Owner-Directors of one man Limited Companies are in a unique position. Due to the flexibility of being able to manipulate payment types and timings, it is possible to pay an overall tax rate of around 20% on earnings of up to £100,000. Despite HMRC’s attempts to curtail the tax advantages of the way small companies and their owners are taxed, there are a few simple tax planning strategies that can be put in place to significantly enhance your take home pay:
Low Salary / High Dividend
Under normal circumstances, salaries are taxed under the PAYE system and employer’s and employee’s NIC’s are chargeable on them. Dividends, however are taxed differently and they do not attract any national insurance.
It is normally a fairly tax efficient process to set your salary level at £624 per month and take the rest of your income in the form of dividends.
If your contract income is around £50,000 per year, just applying this single strategy will save you around £X,XXX every year.
Spouse as Shareholder
If you are married, and your spouse or partner does not have income exceeding £42,475 per year, it is normally tax efficient to split the shareholding between you. For example, if you have income of £60,000 per year, there will typically be £18,000 taxed at the higher tax rate of 40%.
It is possible to avoid this higher rate tax by apportioning a percentage of the shareholding to your spouse so that £18,000 of the dividends is paid to her/him*
This will equate roughly to a tax saving of £4,000 each year.
*before putting this strategy into place, it’s important to ensure that the combined income of the spouse / partner does not exceed £42,475, otherwise they will be liable for higher rate tax and therefore the purpose of the exercise is defeated.
The flexibility of a limited company allows a contractor to defer income from a tax year in which a high rate of tax would normally be payable until a tax year in which a lower rate is due. This could be because of a change in official tax rates or because of a change in individual circumstances.
If you were to defer income of £20,000 in this way, you could expect to save approximately £5,000 in higher rate tax.
Tax efficient company closure
If you don’t mind locking your income away in your company for a few years, there are considerable tax savings to be made. This is a natural extension of the above Income Deferral process: Once the company has fulfilled its purpose, the director(s) can close it down via a Members’ Voluntary Liquidation and the company. The funds in the company can then be distributed as capital and the shareholders can take advantage of the CGT annual exemption (currently £10,600) and the balance will be taxed at just 10%.
Sometimes, if the contractor is retiring, and the company has built up considerable funds, he can choose not to withdraw the funds as capital but continue to withdraw as dividends. If it is possible to do this and keep total income below the £42,475 level, then no further tax will be payable.
Profit from the VAT Flat Rate Scheme
By voluntarily registering the company, you can take advantage of an anomaly in the current VAT system. Your company charges VAT to your client or agency at 20%, but only needs to pay a lower amount of between 12% and 15%, dependent on the type of business.
Typical savings from the VFRS are in the region of £3,000 to £5,000 per year.
Typically we will use a blend of all of these strategies to come up with the most tax efficient structure.