Written by Ray Coman
A reminder to pay tax is not generally welcome on the doormat. Less so when it is scarcely possible to make sense of, and is unexpected or well overdue, as is often the case. So , to set the mind at rest, this guide briefly outlines the rules for PAYE payments, and in particular the options available to self-employed people who are directors of their own company.
For employers, PAYE is due seventeen days after the end of the tax month. The tax month ends on 5th of each month. Therefore payments are due by the 22nd of the month, relating to pay for the month ending on the 5th. Where estimated payments of tax are less than £1,500 per month, an employer can arrange with HMRC to make quarterly payments of tax.
Reminder letter from HMRC, where no tax is due
Regardless of whether the business has a PAYE liability, HMRC havebeen routinely issuing reminder letters for payments of PAYE tax. One response is to file a nil monthly PAYE Return. However, this can be a time-consuming process, particularly where no PAYE payments are expected for several future months. An alternative is to arrange with HMRC for an annual payment to be made. At present the drawback here is that the transfer to an annual basis involves often less than straightforward arrangements with HMRC which have to be re-performed each year. Furthermore, on account of the various and ever-changing HMRC offices which seem to administer PAYE, HMRC have not been effective in their response to arranging for an employer to be entered onto an annual payment basis. In practice the outcome is typically that undue time and resources are spent by both employers and HMRC in responding to debt collection letters.
Reasons to register as an employer but make no payments of PAYE
Use of a company can save a self-employed individual considerable tax, where that person’s withdrawals from the company are treated as a salary no greater than the tax free personal allowance and as dividends thereafter.
The national insurance saved using a limited company rather than being a sole trader is at least 9% on any income between the Class 4 lower profits limit and upper profits limit. Therefore, for 2012-13, profits between £7,605 and £42,475 per year made in a limited company will suffer 9% less tax than those made as a sole trader. In money terms, up to £3,138.30 could be saved on a profit of £42,475 by operating the business through a company, rather than being a sole trader.
The savings are even higher when company income is compared with employment earnings. In employment, national insurance is 12% for employees between the earnings’ threshold and upper earnings limit. For 2012-13 the applicable limits are £7,592 and £42,484 respectively. In addition, there is a further 13.8% saving for employers on earnings over the secondary threshold (of £7,488 for 2012-13.) Where a contractor is prepared to forego their employment rights, and they consider that they can justify their self-employed status, the limited company option could save a lot of tax.
However, a key drawback is that the taxpayer’s national insurance record will not be updated and therefore social security benefits will not accrue. In particular, each year that a taxpayer makes national insurance contributions (NICs) adds a qualifying year towards the total number required to secure entitlement to the basic state pension. State pension accrual is explained in further detail later.
A salary up to the lower earnings’ limit (of £5,564 per year for 2012-13) will not require the business to register as an employer. A salary above the lower earnings’ limit and up to the earnings limit (of £7,488 per year), will require the business to register as an employer, but will still not give rise to a national insurance liability. Therefore, it is possible to accrue social security benefits by paying a salary equal to say £7,488 per year, which is above the lower earnings limit but not over the earnings threshold. The advantage to the taxpayer is that a year is counted towards social security benefit, even though no liability to settle NICs has arisen.
Drawbacks of registering as an employer
However, as previously explained there is growing evidence of the practical obstacles in arranging to be an employer who makes no payments of PAYE. As a consequence, considerable time and resources can be used by HMRC and the business owner in bringing about the intended outcome. As a further drawback, an employer is open to penalties for late submission of an employer’s annual return, for missing the submission deadline. The deadline is 19 May following the 5 April year end. The late filing penalty is typically £100 per month for a company with only one director. The penalties can be appealed against and often reduced to nil where there is no PAYE due. Nevertheless, the appeal process can be bothersome and time-consuming for both business owners and HMRC.
Voluntary national insurance for business owners
Business owners wishing to benefit from the national insurance saved by operating through a company, but still wanting to contribute towards their state pension may consider voluntary NICs as a slightly dearer but less bureaucratic alternative.
Voluntary, or Class 3, NICs are a facility for individuals to contribute to their social security, and in particular their state pension, where the contribution would not otherwise be made. No NICs would be made by a contractor using a company not registered as an employer. Voluntary, or Class 3, NICs are currently £13.25 per week. At the time of writing, the basic state pension is £107.45 weekly. To receive the basic state pension, a taxpayer should have made 30 years of NICs. The state pension age is currently 65 for men, and due to rise to 65 for women, with further plans afoot to increase the overall age to 67. Evidently, the above is an overview only on the UK state pension, and you should seek further advice before taking any related action.
We are not authorised as financial advisers and therefore encourage you to draw your own conclusions from the above. The above information is aimed at helping you to make a decision on whether to make voluntary contributions, where you are not adding to your state pension because you invoice from your company, and are not registered as an employer.
By most accounts, the basic state pension would not be sufficient to support a comfortable retirement, and therefore you should consider additional provisions, such as private pension contributions as part of a structured retirement arrangement.
To recap, a company is not required to submit an employers’ annual return until the director’s salary exceeds the lower earnings limit, which would still allow for most of the personal allowance to be used up. As a result, there would be little or no gain in corporation tax by not registering as an employer. To accrue social security, the route which is expected to be the least bureaucratic is reached by paying Class 3 NICs, and in the majority of cases the NIC payments would still be a lot less than that suffered by a sole trader.
In summary, for ‘one man band’ companies, not registering as an employer could prevent a lot of hassle dealing with HMRC reminders. A state pension is likely to be only one component of a retirement plan, and the requirement can be fulfilled where necessary by delaying NICS or through a voluntary scheme. In many cases, a voluntary scheme is a more ethical approach as well as making more commercial sense. More broadly, a reduction in nil returns should prevent HMRC transferring PAYE administration to debt collection, often an outsourced service. Please contact us for further advice relating to your intended plans as a business owner.