There seems to be an unprecedented number of tax changes hitting the contractor world recently.
We take a tour through these changes and have included some suggestions for mitigating the impact of them.
Big changes to the Flat Rate VAT scheme
The Flat Rate Scheme is used by many contractors as a way to reduce the administration of VAT accounting which is exactly why the Flat Rate Scheme was introduced in the first place. However HMRC believe that the scheme is being abused. Not surprisingly, they have changed the rules to close the perceived loophole.
Unfortunately, they have done this in a way that affects a far wider range of businesses than HMRC perceive were abusing the scheme with the result that the Flat Rate Scheme has been all but killed off.
You can read about the changes and their impact at:
Public sector contractors and IR35
From April, most contractors working on public sector contracts are likely to be subject to IR35 rules. This usually means that the contractor will pay much more in tax/NI as they will be classed as an “employee” although it appears that they will be without the usual employment rights.
If you are in this position, you must talk to your Agency – it will be their responsibility to apply these new rules.
The rules will apply to all money received from 6 April onwards.
We predict that anyone with options to move across to work in the private sector will take them at the earliest opportunity unless there is a substantial rise in rates to compensate for this change which is unlikely to happen.
At the time of writing this it is unclear if continuing with a company would be worthwhile or if Agencies will still insist on workers operating a Limited company to avoid potential employment law claims.
Employment Status Check
As part of the continued targeting of contractors HMRC have introduced a new online tool to help decide if IR35 applies to your circumstances.
The “employment status for tax” tool can be found at:
This is free to use and anonymous although it is uncertain if HMRC capture any details such as IP addresses. So whilst it would be worthwhile for all contractors to use it you might want to do it on someone else’s device!
A word of caution – experience of this type of tool suggests it will give a biased result so is more likely to say IR35 applies than a court of law would say. Still, it is evidence of what HMRC could think if they checked your status.
As usual we would suggest that contractors ensure that they have tax investigation insurance to safeguard against any type of HMRC review.
Many will, or hopefully should know that the way that dividends are taxed changed in April 2016.
Briefly the changes mean that tax will be paid on dividends received above the tax free dividend allowance at the following rates:
- Dividends falling within basic rate tax – tax at 7.5% of the dividend received is due
- Dividends falling within higher rate tax – tax at 32.5% of the dividend received is due
- Dividends falling within the additional rate of tax – tax at 38.1% of the dividend received is due but remember that for income over £100,000 your personal allowance also starts to get restricted
In all cases this means that an extra 7.5% of tax is due on dividends across all tax thresholds.
Tax Free Dividend Allowance
From April 2016 the amount of dividends that could be received without paying any additional tax was £5,000.
From April 2018 the £5,000 allowance will be reduced to just £2,000.
The dividend tax is a personal tax and should be paid from your personal bank account; the company does not pay it.
Anyone receiving more than £5,000 (£2,000 from April 2018) in dividends will certainly have to file a self assessment tax return for 2016/17 onwards. If you have not had to do this previously you will need to register. We suggest that you do this as soon as possible.
Tax due date
Any tax due as a result of the new tax on dividends in the 2016 / 2017 tax year has to be paid on or before 31 January 2018.
This could also trigger a Payment on Account which will mean paying 1.5 years’ worth of tax in January 2018. A second payment on account will be due by 31 July 2018.
Payments on Account often confuse. You can read more about these at https://www.gov.uk/understand-self-assessment-bill/payments-on-account
Mitigating the impact of the dividend tax
The extra dividend tax will hit some hard. Whilst we are not about to promote any tax avoidance schemes or such like we’ve listed a few things that you can do to help mitigate against the financial impact of the dividend tax.
Pension contributions are certainly the most tax efficient way of extracting money from your company IF that is what your preferred investment option is.
Twenty years ago, clients routinely put large sums into their pensions to reduce tax before scandal, poor investment performance and inflexibility made other options popular (ISAs, paying down debt including mortgages, investing in buy to let etc).
The popularity of this option may increase, due to recent changes in the pension rules to make them more flexible and the extra cost in taking money out of a company as a dividend.
However, this should still be seen first as an investment decision with tax benefits rather than just a way of reducing tax.
We must stress that you should seek appropriate financial advice on pensions.
