During the budget on Wednesday 8th July, the Chancellor announced a fundamental change in the way that dividends are to be taxed from April 2016 onwards and we feel it is important to give you warning of these changes as early as possible.
The basic change
In very simple terms all dividends taken from your company (excluding the first £5,000) will be taxed at a rate that is effectively 7.5% higher than today’s rate. This will mean a real increase in your tax liabilities from the 2016/17 tax year onwards.
Why has this come about?
The government has long held the view that people are setting up companies for the primary purpose of reducing their tax bills and feel that this is a form of tax avoidance. The increased tax on dividends will go some way to reducing the gap in tax liability between businesses operating as sole traders and limited companies - and the government expects to raise in excess of £6bn per year as a result of these changes.
Is it all bad news?
There are some changes that will serve to mitigate the increased tax liabilities for company directors/shareholders. In particular:
1) The corporation tax rate will reduce to 19% in 2017 and 18% by 2020.
2) The Employment Allowance which is currently set at £2,000 will increase to £3,000 from April 2016 and this will increase post-tax profits in companies by at least £800 per year. The allowance will, however, be withdrawn for companies with just one director/shareholder as it is designed to be a tax break to encourage employment.
Does this mean I should disincorporate my business?
Typically the answer here will be ‘No’. Whilst the tax benefits of trading as a company will reduce, our calculations show that you will still be better off and a salary/dividends remuneration package will result in you paying the least amount of tax when compared to other structures and remuneration methods. Do not forget that there are other benefits of operating as a company, in particular your personal assets can be protected thanks to the limited liability provided by this structure.
What can I do about this?
As mentioned, a salary/dividend package will remain the most tax efficient method of remuneration. There are some things that can be considered:
1) One-off large dividends in 2015/16 to provide a director’s loan account for more efficient drawings in the future.
2) Although we do not know yet what the definition of a sole director company is for the purposes of the employment allowance, you may wish to consider ways in which you can bring an employee on board.
Unfortunately we feel that this is a very punishing development for owner managed business operating as limited companies. A one director/shareholder company earning £50k before salary and tax could be as much as £2,000 per year worse off.
Whilst the government might feel that tax motivated incorporations are a form of tax avoidance, it is our opinion that entrepreneurs must have tax incentives for taking risks, creating employment and contributing to the economy. We will be working hard, as ever, to minimise tax bills, once this new legislation kicks in next April.
If you have any concerns or queries about how any of the above affects you, please get in touch us at DRG on 01628 760000.