Some of you may be wondering how off-shore tax companies save you tax, and how it all works. It may surprise you to know that I looked into it about 20 years ago, when I was getting fed up with the enormous amount of tax I was paying. And no - I wasn’t earning enough to make it worthwhile.
Some details have changed, and I have simplified the situation, so please don’t take any figures I am quoting as exact - they are merely an illustration to give you an idea of how it all works.
First of all, why do we have a problem. Well, the answer is that we pay an awful lot of tax, one way or another.
Employed in the UK?
First of all remember that, as well as Income Tax, most have to pay National Insurance at 12%.
After roughly £43K taxable income (thats about £54K for most employees) the NI reduces to 2%, so the total percentage you pay reduces as you get paid more. If you are lucky enough to earn £150K or more, the Tax rate goes up to 45% with the extra 2% NI.
So, although the basic rate of tax is 20%, the total actual deductions are 32% and 42% once you get into the higher tax band. The more money you make, the less the overall impact of NI, so the more you make, your percentage deductions come down until you hit £150K. Either way, the moderately better off are losing nearly half their pay in deductions.
Actually, it’s worse than this. Your employer is paying an extra 13.8% NI contribution. If you’re self employed and paying PAYE, then that’s you as well.
So, of the money an employer pays for your services, anywhere between 45% and about 66% goes to the Government. That’s why there's a strong incentive to reduce it.
Investment Income and Dividends
Interest and Dividends are treated as “unearned income”.
You are allowed £5K worth of dividends tax free. After that the tax rate depends on what tax band you’re in, from 7.5% to 38.1%. NI is not payable on unearned income.
If you can be classed as self-employed, and set yourself up as a limited company, you can pay yourself a modest salary and then pay yourself some nice large dividends. That way, your tax rate is a little less, and you avoid a large lump of NI. For most people, this reduces the overall percentage of tax paid to somewhere between 35% and 40%.
There are other costs - accountancy fees tend to be higher, for example, but it is a good way to keep more of your money for yourself.
How Does an Off-Shore Company Help?
Let’s say that you have your limited company, are doing well, but want to pay less tax.
If you set up a company based in, say, the British Virgin Islands, and that company invoices for your work, it is subject to local taxes there. BUT, they have
- no capital gains tax,
- no gift tax,
- no sales tax or value added tax,
- no profit tax,
- no inheritance tax or estate duty, and
- no corporation tax.
It will cost you a few thousand quid in fees to run the company, but you could end up paying no tax at all - zilch!
There is a snag though. Any money you take out and bring into the UK will be treated as income. So, if like most of us, your monthly spend (mortgage, subsistence and so on) is roughly your monthly income, you get no benefit. The REAL benefit comes when your income is much more than you need in the UK on a day to day basis.
Imagine you earn £100K a year more than you need, you can save something like £40K tax by keeping it off shore. And the whole £100K can be invested elsewhere to earn compound interest, whereas you could only invest £60K if you kept it in the UK. And all legal.
This assumes you operate everything strictly according to law. There are things you can do which those sins of fun at HMRC may, or may not notice. Children at private school? You might get away with paying fees via an off-shore foundation run by nominee shareholders so there’s no paper trail back to you. If you’re one of the seriously rich, you may be able to swan round the world living in accommodation provided by your off-shore company, in boats owned by it, and so on. All tax free.
Of course, those sons of fun at HMRC may decide to take an interest in you. That’s where nominee directors come in. For a modest (well, not that modest actually) local citizens will take on the duties of your company directors, acting entirely on your instructions. So it can be very difficult to identify who owns (and should pay tax) on what.
The British Virgin Islands has a population of about 29,000, with about 30 registered companies per head of the population. It’s obviously doing well out of the whole business.
So there you have it. The more surplus cash you have, the easier it is to avoid paying tax on it. The mega-rich need pay hardly anything at all compared to their overall income.
Even with companies that don’t use tax havens, there are many dodges that can, quite legally be used to minimise tax. For example, assets - particularly movable ones like lorries - can be owned by subsidiaries where the capital allowances are most attractive. Head offices can be based where taxes are lowest, and management fees charged to move money to where it is most tax-efficient. For example, lets pretend you are a large American coffee chain. You have spent a lot of money building up your brand and putting in place all the quality control, supply chain, training, marketing materials an so on. And you then spend a great deal setting up a European operation. Actually, it’s perfectly reasonable to charge your subsidiaries a management fee for all this, and to incorporate appropriate overheads into the price you charge them for the actual coffee.
Where it all falls down is when these charges are set simply as a means of moving taxable profit from one place to another. Then it’s just taking the mickey!