Let's imagine a law-abiding* sole trader with a turnover of £60,000 a year and minimal expenses - a painter and decorator, a mobile hairdresser or a gardener or something - whose taxable profits are therefore about £60,000. He or she is given an opportunity to double the size of the business to £120,000 a year, which would involve employing two people on a salary of £20,000 each, thus leaving him, one would assume, an extra gross profit of £20,000 a year.
The sole trader is fairly naive about tax. He thinks he'll have to pay over 40% income tax on the extra £20,000, so he'd end up better off by £12,000, which he thinks makes the expansion worthwhile. And if we only had a flat income tax, he would be right, of course.
His accountant explains to him that it doesn't work like that. He would have the hassle of registering as an employer (and dealing with PAYE deductions, statutory maternity or paternity pay and so on) and registering for VAT (yet more form filling and faff), which costs money and hassle, and his profit and loss account will look like this:
Turnover £120,000, less 7/47 VAT = £102,128, less 2 x [£20,000 salary plus £1,828 Employer's NIC**] = £58,472, so before income tax he would actually be £1,528 worse off (even ignoring all the extra form filling and red tape). And in any event, he isn't just paying 40% income tax, he's paying 41% income tax plus Class 4 National Insurance on his net profit.
So the sole trader doesn't bother.
Bonus round: what is the maximum annual wage that the sole trader can pay each of the two employees he needs to be able to double his turnover from £60,000 to £120,000 if he wants to end up £12,000 better off, after all taxes?
Click and highlight to reveal: £10,300 (to the nearest £100)
Bonus bonus round (h/t Man Widdecombe): assuming the two employees are aged 22 or over and are working 40 hours a week, which other law would the employer then be breaking?
Click and highlight to reveal: The National Minimum Wage
* 'law-abiding' inserted for the benefit of TFB.
** £20,000 minus 52 x £110 threshold = £14,280 x 12.8% = £1,828.
Surprised by the outcome
2 hours ago
15 comments:
If the employees are working a 35 hour week that wage would be below National Minimum Wage.
Which I guess is part of the point you're trying to make .. ..
MW, well spotted. I hadn't noticed that.
That is EXACTLY, well nearly exactly (we are two man business) the sums I have been doing to find out whether I can take on one new adviser and one trainee adviser to do the work I can easily generate. It's just not worth it is it.
And in my business you have to add on regulatory fees of £1500 per adviser! Plus lots of other hopps to go through which add about 15% regulatory costs to our expenses.
The thing is, you and I might know this but the vast majority of the population has no bloody idea how dire it is. Do they?
L, no, but if I keep repeating it, then maybe another dozen or two will realise.
The FSA fees are a real killer, £400 million a year they burn through.
Related BBC News piece - The TUC are moaning that there is a rising number of underemployed workers. With the figures above is there any wonder that small business prefers part time workers?
The general point you make is sound, but it masks one important factor.
The traders mentioned (painter & decorator, hairdresser, gardener) operate in the wonderful world of cash. Nothing allows the industrious to defeat the advances of the Treasury like a roll of £20 notes held in place by a sturdy rubber band.
Of course only so much flexible accounting can be done before it oversteps the mark. But the real turnover threshold is far higher than £60k for a great many.
MW, the TUC have a good point, but maybe they'd like to take it up with this fakecharity who are calling for a 21-hour working week?
TFB, true. But that makes the barrier to growing your business and taking on employees even worse.
And if your employees work cash in hand as well (while claiming dole), if and when they catch up with you, your life is over.
TFB - why do you think all the great and the good want a 'cashless society?'
My brother and I used to run a shop. We took on a friend part time and paid her cash in hand. We were rumbled and sent off for a "PAYE pack" from the Inland revenue. When it arrived, it was two inches thick and my brother threw it in the bin. We had to do without the services of our friend.
Anon, those packs are insane - but what the cunning cove does is make the new person a partner rather than an employee and reports their profit share on the annual tax return for the partnership.
That way the new person has to sort out their own income tax*, and there's no Employer's NIC involved!
* The sensible partnership only pays out two-thirds of gross profit share every month and keeps a third back to foot the income tax bill at the end of the year.
Lola said...
"The thing is, you and I might know this but the vast majority of the population has no bloody idea how dire it is. Do they?"
Its actually a national scandal.
Until a year ago I was involved with a business and have watched the regulation, paperwork and taxation grow... and grow, and grow. Ever greater amounts of time and expense was wasted on crossing t's and dotting i's etc. Not only that, we were seeing something like 20 or 30 'officials' each year, all armed with their own bulging folders of pet projects and dictats from Government and the EU.
In the current climate, labeling yourself an employer is tantamount to an admission of insanity... and if you weren't you soon will be a candidate for the crazy house.
To the country I say this: If you're unemployed or facing unemployment, remember that there is not a single regulation or tax in existence which will make finding a new job easier but several hundred that will make finding one infinitely harder.
We all know who is to blame, the question is will the new lot fix the problem?
Or will the scandal continue unnoticed until we're all out of work?
"but what the cunning cove does is make the new person a partner rather than an employee and reports their profit share on the annual tax return for the partnership."
We thought of that, but then she would have been working for nowt, like me and my brother and she declined the offer.
JP, fret yet not! We will all have jobs inspecting each other. With free clipboards.
Anon, under the partnership profit share agreement you could have offered her a basic profit share of £12,000 (or whatever) plus x% of the remainder. That's what I recommend to my clients. If the overall result (before giving her her profit share) is £nil, then there is no tax to pay by anybody (not even by her).
TFB
Far fewer domestic customers pay by cash now than in the nineties, unless it is around £50 or under. Far more tradesmen have credit card facilities now, many customers cannot even pay by cheque.
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