltd with 100% of shares, your actual income after tax would be £64,800 from £81k. If you were self employed your income would be £73,450. The company has to pay the £19k CT, not you personally.
Or at least that's my simplistic view, is it right Eric? I'm no accountant.
>> Edited by mike_e on Tuesday 30th May 15:35
Bingo! Thanks mike_e, i've just realised now that I was forgetting that i wouldnt pay the 10% and 22% taxes, only the amounts in the 40% range. Makes sense to me now. Looks very beneficial too, so I can see why so many people take that route.
However, do they only get their divs once a year, or can you pay divs monthly in order to get regular cash? If not do people generally pay themselves a nominal wage, in order to maintain this monthly income?
However, do they only get their divs once a year, or can you pay divs monthly in order to get regular cash? If not do people generally pay themselves a nominal wage, in order to maintain this monthly income?
If you pay yourself a dividend of £81,000, that is "deemed" to be net of the notional tax credit of 10%. In other words, the Grossed Up value of the tax inclusive dividend for tax calculation purposes is £90,000 (£81,000 x 100/90).
Under current tax rules, this calculates as follows:
Income for year £90.000
Tax free allowance £5,035
Taxable income £84,965
As all your income is derived from divdends only, the way the tax is calculated is not straightforward at all. It goes like this -
Nothing is calculated at the normal starting rate band of 10%
£33,300 is calculated at the special dividend rate of 10% i.e £3,330.00
The balance of £51,665 (£84,965 minus £33,300) is calculated at the special Dividend Higher Tax rate of 32.5% i.e. £16,791.13.
The total tax liability arising is therefore £20,121.13.
However, you are given credit for the "notional" tax on the dividend but this itself is restricted to 10% of the gross dividend less your pesonal allowances i.e £90,000 - £5,035 = £84,965 x 10% = £8,496.50.
Therefore the bottom line amount due and payable to the Revenue is £11,624.63 (£20,121.13 minus the tax credit of £8,496.50)
If you add onto that the company's Corporation Tax bill of £19,000, the Revenue actually get in total £30,624.63 (£11,624.63 plus £19,000.00).
If you were a sole trader with £100,000 taxable profits, your overall Income Tax and Class 4 National Insurance liability works out at £34,292. You would also have paid a further £109 during the year on Class 2 NI.
The requirements of IR35 is an issue for many contracting limited comapnies and needs to be carefully considred.
>> Edited by Eric Mc on Tuesday 30th May 14:50
Under current tax rules, this calculates as follows:
Income for year £90.000
Tax free allowance £5,035
Taxable income £84,965
As all your income is derived from divdends only, the way the tax is calculated is not straightforward at all. It goes like this -
Nothing is calculated at the normal starting rate band of 10%
£33,300 is calculated at the special dividend rate of 10% i.e £3,330.00
The balance of £51,665 (£84,965 minus £33,300) is calculated at the special Dividend Higher Tax rate of 32.5% i.e. £16,791.13.
The total tax liability arising is therefore £20,121.13.
However, you are given credit for the "notional" tax on the dividend but this itself is restricted to 10% of the gross dividend less your pesonal allowances i.e £90,000 - £5,035 = £84,965 x 10% = £8,496.50.
Therefore the bottom line amount due and payable to the Revenue is £11,624.63 (£20,121.13 minus the tax credit of £8,496.50)
If you add onto that the company's Corporation Tax bill of £19,000, the Revenue actually get in total £30,624.63 (£11,624.63 plus £19,000.00).
If you were a sole trader with £100,000 taxable profits, your overall Income Tax and Class 4 National Insurance liability works out at £34,292. You would also have paid a further £109 during the year on Class 2 NI.
The requirements of IR35 is an issue for many contracting limited comapnies and needs to be carefully considred.
>> Edited by Eric Mc on Tuesday 30th May 14:50
Plotloss said:
If you're planning on contracting it may be worth mentioning IR35
If your contract falls inside IR35 you dont get the option of dividends and you have to pay your tax PAYE as an employee would.
(Though no doubt I've got this wrong, Eric or Jaglover will qualify)
You have the option; but it is doubtful you will have any significant distributable profits left to make a dividend.
IR35 is a very real threat if you are contracting; however many contracts are worded such that it is POSSIBLE you may not be subject to IR35.
This is what is needed to prepare accounts on the basis you are not subject to IR35. If the IR do happen to investigate then they may decide to challenge this.
has been ordered to recalculate the tax liabilities using IR35 provisions.There's one clincher that nobody has mentioned yet, and it's not a tax concern it is a business one.
Almost all clients simply will not deal with a Sole Trader freelancer / contractor. I think it's something to do with the Sole Trader needing to be on their payroll and the client is more open to claims for employee rights (which is ironic when you consider some clients' attitudes to IR35).
>> Edited by JonRB on Tuesday 30th May 15:11
Almost all clients simply will not deal with a Sole Trader freelancer / contractor. I think it's something to do with the Sole Trader needing to be on their payroll and the client is more open to claims for employee rights (which is ironic when you consider some clients' attitudes to IR35).
>> Edited by JonRB on Tuesday 30th May 15:11
Not ironic at all, in fact.
Many companies were extremely reluctant to deal with "Self Employed" individuals PRECISELY because they knew that the Revenue could force them to be put onto the company payroll. It was because of this factor that many contractors were encouraged to incorporate in the first place. It totally removed the "employer's" resonsibility for paying them under the PAYE regulations..
The added bonus for the incorporated contractor was that he/she could now exploit payments throgh dividends - thus making big tax and NI savings.
IR35 is an attempt by the Revenue to restore some of the lost tax income resulting from dividend payments in these contractor companies.
Many companies were extremely reluctant to deal with "Self Employed" individuals PRECISELY because they knew that the Revenue could force them to be put onto the company payroll. It was because of this factor that many contractors were encouraged to incorporate in the first place. It totally removed the "employer's" resonsibility for paying them under the PAYE regulations..
The added bonus for the incorporated contractor was that he/she could now exploit payments throgh dividends - thus making big tax and NI savings.
IR35 is an attempt by the Revenue to restore some of the lost tax income resulting from dividend payments in these contractor companies.
Eric Mc said:Indeed. Trouble is their definition of "restore" is "claw it all back and then some" rather than simply restoring the balance. That's what made the IR 5.91 bulletin all the more odious when it talked about "proposals […] to ensure that the right amount of tax is paid by owner managers of small incorporated businesses on the profits extracted from their company".
IR35 is an attempt by the Revenue to restore some of the lost tax income resulting from dividend payments in these contractor companies.
I don’t mind paying a fair, appropriate, and above all consistent and predictable, amount of tax on the money I generate via my company. It is true that some contractors have taken the piss in the past, so the Revenue evidently seek to restore the balance these days by them taking the piss instead.
Eric Mc said:I meant ironic in the sense that they were quick enough to restructure matters to eliminate the possibility of being deemed to be employers that time round, but are less accommodating towards PSC contractors trying to stay outside IR35 for much the same reason.
Not ironic at all, in fact.
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