The Fizz! Blog

Should my company pay for this?

A really common question asked by people who are new to limited companies - should I set up the direct debit for the company’s accounting fees from the company’s bank account, or my own?

The answer (which is - from the company’s bank account) is obvious to us, but it’s asked often enough that it’s clearly a reasonable question for a non-accountant to ask.

Extreme examples of companies paying for things might be helpful: you probably would not imagine that Richard Branson buys aeroplanes personally and then claims them back on his expenses from Virgin Atlantic, or that Mark Zuckerberg rents Facebook’s offices himself and gets reimbursed at the end of the month. Those companies happen to be very big, but it’s the same principle for smaller ones too. If an accountancy firm is providing services to a company, the company pays for the service. If the company needs a laptop for a director or employee to use, the company buys a laptop for them to use. If the company needs an office for directors or staff to work in, the company rents space for them to occupy. In fact, generally, directors need pay absolutely no company-related costs themselves at all. If you just set things up so that the company pays for all its own costs in the first place, you’ll have less admin to do - everything gets recorded once and once only. And you’ll have a better idea of where you stand financially - you’re not temporarily impoverished until your expenses are reimbursed, and your company doesn’t look richer than it really is because you’ve temporarily borne a bunch of costs yourself.

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Why isn’t PAYE perfect?

For people earning less than £50,000 who stay in employment all year and who have no other income, PAYE is a great system - it’ll usually collect the exact right amount of tax, spread evenly over the year.

For people earning between £50,000 and £100,000 with no other income, PAYE might get it exactly right, but it might not. Even in the absence of any other income, there are many other things that could affect your tax bill, in that bracket, including High Income Child Benefit Charge, higher rate tax relief on charitable donations and higher rate tax relief on pension contributions.

For people earning over £100,000, it’s highly unlikely that PAYE will get it exactly right. From that point you’ve got all the potential problems from the previous bracket, plus the gradual tapering away of the tax-free personal allowance, which the PAYE system does not cope with well.

For people earning over £125,000, the chance of PAYE getting it exactly right is close to zero. At lower levels, you’ve got a savings allowance, meaning £500 or £1,000 of interest is tax-free. Over £125,000, there’s no allowance, so £1 of interest is going to trigger a tax charge.

And if any of those people have some other form of taxable income, they’re going to have tax to pay. The PAYE system can’t possibly collect the right amount of tax on that, because it doesn’t know how much it is, or even if it exists. The PAYE system *will* try and collect an estimate of how much tax it thinks might be due based on previous years, but unless nothing changes, it won’t be right.

For high earners, the best way to look at PAYE is as a system that tries to collect approximately the right amount of tax, with the final bill to be established via your tax return (or an HMRC calculation if you don’t have to file a return). You can keep an eye on your PAYE coding notices (if you learn how to read them!) to check that HMRC’s estimates are reasonable in the light of what you know about your expected reliefs and other income, but don’t expect the deductions to be objectively correct - just see them as 12 reasonably estimated payments on account towards the eventual bill. And, if you do a tax return, try and get it done as quickly as you can after the end of the tax year so that you know about any shortfall (or receive any refund!) as soon as possible!

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On fiscal drag

Fiscal drag is the process by which a government can stealthily increase the tax they collect by leaving the thresholds and bands unchanged (or insufficiently changed) as incomes rise with inflation. If that happens for one or two low-inflation years, you’ll hardly notice it. But if it happens over a long period, or in a year of high inflation, you will notice. Unfortunately, both of those things are now the case! The important tax thresholds have been frozen for five years, and inflation is no longer trivial.

Five years ago, someone with a sufficiently profitable limited company might have looked with their accountant at the tax landscape, and their domestic income requirements, and decided to draw £50,000 a year from their company. They’d have known that they’d get a tax bill themselves of around £3,000, leaving them with effective net pay of £47,000 (or a little under £4,000 a month). That might have been fine to meet their requirements both for current spending and personal saving, and they’d stop there, given the sharp increase in tax rates if they paid themselves more.

