Tag Archive | "dividends"

Contractors to foot £7bn bill envisaged from dividend tax hike

The Telegraph reports today that contractors billing £80,000 per annum will be £2,000 a year worse off under the new dividend tax system. That’s based on advice from WTT Consulting’s Graham Webber, after adding the additional 2.5% tax shareholders will sucker for come April 2016.

Should a contract be worth double that, £160,000 per annum, the shareholder will have to pay an extra 3% on their dividend drawings. That’s due to their higher tax bracket, thus they’ll pay £4,800 extra from next Spring.

Some may argue that anyone billing so much can afford to pay the extra. First, there’s the defence that people live to their means (or beyond them). Contractors who’ve secured mortgages and other finance based on the existing dividend set-up may have to rethink their budget.

Second – applicable to the most vulnerable sector – are contractors whose total annual billings are below the basic tax rate allowance. Yes, there’s another argument here: if you’re only billing £42k, are you really a contractor?

The answer is yes; there are genuine multi-client contractors – like writers, for instance – with several contracts on the go. But despite their number of clients, the going rate may not bill enough to catapult them into the 40p-in-the-pound bracket.

What’s the effect of the dividend tax hike?

Up until now, basic rate tax payers have paid no tax on dividends. From April 2016, only the first £5,000 of dividend drawings is tax free.

So, let’s imagine a contractor with two clients, billing them both £20k per annum. Their total income of £40k means they retain their basic tax-payer status. All good so far.

Let’s then imagine that they – quite legally – put £120 pounds a week through the books to maintain their NICs, but keep payments to a minimum. For contractors billing so little, they’ll want to ensure that there’s a State Pension pot when they retire, for sure.

Let’s also work on a 50-week year (that’s to keep the maths simple – normally, 46 or 48 weeks would represent a fiscal year). So, 50 weeks x £120 = £6,000 per annum the contractor draws as salary.

Take that £6k from the £40,000 earnings, the contractor then has the potential to draw the £34,000 in dividends. Less Corporation Tax @ 20% (at source) gives the contractor £27,200 to play with.

This is a very simplified explanation, remember (Whitfield Tax go into much more depth). It doesn’t take into account Personal Allowance – next year to rise to £11,000 – which can’t be used against dividends, anyway. Nor does it factor in any expenses, as few and far between as they’ll soon become.

So, in the 2015/16 tax year, this year, the contractor will not pay tax on those dividend drawings. The £27,200 will be theirs.

Come next year, 2016/17, the only chunk of that £27,200 not subject to dividend tax will be the £5k allowance. The balance of £22,200 will be subject to dividend tax.

The net effect of the new charges will mean that this basic-rate contractor will pay £1,290 next year that they haven’t this. That leaves £20,910, plus the £5k tax free = £25,910, or a net loss (all other factors being equal) of 4.98% next year.

If we shoot everyone, we’re bound to get our man

By the time the National Insurance personal allowance changes come into effect, many contractors are going to wonder whether it’s worth creating a company at all. Even genuine contractors, let alone those who are inside IR35 and are the genuine target of these changes.

The government hopes to raise £6.8bn from the changes to dividend tax. Limited company contractors and independent professionals will foot that bill. Then, there’s the discussion document coming on IR35, too

The government could well be shooting itself in the foot by killing the flexibility that contracting brings to the economy. The ability to employ specialists on a short term basis is what’s helped the UK recover. It’s also what will see UK businesses become more competitive in the global market, too.

The £7bn the government wants to raise from dividends will be pittance compared to the additional cost to businesses. With few skilled contractors, they’ll have to employ full time staff for tasks that don’t need full time supervision, direction or control. But that’s another story, entirely…

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Good contractors are worth every bit of their day rate!

Regular readers will know I have never had a lot of respect for the average agency, thinking that most of them exhibit a degree of professional casualness totally at odds with their advertising. Today, for example, I got another email offering me work as a support technician in the Midlands at a whole £20k a year. Be still my beating heart.

