Limited company dividend tax guide for April 2018
As many contractors feared, the measure to slice the tax-free dividend allowance from £5,000 to £2,000 from April 2018 has been officially re-tabled. This adds a slight dint to your pocket as a PSC owner, but taking dividends is still going to be the most tax-smart way to pay yourself, writes Craig McCall, a director at Gorilla Accounting.
Dividends: in a nutshell
A dividend is a distribution of company profits from a limited company that are paid to the shareholder(s) according to the number of shares they hold.
The most tax-efficient way of operating is to set a low salary, in order to minimise the amount of National Insurance Contributions you need to pay as the director. The remainder will typically be made up of dividends, but this should not exceed the amount of profit made by the company.
Cutbacks on the horizon
PSC contractors should already be taking at least £5,000 in dividends each year as this can be taken tax-free, but it is soon to be whittled down by £3,000.
Despite the dividend allowance being reduced, dividends will remain the most tax-efficient way for contractors to pay themselves, alongside that small salary. Dividends are paid after both tax obligations and expenses have been met, and the company should have enough distributable reserves in order to pay dividends.
Implications arising from the Personal Allowance threshold are yet to be determined, but chancellor Philip Hammond announced during his last Autumn Statement 2016 speech that he aims for personal allowance to be set at £12,500 by 2020/21. This increase is to be made, he said, in order to give a “massive boost to the incomes of low and middle earners.”
The Personal Allowance currently stands at £11,500 and the higher rate threshold sits at £45,000 for the current tax year.
Exposure is inevitable
The reduction of the tax-free dividend allowance is another blow for contractors. We say ‘another’ because it comes after the financially-erosive reform of IR35 in the public sector. These reforms haven’t just hit the bottom line of contractor companies; Hays and Parity have blamed them for their less than stellar results in the public sector, which itself -- these agencies say -- is in decline due to the reforms.
Having suffered an increase in dividend tax in 2016, for those with a ‘pre-dividend income’ below the higher rate threshold, the income tax due on dividends will increase by £225 next year, assuming all other thresholds remain the same and the director takes the same amount.
But the exposure cannot be reduced, and there are no other alternative measures that can be enforced to shield contractors from the tax rise. Exposure is inevitable.
The government claims that the £3,000 cut will “partially reduce the tax difference between the self-employed and those working through a company,” and should eventually raise between £800million and £900million a year for the Treasury. That’s enough to make it the one measure that raises the largest amount of revenuefrom Budget 2017.
Take-home pain
A change in take-home pay of £225 is unlikely to make contractors want to ‘vote with their feet.’ But the measure may sting the pride of contractors, as the dividend allowance cut comes not just after the IR35 public sector reform; but it also follows the removal of the NI Employment Allowance for one-person director companies. Add on the fact that expenses claims have been tightened due to the 'Supervision, Direction or Control' test, and you begin to see why contractors might feel picked on.
Offering an explanation, of sorts, in March, Mr Hammond said: “People should have choices about how they work, but those choices should not be driven primarily by differences in tax treatment.”
So it should only be of secondary importance to you, then, but the alternative of an umbrella company will yield a take-home pay lower than a PSC (outside IR35) is able to achieve after the change has been implemented in April 2018. In short, contractors operating through a limited company where IR35 does not apply are better off remaining this way, compared to an umbrella.
Be in no doubt; the cut will bruise contractors, but we do not regard it as deep enough to either deter people from taking the leap into contracting, or encourage them out of contracting. And in comparison to four years ago, despite the numerous financial challenges faced by those who work for themselves, the number of self-employed people has soared to a record high (only recently in May) of 4.8 million.
Financial break points
The dividend-related break-even points established by Deloitte might have prompted you to make some initial calculations as to what you’ll draw in dividends, come April 2018. But these thresholds compared 2018 to four years ago, and from the point of view of a high-net-worth person with high levels of non-dividend income, over the typical PSC contractor. Meanwhile, other tax advisers have set in stone and published specific, recommended dividend and salary figures to abide by, as part of a ‘one-size-fits-all approach’ to minimising the impact of the allowance reduction.
More comprehensively and realistically, the following tables illustrates that for contractors, who have no other source of income, typically taking a salary just below the NI threshold, the maximum that they would be adversely affected by is £225. The first table compares take-home pay via a PSC between 2015/16 to 2018/19, and a second table via an umbrella company.
