Contractors, with your dividends, it’s business as usual

While we have to acknowledge that there may be some distant clouds on the horizon in the contracting world, for the 2019-20 tax year at least, it’s business as usual, especially on dividends, writes Daniel Mepham, managing director of contractor accountants SG Accounting.

Those clouds relate to changes to the Intermediaries legislation for contractors who work with private sector organisations, but they do not come into force until April 2020. Not that it’s probably too early to start planning IR35 compliance, given the huge scale of the change.

More pressingly for some ContractorUK readers who are a resident of Scotland, it is worth noting now the changes to Scottish rates of income tax -- particularly if you are caught by IR35 -- as these will differ from the rest of the UK.  

An extra £1.5k tax liability!

Expect to pay more tax on a salary of £50,000, for example, to the tune of an additional £1,544.48p. See the table below, which sets out the rates and thresholds.

  Scottish Tax Rate 2019-20 (Total Income)
Tax Free Allowance 0% £12,500.00
Starter Rate 19% £12,501.00 - £14,549.00
Basic Rate 20% £14,550.00 - £24,944.00
Intermediate Rate 21% £24,945.00 - £43,430.00
Higher Rate 41% £43,431.00 - £150,000.00
Additional Rate 46% £150,000.00 +

However, savings tax and dividend tax are not devolved, so will remain the same as the rest of the UK. Therefore, if you are keeping to the traditional contractor structure of small salary (under the tax free allowance) and dividends, your tax will be calculated in the same way as the rest of the UK.

The dividend allowance, which HMRC first introduced in the 2016-17 tax year and then quickly cut by £3,000, remains unmolested in the 2019-20 tax year at £2,000.

The personal allowance will increase to £12,500 and the higher rate tax band kicks in after £50,000. Set out below are the changes between both years.

  Employment & Savings Rates/Dividend Rates

2018-19
(Total Income)

2019-20
(Total Income)

Tax Free Allowance   £11,850.00 £12,500.00
Basic Rate 20%/7.5% £11,851.00 - £34,500.00 £12,501.00 – £37,500.00
Higher Rate 40%/32.5% £34,501.00 - £150,000.00 £37,501.00 - £150,000.00
Additional Rate 45%/38.1% £150,000.00 + £150,000.00 +

In effect, these figure mean that if in the 2019-20 tax year you were to draw dividends up to the 2018-19 basic rate limit, you would be able to take a further £650 in salary and dividends and still pay the same amount of tax.

If you were to utilise the whole 2019-20 basic rate band -- by taking a further £3,000 in dividends, the additional tax would be just £225.

The optimal salary-dividend mix

In terms of what PSCs often ask most about -- the most optimal salary and dividend combination, this depends on how many employees you have in your contracting business.  If you are a single employee/director contractor, it would typically be prudent to draw from your company a salary up to the primary threshold for national insurance and the rest of your drawings as dividends, for the 2019-20 tax year -- this would be £8,632 per annum.  The reasoning behind this is that the salary will not attract any national insurance and is the lowest amount you can draw and still receive a year’s credit towards your state pension.

If you have another director/employee, you would want to take a larger salary for each of you, up to the personal allowance, £12,500 per annum. You can then utilise the Employment Allowance, which will reduce the amount of Class 1 National Insurance payable.

Final thoughts

It’s impossible to foresee the contents of today’s Spring Statement 2019, but we are not due any changes on dividends. And even more certainly, there will be nothing from chancellor Philip Hammond to up end the rates and allowances for 2019/20.

But as the tax year draws to a close, it’s wise to make sure you have utilised as much of the 2018-19 basic rate tax band as possible. Talk to your accountant to see if you have any of the basic rate tax band remaining and, of course, the profits to draw down the dividends.

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