While tax isn’t everyone’s first choice of topic for dinner party discussions, it really should be. Because tax is important. And paying tax is important. It is how we fund the things that our society needs. Like healthcare, roads, defence and environmental protection. And so, with this week just gone being Fair Tax Week, I thought I’d take a few moments to talk about my own company, Sockmonkey Consulting’s, approach to paying tax fairly.
One of the first things that people say when they learn that I run my own business is something along the lines of ‘oh, I bet you hardly pay any tax at all’. And it is true that there are many ways for the business owner to reduce his or her tax burden, all entirely legal. Some of them, such as offsetting business costs against tax, are fair enough. But others don’t sit too well with me, so I do what I think complies with both the letter and the spirit of the law (and my own conscience).
The first thing to note is that Sockmonkey Consulting it a limited company, so its financial affairs are completely separate from mine as an individual. And while I’m a shareholder of the company, I’m also its employee. I can’t just take money out of the business whenever I feel like it, unless I report it appropriately and pay tax on the amount I take.
Turnover and VAT
My annual turnover usually hovers somewhere around the £65,000 to £70,000 mark, sometimes a little more and sometimes a little less. This puts me slightly below the threshold at which I’d have to register for value added tax (VAT). I’ve always been VAT-registered, though, as I think (rightly or wrongly) that it sends a positive message about the size, standing and professionalism of my business.
Being VAT-registered means that I add VAT to my invoices at 20% of the invoice amount and receive this from my clients when they pay the bill. I then keep this money until the end of the quarter, at which point I complete a VAT return and pay the VAT money to HM Revenue and Customs. Actually, I’m on a thing called the ‘flat rate scheme’, so I get to keep a small amount of the VAT money to contribute to the VAT that I pay on the things that my business buys.
Salaries, income tax and national insurance
Clearly, I need to eat. So I take a salary each month, just like any other company pays its employees. There are various things that business owners can do here to reduce their tax liability, but this is one of the things that doesn’t sit too well with me. And so I pay myself a monthly salary of £3,000 (that’s £36,000 a year), which seems reasonably fair to me and is enough for me to live on.
On this salary, I as an individual pay income tax and national insurance contributions. This comes to about £750 a month, which the company pays before I get my actual ‘net’ salary. And so the amount that appears each month in my personal bank account is around £2,250.
The company also pays national insurance contributions on my salary cost, which comes to just over £400 each month.
I addition to my salary, the company also refunds to me any travel costs that I have incurred while doing my work, just as any employer would. This is usually car mileage (at 45p a mile, which it what the taxman allows) and things like train fares and hotel bills (standard class rail and budget hotels only, mind).
45p a mile is, I’ll admit, a little more than the cost of diesel, but once you add in the cost of MOT, servicing and repairs, I’m certainly not making any profit on my expenses.
Business expenses and corporation tax
The company incurs expenses in the course of the work that I do, for things like professional indemnity insurance, bank charges, professional registrations, stationery and such like.
The taxman has a long list of expenses that are ‘allowable’ for tax purposes, so I make sure that I comply with this. But because I’m careful to make sure that I keep my costs low, only buy what I need and don’t take my clients out for lavish dinners (sorry about that), there’s nothing overly complex here to worry about.
There are allowances that I could take for using part of my home as an office, but the costs involved aren’t huge and it would be a faff to work it all out, so I don’t bother.
When I’ve deducted my salary and the business costs from Sockmonkey’s turnover, I’m left with the company’s profit for the year. This is usually between £15,000 and £20,000, from which I make donations to local charities of 10%, as part of Sockmonkey’s commitment to the local community. This is usually also ‘allowable’ as an expense for tax purposes.
Like all companies, I pay corporation tax on the company’s profit for the year. This is currently payable at a rate fo 19% of profits, so I pay about £3,000 or so in corporation tax each year.
Retained profits and dividends
If there’s any money left after I’ve paid the company’s corporation tax (and there’s usually a little bit), I keep it in the company’s bank account for when it’s needed. There’s always the chance, for example, that business might go through a quiet period. Or I might get sick and be unable to work. So it’s good to know that there’s a financial buffer to get the company through any hard times.
If I, as an individual, need to buy something big (like two years ago, when I bought a new* car), I sometimes take money out of the company to pay for it. This comes out of the company’s after-tax profits and is known as a ‘dividend’, which is a payment made to the shareholders of a company.
Dividends up to £2,000 are tax free, but for anything over that I pay tax at 7.5%. If the dividend were to take me into the top income tax bracket (i.e. above £50,000 total taxable income), I’d pay tax at 32.5% on the bits above £50,000. To be honest, though, this hasn’t been an issue so far.
Adding it all up
So to add it all up, on my turnover of about £65,000 and with a salary of £36,000 and dividends of, say, £10,000, I pay the following amounts of tax (roughly):
- Value added tax: £12,000
- Personal income tax and national insurance: £9,000
- Employer’s national insurance: £5,000
- Corporation tax: £3,000
- Income tax on dividends: £600
Which comes to a grand total of £29,600 in tax a year, some of it from the company and some of it from me as an individual. This is over 45% of Sockmonkey’s annual turnover. And, it strikes me (and I’m just putting this out there), this is possibly slightly more, as a percentage of turnover, than a lot of well-known companies out there.
It also means that, by paying what I see as a fair amount of tax, Sockmonkey is funding – each year – the equivalent of a place for an elderly person in a residential care home, about two thirds of a nurse, four ‘lollipop people’ for school crossing patrols, or two police cars for local beat officers.
Which, when you think about it, is rather cool. And well worth bringing up at your next dinner party.
* Well, new to me, anyway.