PSC
| 2015/16 | 2016/17 | 2017/18 | 2018/19 | |||||
|---|---|---|---|---|---|---|---|---|
| Turnover | £100,000.00 | £100,000.00 | £100,000.00 | £100,000.00 | ||||
| Flat Rate Saving | £2,600.00 | £2,600.00 | £0.00 | £0.00 | ||||
| Salary | £10,600.00 | £8,060.00 | £8,164.00 | £8,164.00 | ||||
| NI | £0.00 | £0.00 | £0.00 | £0.00 | ||||
| Profit Before Tax | £92,000.00 | £94,540.00 | £91,836.00 | £91,836.00 | ||||
| Corporation Tax | £18,400.00 | £18,908.00 | £17,448.84 | £17,448.84 | ||||
| Profit After Tax | £73,600.00 | £75,632.00 | £74,387.16 | £74,387.16 | ||||
| Salary | £10,600.00 | £8,060.00 | £8,164.00 | £8,164.00 | ||||
| Employers NI | £304.80 | £0.00 | £0.00 | £0.00 | ||||
| PAYE Tax | £0.00 | £0.00 | £0.00 | £0.00 | ||||
| Dividends | £73,600.00 | £75,632.00 | £74,387.16 | £74,387.16 | ||||
| Dividend Tax | £11,248.38 | £15,249.90 | £14,341.63 | £14,566.63 | ||||
| Take-home Pay | £72,646.83 | £68,442.10 | £68,209.53 | £67,984.53 | ||||
| 72.6% | 68.4% | 68.2% | 68.0% | |||||
| Personal/Dividend Allowance | £0.00 | £0.00 | £7,040.00 | £0.00 | £8,336.00 | £0.00 | £5,336.00 | £0.00 |
| Basic Rate | £31,785.00 | £0.00 | £27,000.00 | £2,025.00 | £28,500.00 | £2,137.50 | £31,500.00 | £2,362.50 |
| Higher Rate | £49,992.78 | £11,248.38 | £40,692.00 | £13,224.90 | £37,551.16 | £12,204.13 | £37,551.16 | £12,204.13 |
| NI Threshold | ||||||||
| Below UAP | ||||||||
| Above UAP |
Umbrella
| 2015/16 | 2016/17 | 2017/18 | 2018/19 | |||||
|---|---|---|---|---|---|---|---|---|
| Turnover | £100,000.00 | £100,000.00 | £100,000.00 | £100,000.00 | ||||
| Flat Rate Saving | £0.00 | £0.00 | £0.00 | £0.00 | ||||
| Salary | £88,857.17 | £88,857.17 | £88,863.47 | £88,863.47 | ||||
| NI | £11,142.83 | £11,142.83 | £11,136.53 | £11,136.53 | ||||
| Profit Before Tax | £0.00 | £0.00 | £0.00 | £0.00 | ||||
| Corporation Tax | £0.00 | £0.00 | £0.00 | £0.00 | ||||
| Profit After Tax | £0.00 | £0.00 | £0.00 | £0.00 | ||||
| Salary | £88,857.17 | £88,857.17 | £88,863.47 | £88,863.47 | ||||
| Employers NI | £5,048.44 | £5,109.94 | £5,297.59 | £5,297.59 | ||||
| PAYE Tax | £24,945.87 | £24,742.87 | £24,245.39 | £24,245.39 | ||||
| Dividends | £0.00 | £0.00 | £0.00 | £0.00 | ||||
| Dividend Tax | £0.00 | £0.00 | £0.00 | £0.00 | ||||
| Take-home Pay | £58,862.86 | £59,004.36 | £59,320.49 | £59,320.49 | ||||
| 58.9% | 59% | 59.3% | 59.3% | |||||
| Personal/Dividend Allowance | £10,600.00 | £0.00 | £11,000.00 | £0.00 | £11,500.00 | £0.00 | £11,500.00 | £0.00 |
| Basic Rate | £31,785.00 | £6,357.00 | £32,000.00 | £6,400.00 | £33,500.00 | £6,700.00 | £33,500.00 | £6,700.00 |
| Higher Rate | £49,472.17 | £18,588.87 | £45,857.87 | £18,342.87 | £43,863.47 | £17,545.39 | £43,863.47 | £17,545.39 |
| NI Threshold | £8,060.00 | £0.00 | £8,060.00 | £0.00 | £8,164.00 | £0.00 | £8,164.00 | £0.00 |
| Below UAP | £34,325.00 | £4,119.00 | £34,940.00 | £4,192.80 | £36,836.00 | £4,420.32 | £36,836.00 | £4,420.32 |
| Above UAP | £46,472.17 | £929.44 | £45,857.17 | £917.14 | £43,863.47 | £877.27 | £43,863.47 | £877.27 |
A universal ‘one-size-fits-all’ recommendation cannot be issued to PSCs hoping to beat the dividend tax shelter being pared back. This is the case because it is entirely dependent on the contractor’s situation, as not every contractor will want to take out all the money from the company. Factors such as lifestyle preferences, mortgage and other financial obligations, investments or savings and business ambitions are among those that will affect how much you -- the company director -- should take in dividends.
Lastly, consider carefully that if factors such as paying a mortgage have not been met, and tax legislation unexpectedly changes (as it has in this case), the director could be left clawing back money through alternative methods, hoping to maximise tax savings in any remaining ways possible. So, the tax ‘break points’ touched on earlier really have to be tailored around the contractor and their individual mitigating factors.
Open for business?
Standing back from the specificity of personal circumstances, the bigger picture shows the cut to the tax-free dividend allowance to be a much-disliked, yet unavoidable change which arrives in time for the recommendations made by Matthew Taylor in his Modern Work Practices Review. Something else bonafide contractors probably won’t be thrilled about, for its potential to sting them.
It all comes at a time when Mr Hammond has committed to dropping corporation tax to 17% in 2020, in a bid to send “the clearest possible signal [that] Britain is open for business.” With the uncertain Brexit process still sounding static, and his cut to how much firms get tax-free in dividends being retuned, contractors are the likeliest businesses within range of the chancellor not to detect it.
