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Following the Summer Budget, the forums have been abuzz with the negative impact to contractors working through a Personal Service Company from the changes to Dividend taxation and the Employment Allowance, the review of the rules for tax relief on travel and subsistence expenses and IR35 reform.
This newsletter aims to get behind the headlines and look likely actual effect and emphasize the importance of business management.
Whilst the new tax rates on Dividends are a net increase in taxation, it is worth considering how the current Dividend Tax Credit works.
If a contractor is paid a Dividend of £18,000, from a total income perspective, this is deemed to be a net payment after the 10% tax deduction. In other words, a Dividend payment of £18,000 equates to £20,000 of taxable income. In the new regime, the contractor would receive the full £20,000.
Taking the scenario where the contractor is paid a salary of £15,000, is paid Dividends to the higher rate threshold and has no other income, we have summarised below the overall impact of the changes for the 2016-17 tax year between the current and new systems:
|2016-17 – Current Tax Structure||2016-17 – New Tax Structure|
|Higher Rate Threshold||£32,000.00||£32,000.00|
|Income Tax at 20%||£800.00||£800.00|
|Employee National Insurance at 12%||£832.80||£832.80|
|Employer National Insurance at 13.8%||£957.72||£957.72|
|Dividends Available (No Tax)||£25,200.00||£5,000.00|
|Dividends at 7.5% Tax||£23,000.00|
In this scenario, whilst there will be a new tax liability of £1,725.00, the abolition of the Dividend Tax Credit system would increase the overall payments to the contractor by £2,800.00.
The contractor that can live on an average monthly take home pay of £3,450.00 would, in fact, be better off.
It is also worth bearing in mind the overall tax and National Insurance burden remains considerably less than for an employee on a £43,000 salary.
However, the new system will disadvantage those who take Dividends beyond the Higher Rate threshold. For every extra £1,000 of Dividends, there would be an additional £75 of tax to pay than there would have been under the old system.
Essentially, this make the approach of a salary and high Dividend remuneration strategy extremely unattractive and should encourage contractors to run their Personal Service Company as a business. The more costs that can be directly paid by the company, the less the necessity to draw a high level of Dividends.
The Budget document states “To ensure that the NICs Employment Allowance is focused on businesses and charities that support employment, from April 2016, companies where the director is the sole employee will no longer be able to claim the Employment Allowance.”
The actual framework of the legislation will determine whether simple steps such as appointing a fellow Director or employing a family member will enable the company to continue the entitlement to the Employment Allowance.
For a contractor with an annual salary of £15,000, the Employment Allowance will save their business £957.72 in the 2015-16 tax year.
The review of the rules for tax relief on travel and subsistence dates back to the 2014 Budget. The envisaged change is targeted at the use of the reimbursement of home-to-work travel expenses by Employment Intermediaries. However, although this is due to come into force from April 2016, at this stage the government have not published the detail of the changes.
Finally, the Summer Budget promises IR35 reform and that a “discussion document will be published….”.
Going back the 2010 Emergency Budget at the start of the last parliament, it stated “The Government remains committed to a review of IR35 and small business tax and will release further details shortly.”
The reality is that the world of contracting is so diverse that finding a workable mechanism to identify disguised employment is nigh on impossible. IR35 legislation has been in place since 2000 yet the impact has been minimal to this lack of clarity and, to date, the promise of reform has not yielded any delivery.
However, we strongly encourage our contractor clients to run their Personal Service Companies as businesses and not merely as a mechanism to convert day rate revenue into remuneration.
We anticipate the Summer Budget will generate a large number of questions and, as a result, we are offering a free Q & A forum.
If you email your question to us at firstname.lastname@example.org by Wednesday 15th July, we will include it and our response in a Q & A newsletter we will be publishing on Friday 17th July.
Further, if you have deeper concerns over your Personal Service Company, we have a limited number of free Company Healthchecks available which are offered on a first come, first served basis and without obligation. Please email us at email@example.com for more information.
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