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That's an interesting case to bring up. In the UK, it is very common (I'd go as far as to say it's the norm) for software contractors to start a single-person l

That's an interesting case to bring up. In the UK, it is very common (I'd go as far as to say it's the norm) for software contractors to start a single-person limited company and pay themselves through a mixture of salary and dividend in order to optimise their taxes. I wonder how many of these people consider that they are committing "tax avoidance" and "exploiting legal loopholes" too.

mprev 9y ago
Maybe 15 years ago. IR35 has made that approach tax-neutral, at best.
- Cakez0r 9y ago
  I am new to the contracting game in the UK, but I haven't met a software contractor yet who isn't using this approach. My accountant even recommended it to me when I set up. It is definitely a non-trivial tax saving. Do you pay yourself dividends from your company? Or do you use your profits to increase your director salary so that you pay tax at the same rate as a full-time PAYE employee? Not meaning to call you out personally on this, but I want to highlight that "tax avoidance" is a weasel word. Most people can and do optimise their taxes if the law allows it and don't consider themselves to be "avoiding tax" or acting immorally.
  - Swinx43 9y ago
    Accountants keep on recommending this method for some reason but honestly if you do the tax calculations yourself you realise that you are not much better off. It used to be the case that you were better off but the last 5 years the options for UK limited Company contractors have been reduced to a point where the running costs of the company combined with the taxes bring you to effectively the same amount of tax paid as a permanent employee.
  - mprev 9y ago
    I didn't say anything about avoidance, so I'm not sure your questions about dividends etc were directed at me. At the turn of the century, it was common for software developers in the UK to leave their job on a Friday and then show up to do the same role at the same desk on the following Monday but suddenly they were a LTD company acting as an independent contractor. IR35 sought to put an end to that. It didn't apply to genuine freelancers, although there were risks. And, I'm not sure I understand what you mean about not meeting a software contractor who isn't taking that approach ... as that approach is the very definition of software contracting :)
    - Cakez0r 9y ago
      Ah, my apologies. I got you mixed up with the parent comment poster. To explain anyway: As a contractor with a limited company, I have two options when it comes to moving money from my company to my personal account. 1) Set my salary to be the same amount as the money I've earned from contracting, thus paying the same amount of tax as a "regular" PAYE employee who works full time 2) Set my salary to be minimum wage and pay everything left in my company account as a dividend, resulting in paying less tax. My point is that option number 2 is "tax avoidance exploiting legal loophole" or "sensible tax practice" depending on how you want to frame it. Businesses will use whatever legal options they have to pay the least amount of tax, including small businesses (although small businesses might not even consider that they're already doing it).
      - Swinx43 9y ago
        But have you done the calculation on option 2 to see what you will end up paying in tax (Both corporate as well as personal income tax) when you do pay out those dividends? You will realise that you have not "avoided" any tax really compared to a normal salaried employee due to not being able to reduce your corporation tax in the way other big organisations do. Accountants make it sound really good but when you get down to the actual tax being paid you are not saving much, if any given the new rules implemented in the last couple of years. Have a look at the example that I have shown as a reply to your parent comment. I would be very interested to hear your take on this.
Swinx43 9y ago
That is a common misconception due to tax law changes in recent years. It used to be the case that a UK contractor paying themselves through this structure was significantly better off due to the large amount of dividend tax credits that were available. So let me outline how this works these days as I run up against this argument a lot. 1) Any income that comes into the UK Ltd company is taxed at the corporate tax rate which as of this year is 19%. 1.1) This tax is paid on profit so if you pay yourself a normal salary out of this you will deduct this from the profits. Take note that dividends are NOT deductible from company profits before tax and as such is not a way for you to reduce your tax liability as a UK company. Dividends are only payable from after taxed money in your UK Ltd company. 1.2) Any expenses your company has in providing its services are deducted from profits. There is a misconception that you can write off A LOT of expenses but in actual fact that is not true. There are strict guide lines. Most of these expenses are also only valid if you are truly outside of IR35. Once you fall inside of it your allowed expenses decrease even more. The above leaves you with your taxable company profit on which you pay your 19% corporation tax. (This is the tax that are being circumvented in the article by big companies.) So now you as a UK Freelancer you now get the opportunity to pay yourself money from your UK Ltd company. You are then subjected to the following personal income tax: 1) Your tax free allowance as an individual is applied so you pay no tax on the first £11500 of income. 2) The first £5000 of dividends are also tax free. (remember this money has already been taxed at 19% in your corporation tax so is hardly free) 3) All other dividends that you then pay out to yourself are taxed as per the different tax brackets set out for personal income tax on dividends. (Again remember that 19% tax has already been paid on the this money before you can distribute it to yourself.) So lets look at an example: - Lets say that as a contractor you work for 10 months (42 weeks) out of the year at £500 per day. We also assume you have no problem in getting your clients to pay (a real risk in certain industries). That leaves you with 210 days that you bill at £500 per day. 210 * 500 = £105000 which is your income coming into the company before deducting allowed expenses. - Lets now say you are not inside IR35 and you can claim travel and subsistence against this amount. That normally works out at around £500 per month of expenses you can deduct. (We assume you have already bought your equipment that you use on site etc.) - You also need to pay your accountant, which does not work for free, the going rate in London is around £130 per month - You now pay yourself a small salary up to the allowed personal allowance for the year of £11500 Your total corporate taxable income is now as follows: 105,000 -1,560 (Accountancy fees £130 x 12 months) -5,000 (£500 expenses for the 10 months of billable work) -11,500 (salary of around £958 per month for the 12 months of the financial year) =86,940 (This is the amount you pay corporation tax on) -16,518.60 (The amount of corporation tax you pay at 19% on the above £86940) =70,421.40 (This is the amount you can now distribute to yourself in dividends) So now your personal income tax looks as follows: 11,500 (Salary received up to tax free allowance and tax of 0%) 5,000 (Dividends with 0% tax allowance) 65,421.40 (Remaining dividends that you are taxed) -14,136 (Tax levied on the 65,421.40 dividends that are taxable, combination of the different tax bracket rates on HMRC website.) =67,785.40 (Income you receive after tax) So on £105,000.00 of earned income as a freelancer you end up paying £30,654.60 of income taxation (Corporation and Personal tax). If you were a normal salaried employee you would pay £31,696.40 on £105,000 salary. (www.listentotaxman.com) So I would argue it is hardly tax avoidance and if I take into account the risk I take as a freelancer then I am hardly working through a UK Ltd company to avoid tax. Most people still believe that the same rules of the 90's apply to UK ltd companies and freelancing but it is simply not the case. Please do check the above with your accountant to confirm as this is not financial advise and I am not an accountant. However there are really not many options for avoiding paying tax as a UK freelancer. Keep in mind that the £5k dividend tax free allowance is also being reduced to only £2k from 2018 onward.

