Dividend taxation forces rethink on incorporation
Last week’s shock announcement of the introduction of a 7.5% tax on dividends above £5,000 from April of next year will cause businesses and their advisers alike to reconsider the virtues of incorporation.
For those of us old enough to remember, this dividend tax reform is a bit of a throwback to the days of the investment income surcharge when, under a Labour government in the 1970’s, the top rate of income tax rose to 83% and reached 98% when investment income surcharge was applied.
The point at which incorporating a business to save tax has normally been when profits hit the £40,000 mark. If the director/owner extracts profits by way of salary below the NIC threshold and higher dividends, then there is a saving of around £2,500 per annum to be made. As from April 2016 however that will be dramatically reduced to approximately £600, which will be absorbed by the compliance costs of running a company anyhow!
Also announced in last week’s Summer Budget was the abolition of the NIC employment allowance for PSC’s, so any notion of increasing the director’s salary to utilise the increased personal allowance is stymied by the additional NIC.
NIC on dividends has always been dismissed in the past because of the way tax and NIC legislation works but the introduction of this new levy circumvents that problem.
Business owners and entrepreneurs are risk takers and make sacrifices to enable their businesses to grow but if they are simply going to be taxed in a similar fashion to their employees then what incentive is there to endure the hassles of running a business? The Conservatives are the self-proclaimed friends of entrepreneurship but they have a funny way of showing it.
“Business owners and entrepreneurs are risk takers and make sacrifices to enable their businesses to grow but if they are simply going to be taxed in a similar fashion to their employees then what incentive is there to endure the hassles of running a business?”
A. Contractors are NOT entrepreneurs and only run a business in name.
B. The incentive is that they can earn up to 3xSalary of equivalent permie role.
This is absolutely fair. Stop being so bloody greedy.
Couldn’t agree more. Add to this the removal of goodwill on incorporation, auto enrolment, the introduction of RTI, the increases in the minimum wage. The government couldn’t be doing more to destroy the entrepreneurial spirit.
Just as an aside had this been mentioned in the manifesto would the conservatives got as many votes at the election.
3 times your salary depends on what rate your on.. 3 times is an overkill… PAYE employees are just jealous… we contractors dont get sick pay.. holidays etc…
I disagree with ‘Whatever’, as a contractor often takes short-term positions, effectively putting himself in an often dangerous situation of having to find new employment several times a year.
I would therefore consider contractors to be entrepreneurs as they rightfully run a business in their name and reap benefits employees do not have, as they offer a service permanent employees do not. This is not about being greedy, this is about being paid for a particular service.
This dividend tax will undoubtedly lead to a decrease in general entrepreneurship in the UK. This is not what the tories promised us and feels like a betrayal to many of its voters.
This is not fair. The days of earning 3 times the permanent equivalent are long gone for most contractors. There is no holiday pay, nor do most companies expect contractors to take long holidays anyway. There is no sick pay. Contracts can be terminated at short notice with no requirement for the client to find alternative work (unlike for a permie). There are often long gaps between jobs. The higher rates and tax benefits compensated for this but if you remove these advantages, then for most contractors, they may as well take a permanent role with all of the benefits (holidays, sick pay, pensions, company cars, training, medical insurance and others)that apply. This will just diminish the flexible workforce. I’ve been a contractor for 30 years – in good times and bad. This is the end of the road for me and it won’t be to the benefit of anyone, including HMRC. This is not about greed. It’s about choice.
I think it’s clear that the current government views contractors (in all sectors) as tax avoiders full stop.
Due to yet even more limits being placed on PSC’s i’m now hearing colleagues discussing whether it’s worth the risk of going offshore and taking the gamble.
The government is pushing so hard and so fast to tighten the rules that I can see it having a completely negative impact and ending up pushing people towards the very thing that the government are desperately trying to stop.
Just to clarify when I said “couldn’t agree more” I meant with the article not with the post from whatever.
I am going to make a prediction. The government has forecast 2million new jobs. My prediction is that it will be half that figure, and the reason is that many contractors of today make the businesses of tomorrow. I cannot tell you the number of times I have seen people go from employment, to contracting, to running your own business with employees. It’s a like a halfway house to setting up your own business. Yes there was some abuse but it was an acceptable trade off. The government has put a metaphorical concrete wall in front of the entrepreneurial train.
If this makes IR35 even more unsustainable, then I’m happy. If it makes it more marginal for some contractors and they go back to the permie fold, again I’m OK with that.
I’d still rather be a contractor.
I agree with the comments made about this government viewing contractors as tax avoiders, but those contractors are simply working within the rules on taxation to maintain financial efficiency – who wants to pay more tax than they have to? As a contactor of 8 years, who accepted the considerable company and personal taxes to be paid, this latest change is a tipping point for me and I’m now exploring alternative ways to operate my business, some of which I would not have previously considered. HMRC are going after the easy pickings in this short sighted change but in the medium to longer term this change will be counterproductive to entrepreneurship and will suppress new business startup and no one will gain from it
I incorporated as a consultant finding my own work (not as a discussed perm) for 5 years. I was talked back into a perm. role a couple of years ago which I am now just exiting. As someone else had said, the PSC was a stepping stone for me – it had given me the confidence to attempt something more entrepreneurial (despite the increasing red tape). I have been working on a business plan for a new business which would have involved consulting but with employees and creation of software products as well. The budget changes on top of everything else in the last few years are very discouraging and I’m having to rethink the risk.
