It’s levelling up, but not as we know it…

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TUE, 26 OCT 2021

Boris Johnston and the Conservative Party’s mantra of “level up and unite the country” is constantly ringing in our ears. The aim of spreading investment more widely throughout the country and rebalancing the economy, bringing high quality, well paid jobs to communities that have, for a long time, felt ignored, is surely a positive. As to how long this noble cause will take, we will have to wait and see.

That said, one area where the government has succeeded in “levelling up” is in taxation. For those who own their own business, the ability to incorporate, pay themselves sufficient salary to become entitled to contributory social security benefits such as the state pension, but with the bulk of their renumeration being paid through dividends, has long been an effective tax planning strategy.

The opportunity to avoid national insurance and pay corporation tax at low levels is a win-win situation. The advantage, however, has been eroded of late, starting in April 2016 when dividend tax credits were abolished, and a £5,000 dividend allowance introduced. New rates of tax were also brought in on dividends above the dividend allowance; 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers. Just two years later, the dividend allowance was reduced to £2,000.

In the 2020 Budget the government announced that the earlier proposed reduction in corporation tax to 17% was not going ahead and it would remain at 19%.

Then in this year’s Budget in March, the Chancellor dropped the bombshell that from April 2023 the main rate of corporation tax for companies with profits over £250,000 is to be hiked to 25%, the highest rate since 2011. The rate of 19% will remain for profits up to £50,000, with an effective rate of 26.5% applying to profits over £50,000 and up to £250,000. If any consolation, the government advised that around 70% of active companies would still benefit from the 19% rate.

Further bad news arrived in September this year. In the government’s policy paper ‘Building Back Better: Our Plan for Health and Social Care’, it set out intentions to raise an additional £12bn a year over the next three years, which is to be invested in frontline health and social care. This includes an increase of 1.25% in the rate of tax on dividends from April 2022, increasing them to 8.75%, 33.75% and 39.35% respectively.

So all this change begs the question, what is the actual impact going to be on business owners and from a tax perspective, is incorporation still attractive?

The tables below show the effective rate of tax for 2021/22 and 2023/24 based on the 2021/22 income tax and NICs bands and assuming the Class 2 NICs remain at £3.05pw. I have also assumed that the National Insurance secondary contribution threshold remains at £8,840 and in the case of a company is paid as salary. For the self-employed they will be liable to the Health and Social Care levy of 1.25% from 2023 and this is included in working out the effective rate of tax.

Summary of effective rates

As can be seen from these examples, incorporation still holds a tax advantage where profits are below £50,000 but thereafter, the advantage diminishes and at profits of £250,000 the effective rate of tax is 4% greater than that of someone who is self-employed.

So, can anything be done?

Some initial thoughts that spring to mind are:

• Where companies have built up cash reserves, should they consider taking some out through dividends now?
• Consider maximising company pension contributions but be mindful of them satisfying the “wholly and exclusively” test.
• Company owners may be tempted to retain profits within the company to defer tax. This gives advisers the opportunity to give investment advice on these surplus funds. Again, care is required as to the impact on the shareholders in relation to Business Asset Disposal Relief and Business Relief.
• For someone starting a new business, incorporation may not be the best thing from a tax perspective but of course tax may not be the only factor to consider.

This is a complex area, but working closely with the client and their accountant is the key to maximising tax planning. But as always, when such major changes come into play there can be opportunities, although in this case, some require urgent action as who knows what the next Budget might bring.

This blog first appeared on Professional Adviser

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