mprev 9y ago

Maybe 15 years ago. IR35 has made that approach tax-neutral, at best.

Cakez0r 9y ago
I am new to the contracting game in the UK, but I haven't met a software contractor yet who isn't using this approach. My accountant even recommended it to me when I set up. It is definitely a non-trivial tax saving. Do you pay yourself dividends from your company? Or do you use your profits to increase your director salary so that you pay tax at the same rate as a full-time PAYE employee? Not meaning to call you out personally on this, but I want to highlight that "tax avoidance" is a weasel word. Most people can and do optimise their taxes if the law allows it and don't consider themselves to be "avoiding tax" or acting immorally.
- Swinx43 9y ago
  Accountants keep on recommending this method for some reason but honestly if you do the tax calculations yourself you realise that you are not much better off. It used to be the case that you were better off but the last 5 years the options for UK limited Company contractors have been reduced to a point where the running costs of the company combined with the taxes bring you to effectively the same amount of tax paid as a permanent employee.
- mprev 9y ago
  I didn't say anything about avoidance, so I'm not sure your questions about dividends etc were directed at me. At the turn of the century, it was common for software developers in the UK to leave their job on a Friday and then show up to do the same role at the same desk on the following Monday but suddenly they were a LTD company acting as an independent contractor. IR35 sought to put an end to that. It didn't apply to genuine freelancers, although there were risks. And, I'm not sure I understand what you mean about not meeting a software contractor who isn't taking that approach ... as that approach is the very definition of software contracting :)
  - Cakez0r 9y ago
    Ah, my apologies. I got you mixed up with the parent comment poster. To explain anyway: As a contractor with a limited company, I have two options when it comes to moving money from my company to my personal account. 1) Set my salary to be the same amount as the money I've earned from contracting, thus paying the same amount of tax as a "regular" PAYE employee who works full time 2) Set my salary to be minimum wage and pay everything left in my company account as a dividend, resulting in paying less tax. My point is that option number 2 is "tax avoidance exploiting legal loophole" or "sensible tax practice" depending on how you want to frame it. Businesses will use whatever legal options they have to pay the least amount of tax, including small businesses (although small businesses might not even consider that they're already doing it).
    - Swinx43 9y ago
      But have you done the calculation on option 2 to see what you will end up paying in tax (Both corporate as well as personal income tax) when you do pay out those dividends? You will realise that you have not "avoided" any tax really compared to a normal salaried employee due to not being able to reduce your corporation tax in the way other big organisations do. Accountants make it sound really good but when you get down to the actual tax being paid you are not saving much, if any given the new rules implemented in the last couple of years. Have a look at the example that I have shown as a reply to your parent comment. I would be very interested to hear your take on this.

