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£5000 salary and dividends still??

My query basically just centres on whether a lot of directors are still having this low salary with regular dividends. I believe that this still seems to be favourable from a tax point of view for profits under £300k but just concerned about the commerciality of a low salary. Is this an area that the Revenue could argue is too low and stipulate that salary must be higher?

Thanks for any help
david

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Don't Volunteer Nicholas
On the basis that the director is paid £5200 for a year, his/her NIC records will show this as a qualifying year for pension purposes. This is because it is over the lower earnings limit.

This is even though no Class 1 NIC is paid! So no need to pay Class 3 contributions.

With the proposed changes to qualifying years for state pensions, I would advise a wait and see policy in any case.

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very few
I believe companies using the arrangement you refer to are few and far between. Most of the company directors I deal with are on a salary of around £30K. hope this helps.

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Yes
I am surprised by Tony's comment. The vast majority of our one-man and husband-and-wife company clients are paying the directors a £5,000 salary and the balance of the company's profits as dividends in order to qualify for state benefits whilst paying no NIC.

We are not yet in the era of a Big Brother who can instruct companies what salaries they should pay.

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Yes but
I must admit I do feel a bit squeamish about it. I think the only legitimate tactic the Revenue have is claiming that there is a breach of the minimum wage legislation, but that usually requires a complaint.

Maybe the revenue would have an argument on an IR35 basis but since our lot don't focus emtirely on one customer at a time, it's unlikely.

Our little group of companies are all, with one exception, operating on a £5K + divs basis. It's wrong and unhealthy tax avoidance and encourages people to behave in an artificial way so as to save tax. It would be such an easy loophole to close by charging NI on divs paid to a shareholder with more than say 25% of a close company. I'll sleep better once they do.

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.
I would definately agree with Euan. Majority of my clients are paying themselves £100 per week and taking quarterly dividends.

A few have elected to pay a voluntary NI contribution also.

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Changing times...continued
My comments below also take on extra significance since the average number of incorporations had more than double for the first three months of this year, one would imagine due to the announcement in the PBR at the impending attack on MSC's and as a result thousands of PSC's are being established. Obviously bearing in mind the success of IR35 (not!) HMRC need to have a different approach.

Quite what they will/could do about it is another question, however one only needs to look at s.447 ITEPA to see there is scope for 're-interpretation' (like they did with s.660). HMRC did release guidance on the above which stated that:

"...the legislation is directed towards complex contrived arrangements to avoid tax and national insurance contributions, in particular the use of special purpose vehicles, the use of managed service/composite companies (notwithstanding further legislation applicable to such companies effective 6 April 2007, as previously detailed) and the use of alphabet shares with little value or rights being used to pay dividends to a range of employees. The ministerial statement also included a comment that "this measure will not affect the taxation of those small businesses that do not use contrived schemes to disguise remuneration to avoid tax and National Insurance".

Dawn Primarolo subsequently stated that "I want to make clear that this change does not bring all benefits derived from securities into a tax and National Insurance charge. A reference to benefits in the context of the schedule means the employment reward - the passing of value to an employee in return for the employee's labour. Where investors are carrying out their normal investment transaction, this charge will not affect them."

...one further post to come!

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There is no problem
Unless IR35 is an issue, then there is absolutely nothing HMRC can do to stop the low salary - high dividend option. It is not illegal. HMRC were party to a joint statement confirming minimum wage didn't apply to directors without an employment contract. In my current firm, and previous firms, for virtually all my time as an accountant (25 years), small family owned companies have adopted this policy, whether they be IT consultants, factories, shops, tradesmen, etc. Just make sure the minutes and vouchers are in place, the Memo & Arts allow it, and there are adequate reserves and you won't go wrong.

In 25 years, I have never had a corporation tax or personal tax enquiry where the inspector has questioned or argued against the low salary - high dividend route. Only once has it been mentioned by a PAYE inspector - and she was off her trolley - she told the client that they shouldn't be doing it and that if they continued, they would be prosecuted - I complained about her and shortly after the client got an apology and retraction.

