This comes from:
Business owners earning £40k pay £4,500 less tax than employees, figures show.
With the 31 January self assessment deadline looming, a campaign group has highlighted statistics showing the ongoing unfair tax advantage available to self-employed business owners.
Figures from the Institute for Fiscal Studies (IFS) show that an employee earning £40,000 a year will pay £12,262 in tax. This is £4,556 more than a self-employed person who earns the same but has opted to incorporate as a self-employed company manager/owner. The overall rate of tax paid by self-employed manager/owners can be as low as 19%, far less than the 32% rate likely to be paid by an employee earning the same salary.
Robert Palmer, Executive Director of Tax Justice UK said: “At a time when people will be rushing to file their tax returns ahead of the self-assessment deadline, it seems unfair that a self-employed company owner can pay significantly less overall than someone doing the same job for the same wage, but as an employee of a company.”
In recent years the difference in tax between the employed and self-employed has regularly been highlighted by the Institute for Fiscal Studies (IFS) * and the Office for Budget for Responsibility (OBR) **.
Instead of paying employment income tax and national insurance, people who incorporate can pay income tax on dividends, which are wholly untaxed up to £2,000 and avoid national insurance contributions altogether, whereas a normal employee is liable for income tax and national insurance
Treasury takes a £3.5 billion hit, but the economic benefits are questionable
Despite self-employment being a significant driver of employment since 2008, the OBR predicts tax revenues will be £3.5 billion lower in 2021/22 as the rate of people incorporating grows faster than employment. Research by the IFS has shown that the number of owner managed businesses (one owner and manager) has increased by 600% to 300,000 since 2007/08. People working in ‘business services' make up by far the biggest proportion (30%) and owner managers earn up to 4.5 times more than others in self-employment. Meanwhile the share of these business owners investing, or employing others has dropped dramatically in recent years, according to the IFS research.
Mr Palmer said: “Self-employment has been a significant driver of overall employment in recent years, but the move from employment to self-employment can come at a cost in terms of overall tax revenue This reduces the money available to fund public services like health, housing and social care.
“The government needs to explain why owner managers are able to pay less tax and consider removing the tax difference between owner managers and those in other forms of employment, altogether.”
And this, of course, ignores the risk of fraud and non-payment because UK regulation of companies is so weak.
The question is, what to do? And will anyone do it?
I am an adviser to TJUK.
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Hi Richard,
In my younger days I took advantage of incorporating whilst working as an IT contractor – in fact the companies that I worked with insisted on it.
It seemed to me at the time that the easiest way to stop the abuse of the system, e.g. people paying themselves the minimum salary that counted for pension contributions (about £3,500 at the time?) and the rest as dividends would be to insist on a reasonable salary for the work being done. It would be impossible to hire someone to do an IT consultant job for £3,500 a year so this would be relatively easy to enforce.
In this way the correct amount would be liable for PAYE/NI and the “profit” over and above the salary could be taxed via corporation tax/dividends. This would then be the same situation as a larger business service company employing multiple employees.
The trickier part of this to regulate is the explosion in “gig” self-employment (non-incorporated) where the solution would seem to be equalizing the tax treatment of employed and self-employed and putting in place regulations to stop companies avoiding their responsibilities as employers by using this structure.
I suggested this a long time ago
I know plenty of people who have gone down this route to get around low paid jobs or just to try to better themselves.
All I hear is that the earnings that they were chasing were not there. Austerity has crept in to all the nooks and crannies of the economy and some people are trying to break into mature markets where low cost is beginning to dominate as the only means of competition. The lower tax obligation certainly helps those in this situation trying to get along in an economy denuded of base money. The lower taxes can be seen as an incentive for people to do this in the first place.
But why does the Government insist on foregoing tax, when if it renounced austerity and actually invested in the economy through GQE or other infrastructure investment, earnings might very well go up and so might the tax take from an invigorated economy?
I’d rather see an investment state than a low tax state. Wouldn’t you?
BTW – expect a long tirade of ‘trickle down’ response to this post.
I’ve heard the ‘trickle down’ theory called the horse s**t theory. It runs thus – feed a horse enough oats and some will eventually be deposited on the road for the birds to eat. I think the Pareto distribution theory has a stronger evidential base but seldom see it mentioned. I wonder why?
Because the assumptions underpinning it are absurd
Genuine self employed business owners ought to have the same access to tax efficiency as any company, director and shareholder.
They take the risk. They invest. They have no security as an employee does.
What can be done about it?
Marginal rates on dividends is about the only thing on that front.
Excluding indirect income from pension tax rebate would help.
Rewriting and simplifying tax is long overdue.
But I would rather see the genuine self employed succeed and start employing others in their venture – i’d say that is a better outcome than bashing the possible future employers.
It’s at the top end of earnings (of whatever ilk) that the billions can and should easily be recovered.
Whats wrong with ultimately charging 99.99% say on income (including interest) of over £10,000 a day, say? (Yes I am exaggerating).
Would people refuse to earn the first £100 a day to spite the state for taking most of their earnings at the top end? I think not.
Oh yes definitely worth it!