Swinx43 9y ago

That is a common misconception due to tax law changes in recent years. It used to be the case that a UK contractor paying themselves through this structure was significantly better off due to the large amount of dividend tax credits that were available. So let me outline how this works these days as I run up against this argument a lot. 1) Any income that comes into the UK Ltd company is taxed at the corporate tax rate which as of this year is 19%. 1.1) This tax is paid on profit so if you pay yourself a normal salary out of this you will deduct this from the profits. Take note that dividends are NOT deductible from company profits before tax and as such is not a way for you to reduce your tax liability as a UK company. Dividends are only payable from after taxed money in your UK Ltd company. 1.2) Any expenses your company has in providing its services are deducted from profits. There is a misconception that you can write off A LOT of expenses but in actual fact that is not true. There are strict guide lines. Most of these expenses are also only valid if you are truly outside of IR35. Once you fall inside of it your allowed expenses decrease even more. The above leaves you with your taxable company profit on which you pay your 19% corporation tax. (This is the tax that are being circumvented in the article by big companies.) So now you as a UK Freelancer you now get the opportunity to pay yourself money from your UK Ltd company. You are then subjected to the following personal income tax: 1) Your tax free allowance as an individual is applied so you pay no tax on the first £11500 of income. 2) The first £5000 of dividends are also tax free. (remember this money has already been taxed at 19% in your corporation tax so is hardly free) 3) All other dividends that you then pay out to yourself are taxed as per the different tax brackets set out for personal income tax on dividends. (Again remember that 19% tax has already been paid on the this money before you can distribute it to yourself.) So lets look at an example: - Lets say that as a contractor you work for 10 months (42 weeks) out of the year at £500 per day. We also assume you have no problem in getting your clients to pay (a real risk in certain industries). That leaves you with 210 days that you bill at £500 per day. 210 * 500 = £105000 which is your income coming into the company before deducting allowed expenses. - Lets now say you are not inside IR35 and you can claim travel and subsistence against this amount. That normally works out at around £500 per month of expenses you can deduct. (We assume you have already bought your equipment that you use on site etc.) - You also need to pay your accountant, which does not work for free, the going rate in London is around £130 per month - You now pay yourself a small salary up to the allowed personal allowance for the year of £11500 Your total corporate taxable income is now as follows: 105,000 -1,560 (Accountancy fees £130 x 12 months) -5,000 (£500 expenses for the 10 months of billable work) -11,500 (salary of around £958 per month for the 12 months of the financial year) =86,940 (This is the amount you pay corporation tax on) -16,518.60 (The amount of corporation tax you pay at 19% on the above £86940) =70,421.40 (This is the amount you can now distribute to yourself in dividends) So now your personal income tax looks as follows: 11,500 (Salary received up to tax free allowance and tax of 0%) 5,000 (Dividends with 0% tax allowance) 65,421.40 (Remaining dividends that you are taxed) -14,136 (Tax levied on the 65,421.40 dividends that are taxable, combination of the different tax bracket rates on HMRC website.) =67,785.40 (Income you receive after tax) So on £105,000.00 of earned income as a freelancer you end up paying £30,654.60 of income taxation (Corporation and Personal tax). If you were a normal salaried employee you would pay £31,696.40 on £105,000 salary. (www.listentotaxman.com) So I would argue it is hardly tax avoidance and if I take into account the risk I take as a freelancer then I am hardly working through a UK Ltd company to avoid tax. Most people still believe that the same rules of the 90's apply to UK ltd companies and freelancing but it is simply not the case. Please do check the above with your accountant to confirm as this is not financial advise and I am not an accountant. However there are really not many options for avoiding paying tax as a UK freelancer. Keep in mind that the £5k dividend tax free allowance is also being reduced to only £2k from 2018 onward.