The March 2017 Budget delivered by Chancellor Hammond this afternoon added further tax pressure to the self-employed and owner manager business sector. The speech descended into Pantomime at one stage with Hammond retorting 'oh yes we will!' to a heckle from the opposing benches. If it was a Pantomime Budget, the accountant was yet again cast as villain.
Increase in national insurance rate for the self-employed.
A self-employed individual is subject to a rate of (Class 4) national insurance of 9% on any profits over the small profits limit, currently £8,060 per annum. Announced in the Budget was a rise in this rate to 10% from April 2018 and again to 11% in 2019.
Cut to dividend allowance
A dividend allowance was announced by the preceding Chancellor, when the rate of income tax on dividends was hiked. Its effect is to treat as tax exempt the first part of any dividend received. The allowance, currently £5,000 will be decreased to £2,000 from 6 April 2018. This will affect self-employed people who conduct business through a company.
The government is introducing policy for businesses and landlords to report profits to HMRC once every three months. In today’s announcement, this requirement will be delayed by a year, to April 2019, for landlords, sole traders and partners with a turnover below the VAT threshold. Companies will be required to report profits once every three months from April 2018.
Promoter of Tax Avoidance
As previously announced in the 2016 Autumn Statement, a financial penalty will be imposed on any person involved in the promotion of a scheme which is defeated by HM Revenue & Customs.
Certain unincorporated business can account to HMRC for profits on the basis of cash paid and received. This contrasts with the accruals basis used for other entities, where profits would be determined to a greater extent by invoice date. The government has increased the threshold for accounting for profits on the cash basis to £150,000. Once the basis is applied it can continued to be used until profits reach £300,000. The threshold is currently £83,000 and the proposal is due to be effective 6 April 2017.
Recap on previous announcements
The list below summarises forthcoming changes announced prior to the Budget:
Personal allowance to increase by £500 to £11,500 on 6 April 2017.
A £2,000 increase to the higher rate threshold
Class 2 NICs to be abolished from April 2018.
A cut in the rate of corporation tax to 19% on 1 April 2017 and again to 17% in 2020.
The newly appointed chancellor’s speech yesterday included many confirmations about the tax changes announced by his predecessor, Mr Osbourne. However, the full report introduced an alteration to the flat rate scheme that will have a significant impact for contractors and other self-employed individuals.
The Autumn Statement brought an increase in the flat rate scheme to 16.8%. The new percentage will apply to most contractors, regardless of their business activity. Since the percentage is applied to VAT inclusive turnover, a flat rate scheme trader will now pay 19.8% of the 20% VAT collected. This 0.2% benefit will effectively cancel the tax benefit of using the scheme.
The new percentages take effect from 1 April 2017. At that point, most traders will be better off using standard VAT accounting, and recovering VAT on expenses. For many, the accounting cost and hassle of being VAT registered will not outweigh any VAT recovery on expenses. Traders registered voluntarily should consider VAT deregistration.
The flat rate scheme currently ranges between 11% and 14.5% for most businesses. The highest percentage a trader can currently pay is 14.5%. However, a contractor providing services typically has has relatively 'low costs' relative to providing services. Only business that are not ‘low cost traders’ will be exempt from the new rules. To continue to use the lower flat rate percentage, a business has to spend at least 2% of turnover on goods. Goods in this case exclude:
Any services (such as telephone, rent, professional fees, insurance and sub-contractor costs.)
Capital items, (such as computer equipment and office furniture.)
Even where the 2% test is met, a trader will not be excepted unless total expenditure on goods exceeds £1,000 per year.
Retailers, restaurants and other business with high cost of sales will, by and large, meet the test. For IT contractors, management consultants and other service providers, the flat rate scheme is unlikely to be of any practical use. For instance, it is remote that stationery and office consumables will comprise 2% of turnover.
The Chancellor confirmed plans to lower corporation tax to 19% in April 2017 and eventually to 17% by April 2020. The rate by 2020 is expected to give Britain the lowest company tax in the G20.
The employer’s (or secondary) national insurance limit will be slightly increased so that it is the same as the employees’ (or primary) national insurance limit. The two thresholds will be aligned at £157 a week with effect from April 2017. The change would not result in any extra tax liability for an employee. The extra liability for an employer would be no more than £7.18 a week per employee. The alignment is intended to simplify national insurance.
