Benefits recipients, “non-doms” (those living in Britain treated as foreigners for tax purposes), banks, and landlords weren't the only losers in George Osborne's recent budget.
Although they weren’t explicitly mentioned, the chancellor put many contractors, including those working in IT, on his hit list by changing the taxation of company dividends.
The idea is to bring in £2.53bn by the 2020/21 financial year.
Many contractors save tax by working through a limited company and paying themselves partly in dividends. There are also other reasons, such as clients that insist on dealing with a limited company rather than an individual.
At present, for basic rate taxpayers there is effectively no tax on dividends, although these are paid out of company profits taxed at 20 per cent, plus the cost of running a limited company.
However, this often works out cheaper than basic rate income tax and national insurance contributions for the self-employed, totalling 29 per cent, with similar differences in higher tax bands.
The latter have tax-free allowances but those using limited companies typically pay themselves a small salary of around £8,000 or so to take advantage of them.
From next April, corporation tax on company profits will fall to 19 per cent, before ticking down to 18 per cent in April 2020 – but the effective tax rate on dividends will go from zero to 7.5 per cent for basic-rate taxpayers, and increase by 7.5 percentage points at higher rates.
There will be a new tax-free allowance on dividends, but this will only cover the first £5,000.
The chancellor claimed the special treatment of dividends had been standing in the way of his cuts in corporation tax: “We can’t take it lower than that while such strong incentives are created for people to self-incorporate and pay the lower rates of tax due on dividends,” he said.
“You’re going to be paying more tax than you are now, but you’re still going to be better off than a sole trader,” said Chris Barnard, accountancy technical manager at Crunch Accounting, which specialises in contractors, and has a third of its clients working in IT.
The government will not publish draft legislation on dividend tax changes until the autumn, but based on some assumptions Crunch has crunched some speculative estimates of how much contractor tax bills might rise.
For an annual profit before tax and salary of £43,000, a limited company contractor could be £1,500 worse off from next April, although still £1,300 better off than a self-employed sole trader.
At £63,000, the tax increase could be just £500 and the advantage over sole trading £4,000. At £93,000, a limited company contractor could pay £2,200 more tax than this year, but still be £2,700 up on a sole trader.
Given Crunch’s belief that use of a limited company is still likely to save money, Barnard recommends those working through one should sit tight and take out dividends up to the basic-rate limit during the current tax year. Things should be clear by the New Year, he adds: “Next February and March will be a busy time for advisers.”