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Limited company vs. PAYE employee – the real tax differences

The press coverage of the current outcry over public sector figures working via their own personal service companies has resulted in many inaccurate tax claims being made by the media.

PAYE vs. Limited Company

Limited Company owners vs. PAYE employees – the real tax take

The most widely quoted error is that limited company workers pay a mere ‘20% tax’ compared to ‘40% tax’ paid by higher rate taxpayers who operate within the PAYE system. This is confusing the current rate of Corporation Tax with the higher rate of Income Tax. Some media even quote ‘21% tax’, which was the previous rate of Corporation Tax before April 2012.

In reality, limited companies pay Corporation Tax on their profits, and shareholders pay Income Tax on any salaries they receive, plus Dividend Tax on the dividends they draw down from their companies.

The main savings come in the form of National Insurance Contributions, which are not payable on dividends. If a limited company director pays him/herself a salary which falls below the prevailing NIC threshold, then no Employees’ National Insurance payments need be made at all.

This point is highlighted in a viewpoint on the BBC site by Chas Roy-Chowdhury Head of taxation, ACCA.

The post demonstrates that a limited company director on £200,000 per year would actually be liable for a higher level of combined tax (Corporation Tax + Income Tax) than a PAYE employee on the same gross income (paying Income Tax + NICs).

However, the Employers’ National Insurance savings be made by a so-called ‘personal service company’ are considerable. In the above example, the Employers’ NIC savings for a limited company are over £26,000.

Of course, this entire article assumes that the limited company employee is not caught by IR35.

Other limited company benefits

Aside from the National Insurance savings, limited company owners also derive further benefits which are unavailable to traditional employees, however, the value of these ‘benefits’ is counterbalanced by the considerable risks many small businesses make, and the lack of job security.

  • Limited company owners can use tax planning to minimise their tax liabilities, e.g. holding off paying a dividend in the current tax year in order to make use of tax allowances in subsequent years.
  • Company shares can also be split with spouses, which can be particularly tax efficient if the spouse has no other source of income.
  • The Flat Rate VAT scheme will also benefit the majority of professional service companies – and includes a 1% discount on the fixed rate during the first year.
  • Limited company owners can claim back the cost of a wider range of expenses compared to their umbrella company counterparts.

More on limited companies and understanding PAYE.

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