As announced in the 2016 Budget, Class 2 National Insurance Contributions, payable by self-employed people, will be abolished from April 2018. A further Budget announcement confirmed is the liability of termination payments over £30,000 to national insurance. The measure also takes effect in April 2018.
Personal allowance and higher rate tax
The government confirmed the previous announcement that the personal allowance will rise to £11,500 in 2017-18 and again to £12,500 by April 2020. The higher rate tax threshold is also set to increase from £42,000 (in 2016/17) to £45,000 next tax year and eventually to £50,000 by 2020. Following this, the personal allowance threshold will rise in line with the CPI measure of inflation.
Salary sacrifice scheme describe an arrangement where an employee foregoes pay in order to receive some benefit. Employee do not have to pay national insurance o benefits and therefore the scheme can bring a tax advantage. Depending on the rate of an employee’s national insurance, a benefit could be as much as 12% cheaper if paid by salary sacrifice than out of take home pay.
The Autumn statement announced an axing of perks, such as gym and private healthcare memberships and smartphones from salary sacrifice. Nonetheless, a tax benefit will still arise from sacrificing pay in favour of:
The major fiscal announcements have until now been made in the Spring. The Spring Budget will be replaced with an Autumn Budget, with the effect that 2017 will contain two Budget dates. The reasoning behind the change is to announce tax changes further ahead of their implementation on 5 April.
The Autumn Statement will be replaced with a Spring Statement, the first of which will be in 2018. The statements are presented as less major, although the impact of changes will vary from one taxpayer to the next.
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
2015-16 @ 10% basic rate
2016-17 @ 7.5% basic rate
2015-16 @ 32.5% higher rate
2016-17 @ 32.5% higher rate
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 tax @ 20% basic rate
Income tax @ 40% higher rate
National insurance @ 0%
National insurance @ 9%
National insurance @ 2%
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.
Mr Osborne delivered his eighth Budget as Chancellor at round 12.30pm today. The Budget was announced against a backdrop of slowing global growth, recent interest rate cuts by central banks into negative territory and the forthcoming EU referendum in Britain. The first two Budgets of our current government have been far reaching and full of surprises. This contrasts with the Budgets of the preceding coalition government which tended to alter very little.
The overviews below follow the chronological order in which the announcements were made, with some supporting explanation.
From 6 April 2016, the charge for a loan to a participator will increase from its current rate of 25% to a new rate of 32.5%. A participator is typically a shareholder or director of a company with five or fewer owners. Directors of a one-person or ‘contractor company’ and family owned business will usually be participators.
A full summary of the rules can be read here in the article about overdrawn director’s loan accounts. In brief, where a contractor has not retained sufficient funds in the company at the year end to cover corporation tax, it will be a requirement to lend money as a director. This loan gives rise to a tax charge.
Company funds are usually represented by the company bank account, however amounts owed from clients and equipment and other assets brought into the business can also be used as a buffer.
If the bank account is brought back into balance in future years, the charge can be repaid by HMRC. However there is a cash flow drawback and an administrative burden of borrowing money from the company.
Payments on termination of an employment contract receive preferential tax treatment, provided the payments are not an entitlement under the employment contract. Under current legislation a termination payment is not subject to employer’s national insurance and the first £30,000 will not be subject to income tax in the hands of the employee.
This measure has the purpose of an anti-avoidance provision.
Diverted Profits Tax (Large companies)
A series of new rules are scheduled to be introduced to bring profits derived from the UK into the charge of UK corporation tax. The measures are aimed at companies with profits of over £5 million.
The rules will have most impact on multi-national organisations with that particular scope to structure finances so group profits are taxed in jurisdictions with lower than average rates.
For most companies, the deduction from profits chargeable to corporation tax for interest payments will be restricted to 30% of UK income.
Only 50% of current year profits can be reduced by losses brought forward from previous years.
The tightening of rules on withholding tax for royalty payments and other measures will also be presented.
Corporation tax fall
Following previous announcements, the corporation tax, which is currently 20%, was due to fall to 19% in April 2017 and to 18% in April 2020. The Chancellor announced that the rate will now be reduced further to 16% in 2020.
