The Fizz! Blog

One reason the dividend tax changes weren't quickly picked up on

Although the implications of next year's increased tax on dividends are now becoming widely understood (and we've been pointing them out since Budget day!), it took a while for lots of limited company owners to realise what happened.

Partly, that's because the media are obsessed with categorising the Budget news into different sections.  So, the decrease in corporation tax went into the Business section.  Great, thought company owners!  Meanwhile, the increase in dividend tax went into the Personal section, which many business owners aren't going to inspect as quickly or as closely.

If you're going to use that categorisation, those are technically the correct categories.  But it's nonsense to split the two things.  The taxation of profits in companies and then the taxation of what remains in the hands of company owners are inextricably linked.  To understand the big picture you need to look at them together.  The universal media categorisation can be really unhelpful.

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Extra National Insurance for Landlords?

As well as the extra tax likely to (eventually) be payable by many people who rent out property as a consequence of the Budget last week, HMRC appear to be making increased attempts to collect National Insurance from them.

The NI in question is Class 2 NI, the type payable by sole traders and partners.  Historically, it's not been charged on property income, because it's payable where there's income from a business, and it was accepted that letting out a property wasn't generally a business.

However, where someone is letting out multiple properties and putting a level of effort into earning profits from the activity that's consistent with running a business, HMRC are apparently charging Class 2 NI.  I say apparently because we've not yet seen such a demand, despite looking after many landlords.  But it definitely appears to be happening - and happening in many cases where there's no real business being run.

The thing is, Class 2 NI is a relatively trivial amount - less than £150 a year.  So it's at a level where a property owner may just decide to pay it for a quiet life.  Whether HMRC are sending the notices out with that thought in mind, who knows!  It'll be interesting to see if the trend continues - though actually the government are consulting on amending or ditching Class 2, so perhaps it'll be a short-term issue.

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The Fizz Summer Budget email newsletter

We don't usually put our monthly email on the blog, since it's a client care thing to us rather than a marketing thing.  But from time to time we like to give a flavour of it to people we don't work with, so here's this month's email, our summary of the Summer Budget.

More thoughts on dividend tax in our earlier article here.

It was the second Budget day of the year yesterday!  And it was a big one for small business owners - particularly those operating via limited companies, or thinking of doing so.

New tax on dividends

This is the thing that's going to be of most significance overall to small business.  As a basic summary at this stage, as of 2016, for business owners planning on getting most or all of their profits into their own hands each year, there will no longer be any material tax/National Insurance incentive to operate via a limited company, as opposed to operating as a sole trader, partnership or LLP (see later).  We could go through detailed numbers, but that's the key thing to understand.  It's pretty much the same at all profit levels.

There do remain some reasons why limited companies will still be appropriate for many businesses, though!

• Many business owners *don't* want to draw out all of the profits that the business makes - limited companies remain a great way of sheltering profits that you don't need right now from higher-rate tax.
• They remain a very useful tool for keeping income below £50k so as to retain Child Benefit.
• It's easy to forget that the most fundamental benefit of a limited company is the "limited" - provided you're not naughty or reckless, you're less at risk personally if things go wrong with the business than you would be as a sole trader or partner.
• Very often, a customer will insist on your invoicing them via a limited company, so you don't have a choice anyway.
• Limited companies will also remain the most appropriate way for most businesses with multiple owners / investors to be set up.
• We look after lots of businesses that qualify for Research and Development Tax Credits - for those claims, a company is still essential (even an LLP can't claim).

However, it's definitely now the case that there's significantly less of an incentive for a typical one-person freelancer to work via a limited company.

One thing we think we'll see more of is LLPs - Limited Liability Partnerships.  They effectively offer the personal protection of a limited company, but the tax regime of a sole trader or partnership, with more flexible profit splits than limited companies too.  Up until now, they've been somewhat niche, because most people preferred the tax regime of limited companies and the attractions of flexible profit splits weren't enough to tempt them away.  Now that there's not much to choose between the tax regimes, the greater flexibility of an LLP is bound to tempt people towards them.  We imagine we'll be setting up quite a lot of them in future!  They're no good for sheltering "unneeded" profits from higher-rate tax though.

Of course, we'll be talking to all our affected clients about this individually over the year, and we'll be making very clear recommendations to you when the time comes.  It's quite probably going to be the case that most limited company owners remain in their current format, but it'll mean changes for some.  The biggest effect is likely to be deterring small businesses from shifting to a limited company in future.