But this week, one of them has managed to surpass even that fairly mediocre level of success.

Someone in Hays thought it a good idea to remind the people contracting through them to RBS to complete their timesheets prior to the bank holiday weekend. So they sent out an email, with, for some reason, an attachment. Followed very quickly – but not quickly enough, needless to say – by a recall of the email.

Why? Because the attachment contained a list of 3000 contractors, their day rate, the day rate to Hays and a few other interesting details. It seems that some of these contractors are on really quite juicy rates. Oops…

OK, so perhaps that’s the rate for a senior HR manager in charge of a multi-million pound restructuring programme, but needless to say the ignorati rapidly jumped on the bandwagon, demonstrating a total lack of knowledge of several fairly key areas.. The meeja started it, shouting about excess salaries for temporary staff. A spokesman from Unite – who, let us not forget, are representing workers and so might be expected to have at least a working understanding of the labour market – started banging on about “overpaid contractors” taking work from “permanent staff”. Assorted comments in a range of newspapers picked up the baton. A shadow Treasury Minister came out with the same line. OK, so he’s a politician of course, so we shoudn’t expect too much wisdom perhaps.

The thing is, to a man they were going on about excessive salaries. Nobody can possibly be worth that much (well they can, actually, work out the cost of employment of a permie on an £80k salary plus bonus and package). And what is more, as ony fule kno these aren’t salaries, they’re payments to companies for services rendered. To convert them into salaries, you have to knock off the long list of expenses that contractors have to cover for themselves – employers NICs, holiday pay, sick pay, pensions, expenses, bench time funding, corporation tax and all the rest. And even then you probably haven’t got to a salary since you don’t know how much the contractor is taking back out of his company.

Or perhaps these deluded souls actually think that the fitter from British Gas charging you £80 an hour to fix your boiler is on £166,000 a year salary? I suppose that’s quite likely, given the state of our education system…

The really sad thing is that we have a unique and highly effective contractor workforce in this country. Its end clients – like RBS – recognise its worth and understand the economic realities that make a contractor a very good use of money. One recent client of mine paid £60k for a contractor’s services over several months, but he left them with a £430,000 saving. Which I, and they, think is actually not a bad return.

Good contractors are worth their day rate. Such a shame that people who probably understand that perfectly well prefer to distort reality in the pursuit of cheap, and very hypocritical, political point scoring.

About the author: Alan Watts

Alan has worked in IT for most of the last 35 years, and first went freelance in 1996. He has been a PCG member from its start and has been spreading the message that freelancing is a professional career choice for many years. Alan also runs Malvolio’s Blog, a personal but highly informative take on the life of the modern freelance.

Alan Watts, Principal Consultant, LPW Computer Services

© 2011 All rights reserved. Reproduction in whole or in part without permission is prohibited.

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So when is a business not a business?

That is a question that’s been exercising me and a few like-minded souls over the last week. And this existential philosophising has been prompted by the planned creation of the IR35 Forum, which aims to establish who is liable for consideration as IR35 fodder and who isn’t. So first a quick history lesson may be in order.

The idea of IR35 as a way to recover NICs avoided by use of dividends has been around for quite a while. It was certainly floated to the Thatcher/Major governements and was firmly rebuffed as being both ineffective and unnecessary. Still, treasury officials are nothing if not doggedly persistent (or doggedly bloody-minded, if you prefer) and it came up again when we switched to New Labour. And found an ally in the Paymaster General, the fragrant Miss Primarola.

However, Primarola – herself, let it be remembered, a failed tax evader (which takes a degree of ineptitude all by itself, having had a tax bill she didn’t agree with paid for by a supporter with perhaps more money than sense) – was adamant that IR35 was only aimed at people cheating the system,. Those “genuinely in business” need have nothing to fear.

