Company SIPP contribution - effective tax savings?

[acferrad]

I am a contractor outside of IR35. I am trying to determine the tax savings if the company contributes to my SIPP.

Say the company makes £100,000 net (after expenses + paye payment). Corporate tax would be £20,000. I would take the balance of £80,000 as a dividend. As £32,000 is free of dividend tax, I would pay £10,800 dividend tax (22.5% of £48,000). Total tax payable = £20,000 + £10,800 = £30,800.

Now say the company makes a contribution of £10,000 to the SIPP:

Net is now £90,000. Corporate tax is 20% or £18,000. Dividends to me is £90,000 - £18,000 = £72,000. 22.5% dividend tax on (£72,000-£32,000) = £9,000. Total tax = £18,000 + £9,000 = £27,000. So Tax savings = £3,800 on a SIPP contribution of £10,000 = 38%

Let me know if this is correct: a 38% tax savings.

[Clare@InTouch]

I'm not sure about some of your calculations, or that you're being as tax efficient as possible.

£100,000 net, does that include any wages?

How do you get £32,000 tax free dividends? Or the tax on the overall £80,000 in dividends.

Say you have a normal tax allowance, then you can earn £41,450 before higher rates. If you're taking a salary of £7,692 then you have £33,758 left of your basic rate band. That's gross dividends though, so you need to divide by 10 and multiply by 9 to get the net. So that becomes £30,382.

Total net dividends of £80,000 therefore leaves £49,618 in higher rates. That would give a tax liability of 25% of the net (which equates to 22.5% of the gross) = £12,405.

CT of 20% plus the higher rate dividend tax = £32,405.

If you had instead moved £10,000 into a SIPP then you would save 20% CT on that, so £2,000, and 25% higher dividend tax, so £2,500. Saving £4,500 in overall tax. But that's only if the option would be to pay into a SIPP or take the dividend and spend it on chocolate. If you take the dividend but pay into the SIPP personally then your basic rate tax band increases, so there's tax relief personally that way, so not quite the £4,500 gain. It can get quite complex.

You could of course save more tax by simply not emptying the company entirely each year, and saving the funds with a view to closing down in a few years time via a liquidation. The tax on a final distribution would then be under 10% (Entrepreneur's Relief plus annual CGT exemption) which is 15% better than the higher rate dividend would be.

[Smartie]

I've been thinking about similar things, however I wonder whether 'entrepeneur's relief' will still be around in 10 or 15 years time. I guess you could say the same thing about pensions, but I think it's less likely that they'll be abolished.

[Martin at NixonWilliams]

I am a contractor outside of IR35. I am trying to determine the tax savings if the company contributes to my SIPP.

Say the company makes £100,000 net (after expenses + paye payment). Corporate tax would be £20,000. I would take the balance of £80,000 as a dividend. As £32,000 is free of dividend tax, I would pay £10,800 dividend tax (22.5% of £48,000). Total tax payable = £20,000 + £10,800 = £30,800.

Now say the company makes a contribution of £10,000 to the SIPP:

Net is now £90,000. Corporate tax is 20% or £18,000. Dividends to me is £90,000 - £18,000 = £72,000. 22.5% dividend tax on (£72,000-£32,000) = £9,000. Total tax = £18,000 + £9,000 = £27,000. So Tax savings = £3,800 on a SIPP contribution of £10,000 = 38%

Let me know if this is correct: a 38% tax savings.

You are forgetting your personal allowance of £9,440, this can be added to the basic rate tax threshold of £32,010 so you are looking at a threshold of £41,450 before you pay additional tax on your dividends.

As Clare says, dividends are declared net, so any dividend declared from your company must be mulitiplied by 100/90 to determine your gross pay for tax purposes.

Most contractors operating outside of IR35 will pay a salary of £7,696 (or thereabouts). If you are paying this salary you have £30,378 available to take in net dividends ((£41,450 - £7,696) x 90/100). If you are not paying a salary, you have £37,305 available (41,450 x 90/100).

Note that you must also take into account other taxable income you have such as rental property income, pension income, bank interest etc.

