Changes to the taxation of dividends announced in the recent budget will have a big impact on the tax paid by small business owners.
Currently, anyone trading as a limited company can take their income as dividends, thereby avoiding the 9% national insurance that they would have paid had they been self-employed. The limited company paid 20% corporation tax but there was no additional tax to pay on dividends unless the owner was a higher rate tax payer.
George Osborne has effectively nullified this tax break by announcing that from April 2016 the dividend tax credit will be abolished and there would be new tax rates for dividends.
Small savers are protected as the first £5,000 of dividend income shall be exempt, but anything over that limit will be liable to a 7.5% tax charge. This effectively cancels out most of the 9% national insurance saving.
Assuming that the owner pays themselves a salary equal to the income tax personal allowance, a director with an annual income of £30,000 would pay an additional £1,050 in tax. This rises to £1,800 for someone with an income of £40,000 pa.
The Chancellor did announce that the corporation tax rate would be reduced to 18%, which saves approx 30% of the tax increase. However this is being phased in over a number of years so the effective tax charge will be higher for the next few years.
From April 2016 there will still be a small tax advantage for company shareholders over those that are self-employed but nowhere near the current tax advantage. We would therefore not recommend that anyone already trading as a limited company should disincorporate.
However anyone currently considering incorporating to a limited company needs to assess whether the small tax advantage to be gained from April 2016 is worth the additional compliance costs and potential costs of benefits in kind, etc. There may be other good reasons for trading as a limited company but tax savings are no longer a primary reason.