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 thought I'd just update everyone that I will be discussing the matter with my local MP who is on the BIS select committee at some point in the next couple of weeks, so if you have any views or feedback on the issue please don't hold back and I'll do my best to present them.
Also, in terms of practical measures that could potentially be taken, what do people think about the idea of a 'CIC credit' that would mirror the existing 'dividend credit' which benefits standard ltd co directors? It could be set at anything between say 10-30% on director earnings below £35,000, depending on the cost and the level of political will to support people starting and growing CICs.
Limiting (or tapering) the relief to earnings below £35,000 would provide an incentive against CIC directors paying themselves excessive salaries, at the same time as making it much more economically sensible for people to start a CIC.
A relief of 25% would more or less even up the 'real' tax burden between director-employees of small CICs and director-employees of standard Ltd cos.
Such a credit could also be limited to founding directors or to a particular number of directors for each CIC (perhaps depending on the size of the CIC) to avoid it being exploited.
As well raising the profile of CICs and hopefully encouraging more people to start one, such a measure might also reduce a considerable amount of expenditure by HMRC chasing IR35 issues, if the advice I was given about being a self-employed consultant to my own CIC wasn't exceptional.
I would really appreciate any support, criticisms, or potential alternatives that anyone has to offer?
Please ask the MP to take an interest in the dividend cap review, if he supported a particular recommendation it would help us raise the profile of the debate when the review starts. Its a built in opportunity to make a change in this area, and give a strong boost to inward investment into CICs.
I think a CIC credit would be viewed as extra complexity, why not simply be able to utilise the existing dividend credit. Govt have an approach of simplification which this would go against. I also suggest in political reality it wouldnt go down well in an environment where tax avoidance is a heated issue. I know that in many senses the two have nothing to do with each other but my own experience in 'engaging with the process' can see quite a few banana skins for this suggestion.
Would appreciate an update after your meeting and id be happy to meet with your MP should he find us of interest.
Hi John, thanks for that.
I agree that it would be an extra complexity and pragmatically that may well end up being the deciding issue; but it would not be hugely difficult to implement and it could be the least complex way of righting something that is currently manifestly balanced against CICs. There are a number of other ways through which a similar outcome could be reached, but all of them would involve some level of greater complexity.
I will certainly mention the dividend cap review, as I agree that it could be a potentially useful way of bringing in more investment.
The obvious issue regarding using only the existing dividend credit is that the majority of CICs are CLG not CLS.
Such a move would also create a new imbalance (this time between CLGs and CLSs) and necessitate a discussion about the role of each structure moving forward. Could such a move put us in a position where grant making bodies decide to fund CLGs only and not CLSs? (Having the two different structures take on more distinct roles may not be a bad thing, but it would have to be done with eyes fully open to the implications).
I'm very interested to hear about the experience you've had so far discussing these sorts of matters and the reactions you've had from decision-makers. - I really hadn't considered that any tax avoidance charges might/could be leveled at the proposals I've outlined. Personally, i believe there is a good case for offering tax incentives to people setting up enterprises who choose to operate as CICs, given the social benefit of their work and that they can't profit from a sale.
All I'm really suggesting in this instance though is a measure that would go some way (to a greater or lesser extent depending on cost and political will), to create a more level playing field between directors of CICs and directors of ltd cos.
In actual fact, such a measure would most likely reduce any avoidance efforts by CIC directors who cannot countenance (or afford) paying 45.8% over £7,500, who currently declare themselves self-employed consultants.
Perhaps even less controversial would be to exempt the founding (or a small number) of CIC directors from paying Employers' NI on their income from their own CIC up to a certain level (again I would suggest £35,000).
The fundamental issue here is that most people I've spoken to about what I'm doing and CICs in general think you must have to be borderline insane to deliberately set out to start an enterprise from scratch (with all the hard work, blood, sweat and tears that usually involves), using a structure where you pay more than twice as much tax for what is essentially the pleasure of not being able to profit from the sale of the enterprise or the assets that you create.
Such a view is a caricature and doesn't take into account that a major motivating factor is to do something socially constructive and useful, but goodwill alone (no matter how much one has) will not pay the bills.
