Summer Budget 2015 hits PSC contractors, hard
A prediction to ContractorUK that Summer Budget 2015 would contain “bad news” for contractors yesterday rang true.
In fact, the Budget’s measures are so ‘anti-contracting’ that it is as if the new Tory government wants to “kill a limited company’s advantages, and move all contractors to PAYE.”
Sumit Agarwal at accountancy firm DNS Associates made this claim last night, mainly in light of a new tax on dividends that is due to reduce "tax-motivated incorporation" by £190m from 2016; the year it kicks in.
“The government is making limited company usage less lucrative,” he said, pointing also to a new ban on NICs Employment Allowance for directors who are their PSC’s sole employee.
“This [dividend tax] will result in some significant sum of money for HMRC - £565m from stopping tax-motivated incorporation in 2020, so those using a limited company…will [no longer] find [doing so as] lucrative.”
Indeed, initial calculations indicate that, excluding salary and reliefs like lower corporation tax and a higher tax-free allowance, an extra £6,679 in tax will be due on a £50,000 dividend.
‘Sliding scale on dividends’
This reflects the fact that from April 2016, although the first £5,000 of dividend income will be tax-free, all larger distributions will be taxed by a sliding scale starting at 7.5 per cent.
So a dividend over £5,000 will attract 7.5% tax for basic rate taxpayers; higher raters will pay 32.5% (they pay 25% now), and additional raters will pay 38.1% (they pay 30.5% now).
Tax firm WTT Consulting said:“No longer will contractors be deciding the correct mix of salary and dividend from their company, because dividends [will be] tax-free only to £5,000 a year.
“Thereafter, tax will be due in increasing amounts. This [new sliding scale of tax on dividends] will be a critical feature in considerations over whether to incorporate.”
The government agrees. It says the new scale will “start to reduce the incentive to incorporate and remunerate through dividends rather than through wages to reduce tax liabilities.”
But WTT isn’t entirely on-side: “The government claims that the system of tax credits for dividends is now outdated and was based on periods when corporation tax rates were high.
“It’s probably true…[but] to use that to justify a complete withdrawal of the credit system, and instead impose a limit on dividends that can be received tax free,…is stretching credibility.”
It may also stretch the sheer viability of contracting, potentially to breaking point – at least for some one-person PSCs, hints Roger Sinclair, legal consultant at Egos.
‘Double-whammy’
He calculates that, when combined with the removal of the NIC Employment Allowance (EA), contractors will be £1,062 and £3,164 worse off, on a £50k and £150k dividend respectively.
Tax software firm FreeAgent shares his concern, as the dividend tax hike plus EA’s removal suggests a ‘Ltd’ and its sole employee-director together face a “significant increases to tax bills”.
“[These] two measures…will increase the tax bill for these companies and their directors,” warned the firm’s accountant Emily Coltman. “[It’s a] double whammy for one-person limited companies.”
Even for directors who are not their firm’s sole employee, the Low Income Tax Reform Group warns that the new ‘dividend allowance’ is - on its own – enough to make them poorer.
“Some people on modest incomes will now have to start paying tax on their dividend income,” said the group’s chair Anthony Thomas, referring to pensioners as well as directors.
“For some [of the latter’s advisers it will be]…a useful simplification” but pensioners will find it “hugely complex,” as their dividends now face tax for the first time.
Both demographics the chancellor said yesterday he was helping. He told MPs he would support “people that worked hard and saved hard”. The FCSA is understandably mystified.
“[Mr Osborne] claimed to be delivering a budget for hardworking people but…is penalising some of those workers by clamping down on dividends [by limited company] directors”.
‘One-two punch’
Yet Julia Kermode, chair of the Freelancer and Contractor Services Association (FCSA), welcomed the Budget announcing a cut in corporation tax, to 19% in 2017 and 18% in 2020.
A junior accountant at one of the ‘Big Four’ firms is less impressed. She said:“The government is effectively hitting basic rate taxpayer contractors with a one-two punch.
“Not only do they have to pay corporation tax on their company profit, but they are also now going to have to pay a new additional tax when distributing that profit”.
