When the Public Accounts Committee published its report on off-payroll arrangements in the public sector, there was much media attention on the use of personal service companies by TV presenters. The
When the Public Accounts Committee published its
report on off-payroll arrangements in the public sector, there was much media attention on the use of personal service companies by TV presenters. The coverage was heavy on outrage and light on facts. So here at Tax Deductions we thought we'd present a purely factual explanation of the different ways pay deals can be structured.To show this, we have created some relatively simple examples featuring four fictional TV presenters. For just over two years, Davina Daly, Terry Ross, Bruce Edmonds and Judy Britton have each been paid £200,000 per year to co-host the "Weekly Show" show for the fictional National Television Company. Whilst they all appear to be paid the same amount, their take-home pay ranges from £103,788 to £124,955.For simplicity, we have concentrated on income tax and National Insurance Contributions and have intentionally ignored VAT.
The employee - Davina Daly
Take-home pay: £114,537Davina works exclusively on the Weekly Show. She has no other work and no other income. Davina is an NTC employee. Because of this, NTC must make deductions for income tax and National Insurance Contributions by PAYE.
Davina's tax position
Total income: £200,000
| | £ | £ |
| Income tax on £34,370 at 20% | 6,874 | |
| Income tax on £115,630 at 40% | 46,252 | |
| Income tax on £50,000 at 50% | 25,000 | |
| Income tax payable | | 78,126 |
| Employee's NICs | | 7,337 |
| Total deductions | | 85,463 |
NTC's tax position
Summary
| | £ |
| Tax paid by Davina: | 85,463 |
| Tax paid by NTC: | 26,566 |
| Total tax collected by HMRC: | 112,029 |
| Davina's take home-pay (£200,000 - £85,463): | 114,537 |
Advantages for Davina
Davina's income tax is paid directly each month to HMRC by PAYE. She does not have to worry about making sure her tax is paid. She does not have to set aside money to pay future tax bills or pay any money on account to HMRC. She does not have the burden of completing an annual Self Assessment form.As an employee, Davina receives all the benefits employees are entitled to. This includes maternity leave, statutory maternity pay
[1] and protection against unfair dismissal.People don't normally expect that TV presenters on such salaries will need it, but because Davina pays Employee's NICs (Class 1), she is entitled to receive contribution-based Job Seeker's Allowance and Additional State Pension.
Disadvantages for Davina
As an employee, Davina has little or no opportunity to reduce her taxable income by deducting expenses. Expenses deducted by employees must be wholly, exclusively and necessarily incurred in the performance of their duties. The "necessarily" element is a difficult test to satisfy. This generally makes it difficult to deduct expenses from employment income.
Disadvantages for NTC
It pays employer's NICs. It has to administer PAYE.
The freelancer - Terry Ross
Take-home pay: £115,448In addition to co-hosting the Weekly Show, Terry hosts a regular radio programme for a local radio station, occasionally presents a TV show for another channel, writes a newspaper column and has signed a publishing deal. Terry is neither an NTC employee nor worker
[2]. He is self-employed. Because he is not an NTC employee, NTC does not deduct Terry's income tax or NICs though PAYE. He is paid his full £200,000 without deductions. As he is self-employed, he is responsible for paying his own tax which he does through Self Assessment.
Terry's tax position
The example shows his tax position, solely for his income from NTC.
Total income: £200,000
| | £ | £ |
| Income tax on £34,370 at 20% | 6,874 | |
| Income tax on £115,630 at 40% | 46,252 | |
| Income tax on £50,000 at 50% | 25,000 | |
| Income tax payable | | 78,126 |
| NICs | | 6,426 |
| Total deductions | | 84,552 |
NTC's tax position
Because Terry is self-employed, NTC pay no employer's NICs.
Summary
| | £ |
| Tax paid by Terry: | 84,552 |
| Tax paid by NTC: | 0 |
| Total tax collected by HMRC: | 84,552 |
| Terry's take-home pay (£200,000 - £85,552): | 115,448 |
Terry takes home £911 more than his co-host Davina. This is because the NIC rate for self-employed traders is less than that for employees.
Advantages for Terry
He takes home more pay.To aid comparisons, expenses were not deducted in Terry's example. In practice, Terry is likely to reduce his taxable income further by deducting allowable expenses such as for use of a home office. Whilst employees can only deduct expenses which are incurred wholly, exclusively and
necessarily for the performance of their duties of employment, the test for a trader is easier to satisfy because there is no "necessarily" element. To be deductible for traders, expenses only need to be incurred wholly and exclusively for the purpose of the trade.
Disadvantages for Terry
Terry is not an employee, so he has fewer benefits and protections in the workplace than Davina. For example, he is not protected against unfair dismissal or discrimination. He will not be entitled to statutory paternity pay
[3].As he does not pay an employee's NICs (Class 1), he is not entitled to contribution-based Job Seeker's Allowance or Additional State Pension.Terry has the administrative cost and burden of being a freelancer. His income tax and NIC contributions are not deducted by PAYE so he has to complete a Self Assessment form each year. From each pay cheque, he has to set aside money to make sure he will have enough to pay his tax bill. It sometimes happens that people in Terry's position forget to or are not disciplined enough to do this. Paying by Self Assessment can also create cash flow issues because Terry has to make advance payments to HMRC on account of future income tax.Terry is running a business but he has not created a legal separation between is freelance work and his personal affairs. This means he has not taken an opportunity to limit his personal liability. He could do this with a personal service company.
