Stuart Clark: The tax system is not unfair; it’s just a matter of swings and roundabouts
Stuart Clark, managing director at Russell & Russell Business Advisers, based in Glasgow, discusses the complexities of the UK tax system.
I have to wonder if it is the age-old politics of envy, but the number of hostile articles in the UK about the supposed disparity in tax treatment between employees and employers appears to once again be on the increase.
The most recent lamented the “unjustifiable” low tax regime for directors which, it claimed, was costing the Revenue up to £15 billion a year. It argued that they paid less than partners, PAYE employees and the self-employed.
Apart from the fact that the correspondent in question seemed to be conflating the self-employed with owner managers of limited companies, the fact is that even if owner managers were able to pay less tax, perfectly legitimately, they are penalised in other ways.
For instance, over the course of the pandemic, they did not qualify for the self-employment income support scheme, or even furlough income in respect of dividends. In fact, in many cases they got no Covid-related help at all.
But even if there were to be an element of favourable tax consideration for people who have built and maintained their own companies, the rationale for that is reward for risk and recognition of the contribution such people make in other ways.
They generate a disproportionate tax contribution not only through corporation tax and VAT, but also through the PAYE income from the jobs which they have created, and which would not exist without them.
It might be instructive to look at this group from the other direction and assess what they do not get in comparison to a PAYE employee – for instance, job security backed by stringent employment law, paid holiday entitlement, paid sickness benefit and paid pension contributions.
When you run your own business none of these valuable perks apply. Also, if work dries up – or disappears, as it did in many cases last year – the employer remains liable for employee wages and benefits for indefinite periods. Often, they will pay employees before they can reap any reward themselves.
The way individuals of different employment status are taxed is clear cut. If you are a sole trader, you are taxed on the profits. That means that if you take, say, £2,000 a month from the business but the business makes £50,000 profit, you are still taxed as though you have had £50,000 of income rather than £24,000.
Within a company, the business is taxed on profits at a flat rate of 19% and then the shareholders are taxed on any profits that they withdraw via dividends, thereby allowing the shareholders to leave profits in the business for future years.
The dividend tax rates are different from the employment tax rates. The first £2,000 is tax free; dividends falling within the basic rate are charged at 7.5%; at higher rate, 32.5%; and at additional rate, 38.1%.
Even with these potentially lower tax rates, some company directors or shareholders may well pay a salary for themselves through the company anyway as dividends can only be paid from profits.
Roughly speaking though, on £50,000 of pre-tax profits, a combination of salary and dividends would result in a saving of £6,000 as opposed to salary alone, to re-invest or take as cash.
The tax rules are incredibly complex and there is often more to consider than the face value of the rates alone. Doing what’s right for the business should always come first - you would not spend £1 to save 19p.
For businesses large or small, the most effective way to ensure that its liabilities are correct is to seek professional advice.