e4 e5 2. Nf3 Nc6 3. Bb5 a6 4. Ba4 Nf6
The opening moves of a game of chess form the title of this blog. Anyone who plays chess regularly will immediately recognise these particular moves as the first 4 moves of the Ruy Lopez opening. This opening will have been played many times this year by those who play chess be they school children just learning chess or grandmasters. There are however about 319 billion possible ways to play the first four moves of a game of chess. Most have never and will never be played. It is a widely held view that there are more possible 40 move games of chess than there are electrons in the universe.
Of course, a person who develops a level of skill at playing chess can look at a particular position on a chess board and quickly dismiss almost all of the possible moves and concentrate on perhaps 3 or 4 possible moves before deciding which one to play.
Tax planning has many similarities to chess. A tax planner advising a client can come up with a strategy that involves some or all of the following:
1.the share structure between spouses;
2.salary and dividend levels;
6.Enterprise Investment Schemes;
7.Venture capital trusts;
8.Investment bonds; and
Just like in a game of chess, the tax planner must play by the rules and respect the skills and any traps set by his opponent (HMRC). The products listed above have different features and can be likened to individual chess pieces. The tax planner can look at these in a similar way to a chess player studying the position in a chess game after perhaps 20 moves have been played. He can then play his next move. Sometimes a tax planner will recommend a strategy that involves the client paying more tax to get a better position. For example, he might recommend that a contractor increase his gross income from £50,000 per annum to £100,000 per annum resulting in a loss of child benefit. This could be looked at as the equivalent of a pawn sacrifice in a chess game.Those contractors who got themselves involved with the tax avoidance industry of late tried to win their game with HMRC by using one strategy only, loans. Promoters of these schemes came up with clever ways to receive the fees generated by a contractor tax free and then loan those fees to the contractor on the basis that the loans would never be repaid. HMRC saw the weakness and quickly defeated the strategy. The equivalent chess game with the contractor playing with the white pieces and HMRC with the black pieces would be 1. f3 e5 2. g4 Qh4 #.
A typical contractor tax avoidance scheme offered a return of about 82% of fees with no additional deduction for expenses. I believe that most contractors can achieve a similar (and in some cases better) return by regarding tax planning as an ongoing process and using some or all of the products I have listed above just as if they are playing a game of chess with HMRC. They must be alert, respect their opponent (HMRC), and above all play by the rules but play to win.
Let’s look at a very simple example.
John is a contractor generating fees of £90,000 per annum. He is married to Anne who looks after their two children. John has contract expenses of £2000 per annum, and limited company expenses (including an accountant) of £2000. John’s contract has been reviewed and found to be outside of IR35.
If John joined a tax avoidance scheme offering an 82% return his family income would be:
Scheme costs and tax @ 18% 16,200
Sub total 73,800
Less: contract expenses 2000
A tax planner would look at this as a very straightforward case. He would recommend that John and Anne use a limited company with an equal share structure. He would also advise (for the 2014/15 tax year):
1.John and Anne each have a salary of £10,000;
2.All profits are distributed as dividends; and
3.The company registers for VAT and joins the Flat Rate VAT scheme (14.5% rate assumed).John and Anne’s family income would be set out as below:
Add: Flat Rate Scheme benefit 2340
Gross income 92,340
Salary – John 10,000
Salary – Anne 10,000
Contract expenses 2,000
Company expenses 2000
Total expenses 24,000
Corporation tax 13,668
Dividends paid to John and Anne 54,672
Salaries paid to John and Anne 20,000
Less: Employees National Insurance 490
Overall profit £74,182
To beat this sensible plan a scheme promoter would have to offer a return of 85%, and, of course, the tax avoidance scheme will almost certainly be defeated by HMRC whilst the tax planning is robust.
The example of John and Anne was straightforward and used only a sensible remuneration and dividend structure. Where simple planning does the job it’s best to leave it at that. But where income is higher or perhaps IR35 applies some of the other investment products need to be used. So whilst John and Anne’s tax planning may well have resembled a King and Pawn end game, some contractor tax planning will resemble a complex middle game with many pieces still on the board. Of course, there are nowhere near as many tax plans as there are possible 40 move chess games, but because no two contractors are identical there are a large number of different plans and a sensible plan can only be put together once the facts are known. Next month I will look at 3 more complex tax plans. In each case I shall show how returns similar to those offered by the tax avoidance industry can be achieved using non contentious tax planning.