Dear Contractor Doctor
I am an IT contractor and run my own limited company, with me as the sole director/shareholder and my wife as company secretary.
My wife also works in IT, until recently as a permie, and has been offered a short-term contract. If the project goes well, she’ll either be offered a permanent job or have her contract renewed. We’re trying to work out the most tax-efficient process of getting paid.
Should she contract via my limited company?
Contractor Doctor says:
“Putting a single short-term contract through his limited company is certainly one option available to Richard and his wife,” agrees James Abbott, owner and head of tax at contractor accountant Abbott Moore.
“However, there may be considerations, such as the VAT flat rate scheme, Richard’s own earnings and income tax allowances, plus his wife’s long-term contracting intentions, which could suggest alternative scenarios, such as incorporating a second company or using an umbrella company.”
Abbott says accountants tend to prefer keeping their contractor clients’ tax affairs as simple as possible. So, all other things being equal, an accountant would normally advise having only one limited company.
Complications arising over the VAT flat rate scheme
“Based on the drive to keep things simple, Richard’s wife could consider putting her short-term contract through his limited company,” continues Abbott. “However, complications arise over extracting those fees tax efficiently and, if the spouse’s contract is renewed, the VAT flat rate scheme – if Richard’s limited company uses it.
Tax legislation allows outright gifts of ordinary shares between spouses even where one spouse doesn't contribute financially to the company
James Abbott, Abbott Moore
“The flat rate scheme has an annual limit of £230,000 of fee income including VAT. Net of VAT, a contractor can earn up to £191,666 in fees before having to leave the scheme. Most contractors don’t earn £190,000, but many do earn up to £100,000.”
Abbott’s concern is that if Richard’s wife opts for a long-term contracting career, the earnings of both of them will force Richard’s company to leave the flat rate scheme. The scheme is normally advantageous to contractors who can typically make between £1,500 and £3,000 a year by using it.
“If you consider the two scenarios: both contractors use the same company and risk losing between £3,000 and £6,000 each year if forced to leave the flat rate scheme. On the other hand, incorporating a new company is inexpensive and the annual accountancy costs will be well below the savings made by remaining in the flat rate scheme.”
So in this scenario, Abbott suggests running two companies for two full-time IT contractors but keeping a single company for a single short-term contract.
Extracting the cash tax efficiently
If Richard’s spouse’s fee income is paid into Richard’s existing company, the issue of extracting it tax efficiently arises. Abbott explains: “When his spouse’s fees are paid into Richard’s limited company, there is a 20% corporation tax liability. But there are only two ways the profits from the fee income can come out:
“Either Richard’s spouse is paid a salary or Richard takes additional dividends. If paid a salary above the national insurance (NI) threshold, Richard’s spouse faces a 12% NI bill and the company has to pay 13.8% in employers NI contributions.”
If Richard takes the money as a dividend, then that could push him into the higher rate tax band. Once he earns more than £100,000 Richard will suffer a 50% increase in his personal tax rate on the next £18,880 because of loss of his personal allowance. Putting the spouse’s income into the company to come out in the contractor’s name could incur higher income taxes.
Giving the spouse shares in the limited company
“Tax legislation allows outright gifts of ordinary shares between spouses even where one spouse doesn’t contribute financially to the company. It’s fair to say HMRC have not always shared the view that this works, hence the well publicised Arctic Systems case. Notwthstanding this, ” highlights Abbott. “ here we have a genuine situation of a spouse creating income.”
If the spouse becomes a long-term contractor, then there may be a case for the husband gifting his wife shares considering income levels in her name so she can receive dividend income. The settlements legislation makes provision for this kind of share transfer even where there is no financial input by the wife into the company when it is an outright gift..”
“However, if the spouse is likely to stop working as a contractor, then the contractor may wish to think about whether this is the best option,” adds Abbott.
Short-term contracting and IR35
If Richard’s spouse’s role is inside IR35 and very short term, then Abbott would suggest looking at perhaps using an umbrella solutions provider: “An umbrella is a fantastic solution for short-term contracts inside IR35. The arrangement would be simplified as the existing limited company would not be involved.”
However, Abbott warns contractors about temp to perm arrangements: “A short-term contract could quite legitimately be outside IR35 and becoming a permanent employee does not mean the previous contract was affected by the legislation.
“But to avoid the suggestion of IR35 it must be clear that there was a change in the relationship between the former contractor when contracting and their client compared to when they became an employee with an employer.”