As a small, fairly new, Community Interest Company Limited by Guarantee, some of our directors are likely to be the main people doing the day-to-day work for a while. Do they have to be classed as employees for tax purposes for them to take a wage? If they do, it looks like we/they will be paying over 45% tax in total over £7,475, which just doesn't seem right but I can't find out how else it would work.
To explain what I mean I'll use the simplest example I can think of:
A CIC limited by guarantee that had one director as the sole employee driving it forward, if they wished to take a wage, would have to pay 13.8% Employers' NI and 12% Employee's NI over £5,300 and 20% Basic rate Income tax over £7,475. Basically, more than 45% for anything over £7,475.
Someone in exactly the same position but with a standard Ltd Company would not in essence pay over 45% from £7,475, as far as I understand. They would most likely take a dividend after corporation tax instead, so avoiding most of the NI? This isn't an option for a CIC ltd by guarantee, so I was wondering if there was an alternative tax arrangement?
I've just spoken to a local Social Enterprise support organisation and am now even more confused, as what they suggested seems like it might actually be evasion. They suggested the directors should charge the CIC for work done as some kind of self employed consultants. The tax due would definitely be less that way, but it sounds like bad advice?
I'd love to hear from anyone whose been trading for a while and what you did, because I'm sure I've got the wrong end of the stick somewhere here and that there is a relatively simple solution somewhere but I can't seem to find any solid information.
Many thanks for any help anyone can offer!
I'm very interested to hear what anyone else has to say on this issue, as I set up a CIC( providing a very effective school programme to help children improve literacy) with myself as the sole active worker and director, and have just got past the early development stage so that income is starting to be generated. I'm about to register for PAYE, but haven't got as far as working out the tax liability.
If you are right, then the situation is horrendous!
We work so hard to help the community, but there seems to be very little give the other way. Most grants are denied us because of our CIC status versus charity, but I can't do this for nothing!
I join Joseph in asking for advice!
I'll wait for others to discuss the particular figures and what needs to be done, but I would be concerned if that was the advice being given. Would it make sense to ask them to contribute to this discussion? I would like to understand and confirm exactly what they have recommended.
Yes, it certainly didn't seem correct to me either. Absolutely, it was the Social Enterprise Support Centre in Leeds that gave the advice over the phone (I'm afraid I didn't get a name but they conferred with a colleague about it, so it wasn't completely off the cuff). I'm not sure if they're already a member on here somewhere and can be added to the conversation maybe?
The advice from the local SE Support Org is a bit close to dodgy. An individual could in theory split the money they receive as Director away from that they receive for the day-to-day work, and in theory if they also do this same day-to-day work for other organisations they could argue that this part of their income is self-employment. There is a discussion around electricians and wind turbines elsewhere on this forum on this.
However, I would suggest that the money for holding the office of Director cannot be self-employed. A Director is an officer of the company, he cannot send a substitute person to be his stand-in when they are ill, it is employment. Although I bet that there are many Non-Exec Directors of plc's who do charge as self-employed in this manner and get away with it.
If you wanted to try it you would need to advertise yourself as a Director / Consultant to similar firms (preferably acually be hired by similar firms), have business cards in your own right, genuinely be in business in your own right. You'd also need to in theory be able to send a substitute to do the work for you at the CIC.
As to the wider question, Yes a normal company could choose to reduce salary payments and pay dividends to owner-managers instead. This is something done regularly. However even those doing this would normally pay a nominal salary so as to have a fully paid up NI record and all the wonderful life-fulfilling Pension this will give them from the State when they retire. Yes, I am being a little sarcastic.
[Don't bother getting all excited about lobbying to have this changed. Look at the wider picture and you will appreciate that the problem here is that normal companies can do this, not that CICs cannot. And they won't change it for normal companies, as that premise is based on wider aspects of the tax system (the general rules for dividends from listed companies and company taxation etc). Charities face the exact same tax situation as a CIC in this regard.]
I haven't checked the exact figures, but do remember that the 45% quoted above is the marginal rate not the rate paid on the full amount. The first £7,475 is still tax free, it is only the excess that is taxed. Remember that both the Ee's and Er's NI reduces once you earn lots of money - check out http://www.hmrc.gov.uk/rates/nic.htm sadly they use weekly rates but you'll work it out.
How to avoid it? There isn't much you can do.
All of these will save you p's not £'s. The biggest saver is to go self-employed but unless you are going to actively market yourself to other companies in a similar capacity you will struggle to justify this to HMRC. And you would probably need to pay a small amount as Employment Income for the office of Director anyway.