Yeah, right…

So wind on ten years and we have a new government and IR35 cases are still being prosecuted almost at random; a recent case is against someone who has been providing services to multiple concurrent clients for several years. Like I said, the usual dogged persistence by HMRC. Or something canine anyway (or should that be lupine…?)

Anyway, now it turns out that we get to keep IR35 because it will stop people leaping from employment to freelance doing the same job to avoid paying the taxes they now owe since their offshore EBT money boxes have been slammed shut. This is almost as skinny an excuse as the original Dim Prawn explanation, but we can live with it, as long as IR35 is only aimed at these cowboy Friday-to-Monday converts and not us real businesses.

Osborne took the key OTS suggestion and has determined that the administration of IR35 needs to be vastly improved. Setting up the IR35 Forum for that very purpose is happening now. It is something of a shame that he didn’t take the extra step and set up something vastly to improve the administration of HMRC itself, but let’s be grateful for small mercies

So the IR35 Forum’s most knotty problem will be working out the common factors between Mr Patel at the corner shop, the guy with a successful SME business, the average jobbing contractor and the traditional self-employed and separating them from someone who genuinely has incorporated just to save paying some taxes. Perhaps they should look for the crossed fingers?

It ought to be as simple as saying your client today isn’t the same as your employer two days ago, you’re VAT registered and have a company bank account, but the more you look into it the harder it gets. This is one debate that I suspect is going to run and run. And one that whatever the outcome. A lot of people aren’t going to be happy with it.

If only we could wave a magic wand, bin IR35 and start from a clean sheet of paper. If only…

About the author: Alan Watts

Alan has worked in IT for most of the last 35 years, and first went freelance in 1996. He has been a PCG member from its start and has been spreading the message that freelancing is a professional career choice for many years. Alan also runs Malvolio’s Blog, a personal but highly informative take on the life of the modern freelance.

Alan Watts, Principal Consultant, LPW Computer Services

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IR35 – The war is not won….yet

Big news of the day is the release of the Office for Tax Simplification’s report on Small Business Taxation. Well, big news for freelance contractors anyway. This is because this is the report that lays out what they think should happen to IR35. And it’s received a resoundingly cautious welcome from people like the PCG.

So not all good news then?

The main recommendation is that HMG bites the bullet and merges PAYE and NICs into a single tax. This is something that’s been around for a while – the Mirrlees report said exactly the same thing last year, as did a Treasury consultation from 2007. Except we didn’t really have a functional government back then and it went in the “Too difficult” box.

However merging the two has a lot of useful side effects, such as eliminating the advantage of payment through dividends, which among other things would make IR35 completely unnecessary. Which has to be a good thing in anybody’s book.

The snag is this will take years to bring into effect and the more you look at what’s involved the more complicated it gets. For example, the tax system recognises the difference between earned income and risk-based investment income and taxes them separately so as to encourage entrepreneurialism. Pensioners don’t pay NICs, so would need their own separate tax treatment. And so on – getting from here to there is a complicated and politically dangerous road.

But the report goes on to say that if that basic principle is adopted, then IR35 should be suspended with immediate effect. This suspension would allow HMRC to focus on other, frankly rather more important areas of tax gathering – you know, the ones that actually return more than they cost to collect – as well as showing what would happen to tax revenues if IR35 was simply abolished outright. So, for example, all those people who work through umbrella companies out of fear of IR35 may well incorporate and get the benefits of being a real contractor. There may be a rush of companies pushing their employees into turning freelance, which is what IR35 was supposed to prevent (it didn’t, as it happens, but let’s not go into that right now). There’s also a whole industry built on the existence of IR35 that would go into a sharp decline. So lot’s of potential issues to be resolved.

To be fair the report also suggests two other options; firstly that IR35 remains and HMRC are far more sensible, responsible and systematic in the pursuit of its enforcement (which caused me some hilarity and probably wins this weeks Littlejohn prize for “You couldn’t make it up”) or secondly the adoption of a series of tests that put you outside the scope of the IR35 legislation, clearly and simply.

