Thursday, March 15, 2012

More on Ken Livingstone's Income

While looking into the claims being made about Ken Livingstone's tax affairs I was struck by something very strange:
Mr Livingstone has made attacking the rich a major feature of his campaign. In three years, however, he has now channelled total earnings of £755,778 through the company, putting him comfortably in the top 1 per cent of all earners. - Andrew Gilligan
 Livingstone said that he earned £55,000 in the last year and paid the full rate of income tax on that but did not earn enough to pay the top rate of income tax. - The Guardian
Only one of these statements has Ken in the leagues of the mega rich, the other has him earning a decent but by no means excessive amount. I can't help asking myself who's right?

I'm not sure how much Ken's line of work brings in, but to me the lower figure seems more realistic. To get a better idea I took a look over the accounts for Ken's company, Silveta Limited. Looking over the accounts, the history runs a little like this: In 2009, the company retained a significant amount profit, £232,550 of which was retained in the company, in 2010 the retained profits rose to £284,580, in 2011 the retained profits dropped to £238,646 indicating that the company is likely to have made a loss.

At this point I noticed that these three numbers added up to the figure of £755,776, just £2 off Gilligan's figure. The £2 difference could be explained by the fact that figure for shareholders funds in the account is £2 higher and  Gilligan could have read the wrong column. What Gilligan had done was to take the level of retained profits in the company and treat it as the company's trading profits.

What all this means is that the figures that Andrew Gilligan has been putting out on his Telegraph blog about Ken's earnings are complete and utter nonsense.

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.