Follow-up tax poll

[philmophlegm]

Following on from yesterday's poll...

You decide to shop around the next time you need some gardening doing, and this time you choose a different gardener, Adam, who does a good job. This gardener does not ask you to pay him cash-in-hand, but instead his company (Adam the Gardener Limited) sends you an invoice. Since the company is VAT-registered, the fee includes VAT at 20%.

Adam the Gardener Limited has one full-time employee (Adam himself) plus his wife (a rich lawyer) who works part-time for the company (without salary), and owns a small share of the business. Adam and his wife are the two directors of the company, and his wife also acts as company secretary. The company pays Adam a small salary (equal to his personal allowance for Income Tax and less than the threshold at which he and the company would have to pay National Insurance* payments). The company has lots of clients locally and is profitable. It pays Corporation Tax at the small companies rate, and pays most of its profits to its two shareholders in the form of dividends. Adam has no other income other than his salary and dividends from the company. His wife's main income is her law firm salary, which is enough to make her a higher (but not top) rate taxpayer.



* Note for non-UK readers: National Insurance is essentially an additional income tax on employees and a tax on jobs for employers.


[Poll #1856110]

Comments

[wellinghall.livejournal.com]

[x] My thoughts on this are complicated, and I would like to say more, but only once I have enough time and braincells.

On a separate note, it took me some time to work out what your userpic was. At first sight, it looked like a gigantic bear.

[philmophlegm.livejournal.com]

I think his brother is more bear-like.

[wellinghall.livejournal.com]

Hmm, possibly.

[beckyc.livejournal.com]

[X] I have absolutely no clue

[andrewducker]

Yes. My "more information required" was "Some training in tax law, and/or half an hour talking to someone who understands this stuff better than me."

[lil-shepherd.livejournal.com]

Though I used to work for the Customs and Excise (and then HMRC) it was never in the area of actual VAT, income tax or corporation tax admin. However...

My immediately problem with your questions, particularly with the moral issue, is that you would not normally expect to know how a business was set up. Of course you should always receive an invoice and it should show the VAT registration number (if there is one), both because the authorities will need to see the invoice if the accounts are inspected and for your own protection.

That company set up seems a bit fishy to me (in respect, among other things, of the company secretary giving her services for free) but I don't know enough about corporation tax or company law to say - and, of course, I believe income from dividends is taxable. It also sounds a bit fishy because the turnover doesn't sound as if it is above the compulsory VAT registration threshold (whatever that is nowadays) and the only good reason to register if you are below that threshold is if you deal in non-VATable or zero-rated goods and services, in which case you can claim back what you pay in VAT for goods related to the business.

I speak as someone who used to drop the name of the Department I worked for early in my acquaintance with tradesmen (and that I worked for a firm of architects at one point, and that Ina was with the DoE with builders) so that they weren't stupid enough to ask for cash in hand to avoid VAT so I wouldn't have to report them.

[ozisim.livejournal.com]

*blinks*
Is this implying that it could or should be the responsibility of the customer to ensure that their suppliers are complying with local taxation laws?
...and how would I know this anyways? - unless they are a mate (and in that case, they are a mate = I pay them in beer), I'd be talking to them about what I needed done in the garden, and really definately not how much money their missus earns...

[kargicq.livejournal.com]

X More information - and probably some kind of qualification in tax law / accountancy - is required. I have no idea what the tax implications of this set-up are. Although given the context, I assume dividends are taxed at less than salary and so he's minimising his tax by setting a salary below the market rate and paying himself in dividends?? I assume this is a pretty common option for small businesses, and that therefore there are well known guidelines which he is either following or breaking. Look forward to learning the answer!

Re the customer: no moral issues at all; they were given an invoice which I assumed looked non-dodgy to them, and they paid it. That's certainly all I would do... -N

[king-pellinor.livejournal.com]

Yes, at that level of income (I assume somewhere between £80k and £150k or so) the top slice of salary would be taxed at 40%, plus employer's NI at 13.8% and employee's NI at 2%, whereas dividends would be taxed at 25% with no NI - though they'd be paid after corporation tax at 20% in the company.

Using my handy "salary or dividend?" spreadsheet I made a little while ago, I see that going from £80k salary to £8k salary and £65.5k dividends (which would leave the company in much the same position) would save Adam £11.7k in tax and NI.

[kargicq.livejournal.com]

So from your other reply, that's all perfectly standard and accepted is it? Sounds fair enough then. -N.

[king-pellinor.livejournal.com]

Perfectly routine business structuring. No issues with this at all, though a couple of minor questions:

How does he pay a salary of the personal allowance (currently £8,105) which is below the NI thresholds (£7,488 and £7,605)? Normal practice would be to pay at the NI threshold. I'd suggest he checks this with his accountant.

He must be doing pretty well to be VAT registered, given that his supplies will all be standard-rated and he has (one assumes) very little input VAT that might mean he'd want to register voluntarily. Has he considered the flat-rate scheme? Might save him quite a bit.

I assume he's considered the pension implications of not paying NI.

Do they have children? The Child Benefit Charge might become an issue soon.

[philmophlegm.livejournal.com]

You're right - I got the income tax PA and the NI threshold the wrong way round. Told you I was no good at tax...

[gwendally.livejournal.com]

We have a similar situation in the United States where S Corps can pay a very low salary to their owner-employers and only that is subject to the 15.3% social security and medicare tax, whereas dividends earned by their Small Corporation are not subject to that payroll tax.

In practice, S Corps pay very low salaries to their owner/employers. (The same is true for members of LLCs.)

But the rules are that the money you earn from your own labor is the amount subject to self-employment tax, and only the amount that is earned due to your wise investment or from the profits you make on your employees (apparently from luck, not good management skills); only THAT amount, the amount earned by an uninvolved partner, only THAT is not subject to self-employment tax.

In practice the only one who ever catches it is the IRS when they audit small corporation returns and reclassify dividends as salary. It's a nightmare of an audit and can ruin a business and a life, so you avoid being egregious enough to pull an audit. In practice I make sure my clients give themselves a salary that they'd hire in an employee at.