So why a “cautious welcome” from the PG, who have been pushing for the abolition of IR35 for a long time? They are totally in favour of the suspension of IR35 as a step towards its removal but suspensions can be reversed, so it’s not the 100% solution they were hoping for. They also support the idea of the “in business” tests (as does the IoD, come to that), but are not exactly in favour of the “HMRC taking more care option” – to quote them, “This is widely regarded as risible”. And of course, it is all dependent on Mr Osborne taking note of and accepting the main recommendation for merger.

Still, it is a huge step forward and PCG deserve all credit for their work in getting us to this point. The war is not yet won, but we have perhaps now won the El Alamein battle for the abolition of IR35.

About the author: Alan Watts

Alan has worked in IT for most of the last 35 years, and first went freelance in 1996. He has been a PCG member from its start and has been spreading the message that freelancing is a professional career choice for many years. Alan also runs Malvolio’s Blog, a personal but highly informative take on the life of the modern freelance.

Alan Watts, Principal Consultant, LPW Computer Services

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What is the dark art of Tax Planning?

In August 1989 I started my training as an Accountant. Mrs. Thatcher was still the Prime Minister and everyone under the age of 21 wanted an XR3i or a 205 GTi.

I remember on the first day having a meeting with a senior Accountant (in my new grey suit) and he explained that, once I was experienced enough – I could begin my training on tax planning for clients. I nodded to confirm my approval and nearly said “Yes Sir”, but stopped short just before I raised my hand in salute. Obviously, I had no idea what he was referring to.

Over the next few years there would be several occasions when this arcane gift was again mentioned. I was half expecting some Masonic ritual needed to be performed or a secret handshake returned before I could wear the badge of honour and plan my clients entire future in the world of income tax.

Many years later, I realised there wasn’t going to be an initiation ceremony after all and I could roll my trouser leg back down again. It turned out, planning a clients tax – was not a thing you could actually teach. There wasn’t a secret book with a list of examples or a flow-chart to follow. It could only be performed when you are conversing with an individual – and they are all different. Without exception, all of you have a different personal circumstance and aspiration. For some people it is an expensive car or a big house. For others – it is sending their children to private school or five holidays a year.

Tax planning is a term given to the blanket of advice that helps your business to perform the following :-

1. Retain enough money for all of its debts and liabilities.

2. What are the laws you and your company must not fall foul of?

3. Pay the director and employees the salary they need.

4. Pay the shareholders the dividend the company can afford in conjunction with their personal requirements.

5. Have a look at the costs and expenses the company will need to pay for its daily running.

6. When will the taxes be paid and who has to pay them?

7. Where are the savings you can make?

If you are not or have not considered the above – you haven’t really started a framework for you or your company yet.

One day I may even get the chance to teach Accountancy to smartly dressed juniors at one of the many Accountancy colleges around the UK. If I do, I fully intend to walk up to whiteboard and write “Speak to People”. And then walk off.

About the author: Matthew Durrant

Matthew has been an accountant in practice since 1989 and has established a strong reputation in the contractor marketplace. He acts as accountant for a diverse blend of clients from sole traders to medium-size limited companies. An acknowledged IR35 specialist, Matthew’s services are much sought across the UK.

Matthew Durrant. Partner, Forbes Young Accountants

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Economics 101…

The discussion about the Office of Tax Simplification is gaining momentum as the body itself starts to get fully organised. A fair range of interested parties have been discussing how they want to see things change. Naturally, for those of us who have lived with it for eleven years, a lot of this discussion has been about IR35.

Actually that is a little lopsided: there are many aspects of the tax system that need to be looked at, such as the hundred or more tax releifs you can claim for depending on your income, outgoings and inside leg measurement. However, IR35 is an obvious target, being both ridiculous and onerous in roughly equal measure.

But can I point out that much of that debate is starting from entirely the wrong premise?