People will come up with ideas for alternative ways of operating via a limited company to make the position better (we've had a couple already) but overall the tax and NI burden of a business owner is going to become much less of a factor in choosing their business structure.

We're not saying all this is a bad thing, by the way - there's a very good argument that company owner/directors have had things unfairly tilted in their direction until now.  In any case, it's the new reality!

Employment Allowance

At present, employers get let off the first £2,000 of Employer's National Insurance in a tax year.  That's going up to £3,000 next year.

However, it's being withdrawn from "director-only" businesses - allowing such businesses to claim the allowance had created a situation in which we'd been able to save about £200 per year per director by exploiting the interaction between the allowance, National Insurance and corporation tax.  We won't be able to do that for you next year!

For many employers of course, the extra £1,000 saving will be more than wiped out by...

Increases in National Minimum Wage

George got lots of headlines by calling it a new National Living Wage, but of course it's really just a change in the NMW.  It's a big one, though.  Within a few years, the NMW for over 25s will be £9 an hour.  Since it's presently £6.50 an hour, that's a 38% increase.  Anyone employing lots of people at that level but only making modest profits is going to have some serious issues with their business model.  Will it incentivise employers to sack people on the eve of their 25th birthday?  We'll see.

As an aside, it'll also of course mean an equivalent rise in the pension contributions employers will have to make on behalf of their employees once they've got an Auto Enrolment pension scheme in place.  There was nothing of any relevance to Auto Enrolment in the budget, by the way - it remains the case that small employers are going to need to have schemes in place in 2016 or (more likely) 2017.  Do talk to us about that if you've got worries about it.

Annual Investment Allowance

This was non-news really.  The AIA is the cap on the tax relief you can get for buying new fixed assets (computers, machinery, vans, tools etc).  It's bounced around an annual limit of £250k to £500k of purchases for the last few years.  It was due to come down to £25k.  That was never going to happen.  Instead, it's going to be £200k for a year - a level which is going to be completely fine for 99.5% of businesses, needless to say!

Corporation Tax

Big headlines for corporation tax coming down to 19% then 18%.  The reduction to 18% is in 2020 though!  Amazing the headlines you can get for something that won't happen for five years.  For limited company owners, it's a trivial reduction compared to the new dividend tax.

Insurance Premium Tax

This tax (which is added on to your insurance premiums, so you might pay it without even noticing most of the time) is going up from 6% to 9.5%, so a pretty hefty increase if you've large insurance costs.

Tax relief for landlords

At present, a wealthy Buy To Let landlord might save tax at 45% on the mortgage interest they pay for the property.  The maximum tax saving is going to be restricted to 20% (phased in from 2017) - effectively a landlord who is a basic rate taxpayer will be no worse off, but higher earners will be.

In addition, the ability to claim a 10% wear and tear allowance when you're letting out a furnished property is going too.  Though HMRC have previously redefined "furnished" to such a strict level that few landlords could legitimately claim to be letting out a furnished property in any case.

Inheritance Tax

The government's obsessed with the idea of passing on the family home tax-free for some reason.  By 2020 there will be an extra bit of IHT allowance available when a home is included in the estate (or even if it's been sold when the owner, say, downsized but there are equivalent other assets in the estate), effectively increasing the amount a couple can pass on tax-free to £1m.  IHT for estates over £2m will go up to cover the cost.

Decreased pension allowance for high earners

At present (subject to some other rules) anyone can contribute up to £40,000 to a personal pension each year.  That's going to be reduced for those earning over £150,000.  For every £2 your income is over that limit, you lose £1 of the allowance.  So, by the time your earnings hit £210,000, you'll have lost £30,000 of the entitlement, and can only contribute £10,000 in a year.  It stops there - you're still able to contribute up to £10k and get tax relief, no matter how high your income.

If anything else came up in the Budget that you weren't clear on or think could be of use to you, do call or email - we'll be pleased to talk about it.  Similarly, if you'd like to talk about any of the topics above, let us know (although it's a bit early to delve into the detail of dividend tax - let's wait a little while on that until the dust has settled and the small print's clear!).

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Tax on dividends from 2016 - kind of a big deal

Traditionally, the majority of company owners have taken their income as a combination of a) PAYE salary and b) dividends, with the balance skewed towards the latter.  That's because, unlike salary, or the income of sole traders and partners, there's no National Insurance on dividends.

