There have been many headlines written about the above budget but one thing that we can say is that it will likely increase the tax bills of Personal Service Companies (PSC) and their owners. There are three main proposals that are well worth a visit for PSCs:
1. Taxation of dividends
a. The current position
Dividends are paid out of profits after corporation tax, so the company has already paid tax on the money when you receive the dividend. As a result, the dividend is treated as having a ‘dividend tax credit’ in the hands of the shareholder. The result is that the basic rate taxpayer doesn’t need to pay any more tax.
Because corporation tax is only 20%, the dividend tax credit doesn’t fully shelter the dividend from tax in the hands of higher and additional rate taxpayers. So higher rate taxpayers pay an additional 25% on the dividend, and additional rate taxpayers pay an additional 30.56%.
Dividends are not subject to NICs, so they are commonly used by small companies as a tax efficient way of paying shareholder-directors.
b. The new position
From April 2016, the dividend tax credit will be abolished. Instead, everyone will have an extra tax free ‘dividend tax allowance’ of £5,000. Small investors in the stock market will be able to receive dividends up to that amount without paying any tax at all.
However, dividends above £5,000 will form the top slice of your taxable income, and the rates of tax will increase, like this:
If the dividend falls in the basic rate tax band, you will pay 7.5% on the dividend (compared to 0% now)
If it falls in the higher rate tax band, you will pay 32.5% (compared to 25% now)
If it falls in the additional rate tax band, you will pay 38.1% (compared to 30.56% now)
Why has the Chancellor done this? In his speech he said the low rate of tax on dividends was encouraging people to operate through service companies and then pay themselves in dividends. So this is a sort of quid pro quo for the fact that dividends are not subject to NICs.
The Budget documents say this about IR35:
‘The government recognises that many individuals choose to work through their own limited company. However, where people would have been employees if they were providing their services directly, anti-avoidance legislation commonly known as IR35 introduced in 2000 requires that they pay broadly the same tax and National Insurance as other employees. As highlighted by reports from the Office of Tax Simplification and the House of Lords, it is clear that IR35 is not effective enough. Non-compliance in this area is estimated to cost over £400 million a year.’
Where the £400m comes from who knows but we do have yet another consultation on IR35 on the horizon.
3. Travel and Subsistence
The government has issued a new consultation document on the detail of the new provisions, which will take effect from 6 April 2016 and be included in next year’s Finance Bill. The legislation will be amended so that each engagement will be treated as a separate employment for the purposes of the tax relief rules, so it will not be possible to argue that the location is a ‘temporary’ place of work. The consultation also warns that if the PSC does not deal correctly with the travel and subsistence expenses paid to the worker, and is unable to pay when assessed by HMRC, the tax and NICs may be recovered from the end-client. This may mean that clients will require PSCs, either directly or via their agents, to confirm that tax free travel and subsistence is not being claimed in relation to the engagement.