Ostensibly IR35 is about ensuring an individual can’t reduce their tax liability by channelling their earnings through a different commercial vehicle and by not being employed by anyone. For example, if you have a company that has made a handsome £700 million net profit, you could potentially pay a £1.2 billion dividend to your Monaco-resident 100% shareholding other half. Leaving aside the minor detail of how you pay a dividend that represents 130% of your net profit, the point is you pay no tax at all on your personal income, perfectly legally. I mean, how ridiculous is that?

Oh, hang on a minute….

OK, so that’s an extreme case but if you think about it, Mr Green actually has a glimmering of a valid argument in his apparently specious assertion that paying lots of tax through his company somehow compensates for his not paying any tax at all on his beer and skittles money – or at least, nowhere near as much as a Brownian economist might think he owes.

My point is that most, if not all of the IR35 debate is about how to level the tax paid by a small business owner compared to an employee doing much the same job. The answer is actually blindingly obvious: the employee needs to pay more taxes to catch up.

Say what?

Think about it. Assume an individual with a not unreasonable potential income of £75k, either as salary or as net profits from their business. And, for the sake of argument, we’ll assume that none of that money is going to be ploughed back into the business for growth or protection against future gaps in earnings.

An employee would pay roughly 39% in tax and a company owner using the minimum salary and dividends option would pay a mere 26%. Clearly unfair chaps, come on, play the game.

But – and I think it’s quite a big but – look at the actual numbers. Against that income, the employee would pay £29,250 in tax. The company owner, however, would pay £32,625. That’s £33,75 more than the employee does.


It’s because the company owner would also have generated £13,125 in VAT (or £15,000 from January 2011 if you want to be really pedantic, which makes the gap even wider). And since it’s all about income for the Exchequer, the only possible conclusion is that to achieve a level playing field, personal taxation for employees needs to go up by some 13% to ensure they are providing the same level of tax income as the business owner.

Unfortunately I don’t think that is on Mr Osborne’s radar.

Anyhow, I’ve said it before and I’ll say it again; if I’m a tax avoider I’m clearly a very bad one. It really is about time we forgot all about Labour’s stupid notions of fairness and applied a bit of objective thinking to the whole debate. We money-grabbing contractors may take home more than many employees, but we do so by taking much greater risks with our income than an equivalent employee. At the same time we put a lot more back in to the economy.

And after eleven years of IR35, it would really be nice if people began to understand what it is they’re talking about.

Alan Watts can found at LinkedIn.
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HMRC loses s660a dividends tax case

Contractor accountants and limited company contractors might be interested to hear that HMRC has lost their case against a couple who it claimed owed nearly £20,000 tax on four years’ dividends.

The Revenue took the Patmores to court under s660a of the Income and Corporation Taxes Act 1988 but Barbara Mosedale, the tribunal judge, decided that when Mr Patmore paid dividends to his wife this was not an s660a settlement.

In the 1990s the Patmore’s bought a small manufacturing company for £320,000. The first payment of £100,000 was obtained by taking out a second mortgage on their home.

Their accountant advised them to reorganise the company shares into two classes, of which Mrs Patmore owned 2% of the A shares and 10% of the non-voting B shares. Dividends were paid on the non-voting B shares between 1999 and 2003 and this money was paid into Mr Patmore’s loan account to be offset against the purchase price of the company. HMRC’s case was that Mr Patmore was using his control of the company to award large dividends to his wife as a tax saving scheme but that she never received any of them as the money went straight into the loan account.

In court, the couple’s adviser said that the two tier share structure meant the couple did not need to pay dividends to Mr Patmore and it also reflected that although Mrs Patmore was not involved in the daily running of the company, she was at risk because of the mortgage liability.

The judge noted that the accountant had set up the company structure in a tax efficient way but this was not a significant factor in the case. She also stated that the Revenue had not taken a broad and realistic view of the circumstances. Whilst HMRC had accepted that Mrs Patmore shared joint and equal responsibility for the repayment of loans to buy the company, it did not register that this arrangement would mean she was entitled to half of the share capital and a fitting share of dividends.