Perhaps I'm a little naive or others a little jaundiced (or both), but I don't really understand why this issue hasn't been raised more prominently before. People I've spoken to who know nothing about CICs are outraged by the current state of affairs.
Thank you very much for such a detailed reply!
I spoke to a specialist at HMRC today who basically confirms what you say unfortunately.
The upshot is indeed that unless you can make some sort of alternative arrangement re self-employment or through a service company (potentially dodgy ground), the marginal rate over about £7,500 is 45.8%. I should point out that my earlier working that NI starts at about £5300 was wrong and the actual threshold for both Ee and Er NI is about £7000, but it doesn't make a huge difference.
You're also correct to highlight that this is the marginal rate and that below £7,000ish no tax is due, and this should therefore be taken into account when working out your own effective tax rate.
It seems that the fact remains though, that unless you engage in relatively complex (and potentially risky) avoidance/efficiency strategies, social entrepreneurs operating through CICs are at a distinct disadvantage to people using traditional Ltd Cos, from a tax perspective. I always knew that CICs didn't get any extra breaks, but had no idea they were so inefficient for a small/start-up enterprise where the director/s are the main employee/s.
I really can't believe that this issue hasn't been raised more widely before - I understand your point about the problem with lobbying to get it changed in relation to standard Ltd Cos; but there does seem to a pretty big perverse incentive at work here against operating as a CIC, when you would think that the emphasis should be on encouraging existing businesses and potential start-ups to become CICs.
For ourselves, we think we can probably sort something out as our directors are all already self-employed in the same sort of line of work, and that being a CIC is so integral to what we want to do that the benefits most likely outweigh the extra hassle (and possible expense).
This obviously won't be the case for everyone and I think we should as CICs try to help ensure potential start-ups are aware of the tax implications of operating as a CIC, and that we should try and explain to Government that there is a perverse incentive at work here that is far from helpful.
In the short term, I believe there is still a 1 year 'holiday' on employers' NI for new businesses taking on up to their first 10 employees, which should take the sting out of things for anyone starting out, but longer terms solutions really do have to be looked at if CICs as a structure are to deliver on their promise.
I'd still be really interested to hear from any experienced CIC directors about their experience so far too.
Thank you all for you comments, which confirm what I have just discovered. I have three employment contracts and will be consulting/ lecturing on sustainability outside these contracts so I am starting a company for this aspect of my work.
I wanted to set up as a CIC but to do so means on 17,000 income you would pay c.£1200 more in tax (assuming 7457 taken as salary and 1500 expenses) versus a standard limited company or indeed being self-employed. For those who already feel running a business for social purpose not profit is crazy - this would seems to add much weight to their judgment.
For those small set ups like mine we should consider how much more social investment could take place if everyone transferred to a standard Ltd company and used the tax savings for their social purpose (or KIVA for example).
If the regulators do not act on this then maybe we should create a call for this 'boycott' to happen and that might push the agenda!
Although there is of course the central issue of limiting how much profit is used for 'selfish' ends, at the moment there is nothing to stop the CLG or CLS 'one person set ups' deciding to paying themselves all the earnings (or profit however you see it) as a massive salary.
I cannot justify the extra tax to myself (as much as I support the use of taxes) and so am going to set up as a normal company and include clauses that demonstrate my social purpose and commitment to reinvest in my purpose above a certain salary level. This equates somewhat to what has been suggested above re making a tax break for Directors below a certain salary level e.g. £35,000.
I am sad that this means I will be out of the CIC club (and there must be many like me that would like to grow the sector from inside) but will have to wait until changes are made that create the level playing field needed.
I wish I'd realised this before I set up a CIC! However, it is academic at the moment, as the income from the CIC is still very low and doesn't cover costs let alone salaries. I hope that this problem is sorted out before it will directly affect Move4words.
Like you, I support the use of Taxes to distribute wealth and support those in need and am not after a large salary. But as it stands, the CIC will have to charge customers considerably more for the same product than it would if it were a standard Ltd. Not right, surely!