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Director/shareholder reward packages: The dynamics have changed

Introduction

The introduction of the Employment Allowance (“EA”) allows employers a discount of up to £2,000 off their liability to Employers’ NIC. This has added another factor into the salary vs dividend debate.

There is one other complicating factor as well. The level of other taxable, non-dividend, income enjoyed by the director/shareholder.

If there’s no other income

A salary equivalent to the director’s personal allowance is most efficient. The additional NIC paid by the director (at 12% on the excess over £8,060) is more than compensated by the additional corporation tax saving at 20%.

With no other employees, this works for companies with up to 5 directors/ shareholders.

What if the director has other income?

Many directors own the company premises, and enjoy a rent from that. Where rent (or indeed any other taxable income) is enjoyed by the director, a little more care is needed. The optimal position would be to create total taxable income (excluding dividends) of exactly £10,600 (for 2015/16). So if the director was receiving rent of £3,000 a year, the ideal salary would be £7,600.

What about pensions?

There are two aspects to this.

Contributions to a private pension scheme
Dividends do not count as pensionable income, and so tax relief on personal contributions would be limited to the amount of taxable salary. (Rent doesn’t count either).

The simplest way around this is to get the company to make an employer contribution, but you may need a different kind of pension scheme, and this may need to be negotiated/agreed with fellow directors.

I had just such a case where one of three directors wanted to top up his pension. Unfortunately, the wider savings from the low salary route meant his tax relief was limited to just £5,000, as he already had two smaller schemes running, and the company did not have sufficient profits to get full tax relief on even that small amount.

State pension entitlement
Employees are credited with a year’s worth of contributions if their weekly earnings exceed £112.00 (2015/16 rates). Therefore, the director will need a salary of at least £5,824 to add another year to their state pension accrual. In the example above, a salary of £7,000 meets the criteria, but what if the rental income was £6,000?

Voting a salary of £5,824 would take the director into income tax, as total income would exceed the personal allowance.

At 2015/16 rates, this would impose an income tax bill of £244.80 on the director, but would add a year to the pension entitlement. The cost-benefit decision is personal to each individual; is an extra year’s pension worth paying that tax?

The factors to consider are:

  • how many years before you can take your pension,
  • how long you think you’ll be around to enjoy it, and
  • how much more could you generate in income by saving that tax over the years before you retire/

among others.

Creating alternative income

If the circumstances allow, it may be more efficient to draw one’s income as rent or interest from your own company, rather than by way of salary.

Rent

Any rent charged must be at a market rate. We would suggest that a written agreement is drawn up, making it clear who is responsible for repairs etc., as well as covering the amount of the rent.

Interest

A director can only charge interest to his company if he has a loan account in credit, and there is an obligation on the company to pay interest. Any “interest” paid on a loan which was intended to be interest-free could be challenged and treated as remuneration. In order to avoid any uncertainty, we would suggest a written agreement, which makes clear the terms of the loan. The agreement does not need to be onerous, but a clear statement can help to avoid later disputes.

Action

The start of a new tax year is a good time to review your financial position, as many rates and allowances change. Thankfully, for directors’ salaries, the annual earnings period means you haven’t lost out if your review has not yet been completed.

Contact your adviser, or drop us a line if you’d like a review done of your personal situation.

Numbers (UK) Limited

5 May 2015

Can I avoid a tax investigation?

Introduction

So the return is in, and we can breathe a sigh of relief, but is it all over?

We are often being asked this question “What chance is there that I get investigated by HMRC?” The truth is that you cannot entirely eliminate the risk of getting investigated, but you can minimise it.

Some clarification

First we need to tidy up the terminology! The word “investigation” is emotive. It suggests that the person selected is guilty of some misdemeanour, or even a crime!

HMRC use various words on their website, and in their literature to describe the same thing. You might have a “check”, an “enquiry” or a “review”. All of these simply mean HMRC want to check that you are paying the correct amount of tax, and at the correct time.

Time limits

Generally, HMRC have 12 months from the date the return is filed to open an investigation into your return. The deadline can be extended if you file your return late, amend a previous return, or they can prove that you have deliberately misled them.

So I could get a random check, but how do I minimise the risk?

Submit your returns on time

Some people may be tempted to submit returns late, particularly if they have liabilities that they cannot afford to pay. It is much better to submit the return on time, and ask for time to pay. While the response can vary, you are much less likely to get a positive response if you have a history of filing later returns. This applies not only to tax returns, but VAT, PAYE and corporation tax returns as well.

Use the “white space” or attach additional documents (where possible)

Many investigations are raised simply so HMRC can understand figures that fall outside the “norm” expected. Using the white space to explain significant variations from previous years, or from industry averages, can help HMRC to accept the figures without opening an enquiry. If they still open an enquiry, it can help to minimise any penalties if you can show “that we have already told you about….”

Don’t fall out with your staff, spouse or lover!

Many investigations start with a simple tip off to HMRC, usually from someone with a grudge against the taxpayer. The people closest to you often know more than you care to think, and know “where the skeletons are”. While HMRC don’t always take up these leads, they can tip the balance. The worst case we handled was where a landlord fell out with his girlfriend who happened to be his boss’s daughter! He lost his relationship, his job and got a tax investigation all in one week!

Use a good accountant

HMRC will never admit it, but they do know which accountants are professional, and which ones are, shall we say, less than competent.  Using a reputable firm should ensure that your return is correct (assuming you’ve told the accountant everything). Even if it’s not, you may not have to pay a penalty, as using a good accountant demonstrated that you took “reasonable care” over the return, which is one of the main grounds for appealing against a penalty.

Fee protection

Most accountants also offer insurance against their fees if your return is selected for a “check”. Like most policies, they are always conditions, but generally claims are met.

Some accountant’s policies also give them access to free advice lines, so they can clear any difficult or contentious points before your return is submitted.

The policies are not expensive, and can often be part of a membership (e.g. FSB) or as part of your general business insurance.

It helps avoid that irritating position where you have to accept HMRC’s opinion, even though it’s wrong, because “it’s cheaper to pay the tax.”

In summary

You cannot eliminate the risk, but using a good accountant, and paying a small insurance premium, can put you in the best position to defend yourself.

Don’t be frightened by the prospect of an HMRC investigation, be prepared!