Several significant tax changes are set to take effect from April 2016. Here, a leading accountant explains what the likely impact will be, and why the limited company model remains a smart choice for contractors.
We asked Duncan Strike, director of contractor accountants Intouch, how the forthcoming changes to travel and subsistence expenses, and the dividend tax hike are likely to affect contractors, and how the financial benefits of working via a limited company will be impacted once the new rules are introduced.
How will contractor expenses claims change after April 6th?
Most umbrella providers adopt salary sacrifice to reverse engineer income. From 6th April 2016 expenses that are part of a salary sacrifice scheme are no longer given tax relief when reimbursed and are paid to workers after deducted tax and National Insurance (NI).
Mileage is not included in this restriction but the new travel and subsistence (T&S) rules, again starting on 6th April 2016, means that mileage, travelling and subsistence costs are disallowed within umbrellas where supervision, direction or control (S, D or C) exists.
For limited companies, outside IR35, these issues don’t exist. The effect on an umbrella company worker’s take home pay can be quite substantial, further widening the financial gap in favour of the limited company worker.
Do you think these changes to umbrella expenses will result in more contractors deciding to incorporate?
Where it is appropriate to the individual, yes. The real question is whether umbrella workers will be told the truth or misled. Some umbrella companies are looking at alternatives to the traditional umbrella. These may be appropriate, or not, depending on the individual circumstances. Certainly, those umbrella workers that don’t claim expenses will see no difference post 5th April 2016. Whereas others may be persuaded into using an untested alternative.
The best advice would be for every umbrella worker to look at their own circumstances and make an enquiry with their existing umbrella and limited company providers to work out the best solution for them personally.
What about the new dividend tax from April 2016? Will contractors still be better off incorporating?
Generally, limited company contractors take home more pay. The new dividend tax reduces the advantages, but when considered with the limits on umbrella expenses, the effect is often neutralised.
The main advantage of being limited is flexibility. You don’t have to take dividends if the cash is surplus to personal needs. And so, if money is left in the company, the new dividend tax has no effect.
The important issue is that every contractor should be looking at their position and assessing what is the right thing to do. The choice of limited remains advantageous, but then there is the decision on how much to take out of the company, how to take it and when to take it.
What measures can limited owners take to mitigate the effect of the dividend hike?
Limited company contractors should consider their own circumstances. Share splitting and distributing income can be one strategy, as could a policy of profit retention within the company. The timing of dividends around 6th April 2016 is important and basic rules applied to avoid excessive tax.
You should always look to take advantage of the full basic rate tax bands and not to take higher income unless it’s necessary to do so.
Will loans be useful in the future?
As an alternative, a loan could be part of a contractor’s strategy. Where dividends are taxed at 32.5% or 38.1% then taking a loan may be preferable. Loans are taxed at 32.5%, but it’s the company that pays the tax, not you, whereas the additional tax on dividends is payable out of what is received by you.
Let’s take a look at an example of taking a dividend v loan:
Cost to the company: £10,000
Tax paid personally (32.5%): £3,250
Net personal funds: £6,750
Personal funds: £6,750
Company tax paid: £2,194 (32.5% of the loan)
Total cost to the company: £8,944
Conclusion: £6,750 is retained by you in both examples, but the cost to the company is cheaper.
A strategy like this should be carefully considered and the implications fully understood. At some point the loan will be repayable.
What is this new ‘trivial benefit’ rule which has been announced?
From 6 April 2016, a new trivial benefit exemption has been introduced. A benefit arises when an employer pays an amount that confers a personal benefit for the employee. A trivial benefit is one that is not more than £50. Employees can have any number of trivial benefits, however, directors can only accumulate up to a limit of £300 per year.
Umbrella contractors are unlikely to benefit from the new rules, because umbrella companies are unlikely to provide such payments. However directors and employees of limited companies can decide to make these payments available.
What other benefits does incorporating offer contractors?
1. Employment Allowance
Each employer is entitled to reduce its employers NI by up to £3,000 from 6 April 2016. The rules are changing that will restrict its use where there is only one employee, but for those limited company contractors with more than one employee, the allowance remains available. You can find out more about the Allowance here.
As an umbrella company has many employees there is little scope for umbrella workers to benefit from the allowance.
2. Flat Rate Vat Scheme
The flat rate VAT scheme is available to limited company contractors and is a simple way to account for VAT whilst also providing a positive additional contribution to the income of the company. Umbrella companies cannot benefit from the flat rate.
Umbrella workers are paid all their available income and therefore suffer the highest level of income tax and NI. Limited company contractors are able to defer taking surplus income from their company and avoid paying higher rates of income tax. This can be extremely valuable where you earn significantly more than you need to spend on a day to day basis and increases the net of tax amount available for investment.
As the owner and manager of the company a limited company contractor is able to make decisions about income and expenses that suit their individual requirements. This may mean more flexible pension arrangements, making investments in the company rather than personally, and incurring tax advantaged benefit arrangements. Overall, having control over your finances is a significant advantage over the rigidity of the umbrella alternative.
4. Spouse wages
The opportunities to pay your spouse to help administer the company and to absorb unused personal allowances should not be ignored. Caution is required that their pay is reasonable and they should actually undertake some work, but the company will receive tax relief for the cost whilst, within the personal allowance, no income tax is incurred.
Visit our handy comparison limited vs. umbrella table which describes the main elements each business structure provides.
Read our overview of the new dividend tax regime, which takes effect from 6th April 2016