Similarly, someone else might have figured out they’d draw £100,000, knowing they’d wind up paying tax of £20,000, leaving them with a net for the year of £80,000. Again, if that was enough to meet their aspirations they’d probably stick there - above that level of income you begin to lose your tax-free personal allowance, leading to some brutal tax rates between there and about £125,000.

If the bands don’t move for a year or so, it’s no big deal. If inflation is 2%, the things that used to cost you £47,000 now cost you £48,000. You might not even notice, and if you did notice you could manage it by just cutting down on treats, or rebalancing between saving and spending, allocating a bit more of your income to now, and a bit less to the future.

But if there are two years of 2% inflation, a couple of years of 4%, and then a year of 10%, you’ve got a problem. The things that used to cost £47,000 now cost £58,000! Maybe you can still cope by saving less, or saving nothing, or digging into savings. But even when all the treats are long gone most people will find that the maths doesn’t work and that they’re going to have to change something, and most likely pay themselves more and move into a higher tax bracket.

There’s more to it than tax, though.

Our £50,000 person has a couple of kids. If they can cap their income at £50,000 (and they don’t have a partner earning more), then the household gets to keep all its Child Benefit. But if their income goes above that level, they’ll have to start giving it back. Taking that and the increased dividend tax rate into account, the effective tax rate on the next £10,000 is nearly 55%! £5,500 for the government, £4,500 for the household (if they've got a Student Loan, then the effective rate will be even higher - 64%).

Leaving the bands unchanged for so long has really made a punishing difference, as more and more people are dragged into higher bands. If that Child Benefit threshold had risen with inflation over the years, the kind of employees who were originally deemed to not be earning quite enough to repay any of it would, obviously, still not be earning quite enough to repay any of it. Because the threshold has not changed at all, but their salary has, they’re having to repay all of it! The higher rate tax threshold has been frozen for five years - that Child Benefit threshold has been unchanged for 10.

Our £100,000 case could have even bigger problems. They gave up their right to Child Benefit long ago, but at least that “only” meant losing £2,000 in total in respect of their two kids. There are another two child-related issues though:

1. If someone in a household has income over £100,000, then the right to 30 hours a week free childcare for 3 and 4 year-olds is lost! That’s worth much more than £2,000.
2. And you also lose the right to a Tax-Free Childcare account, which could be worth up to £2,000 a year *per child*.

If one takes into account the value of the childcare hours, this person is actually going to find themselves with an effective tax rate way, way in excess of 100% on the first chunk of income over £100,000. This is not an obscure edge case; every year we’ll spot a couple of cases where people have to be careful not to jeopardise free and Tax-Free childcare by creeping over the £100k mark (you can sometimes recover the situation after the event with carried-back charitable donations, if you’re alive to it).

The issue doesn’t just affect people with their own company, making choices about personal income, of course. It applies to anybody managing a balance between consumption and saving, and trying their best to avoid cliff edges where entitlements are lost. Someone with a job could have been managing those issues by making pension contributions to keep their effective income below £50,000 or £100,000 - but the point will come where they no longer have enough money for the present day if they do that.

A government can really only employ fiscal drag as a tactic for a limited duration before things just don’t add up any more. For many people, things are not adding up any more.

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Can Artificial Intelligence provide tax advice? An experiment

The business current account provider Anna recently launched an experimental “tax advice bot”, Terrapin.  In fairness to them, they’re not holding it out as the finished article, or as a substitute for real-life advisers!  But it’s a good illustration of something we often say - the skill in our work often doesn’t lie in just answering the question we’ve been asked, but in identifying what the correct question to ask actually is.

Obviously, what one wants to do is to pick a question where there’s a good chance of getting the wrong advice.  And actually the first one we picked to ask worked perfectly. 

We asked: “Can I save tax on a bike I've purchased to travel to my studio?”