You are reducing your company's profits by making the pension contribution, the saving is 20%. I don't think you can really call the lower income tax paid on the dividends a 'saving'. The lower tax is not a direct saving based on the pension contribution, it is lower because you don't have the funds there to pay the dividend which, as a result, has reduced your total take home pay aswell.

As a simple guide:
- Assuming you pay CT at 20%, any contribution you make will save CT tax at 20%.
- Any contribution made will reduce your distributable profits by 80% which, as a higher rate tax payer, means you would pay £2k less in additional tax on dividends if your intention is to take all of the profit.

Other points to note:
- Personal contributions can be slightly more tax efficient than company contributions, but the saving is only usually worthwhile if you are paying a salary.
- Your earnings are reasonably close to £100,000. Once your earnings exceed this amount you will begin to lose your personal allowance. If this becomes the case, personal contributions (subject to other conditions) will be more effective as you could save tax at an effective rate as high as 60%.
- There are annual and lifetime limits to consider, currently £50,000 (£40,000 from April 14) and £1.5m (£1.25m from April 14) respectively.

To summarise, it is not always as simple as it seems - It is my strong advice that you appoint an accountant if you have not done so already.

Martin

[ContractorsSpouse]

Regarding the comparison of company contribution vs personal contribution: here's how I see it, correct me if I'm wrong (as if you wouldn't):

Option 1: Use the company contribution route.

£10,000 into a pension. No tax issues, you have a pension with £10,000 more in it.

Option 2: Use the profit/dividend/personal contribution route.

£10,000 profit, 20% CT deduction, gives you £8,000 in dividends in your pocket. 25% dividend higher rate tax would be £2000, leaves you with £6,000. Stick that in a pension as a personal contribution. You will then receive 25% basic rate tax relief as an additional contribution, giving you a pension with £7,500 more in it.

Assumptions: you will pay the higher rate dividend tax, you are a basic rate tax payer.

Not saying which of these you should do, or indeed whether you should do either

Hope this helps.

[jmo21]

£10,000 profit, 20% CT deduction, gives you £8,000 in dividends in your pocket.

You pay CT on your profit do you?

[Martin at NixonWilliams]

Regarding the comparison of company contribution vs personal contribution: here's how I see it, correct me if I'm wrong (as if you wouldn't):

Option 1: Use the company contribution route.

£10,000 into a pension. No tax issues, you have a pension with £10,000 more in it.

Option 2: Use the profit/dividend/personal contribution route.

£10,000 profit, 20% CT deduction, gives you £8,000 in dividends in your pocket. 25% dividend higher rate tax would be £2000, leaves you with £6,000. Stick that in a pension as a personal contribution. You will then receive 25% basic rate tax relief as an additional contribution, giving you a pension with £7,500 more in it.

A company contribution would always generate a 20% Corporation Tax saving - there is no effect on Income Tax unless the contribution is subject to a pension charge.

A personal contribution would not effect your Corporation Tax at all. Unless you have the disposable income available already, you would need to make a dividend payment of £8,000 to make a £10,000 contribution. There is no dividend tax to save as a result of the dividend as your basic rate band has been extended.

There are exceptions of course, but the two are very similar most of the time. For example, someone with income capped at £41,450 wanting to make a £10,000 gross contribution:

Personal contribution - Take an £8,000 dividend and pay it into a pension. The contribution is worth £10,000 as the contributions are paid net of the basic rate tax saving.

Company contribution - Pay £10,000, save £2,000 in Corporation Tax. The cost to the company is £8,000.

In each of the above cases the contribution has cost £8,000 and increases your pension pot by £10,000.

Assumptions: you will pay the higher rate dividend tax, you are a basic rate tax payer.

You can't be both!

[ContractorsSpouse]

You pay CT on your profit do you?

Taxable profit.

[ContractorsSpouse]

You can't be both!

Sorry, I meant that your salary was within the basic rate, but that your dividends would take you into the higher rate.

[Clare@InTouch]

I've been thinking about similar things, however I wonder whether 'entrepeneur's relief' will still be around in 10 or 15 years time. I guess you could say the same thing about pensions, but I think it's less likely that they'll be abolished.

I think you'd be reasonably safe to assume there would be something, or that you'd have time to close your company under the old rules before anything new kicked in. Before ER there was Taper Relief for example, and it took a while to fade out.