The Chancellor’s shock announcement about dividend taxation left lots of accountants wondering whether this signals the end of tax motivated incorporation. In response to pleas from AccountingWEB members, Rebecca Benneyworth takes an introductory look at the proposals.
In reality, incorporating to save tax has not really been a practical solution for businesses with profits of less than £40,000 for a few years now. The additional administration erodes the few hundred pounds of tax saved quite quickly, and with the abolition of Class 2 NIC next year the savings are smaller still.
Where business owners decide to do their own admin, the risk of significant fines can soon outweigh any benefits, and the CT return and Companies House filing process is not simple for small businesses to navigate unaided, although the new joint Companies House and HMRC product due to be launched very soon will help a little.
Business owners would probably save more tax by paying a partner with minimal other income to do some administrative work in the business than by incorporating.
The point at which incorporation saves enough tax to make sense is probably at around £40,000 profit. At this point, even with some additional costs for company accounts, payroll and corporation tax, there is still some saving left for the owner.
But the big question is what the effect of the change in taxation of dividends will be for these company owners?
There are a lot of assumptions that can vary, but in simple terms, if a business making £40,000 a year in profit incorporates, it saves around £2,500 in tax for the owner, assuming he or she takes a salary of just below the NIC limit and the rest of the profits by way of dividend.
From 2016, that saving will be reduced to around £600, taking into account the increased personal allowance and the abolition of Class 2 NIC. So the savings are lost – and the extra admin costs probably mean that limited company status is not worthwhile.
It is not worth increasing the salary to use up the personal allowance, as the removal of the employment allowance for one man limited companies from 2016 means that such a move would cost significant amounts of NIC.
So company owners are in for a bigger tax bill in the future.
Make sure to register for her TaxCalc-sponsored Summer Budget report to get the full analysis.
Replies (31)
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It is so refreshing....
again, after 20 years, to be thinking of the pros & cons of incorporation without tax & NI getting in the way.
I think you have missed some important things
There is still a very good argument for incorporating if you are a higher rate taxpayer, I also do not agree that it has only been worth it if your profits were 40k+.
Up to now if I tell a client he can save £1000 tax even with the extra costs involved, and on top of that he will not have any POA in Jan and July, whats not to like?
Even if there was no tax advantage would you rather pay your tax in one go 9 months after Y/E or pay half before your year has even finished and the other half 4 months after y/e.
Every situation is different of course but from April there will still be some where a company will fit for tax reasons.
I couldn't agree more if I tried
I couldn't agree more.
Profits of 30k = tax due of 3880
Class 4 due of 1975
Total tax and class 4 = 5855
Never nice telling a new business client that not only does he have 5855 to pay, but 2927 on top as a POA, making total payment due of 8782.50 plus another payment 6 months later of another 2927.
Clients love that. They say 'I've made 30k and in my first year I've paid over 11,500. Very bad for cash flow.
As a Ltd co, there would be CT due at 4388 assuming a salary of 8060. Then obviously there will now be additional tax on the dividend (I call it the small business surcharge). But up until now, in the above scenario of profits of 30k, most would choose the Ltd option.
Even now, whilst the saving at 30k has been squeezed to a couple of hundred quid, it is still attractive to people wanting to avoid the ridiculous payments on account system.
That's my take
.
The tax saving (pending the legislation when I can run all the numbers properly) would appear to be about my extra fee for for a limited company vs sole trader with a full balance sheet etc, albeit they do not always want that.
That is to say from the clients point of view tax+cost of compliance are quite balanced, then it comes down to risk, cashflow, and the upsides of a limited company in terms of deciding WHEN you take the money, plus the ER relief on winding up.
If its a partnership vs a company then the client would be saving tax.
So no longer a "no brainer" to incorporate (and we do them from about £25k profit and up - the ones on small profits are often the ones who appreciate the extra few pounds) but more balanced.
What I don't see is a rush to get OUT of a corporate structure, but there will certainly be less going in.
Does Anyone Know
If other income (PAYE plus interest say) is less than the personal allowance, whether the £5K tax free dividends are extended to use up the shortfall or is the shortfall effectively lost?
Example - if the regime applied in 2015/2016 and a director took £671 per month (£8,052 per year) and had typically £20K in dividends, what would his tax bill be? I presume the answer must be £28,052 minus PA £10,600 minus £5K = £12,452 x 7.5% = £933.90. But commentators have suggested that it's £15K x 7.5% = £1,125.00.
We've got a while yet to worry about it but it would be good to know.
Useful article, thanks
I assume that once the measure has come in the Treasury will keep increasing the dividend rate until they get the result they want?
Benefits
Regardless of your view on where the profits breakpoint was under the old regime, it is clear that it has moved up by in the region of £15k. But incorporation remains attractive. Benefits only really get hammered for very high profits and at that level it is likely that the client can benefit from a spouse with spare basic rate band and/or keeping profit inside the company.
i now feel so old
the last time i saw this kind of tax it was called investment income surcharge, and i remember doing the calcs...
and it was 98%
Ah carnmores that was
only when you added the iis to the then higher rate of 80% (and people complain now about how much tax they have to pay - huh the youth of today, they don't have a clue).
