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Contractors to foot £7bn bill envisaged from dividend tax hike

The Telegraph reports today that contractors billing £80,000 per annum will be £2,000 a year worse off under the new dividend tax system. That’s based on advice from WTT Consulting’s Graham Webber, after adding the additional 2.5% tax shareholders will sucker for come April 2016.

Should a contract be worth double that, £160,000 per annum, the shareholder will have to pay an extra 3% on their dividend drawings. That’s due to their higher tax bracket, thus they’ll pay £4,800 extra from next Spring.

Some may argue that anyone billing so much can afford to pay the extra. First, there’s the defence that people live to their means (or beyond them). Contractors who’ve secured mortgages and other finance based on the existing dividend set-up may have to rethink their budget.

Second – applicable to the most vulnerable sector – are contractors whose total annual billings are below the basic tax rate allowance. Yes, there’s another argument here: if you’re only billing £42k, are you really a contractor?

The answer is yes; there are genuine multi-client contractors – like writers, for instance – with several contracts on the go. But despite their number of clients, the going rate may not bill enough to catapult them into the 40p-in-the-pound bracket.

What’s the effect of the dividend tax hike?

Up until now, basic rate tax payers have paid no tax on dividends. From April 2016, only the first £5,000 of dividend drawings is tax free.

So, let’s imagine a contractor with two clients, billing them both £20k per annum. Their total income of £40k means they retain their basic tax-payer status. All good so far.

Let’s then imagine that they – quite legally – put £120 pounds a week through the books to maintain their NICs, but keep payments to a minimum. For contractors billing so little, they’ll want to ensure that there’s a State Pension pot when they retire, for sure.

Let’s also work on a 50-week year (that’s to keep the maths simple – normally, 46 or 48 weeks would represent a fiscal year). So, 50 weeks x £120 = £6,000 per annum the contractor draws as salary.

Take that £6k from the £40,000 earnings, the contractor then has the potential to draw the £34,000 in dividends. Less Corporation Tax @ 20% (at source) gives the contractor £27,200 to play with.

This is a very simplified explanation, remember (Whitfield Tax go into much more depth). It doesn’t take into account Personal Allowance – next year to rise to £11,000 – which can’t be used against dividends, anyway. Nor does it factor in any expenses, as few and far between as they’ll soon become.

So, in the 2015/16 tax year, this year, the contractor will not pay tax on those dividend drawings. The £27,200 will be theirs.

Come next year, 2016/17, the only chunk of that £27,200 not subject to dividend tax will be the £5k allowance. The balance of £22,200 will be subject to dividend tax.

The net effect of the new charges will mean that this basic-rate contractor will pay £1,290 next year that they haven’t this. That leaves £20,910, plus the £5k tax free = £25,910, or a net loss (all other factors being equal) of 4.98% next year.

If we shoot everyone, we’re bound to get our man

By the time the National Insurance personal allowance changes come into effect, many contractors are going to wonder whether it’s worth creating a company at all. Even genuine contractors, let alone those who are inside IR35 and are the genuine target of these changes.

The government hopes to raise £6.8bn from the changes to dividend tax. Limited company contractors and independent professionals will foot that bill. Then, there’s the discussion document coming on IR35, too

The government could well be shooting itself in the foot by killing the flexibility that contracting brings to the economy. The ability to employ specialists on a short term basis is what’s helped the UK recover. It’s also what will see UK businesses become more competitive in the global market, too.

The £7bn the government wants to raise from dividends will be pittance compared to the additional cost to businesses. With few skilled contractors, they’ll have to employ full time staff for tasks that don’t need full time supervision, direction or control. But that’s another story, entirely…

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