For many years now, a minority of accountancy practices have been recommending against the practice on the grounds that HMRC don't like it and are likely to challenge it. Maybe one day, the law will change to outlaw the practice, but in the meantime, hundreds of thousands of small limited companies are saving a lot of NIC by adopting this perfectly legal approach. There is no point in changing the practice until the law changes. As long as clients are told of the precautions and importance of proper records, and that it may change in the future, there is no problem.

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Changing from salary to divs?
We act for a company where the husband and wife shareholders have received remuneration, partly for mortgage application reasons - has also helped with SMP. If they were to change to the £5k remuneration + divs route are HMRC more likely to get agitated than if they were starting from scratch?

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The budget increase in CT ..
was imposed with the rationale that director/shareholders are saving NI through the use of dividends. It seems to me that this carte blance to save as much NI as possible otherwise our clients are paying twice!

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Agreed
Steven, I couldn't agree with you more.

Of the companies I deal with, I reckon at least 95% are now paying their director(s) a wage of £100 per week with any extra profits being taken as dividends.

Any higher salary results in them paying more tax & NI than they need to.

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Perhaps times are a'changing!
Whilst I agree with the majority of posts below with regard to what has been standard tax planning for years it is clear that there has been a significant amount of unrest at the Treasury regarding this and they are scratching their head as to what to do about it. They have tried making it unattractive to operate through a Ltd co (NCD's etc), and this latest approach (increasing small co. taxes, etc.) is just another example. One must bear in mind that the following was contained in the recent budget:

"5.113 The Government remains concerned that the corporation tax system is being used to achieve a reduction of personal tax and national insurance liabilities, through the extraction of labour income as dividends. The Government considers that this has eroded the balance
between providing low rates of corporation tax to encourage business investment and maintaining a tax system that is fair for all. It has therefore decided to refocus the way in which the tax system supports investment by small businesses, to provide better incentives for those
businesses that reinvest their profits for growth. Budget 2007 announces the introduction of an Annual Investment Allowance that will provide a major cash-flow benefit to those small businesses that invest to grow their business. The Government will be increasing the Small
Companies Rate to reduce the advantage of incorporation and extraction of labour income by way of dividends, providing a fairer outcome for all (further details are set out in Chapter 3).

5.114 The Government will continue to monitor the level and extent to which labour income is extracted in dividends."

We all await quite what 5.114 means but I was at a presentation yesterday by Franchesca Lagerberg (outgoing Chairman of the ICAEW Tax Faculty) who stated that she had spoken to someone senior within the Treasury who confirmed that they were taking this approach very seriously

….to be continued in another post...

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Changing times....last post...honest!
With regard to s.447 and the subsequent guidance is that there is uncertainty as to what are and what are not "contrived schemes" and what is and what is not acceptable. To date there does not appear to have been any specific attempt to challenge the position of owner managers who hold ordinary shares in a company and draw a low level of salary with the balance of any profits being paid to the same people as a dividend in their capacity as a shareholder. However it may be that at some point in the future HMRC will contend that the "fair" and "correct" amount of tax, where there is "the passing of value in respect of the employment reward" on the payment of a dividend to owner managers, is that due via PAYE with associated National Insurance contributions. If this occurs there may be doubt as to how easy it will be to defend the position of a director employee working (full time) for a very low salary, especially bearing in mind that it was clearly stated in the budget that they are "monitoring the situation".

I'm not actually advocating any particular course of action here but merely adding fuel to the debate. As a matter of practise we are notifying our clients of the potential 'wind of change' and that historic and well established planning structures that have been enjoyed for many years may, soon, become unavailable. Forewarned is....etc!

On with the debate!

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Tax & NIC's will be merged ..
in my view. The budget has clearly aligned tax & NIC thresholds and we are so close to someone saying that the effective lower rate of tax is now (say) 30% for everyone. Takes a bit from the self employed, gives a bit to employed BUT takes a huge chunk from everyone who had previously non NICable income (e.g dividends).

It is now so easy and they achieve overnight an end to all these problems. Whats more, a huge % of the population won't bat an eyelid which is always tempting to a politician. Obviously one group that would have lost out would have been pensioners ... what did he do, increased the age allowance so most won't pay tax anyway.

Its coming .... make hay while the sun still shines!

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very unlikely
No Chancellor is going to stand up in the Commons on Budget Day and say I am increasing the basic rate of income tax from 20% to 30%. It is not going to happen.