Mosedale ruled that the way the Patmore’s bought their company was “a constructive trust in Mrs Patmore’s favour” and not a settlement under s660a as the Revenue had first claimed. The 10% of non-voting B shares were not a gift and they did not fully reflect her investment. The judge also stated that Mr Patmore held in law the 40.5 shares that his wife should have been entitled to but these were in trust for her.

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Contractor accountant answers your questions…

Carrington Accountancy have come up with a novel way to keep their contractors abreast with the latest changes in legislation and tax planning.

From the start of the new tax year, they will be publishing a “Question of the Month” and providing a detailed explanation on their blog. The question will be based on a subject that is relevant to the limited company contractor, as well as the most common queries that their accountants have received over the previous month.

Commenting on the new service, Operations Manager Mary McDonald said:

“We are always looking at proactive and innovative ways to help educate our clients and help them become more “tax savvy”. Our clients love the idea and look forward to a convenient, quick blog on a useful topic each month which they can retweet to interested colleagues and friends via our Twitter Page”

This is not the first time that online accountants have used the web to provide free advice in a questions and answers format. AccountingWeb have already implemented an online discussion group where readers can ask a tax or accounting related question under their ‘Any Answers’ category. According to the website, there are as many as 90,000 members willing to answer the daily feed of questions, and the addition of the Q&A service has been largely responsible for a surge of new visitors to their site.

Carrington’s first question of the month was about the use of limited company dividends and how these can be used as a tax efficient means of remuneration. Since the majority of their clients are working in the freelance marketplace, they anticipate that the subject IR35 will feature prominently over the coming months, particularly since the Tories announcement to review the legislation if they win the election.

Carrington’s next question of the month – “Why am I not paying any National Insurance in April? You must have made a mistake.” can be found on their blog.

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Ways Around the Proposed 50% Tax Rate

Those of us who have an income of £150k+ have the unwelcome prospect of a new 50% tax rate with effect from April 2010.

A multitude of mitigation and tax avoidance options have been suggested by several contractor accountants that range from the sensible to the ridiculous. Below we look at some of the available options and consider what the pitfalls could be.

Speed up the surrender of non-qualifying life policies

Accelerating the surrender of bonds (non-qualifying life policies) can be an effective way for higher rate taxpayers to escape he income tax liability incurred on higher rate taxpayers.

Be warned: The surrender is taxed per “policy year”, not tax year so ensure that any surrenders will be taxed pre April 2010.

Involve your spouse in your business

A taxpayer operating a company can allow their spouse to have 50% of the business shares even if they have little involvement in the business. The new 50% tax band extends the advantage of making such arrangements, as well as encouraging the transfer of income-producing capital to a lower-earning spouse.

Be warned: Make sure any such arrangements are set up correctly, otherwise they will not be successful. Also, the Government wants to block this option so it may just be a short-term solution.

Accelerate the payment of salaries, dividends and bonuses

You will clearly benefit by accelerating the payment of any dividends from your own company to pre 6 April 2010. Some commentators have extended this idea to paying, for example, three years’ salary in return for the employee waiving rights to salary for the same period.

Be warned: The “accelerated salary” will is fraught with potential danger and should only be used for family businesses.

Executive remuneration – use of share options

After the new tax rate comes into force, the difference between income tax (up to 50%) and Capital Gains Tax (up to 18%) will be greater than ever. Converting income into capital is an attractive option, especially for executive remuneration where share options are popular.

Be warned: There is highly complex legislation surrounding employee incentives and you should seek professional advice. Other “conversion” techniques are subject to longstanding and byzantine anti-avoidance legislation. Implement with caution!

Check your bank accounts

Banks pay interest on deposits at regular intervals, sometimes annually. If you’re likely to receive a significant interest payment in, say, May, the only sensible way of accelerating this is likely to be by way of closing the account. Be warned: Banks have penalties for closing accounts that could out-strip the benefits.