Terrapin replied: “Yes, you can save tax on a bike you've purchased for commuting to your studio through the Cycle to Work scheme. This scheme allows your employer to loan you a bike and safety equipment as a tax-free benefit. The cost of the bike and equipment is deducted from your salary before tax and National Insurance contributions are calculated, resulting in a tax saving. The amount you can save depends on your tax band, with basic rate taxpayers saving 32% and higher rate taxpayers saving 42%. For example, if you purchase a bike and safety equipment worth £600, as a basic rate taxpayer you could save £192 in tax.”

But how does Terrapin know that the questioner is an employee?  There’s nothing in the question to imply that’s the case (in fact, “I”, “I’ve” and “my” all suggest it’s not, though to be fair it’s entirely possible someone working via a limited company could thoughtlessly phrase the question that way).

So, we followed up with a clarification: “Those are the rules for employees - I'm self-employed.”

Terrapin replied: “As a self-employed individual, you can claim tax relief on the cost of buying a bike if it's used solely for your business purposes. The cost of the bike can be claimed as a capital allowance, which allows you to deduct the value of the bike from your profits before calculating your tax liability. For example, if you purchase a bike for £500 and use it exclusively for your business, you could claim the entire amount as a capital allowance. This could potentially reduce your tax bill by £100 if you're a basic rate taxpayer.”

Useful links:

1: https://gov.uk/hmrc-internal-manuals/tax-credits-manual/tcm0126220
2: https://gov.uk/hmrc-internal-manuals/tax-credits-manual/tcm0118180
3: https://gov.uk/working-for-yourself/print

There’s a new problem here, though!  Terrapin has now understood what set of rules it should be looking at.  But, a non-accountant is clearly going to quite reasonably imagine that getting to their workplace is a “business purpose” in this context.  It’s not, though.  So we nudged Terrapin towards the right answer once more:

“I think you're overlooking that I use it to commute to my place of work. I understand that's not a qualifying business trip.”

Terrapin replied: “You're correct in your understanding. For self-employed individuals, travel between your home and a regular, permanent place of work is generally not considered a business journey, and therefore the costs associated with this travel cannot be claimed as a business expense. This is often referred to as 'ordinary commuting' and is the same rule that applies to employees. The cost of a bike used for such commuting purposes would not be allowable as a capital allowance. The rules are different for travel to temporary work locations or for journeys that are all at once part of the performance of the work duties. As a self-employed individual, you cannot claim the cost of commuting to your regular place of work as a business expense, including the cost of a bike used for this purpose. This is considered 'ordinary commuting' and the costs associated with it are not allowable as a capital allowance.”

Useful links:

1: https://gov.uk/hmrc-internal-manuals/business-income-manual/bim37600

This is a pretty good answer - but it was only reached by repeated questions from someone who knew the right answer to begin with.  It’s effectively doing the job of an unskilled accountant, who can only get to the right answer with the guidance of a very sophisticated client!.  To repeat, this is not a knock on this particular tool, which is an explicitly experimental one.  But tax and accounting advice very often involves figuring out what the real issue is, rather than simply addressing the initial question.  Of course, it might be that AI quickly catches up with the experience, thoughtfulness and pattern recognition of good advisers.  It’s some way off it at present though.

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Travel and subsistence scale rates are an estimating technique, not an allowance!

Although the rules around the tax-free reimbursement of travel and subsistence costs to employees and directors are complicated, it’s often very appropriate for an employer to pay such expenses. When it is, it’s common for the individual to make an expense claim for the costs they’ve incurred, backed up by receipts (though if it’s your own company it’s easier for the company to just pay the costs in the first place, of course).

There’s an alternative system - fixed “scale rate” expenses, based on typical costs in the place being visited. HMRC are content for these to be used instead of actual costs, as long as there’s some reasonable review process in place before the expenses are paid out. There are costs for accommodation, along with the costs of meals, drinks and travel within the city (the total of those last three things being known as the “residual” costs.

However, this is a shortcut to making a reasonable but admin-light reimbursement of costs that really were incurred. It’s an estimating technique that HMRC are content with, not a flat-rate allowance. If no costs have been incurred, there’s nothing to estimate!

