Response to the Summer Budget
Yesterday’s Summer Budget has mixed news for contractors and small businesses but as always the devil is in the detail and after reading through the budget documents last night the detail is not all there yet (despite being 123 pages!). The budget is a top level proposal and nothing will be enacted until it is written into a Finance Act. We also have another two budgets before most of these changes are planned to come in so plenty of time for George Osborne to backtrack.
There are some major changes proposed both good and bad:
1. Dividend tax
The removal of dividend tax credits and introduction of new dividend taxes. Currently dividends are free of additional tax up to the higher rate tax threshold of £42,385. However it is proposed that a new tax free dividend allowance of £5,000 is introduced with rates of tax above this as below:
- 5% tax on dividends between £5,000 and £43,000 per year
- 5% tax on dividends between £43,000 and £150,000 per year
- 1% tax on dividends above £150,000 per year
These changes would come into effect from April 2016. Based on a salary of £15,000 this means dividends of £24,000 per year would now attract tax of £1,425. However, with the large difference in tax on dividends in higher rate it is recommended that, providing there is sufficient profits, dividends of £28,000 per year are paid (from April 2016) in most circumstances. The government has also signalled its intention to increase the higher rate tax threshold to £50,000, so if it does get up to this level the effect of the additional tax would be mitigated to a large extent.
An example for a contractor withdrawing a salary of £15,000 and dividends of £24,000 per year.
Total personal tax and NI payable in 2015/16 – £1,750 Total personal tax and NI payable in 2016/17 – £3,900
2. Removal of Employment Allowance for single employee companies
The Employment Allowance was introduced a couple of years ago to encourage businesses to employ more staff. This was in the form of a discount of £2,000 per year on Employers National Insurance (NI). Now most contractors and small businesses will be paying a low salary and larger dividends which are not subject to NI, so this won’t be such a big hit. We will also be looking out for further announcements on this to see if it is still removed if a spouse or partner is employed in the business. Again this would come into effect from April 2016. For those still able to claim the Employment Allowance it will be increased to £3,000 per year so good news for those businesses employing more than one person.
3. Introduction of proposals on travel and subsistence consultation (Umbrella Companies and contractors caught by IR35)
Last year the Office of Tax Simplification (yes, there is a department for this and no, we don’t see any evidence of simplification yet!) consulted on a proposal to restrict the travel and subsistence expenses claimed by those contractors working through umbrella companies and also those working through their own limited companies. See here:
The good news for most contractors is this will only affect those who are subject to the control, supervision and direction of their client (broadly those caught by IR35) and those working through umbrella companies. We think we will see a lot more contractors moving from umbrella companies to limited companies over the next year as they look to increase their tax efficiency through claiming travel and subsistence expenses.
4. Review of IR35
The Government have asked HMRC to start a dialogue with businesses on how to improve the effectiveness and fairness of existing IR35 legislation. Although this might sound worrying to contractors, we actual welcome a review of this very grey area. IR35 legislation was introduced in 2000 and we are still no closer to getting a clear definition of a disguised employee or genuine limited company contractor. We find it hard to get too excited about it, as it is just the intention to review and we have heard the same from George Osborne for the last 3 or 4 budgets!
5. Inheritance Tax
The addition of a new nil rate band of £175,000 on top of the existing £325,000 allowance will mean married couples and civil directors will be able to pass on assets worth up to £1m, including the family home, without paying any Inheritance Tax at all. This will be introduced gradually from 2017 with the whole £175,000 being in place by 2020.
6. Personal Allowance
The Personal Allowance (the amount everyone can earn before paying tax) will be increased to £11,000 from April 2016 with a commitment to increase to 12,500 by the end of this government.
7. Corporation Tax
Corporation tax will be decreased from 20% to 19% in 2017 and 18% by 2020. This is good news for contractors and will go some way to mitigate the new dividend tax. For contractors with a £100,000 profit it will mean Corporation Tax savings of £2,000 per year.
8. Trivial benefits
A new trivial benefits allowance will come into place from April 2016. This will mean that benefits of less than £50 per year per employee will not need to be reported or taxed.
9. Buy to let property investors
Two bits of bad news here for some property investors. Firstly the amount of mortgage interest that can be claimed against your rental profits will be restricted to those under the higher rate tax threshold. This will be tapered away from 2017. Secondly the wear and tear allowance of 10% that could be claimed against your profits will be removed from April 2016 and replaced by the original system of just claiming for the actual costs incurred. So it’s important to keep all your receipts for property expenses from April next year.
