Tax is no laughing matter

THE world-renowned Edinburgh Festival is under way, bringing an army of half-starved performers, writers and artists flooding into the Scottish capital. They will be working side by side with many of their idols who hit the big time long ago.

Comedians will be hoping this year will be the year they are spotted by some TV executive, while the authors will be keeping their fingers crossed that they are noticed in Charlotte Square.

But whether you are struggling to get your first book published or have made it to the big time, the taxman will want a huge slice of your success. Given it could be fickle and disappointingly short-lived, how can you hold on to as much as possible to see you through the lean times which could be just around the corner?

Starting out

JK Rowling famously wrote the first Harry Potter book while a young single mother surviving on benefits. Citizens Advice can advise on what benefits and tax credits can be claimed by low-earning struggling artists. But as a rule of thumb, according to the Department for Work and Pensions, an actor looking for their first paying role could work up to 16 hours a week and still be entitled to claim income support.

Once an artist has regular work, but from different sources, they technically become self-employed and must register to pay National Insurance contributions immediately. This is important, as HM Revenue & Customs will impose a 100 fine on those slow to register their self-employed status - even though someone who becomes self-employed in February of one year would not be liable to pay income tax until January 31 of the following year.

Writers, artists and designers who work from home, and who have a study or studio set aside to do so, are entitled to count the cost of heating, lighting, insuring and maintaining this room against their income for tax purposes.

In practice this means that if a person has a five-room house (not counting bathrooms and kitchen) then they can deduct one-fifth of charges such as rent/mortgage and utility bills, as well as any decorating costs for the room, from their taxable income.

However, the flip side of this is that if the room is exclusively used for work (and does not double as a spare bedroom) then when the property is sold capital gains tax will be liable on that proportion of the property.

Making a living

Self-employed artists, like all other self-employed individuals, are required to fill in a self-assessment tax return each year. As part of this they will be asked to provide detailed information about their earnings.

Those who operate as a company will have to provide a copy of their annual accounts alongside their return.

Tax has to be paid twice a year in instalments every six months under the self-assessment system, known as "payment on account". In practice, this means that the Revenue makes a self-employed person pay tax in the current year based on their earnings in the previous tax year.

Since 2001, the Revenue has recognised that creative people can earn substantial amounts in one year, while making virtually nothing in another - a situation that can push them in and out of the 40% income tax band on an annual basis. In an attempt to address the situation, it introduced a tax relief which permits what is known in Revenue jargon as "profit averaging".

This effectively allows artists whose income in one year is 75% or less of that in the previous year to average their profits (earnings minus expenses) over a two-year period.

In practice, because of the way people pay their income tax in the UK, this would mean that the artist would receive a reduction on their tax bill in the second year of the two-year period, rather than a rebate on tax already paid.

Ronnie Ludwig, a partner at Edinburgh-based accountants Saffery Champness, also points out that once the earnings of a self-employed individual rise above 61,000 they will have to register to pay VAT.

However, as VAT is not charged retrospectively, it will only be due on money earned going forward.

Hitting the big time

At some point, many successful performers decide to set up a company into which all payments for their time and work are then made.

A cursory glance at the credits on Absolutely Fabulous or The Vicar Of Dibley illustrates this trend, as they show that both Jennifer Saunders and Dawn French have effectively been loaned to work on the sitcoms by their joint production company Saunders & French.

Ronnie Ludwig explains: "It becomes sensible to incorporate when earnings exceed the amount the artist needs to live on. If someone earned 1m and only needed 300,000 to live on, it makes sense to shelter the rest."

By setting up a company through which to pay themselves, a successful artist in the UK could cut their tax bill in half, as instead of paying income tax on the remaining 700,000 at the 40% applicable to higher-rate taxpayers they would only pay 19% UK corporation tax.

The recent media storm surrounding the revelation that three members of rock group the Rolling Stones had managed to pay just 1.6% tax on their earnings of 80m last year clearly demonstrates that it is possible for mega-earners to significantly shrink their tax bills by relocating outside the UK.

The press reports relate to royalties earnings, with Sir Mick Jagger, Charlie Watts and Keith Richards apparently avoiding a larger tax bill by setting up trusts to manage this part of their business in Holland, which imposes no direct tax on earnings from royalties.

The three have been tax exiles - which according to Ludwig means they can spend no more than 91 days in the UK in any one tax year - since the early 1970s.

Ludwig said: "There are countries which have much more generous tax treatment for artists than the UK. A lot of songwriters set up a company in southern Ireland and then do all their songwriting for that company."