There are only a couple of exceptions to this.

• If the individual is having their accommodation and meals provided for them by a customer, HMRC will permit a payment of 10% of the residual costs. It’s the same if they’re staying with a friend.
• If the individual is being provided with self-catering accommodation, then they can claim 80% of the residual costs for the first week, and 50% thereafter.

HMRC have a bunch of other examples, which are quite helpful if you’re dealing with these situations.

If you’re not paying for your own accommodation and meals, you cannot legitimately be paid the full scale rates tax-free! The daily scale rate for someone paying for their own accommodation and meals in New York is $318.50. If you’re not paying for your own accommodation and meals, then the 10% of the residual costs that you’re allowed to claim is $10.25. Quite a difference! Be careful.

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How does Maternity Pay work for freelancers?

If you’re a sole trader you don’t qualify for Statutory Maternity Pay - that’s only payable to employees. However, there are two bits of good news:

1. You’re very likely to get Maternity Allowance instead. That’s the State Benefit for those who don’t qualify for SMP. Most freelancers will get it at a similar rate to SMP.
2. Unlike SMP, Maternity Allowance isn’t taxable! So someone getting that standard rate of Maternity Allowance will probably be better off than someone getting the same amount of SMP.

The downside is that, unlike an employee, you don’t get 90% of your usual income for the first six weeks - you just get the standard rate throughout. You’re likely to be a little worse off in that respect - but the tax saving will compensate anyway.

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How does Statutory Maternity Pay work for company directors?

Company directors are entitled to SMP on the exact same basis as any other employee - assuming they were on the payroll at the right time, then they’re entitled to 90% of their normal pay for six weeks, and then at a standard level for the next 33. In practice, the company carries on paying the director’s salary as usual, but HMRC reimburses the company for the majority. But, although the rules are just the normal rules, the different circumstances they’re being applied to leads to some wrinkles:

• More often than not (for sensible tax-planning purposes) a director will be paid a pretty low salary compared to other employees. That means that the first six weeks at 90% of normal pay aren’t actually that exciting.
• SMP is only payable whilst you’re still on maternity leave. Business owners tend to come back to the business rather more quickly than the typical employee (particularly if they themselves are the entire workforce!). After 10 “keeping in touch” days, SMP is no longer payable, and that can happen fairly early on for an owner-director.
• Usually HMRC reimburses an employer for SMP by knocking it off the monthly PAYE payments the employer makes to them. But if the director is the only employee, there might be no such monthly PAYE payments. In that case, by default HMRC will reimburse the company after the end of each tax year, but that could cause cashflow issues in the meantime. If so, it’s possible for the employer to ask HMRC to give it the cash up front, to be dripped out to the director as SMP over the period of leave.  That system actually works quite well. Be careful though - if the director comes back to work earlier than anticipated, the company will have to return some of that up front payment to HMRC, and in the meantime the extra lump of money in the company bank account hasn’t really given you any more money to pay dividends or any other costs - else, it’s sitting there to subside the salary over the period of leave.

In general, everything about the system works well - as long as you let your accountant know when you’re going on leave and when you return, anyway!

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Are you getting all the tax relief you can on your workplace pension contributions?

Automatic Enrolment pension schemes have been with us for more than 10 years now. They’ve been a success. They represented a change from “you can contribute some of your salary to a pension if you want to, but you’ve got to set it up yourself” to “some of your PAYE earnings will automatically be contributed to a pension unless you take positive action to come out of it, and then keep taking that action every few years if you want to stay out of it”. It was thought that many people might come out, but plenty would stay in. In fact, the vast majority stayed in. The government tops up your own contribution AND your employer has to contribute too - generally, people have to be very short on income in order to be willing to sacrifice the free money.