[quote name=”Bonzodoodah”]I incorporated as a consultant finding my own work (not as a discussed perm) [/quote]
^ “disguised” – d’oh!
If government is so much concerned about dividends withdrawn, why do they not insist big businesses to hire permanent instead of contractor.
People are living in hypothetical world where they consider that contractor are earning 3-4 times the permanent. Contractors don’t have any paid holiday, no sick leave. Contracts can be terminated at short notice with no requirement for the client to find alternative work (unlike for a permie). There are often long gaps between jobs. The higher rates and tax benefits compensated for this but if you remove these advantages, then for most contractors, they may as well take a permanent role with all of the benefits (holidays, sick pay, pensions, company cars, training, medical insurance and others)that apply. This will just diminish the flexible workforce. I’ve been a contractor for 6 years – in good times and bad. This is not about greed. It’s about choice.
It’s not just the dividend tax, it’s the potential double whammy with them looking to removal travel and subsistence expenses. This will add a huge cost to contractors who travel substantial distances or work away 5 days a week. It’s not even on par with a permie (who would claim business travel and hotel costs from their employer, tax free), it’s actually worse than being permie as our expenses will be subject to PAYE and NIC.
Companies in more remote locations with less local skilled resources (e.g. Scotland) will now have to pay through the nose for resource to compensate for the losses contractors working there will incur.
I can see why they have announced an IR35 review alongside these moves as they have now essentially removed the need for it.
If they do manage to largely kill off contracting the impacts will be huge and far beyond the IT industry. Think of the accountancy firms that specialise in these sorts of companies (e.g. Crunch, SJP). What about insurance companies like Qdos? And then there’s all the agencies too. Many of the people who work for these companies are essentially just general admin staff on average wages with no specific technical skills. This could hurt of lot of people who were not the intended targets…
I think your article is misleading, the proposed changes will put personal service companies more on a par with the self-employed than ordinary employees. One could legitmately ask why should someone in business pay less tax using a limited company than someone self-employed without a company shell. As for risks, well the self-employed are surley taking more risks.
Sorry Nigel but to put it bluntly your wrong. From April 2016 the higher rate tax on those operating through a company will be 32.5% + 20% = 52.5%. Self employed pay tax at 42% higher rate. If you factor in corporation tax relief on Employers NI even wages will be a better alternative. The government promised they would not raise Income tax, Corporation tax or VAT. And then they raise income tax by 7.5% on 4 million people. Make of it what you will.
The idea of contractors (in my area of work at least)earning 3x equivalent permie salary may be a bit optomistic. Until that is, you add on the agents hourly premium etc! I do not believe that I am an “entrepreneur”, working as a contractor, but I work as a contractor out of personal choice. An entrepreneur is something completely different to a person simply working as a sub-contractor.
I largely agree with Nigel – these changes are not really that unfair. Very high earners will be slightly worse off than sole traders, but most others won’t be.
Peter – I’m afraid your figures are wrong. You pay 32.5% of dividends-net-of-corp-tax, so your calc should actually be 32.5%x80% + 20% = 46%.
Whilst I agree with the main message of the article, it’s a little counterproductive to portray incorporation as a tax led discussion. Like the majority of contractors I know, I cannot do business without being incorporated – this is not some kind of divisive ‘option’ that I’ve chosen, it’s the only way I can do business. Even if I could find a client small enough or flexible enough not to demand incorporation, I’d still follow that route because it suits my business model ultimately selling my own employees or subcontractors onto a project. Saving tax comes low on my list of reasons to incorporate. Please try not to feed the fire of the misinformed by making this a tax only argument.
Paul,
Your right my mistake on the rate of tax but it does represent a 15% increase on higher rate taxpayers operating through a company and taking there funds out. I don’t think its fair that contractors pay more tax than self employed people.
We could then discuss the fact that self employed people can take much more generous deductions for car expenses, home expenses. telephone expenses and the admin is much less and you would point out but you don’t have to take your profits blah blah blah
The thrust of the argument stands the government has anti small business policies and in 2017 when the full changes impact you will see the results.
Sorry Rhys,
Your correct it is not a tax based question the problem is that those making the changes view contractors as tax avoiders and are targeting every owner occupied company as such and that is the problem and why you are seeing such an attack on your businesses. It is a massive misconception and will have a huge knock on effect in 2016 and 2017.
re Peter and Paul’s comments on the tax rates of the people using ltd co.’s v self-employed, the position is actually more complex than this. ltd co’s will still be able to obtain significant tax savings over the self-employed in respect retained profits. Back some 10-15 years ago, when considering whether to become self-employed vrs Ltd co. you not only asked what level of profit you had but also the level of drawings. It is only again by factoring this into account can you now determine the overall tax position. Of course some contractors will just withdraw every penny from the company like an employee draws wages, rather than retaining or reinvesting profits but..I say no more…
Actually Nigel W. The self employed take no risk whatsoever, least of all with their taxes. If I were self employed I could, quite legitimately, avoid paying my taxes knowing that my customers will be forced, by HMRC, to pay them. By being a single person limited company this ‘safety net, is removed such that the limited company will be forced to go in to administration.
More folk out of work. How can I afford to work away and pay for hotel bills, fuel and food if treated as PAYE? Make work pay. Absolute joke. People will be forced out of employment with this. They have no concept of real life. I have never claimed any type of benefit in 26 years of my working life. They will get a shock with this as tax receipts will go down as I will seek other employment.