Tax and service companies

Posted by Christie Malry on February 20, 2012 at 9:51 pm

Paintingwithnumbers has a go at calculating the difference between an individual paid through a company and paid as an employee:

Here is an example of two individuals, one who claims to be a contractor and  has set up a service company, the other directly employed by the same organisation. The service company and the employee are both  paid £150k per  annum before tax from this same employer with whom both are contracted to work.

                                                                                   Company         Employee

Earnings before tax £                                                              150,000          150,000

Income tax paid to HMRC                                                             17,700           53,000 1

Corporation tax (20%)  paid to HMRC                                                 30,000              Nil

Take home pay                                                                      102,300           97,000

NB. The taxation figures have been calculated using 2011-12 tax rates and allowances.

And the same calculation can also be found over at Flip Chart Fairy Tales.

Unfortunately it's totally wrong. The calculation for the tax on the dividend (the figure in bold above) is wrong. As I explain over at Rick's, the actual calculation should be:

((£150,000 2 – £30,000 3) x 100/90 4 – £35,000 5) x (32.5% 6 – 10% 7) = £22,130.

Now, £52,130 (£30,000 plus £22,130) is still less than £53,000. But it's not much less. The real saving, as anyone in this business will tell you, is on national insurance. The 'employer' doesn't need to pay employer's NI, and the contractor doesn't need to pay employee's NI. It's a pity the original article rather skims over this point. And a real shame that it got its figures wrong. 

Notes:

  1. The linked blog post has 58,000. But this is clearly a typo, as the table doesn't otherwise add up.
  2. The pre-tax earnings of the company
  3. Corporation tax paid by the company
  4. The dividend needs to be 'grossed up' for the implicit tax credit. See HMRC's website for an explanation.
  5. The first £35,000 of dividends received in any tax year are taxed at 0% (really it's 10% less a 10% tax credit).
  6. After the first £35,000, dividends up to £150,000 are taxed at 32.5%
  7. Less the 10% tax credit

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