Is Going Permanent Tax Efficient for Contractors?

Tax

You’ve been offered a permanent role on a salary you think is too good to be true…what do you do? Well for many, the lure of the apparent big salary is not enough to make them turn their back on their established brand, the autonomy and freedom they have enjoyed as a contractor. But if you find yourself considering this option there are a few financial implications to consider…

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There are two really valuable tax advantages of contracting through your Limited company.

These are:-

  • the ability to be strategic about how much you pay yourself, minimising your tax liabilities and
  • You can pay little or no Ni depending on how you structure your take home money

Go “permy” and you lose these advantages so you need to be certain the proposed salary doesn’t leave you out of pocket (irrespective of considering the other implications of returning to employment and all that that entails).

How does contracting compare with going permanent?

Let’s look at a case study. John, an IT contractor, has been in contract for a while at a private sector end client, operating outside IR35. His day rate is £350 but he has recently been looking for a new challenge and a recruitment agent has put him forward for a permanent role. John is struggling with the whole idea of returning to employment but he is interested to see what sort of salary he would need to earn to at least make sure he was not financially disadvantaged,

John currently takes home around £5,100 per month. This is based on his ability to undertake strategic tax planning and the following assumptions:-

  • Minimal salary drawn of £8,424 and all remaining monies drawn as dividends
  • Not VAT registered
  • Expenses £250 per month
  • Tax code 1185L

Crunching the numbers, John would need to negotiate a salary of £92,600 gross per annum, in order to take home similar sums as an employee. But let’s look a little further.  It’s rare that an offer of employment neatly occurs at the start of a new tax year and you can find yourself with an unexpected tax bill if your jump ship and become permanent mid tax year.

Let’s assume John has been offered this new role from 1 October 2018. He’s already undertaken his tax planning with the guidance of his accountant and taken a salary of £4,212 to date and dividends of £24,000. The first £2,000 of dividends is tax free and at the time of deciding his strategy, he was correctly advised that the dividends would attract tax at the basic rate of 7.5%, costing him around £1,500.

Dividends are always treated as the “top slice” of a contractor’s income so throw the new permanent salary into the mix and the £24,000 dividends suddenly move into the higher rate tax bracket, attracting tax at 32.5% and a tax bill of approximately £6,500. That’s an unexpected tax bill of £5,000!

The financial implications don’t stop there.

If you decided to go permanent what do you do with your company? Close it down or leave it dormant?

Closing your company down may free you from the administration that goes along with the running of a company, but it will then be gone forever if you decided a permanent role is not for you or your probation period does not work out. If you leave your company open, but non trading, you will need to submit dormant accounts and an annual confirmation statement but you could pick straight back up again if the permanent role does not work out.

Closing your company will mean you would need to de-register from VAT and PAYE. You will need to settle all your company debts in relation to these taxes and any outer outstanding amounts, perhaps earlier than they might otherwise have been due. You will need to consider the cashflow implications of this.

You will also need to decide what to do with any cash reserves in your company at the date of closure. You can take out all the final funds in one go – this may or may not be advantageous. If you have up to £25,000 in the company and you are a higher rate tax payer, you can take the funds as a capital distribution and potentially pay only 10% tax on these funds through Entrepreneurs Relief. Better still the first £11,700 (18/19) of gain is tax free assuming you have no other capital gains in the year.

If your reserves are in excess of £25,000 you may still be able to take advantage of the capital distribution route and Entrepreneurs relief but you will need to appoint a formal liquidator to administer the Members Voluntary Liquidation and there will be costs involved.

Deciding to go back to permanent employment is a big decision. There are financial and non-financial factors to balance when coming to a decision. As an OrangeGenie Accountancy client you should always let your accountant know if you are considering a move to permanent, we can make sure you have considered all the hidden costs and make sure all angles have been considered.

If you have questions about this issue or if we can help in any way please call our expert team on 01296 468483 or email info@orangegenie.com

 

 

 

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