2015 Budget aftermath: A look at what the dividend tax change means for contractors
Across the country, contractors are still reeling after the changes announced in the Summer 2015 Budget (see our full Summer Budget review here). In particular, the community has been awash with speculation and concern regarding the Government’s pledge to introduce a new taxation system for dividends taken from companies.
Under the current regime, there is a 10% tax rate for dividends but this is cancelled out by a 10% tax credit, meaning basic rate taxpayers receive dividend income tax-free. According to our man with a plan, Chancellor George Osborne, this system is “Arcane” and “Complex.”
The result of this thinking has been an overhaul of the current dividend tax system, with a new – and supposedly simpler – £5,000 tax-free dividend coming into play from April 2016. So far, so good you might say. However, with the introduction of this new limit comes the creation of three new dividend tax bands, which will apply to all dividend income in excess of £5,000 per year, as follows:
- 7.5% (basic rate)
- 32.5% (higher rate)
- 38.1% (additional rate)
So what can you do about it? Well the first step is to make sure you understand the changes and what they mean for you and your business model. Let’s take a look.
Does it affect you?
The majority (around 85%) of UK taxpayers will, in fact, be safe from the changes thanks to the £5,000 tax free allowance. At normal rates of dividend yields, you would need to own £140,000 worth of shares before you hit that £5,000 sweet spot and the new dividend tax kicks in.
I predict the most affected community will be the middle income entrepreneurs. This will include freelancers and contractors trading through their own Limited Company (see our post on the advantages of contracting through a Limited Company), as well as any family owned businesses that have previously used dividends to reward shareholders, who may or may not also be employees.
The Government appears set on removing the incentive for incorporations that are motivated primarily to allow freelancers and contractors to save National Insurance by setting up as their own boss. It seems an interesting coincidence that the new 7.5% dividends tax works out at the same amount (roughly) as a basic rate taxpayer would save on National Insurance using dividends.
But this is a short-sighted strategy, for it is unlikely to deter people who should have been operating as a Personal Service Company (PSC) in the first place. Instead, it will add an extra tax burden to small and medium sized entities, which create jobs and wealth for UK plc.
I expect it will deter tax motivated incorporations for the vulnerable and lower paid contractors. However, is the likely additional ‘tax take’ from those individuals really worth the political criticism from attacking entrepreneurs?
“How can the Government get away with it?” you may ask. Well, the Chancellor has used smoke and mirrors to distract the business community with talk of a longer-term aim to allow further reductions in the rate of corporation tax. I’m afraid I don’t buy it. To me, this feels like a tax raid upon small and medium sized enterprises (SMEs), micro and nano businesses set up by entrepreneurs in the UK.
How will the changes affect your income?
For contractors and freelancers who earn up to the basic rate ceiling and take a salary of £8,000 and £31,000 dividends, their tax bill will rise by around £2,000.
While this is not an insignificant sum to be taken lightly, the reality could be that the impact is still less damaging than the sacrifice of other perks if a contractor returned to PAYE status. To me, the advantages of contracting – both in the immediate and long term, such as planning for retirement and pension funding – far outweigh the initial financial hit of this dividend tax change.
So as you can see, this is not just an issue for the contracting elite. It affects any business where the owners are also employees. For this reason, I believe this latest raft of changes is an attack on all small family and close company businesses, not just one man band contractors.
If you are unsure about how the changes will affect your income, it would be wise to speak to your accountant sooner rather than later.
Remember the benefits of going solo
Contractors considering jumping ship and heading back into permanent employment would be well-advised not to make a hasty decision they may later regret.
At times like this, it can be tempting to start reviewing your business structure or how your company directors are paid. But my advice is this; Keep calm, and talk to an accountant.
In the same way share valuations can go up and down, taxes tend to ebb and flow with the political agenda. It is therefore crucial not to panic and make knee jerk reactions without first doing the sums and remembering the reasons why you went solo in the first place.
There are still benefits to be had by keeping your business model simple, remaining as your own boss and weathering the changes. It might turn out to be just a storm in a teacup.
What should you do next?
If you don’t already have a contractor accountant, now would be a good time to appoint one. I assume most advisers will be very busy in the run up to 5 April 2016, working out if large dividends should be paid before the rules change, along with which family members should be added to the share register.
The contractor landscape can be daunting enough as it is, so why not give us a call on 01202 375491 and let our team of expert contractor accountants guide you through the choppy waters left in the wake of this Summer’s budget?
In the meantime, watch out for more discussion on this issue over the coming weeks on the Intouch Accounting blog. To subscribe, simply fill in your details below so you can receive the latest industry advice, comment and analysis direct to your inbox.
This blog has been prepared by Intouch Accounting. While we have made every attempt to ensure that the information contained in this blog has been obtained from reliable sources, Intouch is not responsible for any errors or omissions, or for the results obtained from the use of this information. This blog should not be used as a substitute for consultation with professional accounting advisers. If you have any specific queries, please contact Intouch Accounting.