Written by Ray Coman
It is characteristic for the first budget of a new government to be tough, and the announcements today made this budget no exception. In the first conservative only budget since 1996, "Britain still spends too much, borrows too much" Mr Osborne stated. Through a range of measures, the chancellor set our proposals designed to reduce welfare spending by £35 billion and gain tax revenues of' £47 billion by 2020.
National minimum wage hike
The minimum wage, which is currently £6.50 an hour for over 21s, is set to increase. For workers aged over 25 the wage will rise to £7.20 from April 2016 and in stages to £9 per hour by 2020. For Under 25s the minimum way will be set by the Low Pay Commission. The minimum wage is intended to partly offset the cut in working tax credit for those on the lowest income.
Personal allowance to rise
The income at which a person starts to pay tax, or the personal allowance, is set to increase from its current level of £10,600 to £11,000 from April 2016. When Mr. Osborne took office as chancellor in 2010/11 the allowance was £6,475, and it has increased every year since.
The allowance is set to further increase to £12,500 by 2020, in keeping with the Conservative election promise. The previous intention was to raise the allowance to £10,800 in 2016/17 and £11,000 by 2016/17 and therefor this announcement brings forward the tax relief.
Basic rate tax threshold up
In April 2016, the income level at which a person starts to pay tax at 40 percent will also go up, from £42,385 to £43,000. Due to previous cuts this threshold is still lower than where it stood at £43,875 in 2010/11. The election promise is to raise the threshold to £50,000 by 2020/21.
Tax credits fall
Tax credits are a government payment for people on low incomes. Where the household income is low, a working person can be eligible for working tax credit. A household is eligible for child tax credit where income is low and it has children to support.
Child tax credits, and universal credits, will only be paid for the first two children. This will take effect for children born after April 2017.
Tax credit will start to reduce when families are earning just £3,850. This is a steep cut from the existing threshold of £6,420.
The cap on housing benefits that a person can receive will be set at £20,000 outside London, and £23,000 for Londoners. This is reduction from the current level of £26,000. Housing benefit will no longer be available to the under 25s.
The TV license will be free for over 75s.
Currently students from a family with a household income of less than £25,000 can apply for a grant. However from the 2016/17 academic year, university grants will no longer be available, although loans available to students will increase. All benefits for people of working age are to be frozen for the next four years.
People on incomes of over £30,000 outside the capital, or £40,000 in London will have to pay the market rate for rent in social housing.
From 2016, for working parents with three and four year olds, free, state childcare will be provided for up to 30 hours a week. This is an increase in the current 15 hour a week provision.
The child care fund, which was due to be introduced from September this year will now be delayed until September 2017.
Inheritance tax rising to £1 million
From April 2017, the government will reduce inheritance tax via a family home allowance. The rate will be phased in over four years, in 2019/20 reaching £175,000 per person. The current nil rate band is £325,000 per person and therefore £650,000 per married couple. An individual can therefore pass on their home to their children or grandchildren and the first £500,000 will be free of inheritance tax. For a married couple, the family home the allowance is effectively increased to £1 million.
The family home allowance will be gradually tapered for estates valued at more than £2 million. The additional family home allowance will be withdrawn at a rate of £1 for every £2 that the estate exceeds £2 million.
The nil rate band has not changed since 6 April 2009. With rises in property prices since 2009 this had led to a greater number of families exposed to inheritance tax. The rate of £325,000 is expected to stay fixed until 2021.
In order to keep the tax liability as low as possible the £325,000 allowance should be allocated firstly to assets in the estate which are not the family home. For instance, an individual passing on a home worth £175,000 and other assets worth £325,000 will pay no inheritance tax under the new rules. By comparison, an individual passing on £500,000 of assets none of which qualify for the family home allowance would pay tax at 40% on £175,000 of the estate, or £70,000.
A nuance of the rule will allow an individual or couple to keep an ‘inheritance tax credit’ if they downsize. This credit is designed so that the rules do not discourage grandparents from passing on a property which could more suitably accommodate the larger family of their children.
Non-domiciled status phased out
Under the current system a UK resident can be domiciled elsewhere. Domicile is usually determined by the place in which a person is born. From April 2017, a person who has been living in the UK for 15 years out of the last 20 years will no longer keep their non-domiciled status. The ruling mainly benefits the most wealthy of foreign born residents, who can pay a ‘remittance basis charge’ to reduce liability to UK tax. A person will no longer be able to choose to be non-domiciled if person born in the UK to UK domiciled parents.
