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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