By taking some tips from the banks, big businesses and the seriously wealthy, you can make your money work harder in our current inflation-driven economy. The skill comes in legally minimising your tax liabilities, whilst also investing wisely.
Only this week we hear that Barclays paid just £113m in corporation tax (CT) out of its 2009 profits of £11.6bn; canny tax planners cut the usual big business CT charge from 28% to an effective rate of 1%, and did it totally legally.
And in 2005, seriously wealthy entrepreneur Philip Green ducked a huge tax bill by diverting a £1.2bn profit to his wife in Monaco. Green’s tax advisers did this by creating a complex tax vehicle that made Mrs Green the owner of Mr Green’s business empire Arcadia, which includes BHS and Top Shop. And far from being penalised for depriving the Exchequer and UK taxpayers of considerable sums, he was actually rewarded by David Cameron with the honour of conducting a review into public sector efficiency.
This post isn’t about debating the moral rights and wrongs of such actions, but in encouraging contractors to ‘think smart’ and act like businesses. This is becoming more important now, as inflation and low interest rates are combining to take great chunks out of contractors’ savings.
No-one could have failed to notice that food and fuel are driving up the cost of living. Inflation has already reached 4%, which means that for every £100 you invest, it needs to increase to £104 within 12 months just to keep its value. This is a tough proposition when deposit interest rates are lower than 3%, and the government has even stopped National Savings & Investments offering index-linked savings certificates.
The only “winners” right now are those with who have borrowed money, because they will end up paying back less in real terms due to inflation reducing the original value value of those loans. For the majority of working contractors with cash, though, leaving large sums of cash in the business is simply not a sensible option.
Why’s that? Well, if you put your £100 under the mattress, it would only be worth £67 in ten years time after 4% inflation a year, during which time inflation might also be busily reducing the value of all your assets and wealth. So, when it comes to growing any cash you might have in your contractor limited company, your business bank account is currently only slightly better than the mattress option.
The Bank of England’s Monetary Policy Committee can control inflation by raising interest rates, but then businesses won’t borrow to make the investment the UK economy desperately needs. Also, the 66% of mortgage holders with variable rate mortgages would lose the surplus cash they have now, causing the economy to be stifled by lower consumer spending.
So where does this inflationary economy leave you, if you’re a contractor who actually spends well below what you earn and has surplus funds to invest?
Well, the best advice is to follow the example of the banks, big business and the seriously wealthy by holding onto more of what you earn by reducing what’s likely to be your greatest single expense – your tax bill.
Get a really good tax adviser – their fees will be a fraction of the tax savings you could make. Then look to the basics and:
- Claim every expense you legitimately can through your limited company
- Minimise income tax at the higher rates on dividends by leaving some cash in your business, if you don’t need it to live on – use our calculators to work this out
- Consider involving a partner or spouse in the business, paying them a salary or even splitting dividends, but they must be properly involved in the business and you should take note of HMRC’s rules and Section 660a
- If you know your contracting career is ending, take advice and consider leaving cash in the company and extracting it using ESC C16 (entrepreneur’s relief), thereby paying only 10% tax
- Make use of capital gains tax (CGT) allowances and shuffle investments; for example, you could invest £100,000 over ten years, take an annual payout to use your £10,100 CGT allowance, rather than waiting 10 years and taking a single big payout at the end, which would be much more ‘costly’ in CGT.
Your tax adviser will be able to provide numerous tax mitigation strategies that are totally legal to suit your personal circumstances.
So, you’ve saved on your tax and have additional cash to play with. Consider an investment strategy, in line with your own attitude to risk, that will ensure that at the very least you keep up with inflation. Investment is a complex area, so you would be prudent to seek the professional support of an Independent Financial Adviser, preferably one that specialises in the contracting sector.
Making your money work harder in today’s inflationary economy requires you to adopt two strategies that go hand in hand: minimise your tax liabilities and invest wisely.