Previously, it was not worth a spouse who paid the same tax rate as you receiving salary or dividends from your company. Now there is an advantage in them receiving dividends of £5,000 (£2,000 from April 2018) as this will be at 0% tax.
If they work for the company, being paid a small salary could also be an advantage but they must actually do some work!
Check salary levels
If there are at least 2 of you working full time in the business, the most tax efficient salary level may be £11,500 not £8,160 (£680 per month) for 2017/18.
Make sure that you claim for all business related costs. Over time the attention to the bookkeeping for small out of pocket expenses can become lackadaisical. Of course costs must be genuine business costs “wholly and exclusively” for the company’s business.
Charge a market value rent
If you do a significant amount of work from a home office, you can charge a rent to the company which represents a fair allocation of the company’s share of domestic costs. It may now be worth considering going further and charging a full market rent but note this will involve more work and costs and the proper procedures must be followed.
Where trivial benefits are provided to employees they may be exempt from tax if certain conditions are met. This is a small extra claim that can be made but this has to be an actual cost and the conditions (see below) must be met; it is not some form of flat rate allowance.
The conditions are:
- the cost of providing the benefit does not exceed £50
- the benefit is not cash or a cash voucher
- the employee is not entitled to the voucher as part of a contractual arrangement (including salary sacrifice)
- the benefit is not provided in recognition of particular services performed by the employee as part of their employment duties
- where the employer is a ‘close’ company and the benefit is provided to an individual who is a director, member of their household or their family, then the exemption is capped at a total cost of £300 in a tax year.
If any of these conditions are not met then the benefit will be taxed in the normal way subject to any exemptions or allowable deductions. One of the main conditions is that the cost of the benefit is less than £50; if the cost is above £50 the full amount is taxable, not just the excess over £50.
And of course don’t forget that you can claim for your Annual or Christmas Party. To qualify for your knees up being allowable for tax it must be open to all employees, be an annual occurrence and not cost more than £150 per head. Just like trivial benefit this is not a “relief” and must be an actual cost not over £150.
Making Tax Digital
HMRC continue to press ahead with this and quarterly reporting which will affect companies in 2020 but some taxpayers from April 2018. The implementation timescales are a moving target as HMRC recently announced that small businesses and landlords who come under the VAT threshold will have an extra year to prepare for MTD with implementation moving to 2019 for them.
So watch this space as more unfolds.
The main thing to note at this stage is that quarterly reporting will mean bookkeeping has to be up to date and reasonably accurate – at the very least the bank balance shown by your bookkeeping should equal the bank balance on the bank statement.
Quarterly reporting without online bookkeeping (e.g. if you use spreadsheets) will take longer, cost more to deal with and will be more prone to error. It may not even be practical under Making Tax Digital.
We expect to see a huge shift from spreadsheets to Cloud Accounting software in the IT Contractor space over the next year or so.
If you’re not already on a system then our advice would be to move sooner rather than later. Your accountant should be able to advise on what would be best for you to use e.g. FreeAgent, Sage, Quick Books, or Xero to name a few robust systems; if they can’t advise then it may be time to consider a change of accountants! This may even reduce your accountancy fee as using a Cloud Accountancy system through a Digital Accountant would usually save time and result in lower fees.
Do you live in Scotland?
If so, your tax from April 2017 will be a little different as it looks as if you won’t benefit from the rise in the higher rate tax threshold from £43,000 to £45,000 so you will be paying an extra 25% on any dividends on the £2,000 difference.
Small good news
From April 2017, the tax free personal allowance will be £11,500, the higher rate will be £45,000 (except in Scotland) and the corporation tax rate falls to 19%.
A limited company is a formal legal structure, so the formalities should be followed at all times.
Financial transactions cannot be regarded as flexible e.g. dividend payments and director’s loans.
If in doubt ask your accountant BEFORE doing something significant, not after the transaction has been made as it cannot be undone then.
Procedures for paying dividends, taking a salary, charging home rent or child care costs must be followed or they will not work.
The above is general information and should not be used as advice given in any circumstances. You should seek specific advice tailored to your circumstances from your accountant.
Interpretation of new rules may change over time with experience of how they work in practice and further announcements & clarity from HMRC. Always check that you are working with the latest information available.