March 23rd 2017

As you will be aware, the proposed increase in National Insurance paid by the self-employed has now been shelved. Whilst this U-Turn is to be welcomed, the announced reduction in the tax-free dividend allowance will affect those who run their own companies, Julie Robertson takes a closer look.
Salary v dividend
The Chancellor had announced in the Budget that Class 4 National Insurance Contributions (NICs) paid by the self-employed were to increase by 1% in 2018 and a further 1% in April 2019. Whilst the planned scrapping of Class 2 NICs paid by the self-employed will still go ahead, the 2% increase in their Class 4 contributions will be shelved in this Parliament.

But what about company owners?
But whilst this U-Turn is to be welcomed, there does remain concern about the extra tax to be collected from those who run their own companies. The announced £3,000 reduction in the tax free dividend allowance from £5,000 to £2,000 in April 2018 will undoubtedly affect many company shareholder/directors.

They will be worse off by £225, £975 or £1,143 a year depending on whether they pay tax at the basic rate, higher rate or the additional rate. And for a couple who share the running of their company, this is doubled to £450, £1,950 or £2,286 respectively depending on their tax rate.

The dividend allowance of £5,000 (actually a 0% rate band), which was introduced last year will be cut to just £2,000 with effect from April 2018. When first announced, the allowance was viewed as a measure to lessen the blow of the 7.5% across the board rise in tax rates on dividends.

The higher rates were especially aimed at director/shareholders who take their income in the shape of a low salary, topped up with large dividends. Cutting the allowance was therefore an easy target for the Chancellor and anyone receiving dividends of £5,000 or more per year will be worse off by up to £1,140. There is no way to avoid the higher tax unless you reduce the amount of dividends that you receive to below £5,000 per year. That said, even with the reduction in the dividend allowance, dividends do remain the most tax-efficient way to take income from your company.

The Budget document stated that this measure was intended ‘to reduce the tax differential between the self-employed and employed, and those working through a company, to raise revenue to invest in public services, and to ensure that support for investors is more effectively targeted’.

However, this will have a huge impact on the many owner managed small businesses who will have to rethink how they take income following the change.  Large companies do get tax breaks and for these small companies, for whom dividend salary is a useful way of making the risk of running their own business more worthwhile, this change is going to hit them very hard indeed. Especially unfair when you consider that a lot of these businesses will also be limited companies and will have already paid corporation tax on those profits.

If you are the owner manager of a small business this change will affect you, please do not hesitate to get in touch with one of the team at JRW to discuss what it means for you and for advice on how to plan for and manage the change.

JRW Chartered accountants in Edinburgh, Galashiels, Hawick, Langholm and Peebles.