Dividend basic rate

Hoddie_2

If you are self employed and "in business" you don't have what Hoddie describes as "employment earnings" so there is nothing to be "disguised".

You're confusing self-employed sole traders and directors of Limited Companies. There are many advantages to going down the Limited Company route (not least limited liability and filing online incentives), but doing so purely to save National Insurance by disguising employment (or 'earned' if you prefer) income as dividends is not one of them.

I have no problem with those who invest money in a business choosing to take dividends rather than a salary, but those who buy 'off the shelf' companies for a couple of hundred quid should not be allowed to do so the same.

As it stands, the law is unclear and that's why people try and get away with it. But I'm reasonably convinced that if HMRC enquired into the company's affairs, you'd have to demonstrate that the dividends were a return on investment and not a way of disguising employment earnings.

By the way, sole traders pay a comparable amount of National Insurance (through Class II and Class IV) as employees do.

WHA

Hoddie wrote:

Does someone who earns £38,000 but pays only £106 in National Insurance deserve the same right to state benefits as someone who earns the same amount but pays £3,178 in National Insurance?

They wouldn't get the same state benefits. SSP and SMP would be lower, the SERPS proportion of state benefits would be lower, they wouldn't be entitled to tax free lump sums on redundancy, they'd have to fight for state benefits if they became unemployed, etc etc.

What you also fail to mention is that in your hypothetical situation, if the director of the limited company paid a gross wage of £38,000, he would also suffer the employer's national insurance of 12.8% which would be just over £4,200. Add that to the £3,200 employees NIC, and you see that the total NIC paid would be a massive £7,400. Compare that with your £106 NIC on the low salary option, and you see clearly why limited company directors don't generally pay high salaries - it would amount to a voluntary additional NIC contribution of £7,300 per year!!!!!!!! (Of course the tax aspect also needs looking into but this thread is already far enough off topic without complicating the issue even more).

Hoddie wrote:

As it stands, the law is unclear and that's why people try and get away with it. But I'm reasonably convinced that if HMRC enquired into the company's affairs, you'd have to demonstrate that the dividends were a return on investment and not a way of disguising employment earnings.

The law is not unclear at all. People aren't "trying to get away with it". It is a perfectly legal and extremely popular method probably used by the majority of owner-managed limited companies. Please don't make it sound like it is some form of swindle. There is no law requiring a comparison of dividends with investment of capital. As long as the dividend is legal, i.e. there are adequate reserves, it complies with Company Law and the paper trail is done properly, then HMRC have NO right to question the dividend. Upon formal enquiry, the HMRC will only check the formalities, they will not do as you suggest. Paying a dividend instead of salary is not illegal, it is not in contravention of any HMRC manuals or guidance. There are no reported cases where HMRC have won any claim that dividends are void on the grounds of being unrelated to capital investment. This is why they brought in IR35 as a specific anti avoidance measure for those who do as you intimate, i.e. falsely claim to be "in business" by setting themselves up as limited companies, and why HMRC have brought in new rules from April 2007 to stop the avoidance by using MSCs (which the original IR35 legislation didn't seem to stop). You should also remember that the company is paying corporation tax on the profits being paid out as dividends, so it is not tax free. At the end of the day, as long as the person is truly "in business" through their own limited company and therefore wouldn't fall foul of the existing IR35 laws, it is not a matter of law as to whether low salary/high dividend is acceptable - under law it is, it is a matter perhaps of personal morals - but would you, Hoddie, voluntarily pay thousands more in NIC every year if you had the choice?

Also, comparisons of national insurance are ambiguous. What about employers National Insurance of a further 12.8% that isn't paid by sole traders? I think if the total NICs were equalised between self employment, employment and limited company directors, then maybe more limited companies would be happier to pay a higher level of salary and therefore pay more NIC, but at present, a wage from a limited company would result in a total NIC liability of around 25% of the wage, which makes a massive difference and explains why directors won't pay themselves wages voluntarily.

I do agree that the rules should be changed so that there is less difference in tax and NIC between being a sole trader/partnership and being a limited company - now that would be fair and create a level playing field. For a start, they could zero-ise employers NIC on wages and benefits paid to a shareholder/director of a close company - after all a sole trader or partnership wouldn't pay employers NIC on the proprietors drawings. They could also bring in comparable rules for both types of business. The zero rate/10% tax on low profits you mention earlier was NEVER available to sole traders/partnerships so that wasn't fair. Tax relief on purchased goodwill still isn't available to sole traders/partnerships but has been available to limited companies for some years.

The truth is that successive governments have made a right pig's ear of self employment law and taxation, probably due to them simply not understanding how things work. The current set-up harks back many decades when "most" people were employed, small scale self employment was rare in comparison, and most "businesses" were larger scale, such as factories, mills, etc. Despite successive governments championing small businesses and self employment, they have never grasped the nettle and brought in a sensible tax regime that properly covers modern self employment.

In fact, as regards limited companies and the alleged avoidance of tax/NIC, the Govt must shoulder a fair proportion of the blame. After all, many "consultants" and "contractors" working through agencies were happy being sole traders until the Govt brought in new rules that prevented agencies having sole traders on their books, so in a stroke, 100,000's of consultants/contractors were given the stark choice of becoming an employee of agencies (and having to accept a much reduced wage to allow for the agencies having to pay employers NIC and covering other employment rights such as SSP, SMP, holidays and redundancy), or start their own limited company. Those workers would see a massive rise in their employees and employers NIC contributions if they went through a limited company and paid a high salary level, which is why the majority adopted the legal low salary and high dividend route. The Govt had clearly assumed the workers would go on the payroll and HMRC would get a windfall in tax and NIC, but as usual, they didn't understand the dynamics of the market and most went down the limited company route. Hoddie, if you were in that position and given that choice, wouldn't you have done the same?

Like the 10% and zero rate tax bands for limited companies. To everyone in the accountancy profession, it was blatantly obvious that sole traders and partnerships would stampede into limited companies, and the professional bodies actually told HMRC what would happen. What did we get, Dim Prawn stating in Parliament that sole traders wouldn't do it! What happened in reality, sole traders did do it in their thousands. Another example of how the Govt just don't listen and don't understand the dynamics of modern self employment.

As I have said, the Govt need to address the fundamental problems of their own making - that is the 25% total NIC on directors wages from their own limited companies and the differences in taxation between sole traders/partnerships and limited companies. In fact, you may be interested to know that I made representations to the treasury and local MPs a couple of years ago in response to their discussion paper on small business taxation in I basically suggested that owner-managed limited companies should have the exact same tax regime as sole traders and partnerships - i.e. to have a single set of rules and take away "employment" related taxation of owner-directors completely so that wages and benefits in kind had no tax effect in themselves, but that the limited company tax computations would be identical as for sole traders/partnerships, but of course, I got the usual nonsensical replies - especially from the local MP who clearly didn;t even know there was a difference in the first place!!