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potential liability for the PAYE which should have been paid over
without right of recourse to the ‘employee’. If the question is
whether or not IR35 applies, the question (and any liability due)
is for the individual and his/her company (the payee).
Debtors and unbilled work
As we have already discussed, small businesses may opt into the
cash basis and calculate their profits on the basis of the cash
passing through the business. However, it is a feature of the
tax system that other businesses (including all corporates) must
include in their turnover for the year the value of incomplete
work, of unpaid bills (debtors) and of work completed but not
yet billed, all as at the end of the year.
We will need to discuss with you exactly what needs to be
identified and the basis of valuation. Keeping an eye on debtors
and unbilled work is crucial to your cash flow. We can advise
you in all of these areas.
Limited companies
Forming a limited company may be a consideration if the
limitation of liability is important, but it should be noted that
banks and other creditors often require personal guarantees
from directors for company borrowings.
Trading through a limited company can be an effective way
of sheltering profits. Profits paid out in the form of salaries,
bonuses, or dividends may be liable to top tax rates, whereas
profits retained in the company will be taxed at 20%.
Funds retained by the company can be used to buy equipment
or to provide for pensions – both of which are eligible for tax
relief. They could be used to fund dividends when profits are
scarce (spreading income into years when you might be liable to
a lower rate of income tax) or capitalised and potentially taxed
at 10% or 18%/28% on a liquidation or sale.
From April 2016, a new taxation system applies to dividends and
this will affect the decision as to whether to trade as a limited
company. We would be happy to discuss the implications of
incorporation with you, before you decide whether or not to
incorporate your business.
National insurance contributions (NICs)
Leaving profits in the company may be tax-efficient, but you
will need money to live on, so you should consider the best
ways to extract profits from your business.
A salary will meet most of your needs, but you should not
overlook the use of benefits, which could save income tax and
could also result in a lower NIC liability.
Five NIC-saving strategies:
1. Increasing the amount the employer contributes to company
pension schemes. Care should be taken however as there are
limits on the amount of pension contributions an individual
can make both annually and over their lifetime
2. Share incentive plans (shares bought out of pre-tax and
pre-NIC income)
3. For some companies, disincorporation and instead operating
as a sole trader or partnership may be beneficial
4. Instead of an increased salary, paying a bonus to reduce
employee (not director) contributions
5. Paying dividends instead of bonuses to owner-directors
before 6 April 2016.
Increasing your net income as an
owner-director
As an example, consider how much you might save if, as an
owner‑director, you wanted to extract £10,000 profit (pre‑tax)
your company makes in 2015/16 by way of a dividend rather
than a bonus. We have assumed in this scenario that the
director has already taken salary in excess of the upper earnings
limit for NIC and is a 40% taxpayer.
Case Study
As you can see in this case study, the net income is increased
by more than 17% by opting to declare a dividend. Be sure to
discuss this with us, as this is a complex area of tax law.
Bonus
£
Dividend
£
Profit to extract
10,000
10,000
Employers’ NICs (13.8% on gross
bonus)
‑1,213
Gross bonus
8,787
Corporation tax (20% - dividend is
not deductible for corporation tax)
‑2,000
Dividend
8,000
Employees’ NICs (2% on gross
bonus)
‑176
Income tax (40% on gross bonus)
‑3,515
Income tax on dividend
‑2,000
Net amount extracted
5,096
6,000
Remember that dividends are usually payable to all shareholders
and are not earnings for pension contributions and certain other
purposes. It is possible to waive dividends, although this can
result in tax complications. Finally, you need to consider with
us the effect of regular dividend payments on the valuation of
shares in your company.
The Government will abolish the dividend tax credit from
6 April 2016 and introduce a new Dividend Tax Allowance of
£5,000 a year. The new rates of tax on dividend income above
the allowance will be 7.5% for basic rate taxpayers, 32.5% for
higher rate taxpayers and 38.1% for additional rate taxpayers.
These rates replace the current effective tax rates of 0%, 25%