The way companies and company directors pay tax has been at the heart of several leading news stories over the last week. We have had debates over the morality of celebrities and politicians avoiding tax through loopholes involving offshore companies. Meanwhile the HMRC has been attacked by the Audit office for the way it deals with the tax arrangements of large companies. At the same time HMRC are being challenged in court over the ‘sweetheart’ deal it came to with Goldman Sachs.
At the centre of the Jimmy Carr case is the way in which company directors are taxed. The loophole he was using is a variation of one that 2000 senior civil servants have recently been investigated for employing. Essentially this boils down to having your pay fed through a private limited company rather than being paid direct as an employee. By being paid through a private company, which you are a director of, you can take advantage of the lower tax rate charged on director’s dividend payments. This can easily save an individual 10% on their tax liabilities. Another popular tactic is to have the company make a director’s loan to an individual which can be tax free. It would appear that Jimmy Carr was using the director’s loan tactic but feeding it through an offshore company in a tax haven. Both the director’s dividend payment and director’s loan payments are perfectly legal and in many cases are a legitimate way for individuals to be rewarded by the company they work for. The issue arises when people are setting up companies purely to take advantage of lower tax rates rather than because they are creating a new business.
Why all the fuss?
While the actions of celebrities and various large corporations in minimizing their tax bills may be legal it is not always popular. This is shown by the response to Jimmy Carr’s dealings and the current court case against HMRC and Goldman Sachs. Avoiding tax, legally or not, can turn into a PR disaster for individuals and companies. However there are more than the PR, and moral, considerations to take into account when considering using a private company to pay yourself.
Because the use of private companies as a tax reduction channel has become so widespread over recent years the HMRC has begun to specifically target it. They recently introduced their controversial IR35 test to assess when limited companies are being used as a tax dodge. IR35 tests whether a company is really a functioning and trading business entity or simply an entity created to channel pay and reduce tax. If HMRC find that the company is not really a trading business then they can begin prosecutions and proceedings to claw back any unpaid tax. This may not be a quick process either. Recent reports have claimed that at current rates, it would take HMRC 38 years to clear their current backlog of tax tribunal cases.
What can we learn from this?
So basically if you want to avoid being denounced by the Prime Minister on the news, spending the next several decades being investigated by HMRC and potential prosecution and fines make sure you pay your tax. More specifically if you are going to pay yourself through a private company make sure that you can pass the IR35 test. If you are in any doubt speak to a qualified accountant who can make sure that what you are doing is legal and above board.