The new dividend tax has arrived. Following his ‘headline cutting’ of the corporation tax rate, will the Chancellor be better or worse off under the new tax regime for companies?
Not surprisingly, if you read my posts on this subject earlier this year, small businesses will be the losers.
Because, as from 6 April 2016, although individuals can earn up to £5,000 in
dividends without any income tax charge, any amounts received above this level will be taxed at 7.5%, 32.5% and 38.1% depending on the tax band.
This has left many business owners wondering how these new rules will affect them and whether it still makes sense to incorporate.
So how will the dividend tax affect business owners already running one-man band companies?
The table below shows the total tax bill (i.e. both
corporation and income tax combined) for one-person companies with profits of £50,000, £100,000 and £150,000. These calculations assume that business owners draw a salary from this profit equal to the NIC threshold (£8,060 for both years), and that all post-tax profits are paid as dividends. The resulting tax figures are rounded to the nearest £100.
Total tax bills for a one-person company
| Total tax bill |
|
| 2015/16 | 2016/17 | Increase |
Profit: |
|
|
|
£50,000 | £8,800 | £10,300 | £1,500 |
£100,000 | £28,800 | £33,000 | £4,200 |
£150,000 | £53,000 | £60,500 | £7,500 |
So
small companies face substantial increases in their total tax bills as a result of the dividend tax. The percentage increase in the total tax bill ranges from 14% to 17%.
What about a ‘husband and wife’ family business?
If we compare tax bills for a two-person company, where profits are divided equally, the total tax bill will be higher in 2016/17 in all the scenarios above.
The percentage increases are
similar to single-person companies, ranging from 12% to 17%.
Total tax bills for a two-person company
| Total tax bill |
|
| 2015/16 | 2016/17 | Increase |
Profit: |
|
|
|
£50,000 | £6,800 | £7,600 | £800 |
£100,000 | £17,600 | £20,600 | £3,000 |
£150,000 | £37,600 | £42,900 | £5,300 |
So, given these tax rises, does it still make sense to incorporate?
The answer is yes, but only if profits are below a certain level. The table
below shows the tax savings achieved by switching from a sole trader to a single-person company for various profit levels.
Tax savings from working via a single-person company v self-employment
| Tax saving from incorporation |
| 2015/16 | 2016/17 |
Profit: |
|
|
£50,000 | £4,000 | £2,300 |
£75,000 | £4,500 | £1,700 |
£100,000 | £5,000 | £700* |
£125,000 | £7,400 | £3,800* |
£150,000 | £6,000 | (£1,400) |
*
The tax saving from incorporation is higher when profits are £125,000 versus £100,000 because the personal allowance of a sole trader is scaled back sooner than someone drawing (post-tax) dividends from a company. However the tax saving from incorporation starts falling again when this effect ends.
Although the tax savings
are substantially lower than in 2015/16, incorporation still makes sense for businesses with profits below £150,000. But a business with profits at (or higher than) this level will be better off working as a sole trader.
If we compare a partnership to a two-person company, where profits are split equally in both cases,
incorporation still makes sense provided profits are below £300,000.
So what can we conclude from the analysis above?
The first point is tax bills are going to be higher for small companies across the board, and business owners need to start setting more money aside. The rise will vary according to circumstances, but a good rule of thumb is tax bills in 2016/17 will be 15% higher than in the previous year.
The
second point is it still makes sense to operate via a limited company provided profits are below a certain level - £150,000 for a single-person business and £300,000 for a two-person firm. Businesses earning (or expecting to earn) more than these amounts should look at the alternative of a LLP if limited liability is an important issue.
If you run your business as a sole trader or partnership - or know someone who does - then get in touch for a no-obligation chat about whether incorporation may be right for you.
Noel Guilford