Thursday, March 15, 2012

Ken Livingstone's Tax Affairs

There's been an awful lot of discussion on Ken Livingstone's tax affairs recently, I thought I'd add some detail and a bit of actual tax law to the matter.

But First..
At this point I'd like to take this post on a tangent and take us on a walk through a few of the terms we use when dicussing tax. So, "tax evasion" , this is where it's a plain fact that you owe taxes but you don't pay, this is the one that's actually illegal. "Tax avoidance" on the other hand is a much trickier term, technically it means a legal way of reducing your the amount of tax you have to pay, but it has become a far more negative term. Tax avoidance is now often viewed as a way of sneaking out of your obligations to the state.

So, should all tax avoidance be viewed in this way? I think a good test here is to ask whether the legal structure you use is consistent with what the intentions of it's creators. For example, I don't think we should view people who use an ISA to reduce the tax on their savings negatively because the creators of the ISA fully intended it be used in that way. On the other hand a British company that opens a small shell company in Ireland under the guise of moving it's "headquarters" is not really within the spirit of the tax law since it is being dishonest about the extent to which profit is being made in each jurisdiction.

..and so on to Ken..
From what I've heard, Ken Livingstone gets his income from various sources books, speaking appointments, media appearances and so on. Given the diverse sources of his income it's fair to say that he's self employed. As a self employed worker he can either register as self employed or alternatively start a limited company and invoice for the work you do through that company, they work in different ways but neither option is an uncommon arrangement.

Some of the Key Differences:
  • A limited company has limited liability, it means that the company is itself a separate legal entity. In the event of the business failing a self employed individual is personally liable for the debts, for a limited company, liability is limited to the company's assets alone.
  • A limited company pays corporation tax on it's profits, a self employed individual pays income tax. However, the key difference here is that self employed profits after tax belong to the individual, in a limited company they belong to the company.
This last difference is important, even as a director and sole shareholder of a company the money is not yours. Anything that you buy for yourself that can not be justified as a business expense is a taxable benefit and needs to have tax paid on it. You could distribute the money to the shareholders (yourself in this case) but if you do this the individual needs to pay dividend tax credit at a rate of 10%, 32.5% or 42.5% in the 20%,40% and 50% tax bands (the reason these figures are lower is that corporation tax has already been paid on this money). The only other way to get money out of the company would be to wind up the company and take whatever assets were left as a capital gain paying an additional 18% (more or less) on that money.

..and the bottom line..
So let's take an example of an individual who makes £300,000 in a year, as self employed they would pay the following (using this calculator):
£128,000.00 in tax
£8,323.00 National Insurance
£130.00 Class 2 NIC's
Giving a total of £136,453.00 in tax

So, the same individual with a limited company (my working, I'm assuming they pay themself a salary of £10,000):
£57,919.19 in corporation tax
£2000.00 in income tax on salary (because earnings are over 100K, there is no tax free theshold)
£332.64 in Employers NI on salary
£404.06 in Employees NI on salary

The remaining £231,676.75 after tax would be distributed as dividend
No tax is due on the £25,000 up to the 40% rate
£28,750 on the next £115,000 up to the 50% rate
£29,485.31 on the final £82,000 over the 50% rate

The total tax liability in the second situation is £118,891.20, so what in fact we have in this situation is that the limited company arrangement saves a grand total of £17,561.18, not insignificant but a good way off from the £50,000 we've seen in other reports.

There are of course a few Ken specific points worth noting from this: The first is that Ken's company had large cash reserves indicating that not all the money in the company has been taken out as dividends, this could be because Ken sees his future income being lower and wants to draw money out of the company over a longer period of time (he would reduce his tax burden if he did this), or perhaps because some has a future business venture planned with the money; a second point is that Ken very recently reached state pension age and therfore no longer has to pay national insurance; reports indicate that Ken part owns the company with his wife so it's likely that any dividend income would be split between them; as a final point, we don't actually know how Ken conducted the affairs of Silveta Ltd this means that any "figure" you might read is little more than a guess.

The Tax Avoidance Test
So, now we get to the question of whether what Ken has done is tax avoidance. I'd say on this point that ultimately the answer is no, with the caveat that he could potentially cross the avoidance line in future by winding the company up and taking a capital gain. Although he does pay less tax structuring his affairs in this way, successive governments have not tried to crack down on this practice (indeed they have made it easier) the only crackdowns that have addressed employees acting as self employed contractors, Ken is quite obviously not one of these. Ken is ultimately acting within both the spirit and the letter of the law.