Advantages for NTC
NTC pays no employer's NICs. It does not have the administrative burden of PAYE.
The personal service company - Bruce Edmonds
Like Terry, in addition to co-hosting the Weekly Show, Bruce Edmonds presents a local radio show, writes a column, has published a book and hosts another occasional TV programme. Like Terry, Bruce is not an NTC employee. NTC does not deduct Bruce's tax at source by PAYE.For administrative clarity and to attempt to limit his liability, Bruce has separated his work from his personal affairs by setting up a company, Bruce Co. Bruce Co contracts with NTC to provide Bruce's services. NTC pays Bruce Co.The two main ways that Bruce can take money out of Bruce Co are as salary and dividends. Salary and dividends are taxed at different rates. Taking salary will lead to NIC payments by both Bruce and Bruce Co, but drawing dividends will not. Bruce's take-home pay depends on the mix of salary and dividends he takes out of Bruce Co. To show the range of outcomes, we have looked at three simple examples: one where Bruce takes all his pay as salary, one where he takes salary and dividends and one where he takes it all as dividends. His take-home pay in these examples is:
Example 1 - £103,332 - all salary
Example 2 - £116,206 - combination of dividends and salary.
Example 3 - £124,955 - all dividends.
Bruce example 1: He takes the maximum salary available from Bruce Co
Take-home pay: £103,332
Bruce Co's tax position
Turnover: £200,000
| | £ | £ |
| Turnover | 200,000 | |
| Less: Bruce's salary | 176,655 | |
| Less: Employer's NICs | 23,345 | |
| Pre-tax profit | | 0 |
| Corporation tax on £0 at 20% | | 0 |
| Post-tax profit | | 0 |
NTC's tax position
NTC pays no employer's NICs because it does not employ Bruce.
Bruce's personal tax position
Bruce has been paid a salary of £176,655 by Bruce Co.
| | £ | £ |
| Income tax on £34,370 at 20% | 6,874 | |
| Income tax on £115,630 at 40% | 46,252 | |
| Income tax on £26,655 at 50% | 13,327 | |
| Income tax liability | | 66,453 |
| Employee's NICs | | 6,870 |
| Total deductions | | 73,323 |
Summary
| | £ |
| Tax paid by Bruce Co: | 23,345 |
| Tax paid by Bruce: | 73,323 |
| Tax paid by NTC: | 0 |
| Total tax collected by HMRC: | 96,668 |
| Bruce's take-home pay (£176,655 - £73,323) | 103,332 |
Bruce's take-home pay of £103,332 is £11,205 less than Davina and £12,116 less than Terry's. This is because Bruce Co has had to pay employer's NICs. Bruce is unlikely to follow this example.
Bruce example 2: He is paid £50,000 by Bruce Co and draws the remainder in dividends
Take-home pay: £116,206
Bruce Co's tax position
Turnover: £200,000
| | £ | £ |
| Turnover | 200,000 | |
| Less: Bruce's salary | 50,000 | |
| Less: Employer's NICs | 5,866 | |
| Pre-tax profit | | 144,134 |
| Corporation tax on £144,134 at 20% | | 28,826 |
| Post-tax profit | | 115,308 |
NTC's tax position
No NICs are payable under the contract between Bruce Co and NTC.
Bruce's personal tax position
Bruce has been paid a salary of £50,000 by Bruce Co. He draws the £115,308 post-tax profit in Bruce Co as a dividend.Total income: £50,000 salary + £115,308 dividend = £165,308
| | £ | £ |
| Income tax on £34,370 at 20% (salary) | 6,874 | |
| Income tax on £15,630 at 40% (salary) | 6,252 | |
| Income tax on £100,000 at 32.5% (dividend*) | 32,500 | |
| Income tax on £28,120 at 42.5% (dividend*) | 11,951 | |
| Income tax borne | 57,577 | |
| Less tax credit | (12,812.00) | |
| Tax payable | | 44,765 |
| Employee's NICs | | 4,337 |
| Total deductions | | 49,102 |
*Grossed up dividend
Summary
| | £ |
| Tax paid by Bruce Co: | 34,692 |
| Tax paid by Bruce: | 49,102 |
| Tax paid by NTC: | 0 |
| Total tax collected by HMRC: | 83,794 |
| Bruce's take-home pay (£165,308 - £49,102): | 116,206 |
Bruce's take-home pay of £116,206 is £758 more than Terry and £1,669 more than Davina. This is largely because a proportion of Bruce's income is subject to tax at the lower rates for dividends.
Bruce example 3: He draws the maximum dividends from Bruce Co
Take-home pay: £124,955
Bruce Co's tax position
Turnover: £200,000
| | £ | £ |
| Turnover | 200,000 | |
| Less: Bruce's salary | 0 | |
| Less: Employer's NICs | 0 | |
| Pre-tax profit | | 200,000 |
| Corporation tax on £200,000 at 20% | | 40,000 |
| Post-tax profit | | 160,000 |
NTC's tax position
No NICs are payable under the contract between Bruce Co and NTC.