There’s a complicating factor, which is that there are two mechanisms by which the schemes can operate (and all employers pick one and one only - you don’t see them giving employees a choice). There’s no difference in how the employer contributions work, but there is a difference in the tax relief on the employee’s own contributions:

• Relief at Source (RAS). In these schemes, for every £8 you contribute, HMRC add another £2. That means everyone gets 20% tax relief from the outset - £10 in their pot at the cost of £8. If your income is above £50,270, and you’re therefore paying tax at a rate above 20%, you can save more tax, but you have to do a bit of extra work to get it.
• Net Pay Arrangement (NPA). In these schemes, your contribution is knocked off your salary before the tax on your payslip is worked out. That means that the tax relief you get depends upon your income:

1. If your income for the year is going to be less than £12,570 anyway, you’ll get no tax relief at all! The tax on your payslips was going to be zero, it’s still zero.
2. If your income for the year is going to be between £12,570 and £50,270, then the reduction in your gross means that you save 20% tax on the contribution. Just the same as your friend in an RAS scheme.
3. If your income for the year is going to be over £50,270, then you’ll save tax via the tax deduction on your payslip at a higher rate - the exact rate depends on your income. The best case scenario is if your income would otherwise be between £100,000 and £125,140 - the reduction in your gross means that you save 60% tax on the contribution! You don’t need to do anything to get all the tax relief you’re due, it all happens on your payslip.

There’s one type of person who loses out permanently here. It’s NPA person #1. They get no tax relief at all! The lowest income people, if they’re in an NPA scheme, get the least government contribution to their pot. An employer who is likely to employ a bunch of people like this might lean towards an RAS scheme if they were kind.

A person who has income between £12,570 and £50,270 should be indifferent to which mechanism is in use. They save 20% either way.

A person who has income above £50,270 should be more or less indifferent between the mechanisms as they needn’t miss out anything - but if they’re in an RAS scheme they just have to put a little more effort in. If they have to do a tax return anyway, the work is minimal - keeping track of their contributions for a tax year and sticking the number in a box on the return. If they don’t have to do a tax return, it’s still not that much work. They don’t have to join the tax return system - they can just write to HMRC once a year to tell them about their contributions, or tell HMRC via their Personal Tax Account. HMRC will just get the employer to adjust their monthly PAYE deductions to get to the right overall result.

In reality, there are likely to be tens of thousands of people who should be doing this, but aren’t. If you’re a higher-rate taxpayer and you don’t know what kind of scheme you’re in, it’d be a good idea to find out! The most commonly used provider, NEST, is a RAS scheme - 20% relief at the time, but you’ve got to do the work yourself to get any further relief you’re due. The second most commonly used provider, The People’s Pension, offers employers a choice of either option at the setup stage, so it could be either! You’d be able to find out from your employer, or from your online account - or from an accountant or PAYE professional looking at your payslips! And if you’re actually in a salary sacrifice system - which is probably the third most common way of dealing with all this - then that’s effectively an NPA, so you’re getting all your relief up-front.

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Do you always get what you pay for with accounts and tax?

There’s a natural and reasonable assumption in accounts and tax that the quality of the work and service you get is likely to be in some way proportionate to the fee you pay.  This is somewhat true, and somewhat untrue.  It’s somewhat true as there are providers who will focus on a price-based, “conveyor belt” kind of service, and there are providers who will focus on a more supportive and holistic service.  We’re the latter, but there’s a place for both, just as long as you know what you’re signing up for.

But you do come across plenty of occasions where people pay quite a lot of money for something not commensurate with the cost - and also some where people get great work or service for a lower fee than the provider could really charge.

Why might someone be “overcharged”?

• You might not be the kind of client your accountant would generally work with (classically, you might be a small fish in a big pond) but they don’t mind doing the work if the money is right.
• They might not want to work with you at all, and hiked the fees in the hope that you’ll leave.  This is a terrible plan (they’ll find you just as irritating, and now also feel slightly dirty about the amount they’re charging you!) but it’s very common advice on accountancy forums nevertheless.
• They might be overstretched, with good intentions not matched by the capacity to execute.
• They might habitually hike fees up every year until they meet some resistance.  From a cold, commercial perspective that’s not a crazy thing to do.
• They might actually be doing really good work but not telling you about it.  This is surprisingly common.  When we take on a new client who has been unhappy with the work or service levels of their previous accountant, at least 75% of the time the work is actually completely fine, just ill-communicated.
• But they might actually just not be good enough.  You do get cases where an accountant has agreed a premium fee that would be fine if they were doing a great job, but they just don’t have the level of competence to know what a great job is. 

