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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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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The OnlyFans creator tax case actually shows that part of our tax system *is* fit for the 21st century

We were listening recently to a podcast discussing, amongst other things, the tax relief claimed by an OnlyFans creator on costs of cosmetic surgery.  The assertion was made that it’s an example of our tax system not being fit for the 21st century - those who drafted the legislation couldn't possibly have even imagined some of our modern-day sources of income, and it’s in need of overhaul.

Actually, the system of figuring out if costs are tax-deductible is beautifully designed for new and innovative businesses, because it’s principles-based rather than rules-based.  The central principle has always been - “is the cost incurred wholly and exclusively for the purpose of the trade?”.  That trade could be anything - it could be the trade of a blacksmith, but it could be the trade of a fitness influencer.  From time to time there are grey areas, in which case it may go to a tax tribunal (a “tax court”, basically), and there’ll be a verdict that will either be binding or persuasive in similar situations in the future.  Or, in a grey area, a taxpayer and their advisers might just take a view, understanding that HMRC might have a different one if they looked at it (“would you be able to look a tax inspector in the eye and defend your treatment?” is often a good benchmark).  From time to time a government may actually impose rules if they want to encourage or discourage particular behaviours, but in general deductibility is driven by that first principle, which can be applied to absolutely any business.

There are definitely areas where the modern tax system has not kept up!  20th century legislation and international tax treaties were created for a world where global mobility was generally imagined to be fairly rare - nowadays migration and digital nomads are perfectly normal.  Arguably the treatment of cryptocurrencies (in the UK at least) is based on long-used principles, but does seem counterintuitive to many minds.  And our National Insurance system was designed for an era where most people were in salaried work, with both them and their employer paying into the system.  The subsequent proliferation of freelancers and personal service companies has broken that model.  But the framework for figuring out whether a cost is tax-deductible or not is elegant and foolproof!

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Going on maternity leave? Think twice about opting out of your employer’s pension scheme

When someone's about to go on maternity leave, they'll quite often look at trying to temporarily cut all unnecessary overheads.  You might think that one sensible step would be to opt out of their employer's pension scheme for a while.  Cutting this particular overhead is probably a very bad idea though.

If your employer operates their Automatic Enrolment pension scheme on the most common basis, you’ll be making a contribution each month, and so will they.  Those contributions vary according to your income, and get capped if you’re earning more than £50,000 per annum.

If you go on maternity, your income drops, and so do your contributions.  In fact, after the first six weeks of leave, from which point your salary will probably just consist of basic Statutory Maternity Pay, they’re likely to drop to zero.

But, crucially, your employer’s contributions do NOT reduce at all.  They’re obliged to carry on paying into your pension pot at the level mandated by your normal salary!  Other non-salary benefits work on the same basis, too; they can’t take away your company car or withdraw your medical insurance, for example.

So, by opting out at the start of maternity, an employee could lose nine months of employer pension contributions, whilst saving herself virtually nothing.  A very easy trap to fall into!

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Claiming Capital Losses

If you sell assets like rental properties, shares or cryptocurrency at a profit, you have to consider whether you have Capital Gains Tax (CGT) to pay for the tax year.  But you might also have sold some other assets at a loss in the year - if so, you can deduct those losses from your profits to get to a net profit or loss for the year.

If you wind up with net gains, but they’re less than the Annual Exemption - this year, £12,300 - then there’s no CGT to pay and you move on.

If you wind up with net losses, then you get to hang on to them.  If, in a future year, you have net gains over the Annual Exemption, then you can set those old losses against them, using just enough to get down to the Annual Exemption and eliminate any tax that would otherwise be due, and carrying anything left forward still further.  It might be that you never have sufficient gains in a future year to ever use them, in full or at all, but they’re there if you do.

Capital losses are about to become more valuable, because the Annual Exemption is being cut sharply.  Next year, it’ll be only £6,000, the year after, £3,000.  That means that more taxpayers will be dragged into the CGT net.

There’s an easy trap to fall into.  In order to establish entitlement to most losses, you generally have to claim them within four years of the tax year they occur in (there’s a shorter deadline for some niche cases).  That could be on your Self Assessment Tax Return, if you have to submit one for the year, or you could just do it by letter or some other way.  But you have to somehow tell HMRC before that deadline.  We recently saw a case where someone had losses in 2013-14, and gains over the Annual Exemption in 2021-22.  Unfortunately, HMRC hadn’t been told about the losses, so it was too late for the taxpayer to take advantage of them.  Fortunately, the losses weren’t enormous.

A final consideration - you might need to make a judgement about how much effort you’re prepared to put into quantifying losses that you’re not certain will be useful.  If someone is pretty sure that they’ve got losses this year, but they’ll have to put research time into establishing the history of the share transactions, or pay an adviser to work out the actual loss, should they do it when they don’t anticipate having an opportunity to use the loss in future? To begin with they can kick the can down the road, by making a note for three years’ time to look at it again.  The point will come, though, where they have to make a judgement on whether to do the work before the deadline passes.

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Can I make pension contributions for family members through my limited company?

The rules on how much money can go into someone’s personal pension in a tax year aren’t intrinsically complicated - there are just lots of them. Broadly:

• Almost anyone (even an infant) can have up to £3,600 go into a pension scheme or schemes in a tax year.
• The cap each tax year (the Annual Allowance) on what can go in is £40,000.
• However, unused Annual Allowance from the prior three years can be used too (if you had a pension pot of some sort in place at the time).
• Personal contributions in any year are capped at earned income.
• Employer contributions aren’t capped in that way (so a director with a small salary isn’t limited to contributions equivalent to that salary - their company can contribute more).
• Annual Allowance may be reduced for those with income over £200,000.
• The Lifetime Allowance may prohibit or penalise contributions for those with very big pension pots.

All simple individually, but the synthesis of them can be complex!

There’s another consideration involved where contributions are being made via one’s own limited company. For the company to get tax relief on the contributions, the same standard must be met as for any other overhead - is the cost incurred wholly and exclusively for the purpose of the company’s trade? In practice, that means - does the bundle of PAYE salary, pension contributions and other benefits that the director is receiving represent a reasonable bargain for the work being done, or is it excessive?

For a typical fee-earner, generating the company’s income, it’s almost certainly going to be fine. If your company is making enough money to sustain £12,000 of salary plus £40,000 of pension contributions a year, a £52,000 “package” is unlikely to be excessive and there should be no trouble with the company getting tax relief.

A fairly common question from people already doing that is - can I do the same for my spouse or partner too? That’s much more problematic. If they’re doing no work for the company, then a package of £1 would be excessive, let alone any greater amount! If they’re doing some work, you’ll have to take a position on whether the proposed contribution would meet that “wholly and exclusively” test, when considered alongside any PAYE salary also being paid.

In practice, this tends to mean that for fee-earners, big contributions are fine, whereas for a spouse doing some admin support, say, material contributions aren’t really defensible (and there would instead be an argument for their being taxable as income on the director instead!). It’s easy to get confused about the mechanical “how much can go into the pot” rules, and overlook that aspect.

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