Bruce's personal tax position
Bruce draws all the £160,000 post-tax profit as dividends.
| | £ | £ |
| Income tax on £34,370 at 10% | 3,437 | |
| Income tax on £115,630 at 32.5% | 37,579 | |
| Income tax on £27,777 at 42.5% | 11,805 | |
| Income tax borne | 52,822 | |
| Less tax credit | (17,777) | |
| Tax payable | | 35,045 |
| Employee's NICs | | 0 |
| Total deductions | | 35,045 |
Summary
| | £ |
| Tax paid by Bruce Co: | 40,000 |
| Tax paid by Bruce: | 35,045 |
| Tax paid by NTC: | 0 |
| Total tax collected by HMRC: | 75,045 |
| Bruce's take-home pay (£160,000 - £35,045): | 124,955 |
Bruce's optimum take-home pay of £124,955, as seen in example 3, is £10,418 greater than Davina's and £9,507 greater than Terry's. This is because a larger proportion of Bruce's income is subject to tax at the lower rate for dividends and Bruce pays no NICs because he is has not taken salary from Bruce Co. Note also that Bruce Co has paid no employer's NICs.
Advantages for Bruce
Bruce can take home more money.Bruce has flexibility to decide how much of the money left in Bruce Co he draws as dividends and how much he takes as salary. These three examples show just the two extremes (all salary, all dividends) and one middle scenario where he takes £50,000 as salary.Although not shown in the examples, Bruce Co may be able to reduce its tax liability further by deducting expenses from its turnover.Bruce also has the option of leaving his money in Bruce Co until it suits him. For example he could wait until the tax year 2013/14 when the top rate of tax on dividends drops from 42.5% to 37.5%. He may leave money in Bruce Co until much later and take advantage of exemptions on winding up the company.Bruce Co has a separate legal identity from Bruce. This means that Bruce has limited his liability to some extent. The company is also a useful vehicle through which he can take on an employee such as an assistantOften people in Bruce's position appoint their partner, spouse or civil partner as an officer of their company. If this person pays income tax at a lower rate than Bruce, they could draw money from Bruce Co and pay less tax than Bruce would.
Disadvantages for Bruce
Bruce has no direct relationship with NTC so he has no employment benefits or protections.Only in the examples where he draws salary from Bruce Co is he building up entitlement to contribution-based Job Seeker's Allowance and Additional State PensionBruce has the administrative burden of running a company. There are annual reporting requirements to HMRC and Companies House. There are costs involved in setting up the company. It is likely that Bruce will hire an accountant to look after the administration.Bruce is also likely to have the same administrative burdens as Terry such as paying his personal tax by Self Assessment, having to hold back money for tax and paying tax in advance to HMRC.
Advantages for NTC
NTC pays no employer's NICs.
Personal service company subject to IR35 - Judy Britton
Take-home pay: £103,788
Judy Britton works on the same terms as Davina. She works exclusively on the Weekly Show and has no other work or income. This suggests that, like Davina, she would normally be an employee. However, Judy has arranged to provide her services to NTC through Judy Co, her personal service company. Like Bruce, she hopes to use her company and, in particular, the lower rate of income tax on dividends, to take home more pay. However, there are rules, often referred to as “IR35", which impose a different tax treatment on arrangements where a person who would normally be an employee provides their services through an intermediary. The rules apply where:
an individual ("the worker") (eg Judy) personally performs, or is under an obligation personally to perform services for another person ("the client") (eg NTC),
the services are provided not under a contract directly between the client and the worker but under arrangements involving a third party ("the intermediary") (eg Judy Co), and
the circumstances are such that, if the services were provided under a contract directly between the client and the worker, the worker would be regarded for income tax purposes as an employee of the client.
The different treatment imposed by the IR35 rules is that Judy Co is deemed for tax purposes to have been paid a salary by Judy Co. The amount of the salary is determined by a calculation set out in the rules. On our facts, this calculation leads to a deemed salary payment from Judy Co to Judy of £166,960 and employer's NICs of £23,040. Note that for tax purposes, Judy has no control over the amount of this deemed payment. Unlike Bruce, she cannot vary the balance between salary and dividends when taking money from her company. If she does, the rules will, subject to certain conditions, attempt tax Judy on the basis that she drew salary from Judy Co in accordance with the IR35 rules.
Judy Co's tax position
Turnover: £200,000
| | £ | £ |
| Turnover | 200,000 | |
| Less: Judy's salary | 166,960 | |
| Less: Employer's NICs | 23,040 | |
| Pre-tax profit | | 10,000 |
| Corporation tax on £200,000 at 20% | | 2,000 |
| Post-tax profit | | 8,000 |
NTC's tax position
No NICs are payable under the contract between Judy Co and NTC.
Judy's personal tax position
Judy draws the remaining £8,000 in Judy Co as dividends.
Income: £166,960 + £8,000 = £174,960