The 2015 Summer budget was not a good one for Contractors. The removal of the dividend tax credit will cost all Limited Company owners, whether they are Contractors or Small Business owners. However, the calculations below show that once you take into account all the elements of the budget it doesn’t look as bad as some of the scare stories issued immediately after the budget announcement.
Below we summarise the new measures and provide a calculator for you to assess the impact it has had on you.
- First, we discuss the measures likely to impact Contractors introduced in the Summer 2015 Budget;
- Second, we provide a take home pay calculator showing the different take home pay in 2016/17 vs 2015/16 for a given level of income;
- Third, we warn about the impact of having to make Self-Assessment Payments on Account on your cash flow; and
- Finally, we look at the amount of money you can extract from your company while staying within the basic rate tax band.
New measures announced in the Summer 2015 budget that impact Limited Company Contractors from April 2016
Removal of the dividend tax credit
The chancellor replaced the dividend tax credit (representing 1/9th of dividends taken) with a new tax free dividend allowance of £5,000 per annum.
Once you’ve used up the £5,000 dividend allowance you will have to pay Income Tax on dividends of 7.5% for dividends in the basic rate threshold, 32.5% in the higher rate and 38.1% on upper rate earners (those earnings more than £150,000 per year).
On the plus side this is a significant piece of tax simplification and makes understanding the tax on dividends much easier as you no longer have to gross up dividends.
Removal of the Employment Allowance for companies with one employee
In 2014/15 the Chancellor introduced a £2,000 per year tax allowance on Employers NIC applicable for all businesses. In the Summer 2015 budget this allowance was increased to £3,000 but it no longer applies to single employee companies.
The effect of this will be to push the optimal salary for owner/managers down from £10,600 in 2015/16 to £8,060 in 2016/17. Since Contractors on a salary of £10,600 were only utilising about £300 of the £2,000 allowance this is not as bad as it sounds.
What we don’t know at this stage is if husband and wife companies are still able to claim the employment allowance, if so we might see a rush of spouses joining Contractor companies.
Increase in the tax free Personal Allowance from £10,600 to £11,000
This is good news for both Contractors and PAYE employees.
Reduction in Corporation Tax rates to 19% from 2017 (decreasing to 18% in 2020)
This will be beneficial for Contractors but not in the 2016/17 tax year.
The Chancellor announced that measures would be taken to make IR35 more effective. It’s not clear what this means at this stage but it’s likely to result in tougher tests to prove that Contractors are not under the direct control and supervision of their clients.
A consultation on removing the tax deductible status of travel expenses
This is just an idea at this stage but the Chancellor announced that travel expenses may no longer be a deductible expense for all companies, whether a Contractor company or otherwise. If this does happen then it would cost Contractors 20% of their travel and subsistence costs each year.
2015/16 vs 2016/17 Take Home Pay Calculator
Enter your day rate into the calculator below and see what your total take home pay is before and after the budget. Bear in mind that this calculator assumes you take all available cash out of your company.
Payments on Account will impact your cash flow
One of the effects of the new legislation is to increase the amount of income tax paid by individuals via the self-assessment system, if the amount of income tax due is greater than £1,000 it will bring individuals into the payments on account system.
Payments on account mean that you have to pay next years tax in advance. So if you have a tax bill of £2,000 for the 2015/16 income tax year that tax will be due on 31 January 2016. At the same time you will have to pay 50% of the tax due for 2016/17 (HMRC assumes the tax bill will stay the same). Then you pay another 50% on 31 July 2016. So if we assume that you consistently owe £2,000 per year in income tax your payments now look like this:
|31 January 2017||£2,000||£1,000||£3,000|
|31 July 2017||£1,000||£1,000|
|31 January 2018||£1,000||£1,000|
|31 July 2018||£1,000||£1,000|
As you can see, the impact of this is that you effectively end up paying two years worth of tax in the first year of having to pay income tax. This is purely a matter of timing though and over the full life of your business you will not be paying any more tax because of Payments on Account.
How much you can take out of your company in 2016/17 without becoming a higher rate taxpayer
In 2015/16 many Contractors are limiting their earnings to dividends of £28,600 and a salary of £10,600 (total of £39,200), this is the optimal earnings mix to minimise income tax by staying under the 40% higher rate tax threshold. In this scenario no income tax was due to HMRC.
In 2016/17 the higher rate threshold will be set at £43,000, so given an optimal salary of £8,060 the requisite dividends to take a Contractor to the higher rate limit is £34,940. As such by removing the dividend tax credit it means that Contractors can take an additional £3,800 out of their companies before becoming 40% tax payers.
However, since dividends taken in the basic rate range now incur income tax at 7.5%, income tax of £2,025 will be due at the end of the year. Or if we make this a like-for-like comparison by assuming total withdrawals of £39,200 the income tax would be £1,740.
Read more about Payments on Account.
Regrettably, we expect the 2015 Summer Budget to cost all our Limited Company Contractor clients money.
However, we do not believe the true cost is as high as many of the reports in the Contractor media as these tended to focus on the bad side of the announcements without factoring in the positives (such as the dividend allowance and greater amount of dividends that can be withdrawn).
If you have any questions about the Summer 2015 Budget please don’t hesitate to contact your Caprica Accountant who will be happy to help.