Really helpful detailed advice by Alastair, thanks.
The CIC only is liable for the Employers NIC contributions (at 13.8%), not the personal tax and NI contributions, so the liability for the CIC is not anywhere as onerous as Joseph is thinking. Whatever source you get your income from, then the 32% combined Tax and NI has to come out anyway (subject to the relevant thresholds etc).
I don't want to spoil your night! - and really hope I have got something wrong here, but after my discussions with HMRC today I've been taking a look at the various numbers tonight and I don't think I have - and the situation is actually relatively even more onerous than I previously thought, compared to a standard limited company.
I'll try to explain what I mean as best I can, but please feel free to tell me I'm talking rubbish if it doesn't make sense!
Yes, you're definitely correct that technically only the Employers' NI is borne by the CIC as an entity, but with small CICs like our own that are unlikely to generate large surplus profits once wages are taken into consideration, the distinction between what is borne by the CIC and what is borne by the director/employee is pretty limited in practice.
Also, I'm afraid even the 32% technically borne by the individual would be unlikely to do be paid in either a self employed or standard Ltd Co situation.
Self employed people pay 9% NI over the threshold plus a couple of pounds a week (and there's no employers' NI to consider) so what might be termed the 'real' marginal rate is roughly 29-31% as opposed to 45.8%. Perhaps more importantly, the self employed can also directly make use of capital allowances and claim back losses against tax, which is important because tax is paid on profits, not necessarily what is drawn as salary directly, and the business (and/or assets - which can of course be bought using the capital allowance of £50,000 pa) can be sold on (admittedly subject to CGT over £10,000 at 18%).
In the case of a standard Ltd Company director/employee, they would be likely to only pay themselves, as Alastair suggests, just over the NI threshold to keep up their contributions. The rest would be taken in dividends from profits after corporation tax. Corporation tax (up to £300,000 profit) is 20% and you can take up to £35,000 in dividends without paying any sort of dividend or income tax on it because of the dividend tax credit. The 'real' tax rate then up to £35,000 would be less than 20% (as £7,000ish has been taken as below threshold pay). The same annual capital allowances and 18% CGT on sale of business as with self-employed would also apply.
I'm certainly no accountant so may have got some of this wrong, but essentially it seems that someone in your position as a sole director/employee, but of a standard limited company rather than a CIC, would between what is technically borne by the company and what is technically borne by the individual, pay 20% marginal tax on earnings up to £35,000. It seems that in your actual situation as a sole director/employee of a CIC, between what is technically borne by the CIC and what is technically borne by you as an employee, the real marginal rate is 45.8% - more than double.
As I mentioned in my reply to Alastair, the 'good' news in the short-term is that there is a 1 year employer's NI holiday at the moment for new businesses (I'm assuming this includes CICs), so for now we're back to the 32%, which although hardly great, is at least manageable. Longer term, I think Government has to look seriously at the tax issue and at least try and create a more level playing field to incentivise more people to start CICs rather than standard limited companies.
I worked for a short while for an MP who is now on the Business, Innovation and Skills select committee, who I'm sure would be happy to take a look at the issue, but I'd really appreciate it if someone with more knowledge about these things could just take a look over those figures before I get in touch please!
Over 70% of CICs are CLG so this does not apply to them, but it is one of a number of issues that effect the Share CIC.
You'll likely be interested in the discussion here http://cicassoc.ning.com/group/cicshareissues/forum/topics/regulato... , as you'll see No2 and 3 alternate suggestion would allow for payment via dividend as is the case for normal companies, Id welcome your opinion. I doubt we'll be able to build the case for such a decision in time for this review, but I did want to throw it out there to see if it had legs medium term, it would make the whole thing a lot simpler if we wanted to go that way. Anecdotal situation so far is that recommendation 3 (20%) is very popular among most stakeholders.
Please do take this issue forward with your MP, there is a lot of positive ground to be made on these issues and one of the key opportunities is the upcoming Regulators review of the caps, Ive written to Mr Cable and Mr Lamb on recommendation 1 specifically as I believe it is the very least we should do (and this is the framework to agree to do it, it would still be unlikely to be in place until 2014 at the earliest) and would be happy to talk more about other issues that may interest him.
I'll definitely raise the issue and I know the Regulator would welcome any direct opinion you wish to provide. All being well the consultation should I believe start in earnest in late APR/May but dont let that stop you making ground.