Tax relief for ‘micro-entrepreneurs’
Traders and landlords with less than £1,000 will not need to declare this income on a Tax Return. The income will be tax free. This will particularly benefit vendors with a side-line on websites such as E-Bay and AirBnB. Traders bringing in more than £1,000 income can deduct the allowance from their income profits, instead of actual expenses. A total of £2,000 can be exempted from tax, one allowance for property income and the other for trading.
Business rates drop
From April 2017, small business rate relief will be increase. The relief currently exempts businesses with a rateable value of £6,000, however this is set to increase to £12,000 from next year. The higher rate threshold will also increase at the same time from £18,000 to £51,000.
Stamp duty on commercial property
With effect from midnight, the chancellor has brought the stamp duty system for commercial property in line with that for residential property. The tiered system will mean that no stamp duty is payable on a property worth £150,000 or less, 2% is paid on consideration between £150,000 and £250,000 and 5% is levied on the value of the property which exceeds £250,000.
With the stated aim of helping “small firms”, the new duty will benefit all but purchasers of the highest value property.
Indirect taxes mixed
Levy on sugary drinks
Fuel duty freeze (despite lower petrol prices on account of the recent oil glut.)
Tobacco duty rise.
Freeze on beer, cider, whisky and other spirits duty with other alcohol taxes rising.
Class 2 NICs
Class 2 is a flat rate of national insurance which is payable by sole traders and partners. The contribution secures a year towards the number required to qualify for a basic state pension. This tax will now be abolished in 2018. A social security and state pension entitlement will accrue to self-employed people via the Class 4 National Insurance. This is payable at the same time as income tax.
Capital gains tax cut
With effect from 6 April 2016, the basic rate of capital gains tax will be cut from 18% to 10% and the higher rate of capital gains tax will be cut from 28% to 20%.
The rate at which an individual pays capital gains tax depends on their total income. Gains below the annual allowance are not taxable. Taxable gains are added to an individual’s yearly income. To the extent that total income and gains are above the higher rate tax threshold, gains are taxed at the higher rate. Otherwise gains are taxed at the basic rate.
Gains made on residential property will continue to be charged at the existing rate of 18% basic and 28% higher rate tax.
Entrepreneur’s relief for investment in small companies
Entrepreneur’s relief will reduce capital gains tax for the subscription of shares in an unlisted company and held for the longer term. The new rules will apply to any purchase in new shares made from tomorrow. The requirement will be for the shares to be held for at least three years from 6 April 2016 or date of purchase, whichever date is the later.
In effect the rate of tax will be 10% and subject to a life time limit of £10 million. The new rules extend relief currently available for shares purchased under the enterprise investment scheme.
Chancellor silent on entrepreneur’s relief restriction for contractor companies
The government had consulted on the abolition of entrepreneur’s relief on disposal of a business. However, there were no announcements in the Budget about this relief being withdrawn.
There remains an opportunity for company owners to accumulate profits in the company and withdraw this on eventual disposal. The accumulated funds in the business, usually represented by monies in the bank account, can be withdrawn as capital on eventual disposal. The implication is that the funds will be taxed at just 10%, rather than the much higher rates for dividends or salary.
Nonetheless, holding funds in a company in order to save tax carries the risk that the rules about entrepreneur’s relief will be scrapped.
Lifetime ISA of £4,000 a year for the under 40s
From April 2017, the government will introduce a new ISA. Savers who are under 40 on 5 April 2017, will be able to contribute up to £4,000 a year into an ISA. For every £4 contributed by the taxpayer, the government will add £1 to the ISA account. The government contributions will continue until the ISA holder reaches 50.
Some or all of the capital can be invested in an ISA for purchasing a property after just one year. However the property must be the first home owned by the taxpayer and have a value of £450,000 or less.
Alternatively, savers can wait until 60 to use the capital as pension income. Unlike pensions however there is no tax to pay on withdrawing the funds. The tax relief on investment is equal to the current basic rate of tax. To this extent the new ISAs will be more attractive to basic rate taxpayers.
If the ISA fund is not used to buy a home or for a pension on reaching 60, any withdrawals would be subject to a 5% charge and loss of the government bonus. The measure is intended to assist young people saving towards a deposit on their first property.
From 6 April 2017, all savers will be able to contribute up to £20,000 a year into their ISA.
The Budget introduced some expensive tax breaks, with a particular focus on easing the burden for small business. However, with a stated policy of national deficit reduction, it remains to be seen whether this trend of fiscal policy can be upheld.