Contractors, how much will the dividend, income, additional, and corporation rate tax U-turns cost you?
If contractors or anyone else for that matter needed a reminder that a week is a long time in politics, it was this week -- Monday October 17th to Friday October 21st. But the climax was arguably yesterday, with the abrupt resignation of prime minister Liz Truss.
Actually however, you need to go back to then-chancellor Kwasi Kwarteng’s ‘Mini-Budget’ on September 23rd to understand the origins of this long week of political upheaval.
Back then, the future looked significantly brighter and a lot less taxing for limited company contractors, writes Chris James, head of limited company accounting at Workwell.
Historic, but not seminal
On that day, what’s known as IR35 reform – so the 2017 and 2021 off-payroll working rules, was announced for a full-scale statutory repeal, and replacement with IR35 (2000). That reverting to the Intermediaries legislation for all contractors, regardless of size of client, would have returned the decision of IR35 status to the contractor, alongside the financial liability.
There was hope on the 23rd that this would at least partially end the ‘blanket banning’ of PSCs by engagers which took hold when the off-payroll rules were introduced in the public sector on April 6th 2017, and in the private sector on April 6th 2021.
What Mini-Budget 2022 contained
But the ‘Growth Plan’ went further (disastrously further we now know). Planned increases in corporation tax were to be cancelled to promote UK business. National insurance, which rarely impacts contractors unless they are undertaking employed work through an agency or umbrella company, was to be reduced by 1.25% points -- for both employers and employees. And dividend tax would benefit from the same reduction. This meant that thanks to Mr Kwarteng, the tax rate on dividends would return to the level which existed in March 2022, before the sleight of hand that saw the rates on dividends raised to conform with the approaching Health and Social Care Levy.
And yet even more was offered by Mr Kwarteng on the 23rd. For those doing well enough to pay the additional rate of tax (which applies to taxable income over £150,000 a year), another benefit was a fresh reforming of tax rates, with the effect that the higher rate of 40% was now going to be the uppermost rate, effectively consigning the 45% additional rate to the dustbin. Therefore, the dividend ‘top rate’, which had been 39.35% was heading into the sunset too. Along with the 1.25% points reduction, that meant the top rate of dividend tax was to be 32.5% for those PSCs with the highest levels of income.
Unfortunately for the many beneficiaries of all the above Mini-Budget proposals, they didn’t last very long and got rubbed out.
To show you the potentially significant financial impact of this rubbing out, let us consider the case of a few taxpayers, whose circumstances (and names) should ring a bell with contractors.
Meet contractor Liz, and her more financially astute fellow contractor Rishi...
Contractor ‘Liz’ was blanket-banned and so forced into an employed position in 2021 yet later, elsewhere, successfully resumed ‘outside IR35’ operations in early 2022, thanks to her new client offering an entirely deliverables-based contract.
So Liz’s limited company turns over £100,000 a year, with taxable profits of £85,000 subject to corporation tax. Liz draws the amounts after tax as a dividend, and uses the tax-free personal allowance to draw a salary from the company.
Ignoring the advice of her advisers, Liz recently formed a second company, with the aim of purchasing a buy-to-let property. Unfortunately, that company isn’t making very much money at present. But Liz -- ever the optimist and a big believer that saying something simply makes it happen, is keeping the company open for now. She has no other income.
Contractor ‘Rishi’ is, financially at least, more successful than Liz. His company turns over £300,000. The company runs lean, so generates annual profits chargeable to corporation tax of £275,000.
Similar to Liz, Rishi has a property company on the side as well. But Rishi recently had to remortgage (he couldn’t move into the property at No 10 he’d been eying) and he’s not making any profits with his property company. But Rishi likes the high-life and so draws all his post-tax profits as a dividend. Rishi has a small listed share portfolio that generates yields of almost exactly £2,000 per annum.
Both our contractors felt optimistic on the evening of September 23rd, following Mini-Budget 2022. There did seem to be a bad reaction in the financial markets, but Liz and (even) Rishi said to themselves, “hopefully that will pass.” Then they could plan for their future in a new, lower tax world.
After a few days, however the markets still hadn’t got on board with Mini-Budget. In fact, it got worse and worse. Even the Bank of England was critical.