Couple these tweaks with the changes that are coming in the Finance Bill 2012 and we'll have a surge of growth in community activism coupled with a boon retail social investment. driving real growth and community empowerment.
I'd like to add my comment that Recommendation 3 is my preferred option, relating to the discussion you alluded to above. It does sound a much simpler approach to the current situation.
When is the upcoming Regulator's review of the caps which you mention above?
Starts late APR - early MAY for approx 12 weeks, there is a technical panel meeting on March 20th after which i'll be able to message the network with details.
Thanks for that.
I've just read through the discussion and there's some interesting stuff there. The social investment (equity/dividends) side of things isn't really something I've looked at much before. My initial reaction is that I think option 3 is probably best on balance; but I would be concerned about any changes that might impact on the willingness of grant-making bodies to work with CICs (as the post by the gentleman at the end suggests it potentially might), and I think they would definitely have to be sounded out before any changes.
Equity investment is certainly one aspect that could help some CICs grow and prosper, but as you say the vast majority are CLG and I suspect that even many of those that are CLS are quite small and would have resource/knowledge problems in preparing a demonstration of credible investment readiness (though this is of course something that can be also be helped potentially).
Assuming the understanding of the director/employee tax situation I outlined above is correct, I think a far greater barrier to growth in the number of quality CICs is tax.
With the best will in the world, for most socially-minded people considering starting a new business and considering operating as a CIC, while they may actively support features like the asset lock, they do still need to feel that they can at least earn a decent income for their hard work (not to mention the risk and time inherent in any new enterprise).
I really don't mean anything excessive - personally I would be very happy if we got to a position where we could take something roughly around the average income (assuming it was taxed at the average rate too!). More experienced and qualified people (of the type who would be of great benefit to CICs) could hardly be criticised if they would expect a bit more - say £35,000 for the sake of ease.
If such a person decided to set up a CIC as a sole director/employee they would need to also generate enough to pay over £12,300 tax. (35000-7500 allowance) / 100 x 45.
If they decided to set-up a standard limited company as the sole director/employee, they would only need to generate an extra £5,500 for the tax in order to take home £35,000.
This is clearly a massive disincentive - the only way the extra can be generated for most people is by charging more (not generally very ethical, nor good business), or doing more hours (probably not really an option, as most people setting up small businesses tend to work very hard already).
The psychological/theoretical impact of paying 45.8% tax from such a low base is also probably even more damaging than the reality, in terms of disincentivising people from starting or growing a CIC.
From a political perspective, I think perhaps something could be done here. Some kind of CIC credit that leveled the playing field a bit wouldn't be hugely difficult to administer, and wouldn't cost very much at all ( it may even generate/save more tax if it encouraged more people to start and grow CICs).
It would certainly be a relatively very cheap PR coup for any Government trying to look serious about encouraging Social Enterprise. With the current lot, it could easily be packaged together with a few other bits and pieces to be presented as supporting the flagging Big Society strategy.
You obviously have a lot more experience of this sort of thing John, what do you (or anyone else for that matter) think?
I can honestly totally understand where you are coming from Joseph, however you're at the top of a very slippery slope.
If we effectively allow CIC employees lower rates on their salaries, what about employees of charities? They're (mostly) doing good social work.
And then what about employees of Government itself - pretty much every Civil Servant is ultimately in the business of providing for society should they all have lower rates of tax on pay?
And (now being slightly cheeky) RBS is effectively a Government department providing socially useful finance facilities perhaps all those Bankers should pay lower rates on their bonuses!!?!
I definitely take the point. Personally, I would probably argue there is a case for lower NI for employees working in CICs and charities given the social benefit of their work. As regards the public sector, any required incentives would be likely to be more efficiently delivered through pay and benefits packages, rather than a more complex tax code. I'm not entirely sure it would be constructive for me to comment on my thoughts about Mr Hester's tax arrangements!
The point I'm really making though isn't about all employees of CICs, but the anomaly that seems to exist between the amount of tax paid by director-employees of CICs, and the amount paid by director-employees of standard ltd cos. Any changes would be limited to these people - the easiest would be to remove or reduce Employers' NI for director-employees of CICs. This would at least level things up a little bit and put director-employees of CICs on a level with most people re tax. More radical would be to increase the threshold of basic rate of income tax from £7,500 to £35,000 for director-employees of CICs to in effect put them more or less on a level with director-employees of standard ltd cos