The non-domcilied rules will also apply for inheritance tax purposes. A person who is not UK domiciled will no longer be able to exclude UK assets from liability to UK inheritance tax.
Bank levy changes
The current bank levy, introduced in 2011, is based on the balance sheets of banks. The rate of this levy will be reduced over the next six years. The levy will be replaced by an additional 8 per cent tax on the bank’s profits from UK earnings.
Drop in corporation tax
The rate of corporation tax, currently 20%, will be cut to 19% in 2017 and to 18% in 2020. The main rate of corporation tax was 28% when the conserve rates came to power as a coalition in 2010/11, and has gradually reduced since then.
Employers’ annual allowance
Under current rules, the first £2,000 of employers’ national insurance that an employer would otherwise have to pay is exempted by an employment allowance. From next year, the allowance will increase to £3,000 from 2016. A business could employ four employees on the minimum wage without having to pay national insurance.
A director of his or her own limited company will no longer be able to benefit from the employment allowance.
The annual allowance
The annual investment allowance will stay at £200,000 from January 2016. The allowance enables the deduction of capital expenditure (such as on computer equipment) from taxable profits in the same period in which the expenditure is incurred.
Tax relief on pensions to be lowered
Pension contributions are a tax efficient method of saving for retirement. Employee pension contributions are deducted from taxable pay and employer contributions are deducted from company profits (and are not treated as taxable income for the employee.) The most which can be contributed to a pension is the amount of earnings, although this is capped at £40,000. This cap is due to gradually tapering from £40,000 to £10,000 for people with incomes of over £150,000. The tapering will be introduced from April next year.
The lifetime allowance is the total value of the pension fund which will be free from tax. Currently the allowance is £1.25 million. However this is set to be reduced to £1 million, also from April 2016.
A consultation will also begin as to whether pensions should be treated like ISAs. Pension contributions will instead be made from after tax pay. However, pension income will not be subject to tax.
Tax deduction restricted for interest paid for rental property
A landlord is able to deduct the cost of providing accommodation from rental profits. The largest type of expense is usually interest on mortgage used to finance the property.
However, the chancellor announced that the tax relief on interest payments will be restricted to basic rate only. The current basic rate of tax 20%. This will raise the tax liability of landlords who are also higher rate taxpayers. The measure will be brought in gradually over four years starting in April 2017.
Landlords will no longer be able to claim the wear and tear allowance. Currently landlords can deduct 10% of rents received from taxable profits if the property is let furnished. From 2016/17 only the actual costs incurred on furniture can be deducted from profits.
Mr Osborne maintained to be addressing an unfairness in the current system which allows tax relief on interest for landlords but not for homeowners. The forthcoming restrictions on landlords is likely to cool house price inflation.
There is no indication that the restriction on interest relief would apply to companies. This may increase the appeal of a moving a property to a company as a method for saving tax. However the change to the taxation of dividends, explained below, could also eliminate the tax saved through company ownership.
A live–in landlord has two options for calculating taxable profits. The first is to deduct a proportion of expenses, say based on floor area occupied by their lodger. The second is to deduct a flat rate from their rent in calculating taxable income. The rent-a-room scheme has been at the same level of £4,250 since 1997. It is due to increase to £7,500 from April 2016.
Dividend tax credit abolished
The tax credit on dividends will be replaced from April 2016 with a £5,000 tax free dividend allowance. As a consequence many investors who pay tax at a higher rate and shareholders of their own companies could face a higher tax liability.
Under the current system, a credit is given for dividends which are paid out of after tax profits. Therefore, there is no tax to pay on dividends for basic rate taxpayers, the rate is effectively 25% for higher rate taxpayers and 30.5% for those with income over £150,000. Following the proposal, the first £5,000 of dividend income will be tax free. Thereafter basic rate taxpayers will pay 7.5%, higher rate taxpayers 32.5% and additional tax payers 38.1%.
Tax relief for amortisation to be abolished
Tax relief will no longer be available for goodwill on company acquisitions. Until now a company has been able to deduct the cost of buying a business from its company profits. The cost is usually spread out over a number of years, depending on the useful economic life of the business which has been acquired. The deduction from yearly, tax-adjusted profits, known as amortisation, was at least 4% a year. However for acquisitions made on or after 8 July 2015, this tax relief will be abolished. In view of the forthcoming changes, a share purchase (rather than an assets purchase) may be a more beneficial for a company considering an acquisition.