Why might someone be “undercharged”?

• An accountant might not be very good at valuing their services.
• They might have a good idea of the proper commercial value, but lack self-confidence!
• They might be trying to win work on price initially with the intention of hiking fees up later on (we don’t think this is a good plan ourselves, unless you’re completely explicit about what the eventual fee might look like and what the discount is, but it certainly happens).
• They might have a simple life and low overheads and simply be happy with reliable work that gives them an amount of money that they’re satisfied with.  There’s more to life than maximising profits.

Clearly a once-a-year form filling service should be cheaper than a service with more regular support and check-ins.  But it’s possible to get sucked into the former at the price of the latter.  Be careful!

One more thing - it’s tempting to try and negotiate hard and get services at the lowest price possible.  This is quite logical and definitely a reasonable idea with a one-off transaction.  If you’re buying a car, play hardball!  The problem with applying that to an ongoing annual service, though, is that you’re going to quickly find yourself with a provider who resents you, over and over and over again.  Try and find a fee that you *and* your accountant are both content with!

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I've been told my contract is inside IR35 - but what does that mean in practical terms?

Previously on IR35:

• The legislation informally known as IR35 was introduced 23 years ago.  It aimed to prevent those billing via a limited company whilst performing an employee-style role for a customer from benefiting from any of a limited company’s tax advantages; instead they were to pay full employment taxes.
• It didn’t work, because it was self-assessed, and turkeys rarely vote for Christmas.
• In 2017, as a result, the responsibility for making the call changed - if you worked for a public body, the public body would decide if IR35 applied.  If it did, full employment taxes would apply and you’d just be paid the net.
• In 2021 (having been postponed for one year due to COVID), this was extended to large customers - similarly, it became their call on IR35 and their risk if they decided not to account for employment taxes.

If you’re a contractor or freelancer working longish projects with big or public sector customers, it’s therefore quite likely you’ll encounter IR35 these days.  But, if a customer or agency tells you that a contract is inside IR35, what does this mean to you in practice?   This isn’t necessarily a simple question, as there are a number of routes that the customer may take, with the literal implementation of the IR35 rules being the least common by far:

1. They might just put you on PAYE.
2. They might pay you via an umbrella company (from your point of view, this is to all intents and purposes exactly the same as PAYE).
3. They just might actually implement the IR35 process - we don’t see it often, but we do see it occasionally.  If they do, then you’ll send them invoices from your limited company as normal, but they’ll pay the invoices net of tax and National Insurance relating to you personally.  This is obviously a very weird concept, and since all three routes are designed to get to the same split of the money between you and HMRC, the well-worn road of PAYE/umbrella generally looks much more appealing to all concerned.

If you get the choice, your accountant will thank you for picking #1 or #2!  We don’t need the hassle of #3 either.

Here are three practical points to be aware of:

1. Make sure you know whether a contract is inside or outside IR35 before you sign it!
2. Be aware that an inside IR35 contract will leave you with less money in your pocket than an outside IR35 one.  How much less?  That will vary depending on the bigger picture of your whole situation, but as a rule of thumb you might consider that you’d need a 25% day rate hike to stand still.
3. You should talk to your accountant at the outset of the new gig, not later on down the line - as well as the decision on whether to accept the contract, there will very likely be other actions to take too.  It might well be appropriate to pause salary or dividends from your own company whilst working on an inside IR35 contract, and that can’t legitimately be done retrospectively.

It’d be nice if everyone had a common understanding of what inside IR35 means, and the steps we’ll all take when that’s the case.  Until then, you’ll always need to press until you find out what’s actually going to happen in practical terms.

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