Now i feel even older :(
£600 saving
Hello Rebecca,
Would you kindly show the calculations of that £600 saving as I cannot recreate that figure.
7.5% of 30k less5k
Hello Rebecca,
Would you kindly show the calculations of that £600 saving as I cannot recreate that figure.
[/quote]
I presume she means that now 25k is subject to 7.5%, that reduces the £2500 saving by £1875 (she did say rough figures)
and we had to calulate it all by hand
'the taxmans taken all my dough.........' george got it right
even adding machines were is short supply
george?
Or was it Ray?
back to POA - now the director will have to pay it much earlier on dividends...
..
As will savers, unused to receiving gross interest. I wonder if this has been anticipated?
in their greed, I believe they did anticipate this!
a bit surprising for a "pro" business budget
Have I missed something, re class 2 NIC?
OK, we are talking trivial sums in relation to the decision, but it was my understanding that class 2 NIC collection process was being shifted into the self assessment tax return. But that falls short of abolition. Rebecca is now saying that class 2 is being entirely abolished. Did I miss something?
With kind regards
Clint Westwood
yes you missed it
Mad though it may seem they are indeed changing the payment method just a year before totally abolishing class 2, so i believe you missed it.
Increase in tax not so bad
I have plotted the differences between 2015-16 and 2016-17 tax years for a company director on primary threshold salary. These are two not very straight tax curves which show varying differences.
At £15,000 business income they will be £69.40 better off.
At £40,000 business income they will be £1,025.46 worse off.
At £60,000 they will be only £162.43 worse off.
At £100,000 they will be £2,292.42 worse off
At £135,000 they will be only £925.69 worse off
Difficult to put the difference between two wiggly curves into words.
I currently say to my clients that incorporation is worth it from £15,000 business income, but that is only because my fees are very low and I am hoping they will rise to higher levels.
thank you
Thanks for a really useful article!
One person company - dividend tax Apr 16 v Apr17
Could someone check if I am getting this wrong?
Where the company profit available for distribution is in the region 56k to 66k then I don’t think there should be a particularly large increase in the Apr 17 over Apr 16 tax. (Increase in the region of £400)
Say profits are 57,000 and national insurance employment allowance is available in yr to 5 Apr 16 but not available in yr to 5 Apr 17. Then drawing minimal salary each year would give:
Yr to 5 April 16
Yr to 5 April 17
Profit
57,000
57,000
Salary
10,600
8,060
Taxable
46,400
48,940
Corp tax (20%)
9,280
9,788
Available for dividend
37,120
39,152
Personal tax
Dividend
37,120
39,152
Tax credit (1/9th)
4,124
‘gross’ dividend
41,244
39,152
Dividend Tax Allowance
5,000
Taxable dividend income
41,244
34,152
Pers. Allow above salary
2,940 (11,000 – 8,060)
Dividend income after PA
41,244
31,212
Basic rate (10%) / (7.5%)
31,785 x 10%= 3,178
31,212 x 7.5% =2,341
Higher rate (32.5%)
9,459 x 32.5%=3,074
Total
6,252
2,341
Less tax credit
-4,124
Tax on dividends
2,128
2,341
Add employee NI
305
Total personal tax & ni
2,433
2,341
download not working
The Summer Budget Report download isn't working. I get a message saying "The requested page could not be found." Bet I still get Taxcalc contacting me, though.
woody24, I see what you mean. Not having to gross up for the dividend tax credit means the taxable income is lower, so you potentially avoid paying an extra 20% higher rate tax on the difference. That largely offsets the extra 7.5% dividend surcharge, up to a certain level.
Woody
You need to follow your figures through. 2015/16 gives net income of £45,287 and £44,871 for 2016/17.
Not a huge difference, but the reverse of what your analysis would appear to show, based on the personal tax/NI figures only.
tax Apr 17 v tax Apr 16
Thanks BKD,
Agree - the total tax Apr 17 is slightly higher than Apr 16 (increase 416)
Apr 16 (corp tax 9280 + personal tax 2433) = 11713
Apr 17 (corp tax 9788 + personal tax 2341) = 12129
The corp tax is higher in Apr 17 because I have assumed that Employment NI allowance will not be available.
it was George Harrison
i believe
None
Just following.
misquoted
@thacca
Sorry this is a bit late, i have been away.
Sorry but i didn't say what you say i said.
I think that was Ms Bennyworth
Insurance cost of incorporation
Interestingly, talking to an insurance agent the other day who said they were fed up with accountants not taking account of the impact on liability insurances when advising sole traders and partnerships to incorporate. The liability insurance cost can double, really significant for some clients. Not seen this mentioned by accountants - are there any other "hidden" costs of incorporating, besides slightly higher fees?
insurance agent fed up
with higher premiums ?