Even if it did, then assuming you get a basic rate tax credit on dividends, then it would have no effect on small one man companies who are paying the director minimum salary.

The way to tackle this problem if one considers that a problem still exists is to carry on with what has been started in the latest Budget. The small company tax rate could be raised further to 24% or even higher. Take a level of 30% for example. How many one man businesses would you consider would incorporate at this level? Quite a few less than currently I would imagine.

There is no point in using a sledgehammer to crack a nut. If it is considered that the small one man company is "not paying the right amount of tax" (whatever that is), then you just raise the small company rate.
I think Brown has finally realised this and scrapped the NCD rate etc. He has done now in 2007 what he should have done back in 2004.
Better late than never I suppose.

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NI is a tax
Obviously as accountants we realise this but for a long time it has been more convenient for goverments to tell people that the payment funds nice things like pensions & hospitals. For the first time I can ever recall this goverment referred to NIC as a tax. This occurred one month before the respective bands were harmonised in the budget. For most people there is now one rate of tax but two taxes .... doesn't take a genius to work out whats next in my view. This is, however, a "first budget after the election" action just in case everyone is easily spooked as Tony!

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Where does the law say only 2 dividends per year?
HMRC don't have any legal grounds for claiming dividends only twice per year. As long as the paperwork is in place, quarterly or monthly dividends are legally allowed. HMRC may not like it, but there is no law to prevent it.

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Watch for signs
The key to seeing how the wind is blowing is how the next Chancellor (David Milliband or Ed Balls?) refers to the cut in Basic Rate when he speaks in Nov 07 and March 08. If they start referring to "bringing down the combined rate from 30% to 28%", we'll know what's going on - softening the public up for a change in Autumn 09.

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Ding a ling
"Bringing down the combined rate from 30% to 28%".

Hmm, rings a bell.

So in a couple of year's time, we will have:

CT (big) = 28%
CT (small) = 22%
IT/NIC (combined) = 28% (for s/e)

Can it be? The ultimate in tax simplification?

A single tax rate of 25%!

(Or for the more paranoid of us, a single tax rate of 28%).

If you think this is unlikely, just remember I didn't start the theory that IT and NIC will be combined.

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Combined NIC into Tax is the way they're going
With basic rate down to 20% and NIC either 9 or 11% (s/e or ee), people are already paying between 29/31%. So in the name of simplification and harmonisation, I suspect that both the income tax basic rate and corporation tax rate will become a round 30% together with the abolition of NIC.

It's not a vote loser - the spin will be a 1% reduction in tax/NIC for employees who will pay less (the majority of likely Labour voters). The self employed and businesses are probably generally unlikely to vote labour anyway and already get little public support. He can easily find more sweeteners for OAPs whose tax would increase (as they pay no NIC anyway on savings/pensions) such as further increases in the personal allowance for them to compensate, at the same time, taking even more OAPs out of tax altogether (another vote winner).

Small businesses pay more tax, but save on abolition of employers NIC. Those who pay dividends instead of salary will be badly hit, but Govt thinks they're fair game anyway - again, good spin that the govt are tacking "avoidance of NIC by dividends".

It all makes sense when you think about it. Corporation tax at 30% for all sizes of company, 30% basic rate tax for individuals. Tax credit on dividends becomes 30%. Same tax whether you are a sole trader or limited company - after all it is the NIC that is now the only significant difference.

Whatever the Govt say, they havn't a hope in stopping the low salary, high dividend idea, so the logical way forward is to look at where the differences really lie - the only difference is NIC - incorporate NIC into income tax and you solve your problem - do it with spin and an imaginery tax/nic cut for the masses and you've a vote winner.

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Just to help them out ...
... can anyone put a spin on why the hell anyone (now or in the future) should bother taking the risk of self-employment or own Ltd co. if tax rates are so similar? Maybe they will give us entrepreneurs some paid holiday and sickness!?

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Dividend Period important
However no one has mentioned that dividends should only be paid twice per annum, this is standard practice. I always advise clients to take the lowest minimun salary they need to live on from one month to the next and the balance by dividend. Its a compromise really. Maybe some are getting round this with a director loan payment every month and cancelling by journal at year end. This is a clear giveaway to HMRC that the payments should be as salary. The question is can the client get by on bi-annual dividends?

