2016-17 Contract company changes illustrated
Written by Ray Coman
The emergency Budget of 2015 introduced rates of tax for dividends which had repercussions for contractors trading via a company and other owner-managed businesses.
Prior to 2016-17 there was often a clear tax benefit to forming a company compared with invoicing as a sole trader. This is because, unlike a sole trader, a company owner could take profits as dividend and thereby avoid national insurance.
The example below takes a company with profits after deduction of director’s salary of £90,000. Using the corporation tax rate for 2015-16 and 2016-17 which is 20%, profits available as dividend would be £72,000. In this case, the director receives a salary up to the national insurance threshold of £8,060 and withdraws all remaining profit as dividend.
Limited company calculation
| Income | 2015-16 |
2016-17
|
||
|
£ |
£ | £ | £ | |
| Director’s salary | 8,060 | 8,060 | ||
| Gross dividend* | 80,000 | 72,000 | ||
| Personal allowance | (10,600) |
(11,000) |
||
| Dividend allowance | (5,000) | |||
| Taxable income | 77,460 | 64,060 | ||
| Income | Tax | Income | Tax | |
| 2015-16 @ 10% basic rate | 31,785 | 3,178.50 | ||
| 2016-17 @ 7.5% basic rate | 32,000 | 2,400.00 | ||
| 2015-16 @ 32.5% higher rate | 45,675 | 14,844.38 | ||
| 2016-17 @ 32.5% higher rate | 32,060 | 10,419.50 | ||
| Tax credit | (7,746.00) | |||
| Totals | 77,460 | 10,276.88 | 64,060 | 12,819.50 |
Note in 2015/16 the dividend is grossed up by 100/90. Grossing up does not occur under the new rules.
Adding the corporation tax payable of £18,000, the overall tax burden increases from £28,276.88, to £30,819.50. This tax is calculated on a profit, before salary of £98,060.
Sole trader illustration
The following table illustrates the tax implications of the same individual trading as an unincorporated business
| Income | 2015-16 |
2016-17
|
||
|
£ |
£ | £ | £ | |
| Profits | 98,060 | 98,060 | ||
| Personal allowance | (10,600) |
(11,000) |
||
| Taxable income | 87,460 |
87,060 |
||
| Income | Tax | Income | Tax | |
| Income tax @ 20% basic rate | 31,785 | 6,357.00 | 32,000 | 6,400.00 |
| Income tax @ 40% higher rate | 55,675 | 22,270.00 | 55,060 | 22,024.00 |
| Subtotal | 87,460 | 87,060 | ||
| National insurance @ 0% | 8,060 | 8,060 | ||
| National insurance @ 9% | 34,325 | 3,089.25 | 34,000 | 3,060.00 |
| National insurance @ 2% | 55,675 |
1,113.50 |
56,000 | 1,120.00 |
| Totals | 98,060 | 32,829.75 | 98,060 | 32,604.00 |
It can therefore be noted form the above that while a sole trader tax liability has not changed considerably in 2016-17, a company contractor now has a burden about the same as that of a sole trader.
Personal allowance abatement
Income over £100,000 would normally result in abatement of personal allowance. A sole traderdreach this abatementold with lower income than a contractor company. This is because corporation tax is deducted from income subject to income tax.
The tax benefit of a company compared with a sole trader will be significant if the profits in the above example were increased by say £10,000.
Benefits a limited company
Where the shareholder pays another person from their income a shareholder could be added so as to effectively double the £5,000 dividend allowance. A typical situation would be where household costs are shared with a spouse, who has no other dividend income.
The rate of corporation tax drops to 19% on March 2017 and again to 17% in March 2019. Therefore, the tax benefit of company compared with sole trader will become clearer.
It is not necessary to withdraw all remaining profit as dividend. Alternative could be to accumulate profits in the company and extract these as capital gains on eventual disposal of the company.
In the approach to the 2016-17 Budget the government entered a consultation on the abolition of entrepreneur’s relief for contractor companies. However this capital gains tax relief has remained intact.
The protection of limited liability which derives from using a separate entity through which to contract often suits both sides of the arrangement for non-tax benefits.
On account of the above, it can be maintained that a company pulls more credibility.