Written by Ray Coman
Yesterday’s Budget announcement Budget on the taxation of dividends has significant tax implications for company owners.
The current system for contractors
Currently, contractors providing their services via a company are liable to corporation tax on profits. To the extent that dividends increase total income into higher rates of tax there is additional tax to pay.
In a typical scenario where a person has little or no income from outside the company, it is tax efficient to pay a salary up to the national insurance threshold. This is £8,060 for 2015/16. Provided the director has no other income, the salary results in no income tax and is deducted from corporation tax profits. The taxpayer is effectively in the same position as an employee or sole trader who can also have income up to the personal allowance (of £10,600 for 2014/15) tax free.
The remainder of profits are treated as dividends. The basic rate tax threshold is £31,785 for 2015/16. Given the first £8,060 is paid in salary, the most net dividend that can be paid to an individual without making that person a higher rate taxpayer is £30,892 in 2015/16.
In a typical scenario a company owner will receive a salary, so that the first £8,000 of profits are effectively tax free, provided there is no other income, the next £30,000 or so of profits taken out of the company also result in no income tax. To the extent that dividends increase total income into higher rate of tax an effective rate of 25% is payable. Since dividends are paid out of after tax profits, for a higher rate taxpayer, the combined effect of corporation tax (20%) and income tax (80% of 25%) is 40%.
The new regime
From April 2016, the tax payable by a contractor will likely increase. Profits will be calculated after deduction of director’s salary and corporation tax will be applied to profits.
Any contractor, with personal allowance fully used and, with a dividend of more than £5,000 will be paying more tax than before.
In total, transfers from the company bank account to the director’s personal bank account of more than £13,060 (in salary and dividend) will result in more tax. In 2016/17 a person can receive total income of £43,000 before being a higher rate taxpayer. Therefore, a contractor will be taxed at 7.5% on income between £13,060 and £43,000.
In 2016/17, a shareholder with dividends of £34,940 (and salary of £8,060) will be taxed at 7.5% on £29,940 of dividends. An increase in tax of approximately £2,246, compared with the same situation in 2015/16.
The national insurance rates are scheduled to alter in line with the income tax rates. For the purposes of example, I will base 2016/17 rates on the 2015/16 levels. An employee with earnings of £43,000 a year would pay approximately £4,200 a year in national insurance. A self-employed person with £43,000 profit, would pay approximately £3,150 a year in national insurance.
There will still be a tax benefit for a basic rate taxpayer from using a company, although significantly reduced from April 2016.
For self-employed individuals, the increase in accounting costs only justify the saving in national insurance when income reaches about £15,000 to £20,000. For a person self-employed, with profits between £15,000 and £43,000 there is still tax efficiency achieved by operating via a company.
For a higher rate taxpayer, the new dividend rate is 32.5% compared with 25% previously. If all company profits are taken as dividend, the combined income tax and corporation tax rate for a higher rate taxpayer is 20% plus (80% of 32.5%), or 46%. This is higher than the income tax and national insurance paid by higher rate taxpayers who are either employed, sole traders or partners, where the marginal rate is effectively 42%, i.e. 40% income tax and 2% national insurance.
In the example above an employee on £43,000 would save £1,954 (i.e. £4,200 less £2,246) by providing services via a company. A sole trader would save £904 providing services through a company. The extra 4% payable by higher rate taxpayers will gradually erode this tax advantage. A sole trader would be no better off using a company when total income reaches £65,600, and thereafter worse off. This calculation compares saving in national insurance with increase in income tax only.
The comparison with an employee is less relevant since an individual who would be employed ‘but for’ the company should be taxed under the old ‘IR35’ rules. However, for illustration purposes only, an employee may need to earn as much as £91,850 a year to be no worse off than if operating via a company.
Notwithstanding, there are other tax benefits to the corporate structure. An employer saves considerable national insurance by using contactor. Employer’s national insurance is currently 13.8% on earnings over the primary threshold of approximately £8,000 a year. The flat rate scheme will remain available to sole traders and company owners with total turnover of less than £150,000. A considerable potential tax advantage over employees who cannot be VAT registered.
Moreover, there is some respite for contractors in the form of a drop in corporation tax, falling to 19% in 2017 and 18% in 2020. This saving in corporation tax from 2017/18 and thereafter will help to mitigate the tax increase explained above.
A suitable tax plan is to consider withdrawing dividends prior to 5 April 2016. The following article outlines other methods for withdrawing company profits. A further consideration may be to revert to employment which has a number of advantages compared with being self-employed.