Change your accounting periods

A change of accounting date can have the effect of accelerating profits into 2009/10 if you run an unincorporated business.
Be warned: As with most financial dealings, the rules dealing with this are complex and often have unexpected effects. It’s imperative that you seek professional advice before implementing such a change.

What next?

As there are obvious pitfalls attached to all these methods, you should seek professional advice from your financial advisor or online accountant before implementation.

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Contractor mortgages – getting one is easy when you know how

It seems slightly paradoxical that while freelancers frequently earn more than their permanently-employed colleagues, they routinely have issues trying to obtain mortgages. This problem arises when you try to demonstrate to the mortgage provider that you can actually afford it.

Many providers will want to see three years of accounts for your business, in order to ensure you have a consistent income stream. Clearly if you are new to the business, or have changed your limited company in recent years, this may not be possible.

A further complication is if you pay yourself a tax-efficient low salary and take dividends to top up your income. Some providers do not take account of dividend payments – they are, after all, not supposed to be a regular occurrence – and so greatly understate your potential borrowing capacity.

One option is the self-certified mortgage. Self-certification was originally aimed at the self-employed worker or those with irregular incomes such as seasonal holiday workers. Recently they have been extended to freelancers with their own companies and do offer one way forward. However, the suppliers see them as a greater risk and will expect both larger initial deposits and higher interest rates as a result.

If you have been trading more than three years and can provide proof of a consistent income at a suitable level, then you should not have a problem obtaining a competitive mortgage, even in these very risk-averse times. If you can not, then self-certification may be the only option: even then you might consider moving to a more traditional mortgage deal after a few years, when your supplier will know you are a good risk.

There are several financial companies who specialise in obtaining mortgages for freelance contractors. They have studied the market and have a more informed view of the risks of supplying freelance workers. They should be your first port of call.

Finally, a word of warning. Misrepresenting your income to get a mortgage, or any other financial advantage, is a criminal offence. The FSA has recently taken steps to prevent mortgage brokers taking this route. Apart from the legal risks you face, you may find yourself financially over-stretched, so be honest about your income.

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As a contractor, what is a reasonable mix of salary, expenses and dividends?

Choose a Name: The name has to be unique, obviously, and not likely to be confused for someone else’s existing name. The best reference point is the Companies House website – www.companieshouse.gov.uk – which has a simple search facility so you can check your chosen version. Also, try to avoid names that are specifically related to your line of work, just in case you want to change careers later: imagine selling cars though a company called Al’s Bakery.
Decide on Share Ownership: Is this just you, or you and your spouse, or you and two or three other people? This is important, because it defines how to allocate the Ordinary Shares In the company. Dividends are paid in direct proportion to numbers of shares held. A husband and wife typically have 50% each, for example, but if one is already earning money, be aware of the impact of the share income on their tax position. Share allocation can be changed after the event. There are several variations on share management; but for anything other than a simple allocation of ordinary shares, get expert advice.
Register at Companies House: There is an online system you use to set up your company and pay the registration fee. It is fairly simple to use. One question it will ask is who the directors are. For a typical small contractor company you only need one but there’s no reason not to have more. Although not strictly necessary any more, it also helps to nominate a Company Secretary: this could be the same person, but it’s more sensible to have someone else, a partner or relative for example.
Register a Memorandum of Association: Something else to do while you are at Companies House. At its simplest this is a document describing what your company is for and how you wish to run it. You can do it yourself, but the document can have legal implications in a tax investigation so do some online research for a suitable template from sites such as www.simply-docs.co.uk or www.clickdocs.co.uk.
Set up a Bank Account: This has to be a business bank account. Banks are increasingly wary of new business accounts, so you will have to answer some detailed questions and it will help if you have some professional references and a signed contact to demonstrate you actually will have an income.
Register for VAT: You have to do this if your annual income is in excess of a set amount (currently £67,000 pa) but it Is advantageous to register anyway. VAT and the Flat Rate Scheme are discussed in more detail elsewhere.
And that’s it. It sounds complicated but is in fact quite straightforward. You can also take the easy way out; either use a company formation agent, or there are several accountants who specialise in contractors who will set up all if the above for you for a small fee, or even for free, as well as providing expert support. Finally keep track of all your various expenses setting the company up, since you can reclaim these once you start trading.