Update: Have changed the figures, the tax saving is larger than my initial calculation suggested. See comments  for more.


Anonymous said...

I don't think it was in question that what he did was within the letter or spirit of the law.

The point was it was exactly the sort of thing he was campaigning against to the point of saying that people that do it shouldn't be allowed to vote etc.

He claims to have used the money to pay employees to help with his election campaign - I suspect it would have saved him a lot compared to if he'd received his earnings personally then paid them from that (or invested in his own company)... but again it's not the amount that matters, just the hypocrisy.

Andreas Paterson said...

The spirit of the law matters to a great degree, I make that point with my example comparing a relocation of headquarters with an ISA. Under a strict technical definition both are "tax avoidance" but it would be ridiculous to call everyone with an ISA a tax avoider.

When campaigning against tax avoidance what most people mean is the kind of tax avoidance that falls outside the spirit of the law. Unless you can demonstrate that Ken Livingstone is against the wider definition of tax avoidance your accusation of hypocrisy is incorrect.

Pratik Parekh said...

Your figures are wrong, given your assumption of £300k profit, payroll taxes of £135k, as stated, however, under a company, with a £10k salary, total taxes including corporation and personal total £122k -.assuming no expenses etc.
I'm a tax accountant, for reference.

The rights and the wrongs, you can judge for yourself, but trying to blind people with false science (whether by accident or design) is not good.


Andreas Paterson said...

Pratik - Am happy to correct if I've got the figures wrong here, do you have a breakdown?

Leigh Caldwell said...

I had actually done the same calculation and got figures very close to Andreas's, but happy to be corrected as well. Is the personal allowance perhaps not withdrawn above £100k if the income is from dividends instead of salary, or have we made some other mistake?

The big difference comes - and this may be what Ken was originally campaigning against - if the "business" is really a disguised employee, because then employer's NI should be paid. In this example that is an extra £34k or so, though it reduces the salary income so the net effect is about £20k difference. As Andreas says, that does not appear to be the case for Ken.

There is an attitude among some tax campaigners that every limited company must be a tax dodge, but that's not the case. I've had a limited company for many years, employed lots of people and only ever paid one small dividend, taking nearly all of my remuneration as salary.

Pratik Parekh said...

In essence:

£10k salary incurs 333 employee ni and 383 employer ni, after the 7k threshold

Thus corporation tax profit is reduced to £289617, call it £290 k

corporation tax, as you rightly state is £58k, so total dividend payable is profit, less salary, less tax, about £231k

Total taxes thus far £58383

The salary incurs tax at 20% being £2k

The dividends have a tax credit which is never paid to hmrc, so for the remainder of dividend to threshold of £35k, (£25k) there is no further tax

On the dividend between £35k and £150k tax is levied at 25%, being £28750

And the balance between £231k and £150k taxed at 36.1%, being £32860

Total taxes of about £122k, ignoring pension contributions and other relevant expenses

Hope that helps.


Leigh Caldwell said...

Thanks for the info Pratik. Interesting. This contradicts what the HMRC website says here:

But I guess that's why we have tax accountants. What does the tax credit relate to?

Leigh Caldwell said...

Oops sorry, I didn't read the second half of the page I just linked to. It's all explained there.

Andreas Paterson said...

Pratik - Believe that the sticking point is dividend tax credit, am just about to leave work but will correct when I get home.

Anonymous said...

There are two ways that Ken is dodging tax (apart from the obvious Employer's NI contributions on his earnings): one is that half the dividends go to Ms Beal so there is twice the basic rate allowance and the amount retained in the company will only be liable to CGT at 28% instead of top rate tax at 40% or 50% when he sells or winds up the company; the second is that he is paying campaign staff out of pre-tax income.
We are looking at more than £100,000 of tax avoided.

Anonymous said...

the second is that he is paying campaign staff out of pre-tax income
That's what every company does. The chair of Tesco's doesn't pay the staff out of his take home pay.

Or is there a different set of rules for 'campaign staff' vs 'checkout staff'.

Also is there any evidence that any dividends were paid? There's only insinuation so far and apparently no evidence that he's avoided any taxes.