Newbie - Becoming a contractor midway through a tax year.

[Clare@InTouch]

Thanks Guys and Girls, and northernladuk.

Reassuring to know, I wondered whether it would be considered tax avoidance or whether there was a minimum salary that must be paid to keep HMRC happy.

Thanks Clare regarding the advise to keep profit within the company and then liquidate, I'd not considered this. Does this offer tax advantages over drawing dividends, so in theory you can withdraw the profit by liquidating every 5 years or something? (Will search the forums now...)

As NLUK says you have to be careful about pheonixing, so it's not a regular business plan method.

If you stick to dividends up to higher rates through the year then there will be no personal tax to pay (you'll still have CT of course, but you can reduce that via expenses and pensions).

When you liquidate you'll get the benefit of Entrepreneur's Relief and your annual CGT exemption, taking the tax rate below 10%. A higher rate dividend would have been 25%, with additional rate dividends being even higher.

Of course you could avoid personal tax entirely by leaving the company open and paying dividends up to the higher rate limit for years afterwards, but that only works if you have no other income and time on your hands (for example if you retire).

[danny13]

Some great advice, and plenty to think about, but I think malvolio is right.....I better not get carried away just yet although I guess I had totally overlooked what my long term exit strategy might be.

I'll wait until I get some money coming in and have gasped the basics as they are certainly complex enough!

Thanks again forumites

[Old Greg]

Some great advice, and plenty to think about, but I think malvolio is right.....I better not get carried away just yet although I guess I had totally overlooked what my long term exit strategy might be.

I'll wait until I get some money coming in and have gasped the basics as they are certainly complex enough!

Thanks again forumites

Well... see what your accountant says.

[Wanderer]

I'm about to land my first contract following taking a redundancy as a permie back in June. As a permie with my pay off I earnt just short of the higher tax bracket.

Don't be so sure of that. I think there are some odd rules around redundancy payments being tax free up to a certain level so you may still have some lower rate tax allowance that you should use up this year.

You are on the right track but don't go making assumptions, get yourself engaged with an accountant and ask them to review your P60 and the amount of the payoff and advise you how to proceed based on a detailed review of your actual circumstances.

Accountants do cost money but you are going to need one for the end of the year anyway. And remember that if you fail to use up your full tax allowance this year (or make some other noobie mistake) then that's going to cost you extra tax in the long run.....

[danny13]

You're right Wanderer, I received an ex-gratia payment which is tax free up to £30k, I excluded this from my consideration. The rest of my package, prorated holiday, 3 months paid notice, benefits etc will all be subject to tax. Basically my P45 states how much I earnt and how much tax I paid, this was just below the upper tax threshold.

It seems that generally (from my forum research) people claim a salary of within their personal allowance and then rather than pay any low rate income tax at 20% extract the rest via dividends? But you are right I need to talk it all through with my accountant.

[Wanderer]

You're right Wanderer, I received an ex-gratia payment which is tax free up to £30k, I excluded this from my consideration.

OK, you're on it then.

It seems that generally (from my forum research) people claim a salary of within their personal allowance and then rather than pay any low rate income tax at 20% extract the rest via dividends?

Yes, take a salary of £7696 or £641.33 per month and the rest as dividends up to the higher rate limit. Watch out for the goofy way that dividends are calculated too, a dividend of (say) £10,000 paid to you actually counts as £11,111 of income against your allowance. If you are married and your spouse doesn't work then you can potentially pay salary and dividends to them too.

Lots of people try to avoid becoming a higher rate tax payer because it will leave you with an additional tax bill when you do your self assessment and then the year after you may need to make a "payment on account" based on the predicted tax due.

You can then extract the retained cash from the company in a lean year or as a capital distribution a few years down the line if it goes really well and you decide to shut the company.

Good luck.

[ASB]

Possible fly in the ointment regarding payment of zero salary is nmw. It is unlikely to be relevant if you are a director unless you have a service contract.