TAX EFFICIENCY VS TAX AVOIDANCE
With new rules on IR35 just around the corner, it’s no surprise that we’re now seeing a rise in the number of companies offering contractors all sorts of schemes to work around the tax legislation.
Any Umbrella provider who suggests that you can keep 85% or more of your pay is misleading you, even if they state they are IR35 compliant and their schemes are approved by HMRC. The truth is: they are not. No-one can allow you to keep such a high percentage of your take-home pay on an ongoing basis without bending the rules somewhere, somehow. It may be necessary to dig quite deep to find the loophole that’s being exploited, but let us assure you, it’s definitely there!
Tax efficiency, tax avoidance and tax evasion
When it comes to arranging your financial affairs, there’s a big difference between tax efficiency, tax avoidance and tax evasion.
Put simply, tax efficiency is allowed – in fact, it’s probably one of the reasons you use a specialist contractor accountant. Tax evasion, conversely, is not allowed, and you will face criminal charges if you’re caught. Tax avoidance, on the other hand, is the grey area in between – HMRC describes it as ‘operating within the letter, but not the spirit, of the law’.
What is tax efficiency?
Put simply, tax efficiency is about paying the right amount of tax based on your income. If you are an Umbrella contractor and we look after your payments, you will have the correct deductions for tax and National Insurance (and any other deductions which are necessary to your circumstances) detailed on your payslip.
As a limited company contractor, you will work in a tax efficient way if you:
- Claim tax relief allowable business expenses. This will reduce your company’s taxable profits which means you’ll pay less corporation tax.
- Take your tax-free personal allowance, of the National Insurance threshold value, as your salary and then take dividends from your company’s profits. This is a tax efficient way to take money out of your company.
What is tax avoidance?
There is a fine line between tax efficiency and tax avoidance which is why it pays to work with specialist contractor accountants to manage your financial affairs.
Tax avoidance involves bending the rules of the tax system for your own gain, pushing boundaries of the rules in order to minimise the tax you have to pay. Tax avoidance isn’t always illegal, but it is considered by many people to be immoral. We each make different choices about what’s right or wrong, but you should consider the impact on your reputation if clients and other associates think that you’re involved in tax avoidance. And remember, different people have different feelings about what is and isn’t tax avoidance.
According to HMRC, tax avoidance often involved ‘contrived, artificial transactions that serve little or no purpose other than to produce this advantage’.
If you use a tax avoidance scheme you may be required to pay the tax you’re trying to avoid upfront and within 90 days. You may also face legal action if you do not pay the tax and National Insurance you owe, and in future you’ll be treated as a high-risk tax payer, facing closer inspection of your tax affairs in future.
What is tax evasion?
Tax evasion is an illegal activity which involves the non-payment of tax due on income or other proceeds. Tax evasion can involve the deliberate under-payment of taxes, reporting of illegitimate expenses, understating sales or failing to make payment for taxes due.
HMRC has issued the following guidance on how to identify tax avoidance schemes :
- It sounds too good to be true
- Pay is offered in the form of loans
- The benefits of the scheme seem out of proportion to the money being generated or the cost of the scheme to you. See our article 85% take-home pay? Don’t be fooled.
- The scheme involves money circulating and ending where it started.
- HMRC has allocated a scheme reference number which indicates where HMRC has identified the arrangement as having the hallmarks of tax avoidance. Remember – having a DOTAS reference number is not a sign HMRC ‘approve’ the scheme.
It is not difficult to work compliantly as a contractor. Our main piece of advice would be to avoid complicated schemes where money doesn’t simply flow from the engager to your recruitment agency to your Umbrella company (if using) and on to you, the worker.
It would not be a sufficient defence to blame the organisation running the scheme, even if they have assured you they are compliant. By law, it’s your responsibility to pay HMRC what you owe.
The best way to protect yourself as a limited company contractor or Umbrella contractor is to choose an FCSA-accredited contractor accountant like JSA. We have deep knowledge and experience of the rules and regulations which govern flexible working. Our procedures are inspected regularly by independent inspectors, enabling us to maintain our FCSA accredited status which provides assurance to recruiters and contractors alike.