Company Directors: Income Tax Savings

As a company director it is important to take every tax break possible.

Our best-selling business tax report Tax Tips for Company Directors has just been updated to reflect tax changes for 2019/20.

This special guide has been written with the director of the small or medium sized company in mind.

It looks at possible tax planning strategies for such directors at each stage of a company’s life from incorporation through to cessation when either the director leaves or the company closes. When a limited company is formed a new entity is created. Legally, this entity is separate from all other individuals, including the owners (shareholders) who may or may not be the same people as those who manage the company (directors). It is invariably the case that a sole trader or partnership commences in business and the business grows such that the matter of incorporation needs to be considered.

Although the decision to incorporate should be for commercial reasons rather than tax savings, any tax savings that may result need to be factored into the decision. There are tax costs relevant to incorporation that need to be taken into account when making the decision, not least Capital Gains Tax (CGT) and possibly Stamp Duty Land Tax (SDLT) (or Land and Buildings Transaction Tax in Scotland or Land Transaction Tax in Wales) should property be transferred to the company. Although there are various CGT reliefs available to reduce or defer chargeable gains made on incorporation (see sections 1.2 to 1.5), there are no such reliefs available for the SDLT, etc. charge.

Income Tax Savings

The table below shows the comparison in take home pay between continuing as a sole trader and incorporation for the tax year 2019/20, considering the tax savings only. The table assumes that all profits are extracted via salary at the NIC Primary Threshold limit amount of £8,632 (see section 2.3 - 2019/20 Calculations), the remaining profit being taken as dividends, that the director has no other income and as such is entitled to the full personal allowance of £12,500.

The table shows that the additional amount of income obtained on the incorporation at the lower levels of profit is eroded; this is because of the abolition of Class 2 NIC and the increase in the main rate of Class 4 NIC for the sole trader which results in a net reduction in liability for those with low profits. At these profits incorporation will not be worthwhile bearing in mind the additional work and cost involved in preparing more detailed accounts, running a payroll and submitting additional returns to both Companies House and HMRC. However, reach a profit of £60,000 and the situation changes dramatically for incorporation. Greater than £60,000 and the saving/amount of additional income starts to be less becoming nearly level at £150,000; this is due to the extra tax that is payable on company dividends in the higher rates and reflects abatement of the personal allowance.

Profit		2019/20
Profit	*Sole trader net after tax*	*Company owner* *net after tax*	*Savings*
£20,000	17,321	17,589	268
£30,000	24,421	25,082	661
£40,000	31,521	32,574	1,053
£50,000	38,621	40,067	1,446
£60,000	44,421	47,500	3,079
£70,000	50,221	52,967	2,746
£80,000	56,021	58,434	2,413
£90,000	61,821	63,902	2,081
£100,000	67,621	69,370	1,749
£125,000	77,121	82,568	5,447
£150,000	91,621	91,984	363
£200,000	118,121	118,139	18

Tax Trap – Personal Service Companies (‘PSC’)

Many self-employed individual workers who provide professional services are obliged to incorporate because their clients or recruitment agencies will not hire them as they are self-employed. Such companies are termed ‘Personal Service Companies’ (‘PSC’). Contractors working via PSC’s should be aware that HMRC has reviewed such arrangements with the aim for such workers to be taxed under PAYE. Legislation for PSC companies working as an intermediary (termed ‘IR35’) requires the individuals to pay broadly the same tax and NIC as if they were working for the client as an employee. HMRC maintains that too many limited companies are working outside of IR35 and in April 2017, this led to the ‘IR35 off-payroll’ rules being applied to public sector contractors. This initiative has now been expanded such that as from 6 April 2020, the same rules will apply to contractors working in the private sector. From that date, the responsibility for determining the IR35 status of contractors and the requirement to deduct tax and NIC will fall on the medium and large private sector companies that engage them (‘small’ companies will not be affected - ‘small’ meaning companies with less than 50 employees, turnover of less than £10.2 million and a balance sheet total of £5.1 million of less).

HMRC has produced a basic online tool intended to simplify the decisionmaking process (the Check Employment Status for Tax (CEST) tool) which requires answers to just four questions. The aim is to reach an objective verdict however, HMRC will almost certainly side with its own tool if the rules are found to apply. Any PSC contractor who wishes to appeal may face an employment tribunal and the costs that that will entail. HMRC Guidance ‘Off-payroll working for an intermediary’ states that ‘A worker is involved in ‘off-payroll’ working when they work for a client through their own intermediary, often a personal service company (PSC), but would be an employee if they were providing their services directly’. Further information on ‘IR35’ can be found at: https://www.gov.uk/guidance/ir35-find-out-if-it-applies.

Tax Trap - Construction Industry Scheme

Both the ‘off-payroll’ working rules and the Construction Industry Scheme could apply if the worker is a subcontractor working in the construction industry through a limited company. This could happen if you would be considered an employee of the client if there was not a PSC in place. Special rules are intended to stop Income Tax and National Insurance Contributions being paid twice on the same earnings.

The above is an excerpt from Tax Tips for Company Directors. Get the full scoop here