Yesterday’s Budget did indeed unleash a ‘combo’ that will leave contractors “feeling sore,” according to IPSE, the Association of Independent Professionals and the Self-Employed.
‘Clarity on the finer details’
However two Budget measures on top of the dividend tax and the EA ban is what IPSE cited; first, a “clamping down on travel and subsistence” and second, potentially “toughening up IR35.”
The former is not new. A consultation document on it is though and, published yesterday, it proposes to block tax relief on travel and subsistence expenses for ‘SDC’ contractors.
The proposal is broadly what was expected and it is welcome for bringing “clarity” where there was uncertainty about its scope and “finer details,” says Paraplus.
Another umbrella, Parasol, was cautious, and said that although its legal team were assessing the proposal, “we won’t have the full picture until the legislation is published.”
For now though, it appears clear that highly-skilled, project-based contractors should not be caught by the April 2016 legislation, payroll firm ContractorUmbrella advised last night.
“With no actual mention of the SDC rule on T&S expenses in Osborne’s speech, it fell to HMRC to confirm that IT/project-based contractors will not be affected,” the firm claimed.
‘Only the right to supervise needed’
As to SDC, the consultation says a contractor can be subject to (or to the right of) Supervision, Direction or Control (SDC) in their work by “anyone” for tax relief to be denied. It adds:
“This isn’t limited and can include an engager or a subsidiary of that engager, an employment business or other employment intermediary, independent project managers and consultants.
“The right to…SDC would not need to be exercised in practice for the proposed changes to… tax relief to apply, someone only needs to have the right to supervise, direct or control”.
Lucy Smith, a director at ContractorUmbrella, said: “The emphasis on determining whether a contractor is eligible for tax relief will now lie with the umbrella company. So the responsibility for the umbrella company is to ensure they get the confirmation on 'SDC' from the recruiter.
“In short, it will be up to the umbrella to ensure that they request the relevant information with regards to Supervision, Direction and Control from the recruiter.”
‘Unpaid IR35 enforcer’
And umbrellas might not be alone in having to police tax rules - as IR35, the other measure IPSE raised yesterday, may soon be a client’s responsibility, warns WTT’s Graham Webber:
“To make IR35 ‘more effective’ there is a promised consultation due soon as well as talks with employers. The thrust is clear – to force employers to recognise as employees, more people. The employer can then act as unpaid enforcer of tax rules and unpaid collector of tax.”
Mr Webber’s analysis - which implies a sea change for IR35 - was accompanied by his call to action. “The [IR35] consultation will need to be carefully examined [by]…a full blown campaign.
“[This is] to ensure that it produces a fair and balanced position,” he said. “This will require input not just from contractors and all those who advise them, but also those who engage their services. This is not the time to be in silos”.
‘No easier IR35 life for contractors’
Meanwhile, a former tax inspector who is a member of the IR35 Forum and also the co-founder of a leading IR35 advisory agrees that change is, unquestionably, in the air for IR35.
“This is not a case of ‘here we go again’ with another IR35 review but [it] appears to be very much a case of ‘let’s change it in some way’,” said Kate Cottrell of Bauer & Cottrell.
She warned:“We will have to wait for the IR35 discussion document…but the need to protect the exchequer and improve fairness is not consistent with an easier IR35 life for contractors.”
Some contractors already see the writing on the wall. “Well back to a permie life it is then,” wrote one on the ContractorUK Forum. “This is not looking good at all” wrote another.
‘Difficult things that voters will forget’
Ominously, these contractors could be referring to any one of the Budget’s four anti-contracting measures – improve IR35; hike tax on dividends, remove the EA and forge ahead with taking tax relief on expenses.
A Treasury official’s comment before the Budget still holds true as to why this multi-pronged attack on contracting has been launched:“There’ll never be an easier time to do difficult things.”
Or as an adviser to contractors put it: “The new government feel emboldened to make tough decisions, having been given a strong mandate from voters, the next election is also a long way off. The calculation is that, by then, those unpopular changes will be a distant memory.”
Editor's Note: Related Reading -
Why contractors might have the Summer Budget blues
Summer Budget 2015 - overview for contractors
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