Is paying yourself a small salary and claiming dividends bad?

[lastonetime]

Please don't bite my head off, genuine question because I don't understand the system,

MIL and FIL are self employed as they've always said, they are directors of a ltd company. We've recently found out they pay themselves £800 a month and the dividends.
It seems like they won't get anything from the self employed 80% payments and only on their PAYE.

They are obviously worried about the future.
They had been advised to do it this way by their accountant, is it to avoid paying tax? Their argument is that they don't get holiday or sick so it balances out.

I've seen a lot of anger on here for people that do it that way. Just trying to understand why?

It used to be a bit of a tax dodge but things have changed and although they would minimise their income tax / NI payments, they'd still have to pay company tax on the dividend payments so no, they're not doing anything illicit. It's how a lot of company directors pay themselves.

They AREN'T self employed - they are employed by a limited company (which is a separate level entity to the individual) and they are shareholders in said limited company.

The way they have been drawing funds from the company is perfectly legitimate under current UK law, and is done to minimise the overall tax liabilities. Until a few years ago there was a quite significant tax saving. Since the change in dividend taxation the tax saving is much less, although there is still a saving.

At present the UK Government assistance 're COVID 19 only applies to those under PAYE (which will be a small part of their income) and the self employed (which they aren't).

There might be other help that the company is entitled to.

www.gov.uk/government/publications/guidance-to-employers-and-businesses-about-covid-19/covid-19-support-for-businesses lists the various assistance currently available.

Every company director I know pays themselves like this. You have to pay corporation tax on the dividends, and they slashed the amount you could receive tax free last year. It is more tax efficient, but not to a huge extent.

It's not 'bad' per se it's how the system is set up. Nobody pays more tax than they have to and this isn't tax avoidance. .

It benefited them to take a low salary and now it doesn't. That's just how it goes.

Don't they have 3 months savings to tide them over?

You have to pay corporation tax on the dividends

Thank you both for that!

I think that's the thing that confuses me, for the 12 years I've known them and all DHs life they've said they are self employed, so I was surprised when they said they weren't entitled to anything.

It was done to avoid paying as much tax or NI contributions as they would, if they had drawn the full amount as a salary and not split between dividends.

I think some people want their cake. Whilst they've legally been paying what they needed to they have sought to reduce the amount they pay in tax and NI and they now want help from the pot they've not fully contributed to in the same way a PAYE employee would

There has been a big furore recently over proposed changes to IR35 to try and recover more tax and NI from self employed people who are employees in all but name.

Some do it like this, it’s legal, and it did benefit them but now the opposite.

They're not self employed that's why the self employment arrangements don't apply to them. They're employees and shareholders.

You have to pay corporation tax on the dividends

Posted too soon, that's not right, only companies pay corporation tax. If a person gets dividend they still have to pay tax afaik you pay slightly but not much less tax.

It's not good or bad it's how the system works but from what I read it will leave some people worse off now. But as Richi Sunk said they can't possibly account for every situation

It is legitimate and legal but it is done to reduce the tax bill. They will have done it in good faith with proper advice but it was in the knowledge that they would pay less tax than if they'd taken it as "earned" income.

Corporation tax is paid on the company profits (before paying the dividends), not the dividends. They then pay income tax on the dividends.

It used to be a bit of a tax dodge

It still is - to the tune of at least 13%.

It’s legal but a bit shady imo

Lots of lots of individuals in this position do refer to themselves as self employed. But legally this isn't the case.
They either don't understand the position, or aren't really bothered about the semantics (because in layman's terms it doesn't really matter).
Unfortunately when it comes down to the crux of the matter, the true legal position does matter.

BTW they have been legally and legitimately mitigating their overall tax position, this is tax avoidance and is totally legal in the UK - arranging your tax affairs to your best advantage. No different to putting savings in a tax free ISA instead of a taxable savings account.
What isn't legal is tax evasion - which is basically fraud designed to not pay tax you pick legally be paying, be that under declaring income, claiming for expenses which aren't allowed or engaging in illegal schemes.

So here’s a question, if they are employees can they get furlough money if they have to close? Which would be 80% of the £800 they get (jointly?)which is £640 I think? So something like £80 a week each. And would they then be able to claim any working tax credits or anything on top (sorry I’m not good on benefit names) or perhaps they get a state pension too if they are retired so it may be enough to tide them over for a while?

Sorry x posted with others,

I think they might have 3/12, they are slightly cagey on the figures so I know I might now have the full picture,

we've offered help if they need (no idea what amount it would be but even food shops might help) as we are both WFH on full salary and DDs childcare aren't charging us, so can afford to help luckily

It still is - to the tune of at least 13%

Not at lower levels of income, and the saving is wiped out by accountancy costs for running a company. If you want enterprise in the country it's a normal stage of the business cycle, you're going to have people going from sole trader to single director company to larger companies, everyone has to start somewhere. Joules and I think White Stuff used to sell clothes from stalls at events, now they are a global business.

It is legitimate and legal but it is done to reduce the tax bill. They will have done it in good faith with proper advice but it was in the knowledge that they would pay less tax than if they'd taken it as "earned" income.

Yes, exactly. People are allowed to do it, it's legal, so it's daft for anyone to be critical of them over it. However, the cohort who did make this decision in order to pay less tax are now going to get lower state support than they would had they chosen differently.

@Elieza they can get furlough money if they close, but they are key workers (medical type field) so are torn on what to do.

yes assume they can both claim if they close but professional body advice is to remain open for emergencies, but that's likely to be even less financially for them

There are reasons other than tax efficiency for taking money in dividends. It's more straightforward to have a fixed paye income and alter the amount of dividends paid.

It’s also done to mitigate liability on your own assets. It was what my husband’s very straight up and down accountant ADVISED him to do. The small tax benefits were a bonus, but as dh gets no sick pay, no holiday pay and no company pension etc etc it’s not much compared to the benefit of being an employee for someone else.

@Elieza - If they are Directors, they can only furlough themselves through the PAYE method if they have absolutely NO INTERACTION with their business whilst they furlough. So in essence it would mean they have to totally shut down their business for that period. Anyone who continues to do work whilst being furloughed would be committing fraud unfortunately. This is why so many workers are up in arms, employers want to furlough them but also want them to continue working but not say anything!

Agree with all of the above - it's a way to pay less tax on exactly the same income : therefore if they get less state support (this situation was totally unexpected) now it's fair enough.
If they were worried about not having savings they should have put the 13% tax they have saved for decades (was more until recently) into a savings pot for emergencies.

I'm not feeling too sorry for them.