Headline tax rates are never what they seem

If you’re a Sunday Times reader, you could not fail to notice the article in January about footballers and their tax affairs.  This highlighted how many footballers have been avoiding the 50% tax rate by using image rights companies into which the majority of their earnings are paid and then using their director’s loan account to withdraw income. Apparently, it is possible to pay a rate of just 2% by following this strategy.  We wish it were that straightforward!
Since some clients have asked us why they cannot also benefit from a similar approach, we wanted to explain the quite considerable journalistic license applied to this particular article.
It is feasible for professionals such as footballers to use a company to manage their earnings and it is also common practice for consultants across many industries.
IR35 restrictions aside, this is a legitimate strategy which provides individuals with flexibility over the amount of income they draw; the way in which they draw it; and the way in which they pay tax.  Use of a director’s loan account is also a well-used approach to manage drawings – all fine so far.  However what this particular article failed to highlight was that a footballer’s image rights company would have already paid corporation tax on its profits.  For the bigger names like Wayne Rooney, this is likely to have been at the large company rate of 28%.  And unless market rate interest is paid, there is also tax to be paid on the benefit in kind of the loan under Section 455 of the Corporation Tax Act 2010.
Our calculations show that in fact, the effective rate of tax taking into account all the deductions required is more like 47%.  So there is a difference, and for the sums in question it probably represents a big saving from the 50% income tax rate, but that is also a big difference from the 2% headline rate quoted! So whilst this might be a valid strategy for offshore individuals, it is not the suggested panacea for UK players.
The article also suggested that as a result of this loophole, it is likely that in the future overdrawn directors’ loan accounts may be attacked as ‘disguised remuneration’.  There are however already mechanisms in place to tax long term overdrawn loan accounts and as the figures show, the tax lost is not anywhere near that indicated in the press, therefore HMRC probably have bigger loopholes to target!
RJP will be conducting a series of tax planning sessions in February and March for business owners and individuals.  If you would be interested in booking an appointment, please contact Lesley Stalker at las@rjp.co.uk.