The saving is sufficient that, for many business owners, trading via a limited company is worth it on the grounds purely of National Insurance planning, let alone the other tax and commercial benefits of a company.  Rather than paying the 9% National Insurance that a sole trader pays, you paid none, quite legitimately, and still accrued the right to State Pension.

Ever since Jane and Greg began training (i.e. a long time ago), every Budget has been preceded by people claiming that the Chancellor of the day was going to apply National Insurance to dividends, or apply a higher rate of tax to them, to address the perceived unfairness of this.  The issue has been exacerbated over time by changes in the way the UK workforce operates - many people who traditionally would have been PAYE employees switched to contracting via a limited company (either on their own initiative, or encouraged by an "employer" wanting to minimise its liabilities under NI and employment law), an arrangement sometimes referred to as disguised employment.

But, year after year, nothing happened.  In 2000, some rules commonly known as IR35 were introduced in order to try and specifically attack the arrangements of those people who would have traditionally been on PAYE but were now trading via companies.  It was poorly conceived and written law, that HMRC didn't remotely have the capacity to apply on a meaningful scale, and it's been a colossal failure.

This year, something's happened.  Rather than attacking disguised employment, George Osborne's decided to just apply new rules to company owners (actually, anyone receiving dividends, but people trading via a company will be the most affected).  As of 2016, a taxpayer can receive £5,000 of dividends without paying any tax on them, but after that there's tax to pay.  A basic rate taxpayer will pay 7.5%, then the rate will go up to 32.5% for people in the 40% bracket, and 38.1% for people in the very top tax bracket.

So, the person who formed a company to avoid the 9% NI of a sole trader still avoids it - but, if they've got £30,000 of dividend income in a year, they'll pay tax at 7.5% on £25k of the dividends, which is £1,875.  That's less than the NI (by about a thousand pounds), but the saving is quite likely to no longer be quite enough to attract a lot of people towards forming a company.

For dividends above that level, a company now looks less attractive than being a sole trader!  A sole trader in the higher rate bracket effectively pays 42% (40% tax plus 2% NI).  A company owner will pay 46%!  Their company will pay corporation tax of £200 on profits of £1,000, and if the owner takes the remaining £800 as a dividend when already in the higher rate bracket, they'll pay tax of 32.5% of the remaining £800, which is £260.  £460 tax in total on £1,000 of profits.  It'll be a bit less harsh as corporation tax goes down to 19% then 18%, but not much less.

There are other advantages to companies still!  The fundamental one is limited liability, of course, but they remain a great way of sheltering income that you don't need from higher rate tax, for example.  But it seems pretty likely that a large proportion of purely tax-motivated incorporations are likely to be much less desirable than they once were - and there could be plenty of people coming out of limited companies and reverting to sole trader status.

By the way, none of this is to say that the changes are unfair.  There's a strong argument that company owner/directors have got away with an unfair advantage for a long time, and without question George Osborne has done more to address it in one day than has been done in the previous 20 years, albeit by using a blunderbuss rather than a scalpel.  It's a big deal, though, and it'll cause a lot of upheaval for UK limited companies (and their accountants!).

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An interesting and successful appeal against an HMRC penalty

If your income is over a certain threshold each year and you've a student loan outstanding, you have to make repayments of the loan.  If you're in employment, it's usually dealt with via PAYE, but many people aren't in that position and have to make payment as a lump sum via their Self Assessment Tax Return - HMRC collect the payment as part of their January tax and NI payment and pass it on to the Student Loan Company.  We've lots of clients in this position.

If you're late paying the tax and NI bill that's due in January, and still haven't paid it by the end of March, HMRC charge a 5% penalty.

We've a client who had no tax to pay in January, but did have a Student Loan repayment to make.  He forgot to make it (despite our reminder, I should add!).  HMRC then raised a notice demanding the 5% penalty on the late payment.  But the late payment wasn't tax, it was a Student Loan.  So we appealed against it - the penalty was about £100, so no disaster but worth questioning.

HMRC have cancelled the penalty, correctly, since there's been no late payment of tax or NI.  It's interesting, though, that their system is evidently completely unable to identify what the late payment's made up of; it's based on the taxpayer's account as a whole.  You wonder how many people have been penalised for a late Student Loan repayment and paid it without questioning it.  Thousands?  Look out if you're in that position, or you've clients in that position, anyway.

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