Then again HMRC may never raise the point. However they ahould be aiming their effort at 'Umbrella Companies' or MSC's, and not the small family company I would have thought.

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Motives to be self-employed?
I think if people are going in to self-employment/running their own business with tax and NI savings as their major aim, then they've missed the whole point of it, which is that get to keep a bigger share of the profits of their labour than if they are employed by someone else. Control of your life (well the theory's good) and building something for the longer-term are supposed to come into it too.

But if anyone's said "I want to be self-employed because they only pay 8% NI and not 11%", they should be sedated and made to lie down in a darkened room.

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a litle naive, if you ask me
I realise it is pure speculation, but to suggest it is very simple to combine tax and NIC at the stroke of a pen, is a little naive.
There are many issues to consider and it would probably create more problems than it would solve.

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Tony (Lawrence)
Your assertion about dividends is not correct. There is NO way that HMRC can change a legally declared dividend in to salary. Weekly dividends (although not desirable from an admin point of view) are perfectly legal. I would estimate that 90% of small business owners probably do at least quarterly dividends. Do you not think we might have heard about a case by now? What I do agree is that if dividends are subsequently found to be illegal then frequency of payment may come in to play when they attempt to reclassify as salary rather than as a dorector loan.

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Wifes Wages
Could I ask what is the currently accepted practice regarding payment of wifes wages, where she and the husband have a joint personal bank account ? Should I recommend they draw 2 cheques monthly, or will one do. ?

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Employer's NI
Those on this thread that think they foresee a combining of tax and NI are omitting Employer's NI from their calculations.
At 12.8% this is a rather large omission.
This also applies for Marion Morrison's post.

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David - It is the uncertainty
To David Cee,

It sounds like your accountant is suffering,as we all are, with the uncertainty that is prevalent in this whole area.

In relation to the Nat Min Wage: it is commonly quoted that NMW does not apply to directors who do not have service contracts - in fact it does not apply to directors for their work AS DIRECTORS, it does apply to other work, eg fee earning on contracts. On that basis the remuneration = to personal allowances strategy is safe for a business owner who manages,say, a factory business but it is open to challenge under NMW for an IT contractor. How likely a NMW challenge is is an open question. Some of us in our profession do not like the "straws in the wind" on NMW, (the HMRC guidance has recently been toughened up and they say they intend to be more pro-active in enforcement, also cynics like myself see that it is now 6 years since NMW came in - the maximum period the Revenue can generally back-date claims).

Likewise there are uncertainties in relation to taper relief availablilty - clear abuse by Phoenix companies is tax evasion, other circumstances are nowhere near so clear.

Although I cannot comment in detail on your dealings with your particular accountant it sounds like you may well have had very shrewd advice. My adice would be to discuss your concerns in an open fashion.

I do not want to be too defensive on behalf of the accountancy profession but my impression is that we are, (on the whole), far more ethical than most business sectors.

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David Cee
I agree on the whole with Malcolm's comments, I would NEVER recommend closing and reopening companies, nor would I change my advice once a client is on board. I would say that different clients may have different needs - for instance, if you pay yourself £9,500, you would be able to contribute more to a pension scheme that someone on £5,000 - but that highlights the fact that some advice will be generic (particular to the advisor) and some will have to be specific.

I would also endorse the view that you should sit down with your advisor and say "what's going on here?"


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Combining Tax and NI
Yes there are definitely issues associated with the combining of Income Tax and Employee's NI and it will produce winners and losers. The first thing that would have to change would be the reintroduction of an old favourite - Selective Employment Tax. They wouldn't call it that, and it wouldn't operate in the same fashion as SET but it would be a simple enough task to bring it back in order to collect the same money.

Issue 2 is pensioners who currently pay tax but not NI. This could be cured in two ways - either a fixed addition to basic state pension (which would be redistributive) or the use of different tax codes and tax tables so that pensioners paid tax at 20% instead of 30%.

But the biggest issues would surround pension funds and what would happen to pre-10% taxed dividends. That would take a lot of forethought but we already have one system with anomalies. Why not aim for a simpler system with a different set of anomalies?

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