In the 2014 budget it was revealed that HM Revenue and Customs (HMRC) will be clamping down on tax avoidance schemes and they have even been given the power to seize money owed directly from the bank accounts of offenders.
Celebrities including comedian Jimmy Carr and DJ Chris Moyles have both admitted using schemes to avoid paying their fair share of tax and are now facing hefty penalties. It is easy to be tempted by a scheme that offers you the chance to keep more of your earnings, but remember these schemes are often illegal and you should ask yourself is it really worth the risk?
Common offshore tax schemes
Many tax avoidance schemes are offshore, which in itself should send alarm bells ringing because if you predominantly work in the UK and you mainly live in the UK then you should be paying tax in the UK. Some common schemes that contractors may use to avoid paying tax are:
- Employee Benefit Trusts (EBT)
- Devalued currency loans
- S615 Pension Schemes
These schemes are based on existing tax and financial structures, which are often adapted to try and cheat the system. For example, the EBT scheme will pay the contractor a small salary and they will then pay the remainder of the contract rate as a loan, and because the money is a "loan” the contractor will not have to pay tax on the amount. However, with schemes such as this it is important to be aware that once the loan is written off you would be liable for tax on all the loan payments that you have ever received through the scheme.
Devalued currency loans are incredibly complex, but essentially they work by relying on the fluctuation of currency rates to over time devalue the loan on paper. This would leave the contractor with minimal or no tax liabilities despite having "borrowed” the value of their contract.
If a contractor works overseas they may be tempted to partake in a S615 pension scheme, which allows the contractor to make contributions to a pension pot, which can eventually be taken as a fixed tax-free amount.
Is it worth the risk?
The main risk of working through an offshore scheme would be that HMRC investigates the scheme and deems that it is not operating inside the rules. If this was to happen the scheme would be shut down and all participants in the scheme would be required to pay back their unpaid tax plus interest as well as some potentially substantial penalties.
Whether you decide that using tax avoidance schemes are worth the risk or not as a contractor you should be aware that HMRC are not fools and targeting tax avoidance is a top priority for them. As shown in the 2014 budget HMRC are being given more power and resources to tackle anyone who is not paying what they owe.
How can I ensure that I am complying with HMRC?
Some offshore schemes promise that you will take home 95% of your contract rate, but in these cases remember that if something seems too good to be true then it probably is and the scheme won’t be completely legal. That being said, just because you want to comply with HMRC doesn’t mean you shouldn’t work as tax efficiently as you can. Any accountant will tell you that contracting through a limited company is the most tax efficient way to operate as it provides the most tax planning opportunities, such as being able to withdraw dividends in addition to your salary and the ability to claim on a wider range of expenses. Contractors who work through their own limited company will typically take home 75-80% of their contract rate.
Many contractors decide to appoint a reputable accountant who will take care of all their taxation needs. You may want to consider choosing an accountant who specialises in the contractor market as they will be able to ensure that you are complying with HMRC’s regulations whilst still operating as tax-efficiently as possible.
How can Nixon Williams help you?
Nixon Williams have been providing accountancy services to contractors, consultants, freelancers and locums throughout the UK since 1995. Their premier accountancy service will take care of all your business and personal taxation requirements and you will be given a direct line to your own dedicated accountant who you can contact as many times as you wish. For more information about how Nixon Williams can help, please visit our Premier Accountancy Service page.
You may also find the following pages useful:
- Guide to expenses for contractors
- Limited company taxes
- Choosing an accountant
- Contractor's guide to dividends
- Contractor Tax
For more information about working as a contractor, forming a limited company or what expenses you are able to claim please get in contact with a member of our new business team by calling 01253 362062 or emailing email@example.com.