Ditching plans to scrap the 45p rate was a tax U-turns starting pistol
Contractor Rishi got stung first. Ten days after the Mini-Budget’s September 23rd announcements, the government said the abolition of the additional rate of income tax was to be cancelled. Unfortunately Rishi had over £56,000 in dividends in this bracket, and the increase from 32.5% back to 38.1% would – he calculated -- cost him an extra £3,150 in dividend tax. Still, he thought, “I’m still far better off than I was before, so never mind.” The 45p U-turn didn’t make any difference to contractor Liz, who doesn’t pay additional rate tax.
The next change was to adversely affect both contractors. On October 14th the government announced that, aside to sacking chancellor Kwarteng, the corporation tax increase was to go ahead after all.
At a new main rate of 25%, the higher corporation tax for Liz would cost an extra £2,625. But actually, Liz overlooked her second property company. And although the company is without significant profits, its mere existence meant that the additional corporation tax would be £4,500 a year in total. To add insult to injury, each additional £1,000 of profit that Liz’s company makes will suffer £265 of corporation tax – a marginal rate of 26.5% (until profits hit £125,000, at which point the rate reverts to a still-hefty 25%).
Over £16,000 more to pay in corporation tax? Here's how
Contractor Rishi spluttered out his Sprite when his accountant got in touch. Because Rishi’s profits are well over £250,000, such a limited company pays the flat rate of 25% on all profits – although here the existence of a second company makes no difference. But the increased in tax rates hit Rishi hard. A corporation tax bill increase of an eye-watering £16,500, or 31.6% on top of the company’s original CT tax bill of a mega £52,250. “A deeply unpleasant surprise,” he groaned.
Other contractors might very well be in a similar position, and so should check with their accountant too.
On Monday just gone, contractors Liz and Rishi were anxious. They heard early in the morning that more announcements were coming. This time from HM Treasury’s new boss, Mr Kwarteng’s replacement.
Which parts of Kwarteng's Growth Plan were cancelled?
Well, as contractors saw on October 17th, almost every other tax policy got reversed.
- The reduction in the basic rate of income tax from April 6th 2023 was shredded (it will now stay at 20% indefinitely, not fall to 19%).
- The guaranteed support for people’s energy bills was shortened, in terms of duration.
- The pledge to repeal IR35 reform was torn up.
- The dividend tax cut of 1.25 % points, scheduled from April 2023, was reversed.
The IR35 U-turn worried contractor Liz. Remember, she’d had to look elsewhere, and for a quite a time to secure an ‘outside’ IR35 contract. And to Liz, the government now standing by IR35 reform will just make things harder in the future. “Perhaps I might take some sort of sabbatical,” mused Liz.
The dividend tax cut not going ahead represented the front door hitting Liz as she mulled a way out. Due to the dividend rate staying where it was risen to on April 6th 2021, she’s stung for another £803 in dividend taxes. All in all, the tax U-turns of October 14th and October 17th have cost contractor Liz a small No 10 renovation, some £5,303!
Tot up how much your take-home will be down
Contractors, how much is your take-home pay going to suffer because of the two sets of tax U-turns? Hopefully it won’t be as much as contractor Rishi’s. He’s now looking at a further £2,578 in dividend tax payments to HMRC, taking his total outlay from the U-turns to an almost unconscionable £22,228!
“All very unfortunate” thought Rishi, but for reasons he couldn’t quite put his finger on, he felt strangely optimistic for his future.
The big tax reversal that's actually staying? It's National Insurance
Later, gathering her personal effects to soon move out of a home she spent not even 50 days occupying, contractor Liz reflected that the only ‘winner’ she knew; the only person who was a survivor and a bit of a unifier, was her old friend Jeremy.
Well, a bit back, Jeremy decided to work through an umbrella company. And in line with him usually falling on his feet, Jeremy will now benefit from the increase in National Insurance Contributions being reversed -- one of the few tax reversal proposals of September 23rd not to be rubbed out on either October 14th or October 17th.
In the evening, Liz sat alone with a brandy (despite Mini-Budget's duties freeze being reversed). She suddenly remembered that although Jeremy was meant to be off somewhere crunching numbers, Grant, Tom, Penny, and even Rishi were all meant be coming over. Resigned -- to them probably being on their way, she agreed to wait until at least one of them arrived.