If you are in business on your own account and working through a limited company, how you take money from the company to pay your bills is entirely up to you. There are no set rules you need to adhere to about how you do it.

However, how much tax you pay will depend very much on how you structure the payments from your company to you. This can get complicated, especially if there is more than one shareholder to consider, so it is best to get professional advice at first and to review that advice as the taxation landscape changes. However, there are some broad guidelines.

You can take any salary you like or none at all. You need to think about your personal tax-free allowance though; this is the amount you are allowed to earn before tax becomes due and is set by your Tax Code.  Therefore you can take that amount of money as salary and not pay any income tax on it. You should also remember that a range of state benefits depend on you paying National Insurance contributions. These are due once you exceed the earnings threshold (currently £110 a week). So the absolute minimum to pay yourself is £5720 a year, or your personal tax-free allowance, which ever is the higher.

Dividends are payable from net profits after Corporation Tax. You can take them at any time, and as often as you need to, provided the financial status of the company is such that it can afford to pay them. Because dividend payments attract a tax credit – to offset the Corporation Tax already paid by the company – dividends up to the upper-earnings limit – the point when the higher rate of income tax kicks in – will not be liable to further income tax. Once you go over that limit, tax is due at the higher rate less the tax credit; at the time of writing this means an effective tax rate of 22.5% (this is because the tax rates for dividends are 10% and 32.5%, both reduced by the 10% tax credit; hence zero extra tax at lower rate and 22.5% at the higher). Dividends are not liable to NIC payments.

Despite what some umbrella companies claim, expenses are not income. In fact, if properly calculated they are income neutral. Provided you have actually spent the money and that you spent it wholly and exclusively as a result of your work, you can reclaim it tax free. It is not, however, tax-free income, and if you are making money on expenses you are probably doing something wrong.

© 2009 All rights reserved. Reproduction in whole or in part without permission is prohibited.

Image: Inside-out Lego brick by oskay

Posted in contractor expenses, contractor faqsComments (0)

How contractors can use ESC16 to close down their limited company

When a company is closed down and all its various taxes and debts paid off, there is usually a sum of money left over. This money belongs to the shareholders of the company and is usually distributed to them as a final dividend.

As usual this is treated as personal income by the shareholder and tax is to be paid on it, less personal allowances and company tax credits.

However, you can apply for the cash to be distributed as Capital rather than as a dividend. To do this you make an application to HMRC under the provisions of Extra Statutory Concession C16, or ESC c16 for short.

The benefits of doing this are that the monies are then liable to Capital Gains Tax rather than PAYE. CGT is due at 18% of the total less the annual allowable amount, currently £10,100 for the typical shareholder. This can represent a significant saving, especially if the shareholder has already used up their annual tax allowances.

To follow this route you should get professional guidance and write a formal letter to HMRC, signed by all interested parties. Furthermore, the application must be made and approved and all monies paid before the company is closed under the provisions of Section 652 or 652A, so some forward planning will be needed.

You can only apply for ESC c16 if you meet the following qualifications:

The company must not be subject to an investigation either by an individual or a corporation
The company must not intend to trade in the future
All creditors and debtors must be paid
The company will distribute all of its assets to its shareholders
The company must intend to seek or accept a striking off order and dissolution
The company must pay all of its corporation tax due
The officers and shareholders of the company must pay all CGT due
Finally, if the company is not subsequently closed down, HMRC have the right to cancel the order and reclaim the full tax on the assets.

© 2009 All rights reserved. Reproduction in whole or in part without permission is prohibited.

Image: by pheezye

Posted in closing a company, esc16Comments (0)

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