IR35 and the oil and gas scene in Aberdeen

You too can avoid paying higher rate tax on your income. The head of the Student Loans Company has been paid through his personal service company, and it is a growing trend for higher paid employees. The practice has already become common in the North East of Scotland and indeed throughout the oil and gas sector - albeit for other reasons.

You set yourself up as a limited company.  Note that you are taking a financial risk - if you don't work, you don't get paid!  You negotiate a contract between your company and its employer - and it is probably best to move employers at that time. The employer pays your limited company, which has to pay 20% corporation tax. And then you need to extract the funds from your company. You (and your family, if they are bona fide employees) take a small salary - say £8,000 a year. There is no tax and virtually no NI to pay. And then the rest of the funds are taken out in dividends. Dividends have to be paid to shareholders, so you have to take care to establish who the shareholders are going to be when the company is set up.

So how much tax do you have to pay on the dividends? None at all, if you are a basic rate taxpayer.  Dividends come with a "tax credit". For every £9 of dividends you get a £1 tax credit - so you take out £9 in cash but get taxed as if you receive £10. And for basic rate taxpayers dividends are taxed at 10%, so the tax is already paid. If your wife is a shareholder, she gets the same. And if you set up a company with two classes of shares, you can pay dividends to one class (say your wife) without necessarily paying them to the other class (say yourself, if you have over income that would mean you pay higher rate tax).  The tax efficient thing to do is to use up both basic rate bands before either of you pay higher rate tax.

Higher rate tax kicks in at about £43,000. Deduct the salary of £8,000 you are taking and there is room for £35,000 in dividends. But remember that is the gross figure. The net figure of £31,000 approx. is what you can take out in cash. So can you live on £78,000 a year? If so, leave any balance of funds in the company. Take it out in future years when your income is lower, or eventually wind up the company and get the balance back as capital (which is taxed at a lower rate). Easy Peasie.

So is Ed Lester of the Student Loans Company like his namesake Lester Piggot - a man without honour(s)?  Which reminds us, when Fred Goodwin was running RBS he had lots of sleepless nights, and now he is no longer a Sir he can have lots of knightless sleeps!  No, Lester was just engaging in sensible tax planning and any embarassment should be with the goverment and SLC for employing him in this way. And are you doing anything that is actually wrong here? Absolutely not!

You need to be aware of IR35 rules. In passing, we can't help but mention there are 600,000 personal service companies (one man bands) and last year HMRC enforced IR35 in 23 cases. That is 0.004%. But doing the right thing here means being aware of the rules, having the right contract (with a substitution clause etc.), changing contracts or preferably employers from time to time, not getting too close to the employer (working on projects rather than their in-house systems, not having your own parking space and e-mail address, not going to the Christmas party etc.), and reviewing things from time to time. And your accountant can help with that.

Give us a call on 01569 760321 if you are in the North-East of Scotland and want to set up a company, to review where you are at just now, to register for VAT (which most contractors should do straight away, without waiting to hit the registration threshhold of £73,000 in 2011/12), and to get your year end accounts and tax done at competitive rates.