It keeps the unemployment figures down, makes the UK look like a nation of ‘entrepreneurs’, keeps the public sector payroll good and low (70% of my part of the civil service was self-employed from the chief exec down!), all the benefits of a ‘portfolio career’ (easy to hire and fire), generates support industries such as accountants (sorry!), agencies, insurance etc. What’s not to like?
I’m saying that I agree it is a good thing, just saying that is how it looks from this side of the fence having been there. The government must love it!
I suspect a significant element of the iniquity going on here is the employers who can take advantage of this differential to hire ostensibly freelance ’employees’ (often via agencies who of course get their cut too) and take a cut of the tax advantage.
I think it’s called ‘labour flexibility’.
There was, and probably still is, a great deal of this going on often in companies which are effectively outsourced government services.
Employees are encouraged by shorterm headline gains to give away all their erstwhile employment protection.
Spot on
This is supply side reform……
I think Richard has probably said it all in his Joy of Tax book, but I will say this:
My business partner and I run a two person company (XYZ Maps) and we do pay part salary and part dividend (which also goes to the 25% external minority shareholders). We have been poor for the last 20 years, unfortunately, so on about median earnings. However the saving on both individual and employer NIC does help us out quite a lot, though there is now more tax on the dividend than there was as until three years ago there was no tax for a basic rate taxpayer like both of us. Employers NI is a big drain if you pay salaries.
Now as to what should happen, then my view is:
There should be no Upper Earnings Limit (currently around £48k pa) on NI. It seems silly that somebody on £10k pa pays 12% while the person on £100k pays 2%.
What I pay to HMRC each month when doing the company PAYE return is actually significantly more NI than Income Tax. So for anyone on less than £40k pa NI is a much bigger tax (since it is 12% for the employee plus 13% for the employer) than is Income Tax. Most people have no idea of that since there is an obsession about Income Tax in the media, etc. Employers NI is a tax on employment which will, all other things being equal, reduce employment. In this day and age perhaps we should put the tax on robots instead.
All income should be taxed the same. I don’t see why there should be any distinction between Dividend Income, Interest Income or earned Income. At the moment we penalise Earned Income.
You would also need to look at ways to ensure that Income stays Income and does not get converted into Capital (where the tax is much lower). You have to be rich and with full control (as opposed to a normal employee) but e.g. the Duke of Westminster could pay a minimal salary or dividend and convert the rest of the ‘income’ into capital by keeping it in the estate and buying ‘things’.
Don’t forget the “partners” in law firms and the like, many of whom have little or no say in how the firm is managed and little or no equity in the firm. Their profit share is largely fixed and looks much more like a salary plus variable bonus than a genuine share in profits. The truth is they’re not really “partners” in any meaningful sense. They’re much more like middle/high ranking employees. They’re only “partners” in the sense that Class 4 NIC rather than Class 1 applies.
Some of them actually are on PAYE
A few years ago I worked for an accountancy firm catering to one man companies. Clients were sold the idea of more take home pay.
Part of that tax advantage was swallowed by our high accountancy fees, sometimes all of it, and they also had the burden of learning bookkeeping and comply with regulations.
There was rarely any sign of real entrepreneurship with most firms only having a single “customer” at a time.
If there was no tax incentive, HMRC would have received more tax revenue since it wouldn’t have become my employers profit and most of those IT contractors, etc, would have wanted employment rights and protections instead.
I agree…
In many cases the client was conned
Well over 20 years ago I wrote an article for Accountancy Age called ‘Don’t limit the small business’ for precisely that reason
There are a lot of good comments here about the ‘gig economy’ and fake freelance abuses where employees are required to pretend that they are small businesses.
Other countries have strong rules with fairly simple principles that are now being used to bring these abuses into check. In Australia the tax office has a rule which basically ensures that anyone who receives more than 80% of their income from the one “client” is an employee not a business.
The industrial relations system there has quite recently found that some of the uniform-wearing, tightly controlled servants of the gig economy are in effect employees and entitled to employees rights and conditions. As a result Foodora has been prosecuted, is being sued and has now fled the country . More cases are expected to follow.
https://www.businessinsider.com.au/foodora-is-being-sued-by-the-employment-watchdog-for-alleged-sham-contracts-2018-6
https://www.theguardian.com/business/2018/nov/16/foodora-riders-ask-government-to-sue-german-parent-over-unpaid-wages
The only difficulty with that rule is a start up
But it has merit….
I have argued the top ten customers of all businesses should be disclosed to HMRC
They could then decide where they thought there was abuse
It’s really not hard….
I don’t see this as a problem. It is easy to compare an employee on £40,000 a year with a self-employed person earning the same but in reality most self-employed people earn 20-30% less for the same work as their employed counterparts.
Add the risk (often personal liability for loans even if incorporated), lack of security and benefits and the ‘extra’ tax paid by the employee is the cost of being largely risk free.
Add the incentive that (admittedly a few) some self employed earn significantly more than they would as employees and pay much higher tax and I think overall this disparity in the tax that is paid is about right.
From a different perspective it can also be seen that the lower tax rate encourages and partly facilitates the underpayment of sham contractors.