10. Rent a room scheme
Income received from renting a room in your main residence was subject to a free of tax annual allowance of £4,250 for many years, this has now been increased to £7,000. So good news for those renting a room either privately or through sites like Airbnb.
11. Childcare
From September 2017 free childcare entitlement to be doubled from 15 to 30 hours per week for working parents of 3 and 4 year olds.
12. Tax compliance
HMRC have been cracking down on the use of tax avoidance schemes and well within their sites are some of the schemes that contractors have been using like Employee Benefit Trusts (EBT) and various off shore arrangements used to avoid tax. The Government has committed to a further £800m investment in HMRC compliance units to tackle this. We have always steered contractors away from these schemes and are glad we did now that we have seen a lot of contractors with backdated tax bills, penalties and interest causing bankruptcy (plus the providers of the scheme running off into the sunset with the fees they have charged leaving the contractors….or more likely their new accountants to try and sort out). With the extra impetus directed on this shady area of tax by HMRC it is hard to see how these schemes can fly under the radar any longer.
13. Savers
Some good news here for savers in a few forms:
- The new ISA limit of £15,240 remains for the tax year ending 5 April We would not be surprised to see this increased next year also.
- Personal Savings From April 2016 no tax will be paid on the first £1,000 (or £500 if a higher rate taxpayer) of interest received.
- A new Help to Buy ISA will be introduced in December Those saving for their first home will be able to save £200 per month in a help to buy ISA. The Government will then top this up by 25%. This will be capped at a maximum of £3,000 topped up for £12,000 of savings.
14. Pensions
The Government will consult on a new ISA style pension tax system. At the moment pensions receive tax relief on the way in, growth within the pension is tax free, however, the pension is taxed on the way out. An ISA style system would mean that pensions are paid after tax, growth in the pension is tax free and no tax would be paid on the way out. We will keep an eye on this over the coming months however we can’t see this coming in anytime soon.
Pension tax relief will also be limited for those employees earning over £150,000 from £40,000 to
£10,000 per year. This will not affect the Employer pension contributions made by the majority of contractors working through a Limited Company.
Our recommendations
The good news is we believe with the right tax planning we can mitigate a lot of the “bad news” changes and take advantage of the “good news” changes.
We will need to wait until the Finance Act is drafted to get more detail on some areas but things we can look at are:
- Bringing in new employees to retain the Employment Allowance (which actually increases to £3,000 per year from April 2016).
- Decreasing salary levels so that more income is taxed at 5% (as dividends) rather than 32% (as salary).
- Actually increasing the amount in dividends that can be taken due to the removal of the dividend tax credit, introduction of new £5,000 tax free allowance and increase in basic rate tax
A typical structure may then be:
£11,000 salary and £32,000 dividends per year – total personal tax payable c£2,000 Compared to a current structure of:
£15,000 and £24,000 dividends per year – total personal tax payable c£1,710
In this example you have taken out another £4,000 per year from the business for only another £300 in personal tax.
- Tax planning strategies in terms of how much is drawn as dividends and how much is left in the Money left in the business may then be drawn out as a lump sum on closure of the Company at a rate of 10% by using Entrepreneurs Relief.
- Review of all of the expenses that you can claim through your business and advice on employer pension contributions that can be made from your ltd
- Review of VAT The Flat Rate VAT scheme still remains a great benefit for contractors and far outweighs the additional tax in basic rate on dividends.
- Bringing in a spouse as a shareholder/employee to make use of their tax free or lower tax allowances for both salary and dividends.
- Bringing in a spouse as a minority shareholder where before it was not as tax efficient to do so (maybe they were earning higher rate income elsewhere). We can now make use of a spouse’s £5,000 tax free dividend
- Ensuring full use of the tax free basic rate band is used in 2014/2015.
Summary
For the last few years there has been some really good news for contractors in the budget. Reductions in Corporation Tax, Employment Allowance, increases in Personal Allowances etc were all benefiting the small personal service company, so it is not entirely unexpected to see an increase in taxes now. With a Tory mandate for 5 years this was always going to be the “bad news” budget.
There are still some positive things for contractors like the reduction in Corporation Tax, increase in Personal Allowance and basic rate band, large increase in Inheritance Tax thresholds and this is offset by the increase in tax on dividends. As you can see from the example above we are already thinking of ways we can take advantage of this for you and will continue to do so.
There is a lot for us to look at over the next few months and we will keep you updated with the changes as we know about them.
As always any questions please ask.
Note: All the information and advice in this blog post was correct at the time of writing.
