Budget briefing: Turn around when possible
Professional practice partners will cautiously welcome the chancellor's NIC U-turn, but need to watch out for his next move, advises Louis Baker
Partners in professional practice firms are welcoming the national insurance contributions (NIC) U-turn performed by the chancellor of the exchequer, Philip Hammond, but are wary that he must be plotting another move to recoup the revenue shortfall as he struggles to balance the books.
First things first: let’s clarify the confusion. The chancellor proposed in his Budget to increase the class 4 NIC rate from 9 per cent to, initially, 10 per cent in April 2018 and then up a further percentage point to 11 per cent from April 2019. This rate of class 4 NIC only applies to partners’ profit shares in the range from £8,164 to £45,000. There is a 2 per cent class 4 NIC rate on income profit shares above £45,000.
Unless you have been on a desert island since the Budget, you will know that the government has since withdrawn the proposal to increase the class 4 NIC rate. It has reconfirmed the manifesto commitment for there to be no increase in the rate of income tax or NIC in this parliament, so until summer 2020.
But there is yet more good news for partners in professional practices. The chancellor announced in the Budget that the threshold at which the 40 per cent tax rate bites is to increase to £45,000 (from £43,000). The tax saving on this will outweigh the extra NIC on this expanded band of income (on which the 9 per cent rate applies, rather than the 2 per cent rate on income above the threshold).
It is all a bit fiddly, but partners will be about £170 better off due to the changes – assuming their income is above £123,000. For those earning below this, the benefit will be up to £200 higher, as they will also benefit from the increase in the personal allowance.
In a year’s time class 2 NIC is being abolished, which will save partners a further £150 a year. And, within the life of this parliament, the government has promised to raise the threshold for the starting point of the 40 per cent tax bracket to £50,000. This will see a further tax saving (after the NIC impact) of about £450, with a further benefit to those who also retain the benefit of a promised increase in the personal allowance to £12,500 (which Hammond reconfirmed in the Budget speech).
Considering the backdrop of relative austerity, combined with the fact that economic growth is forecast to remain low while Brexit negotiations rumble on, this is all quite surprising from the point of view of the government’s finances, but has been politically promised. The chancellor still faces demands on spending and he is still attempting to significantly reduce the deficit. As he has reiterated the commitment not to raise tax rates, where might the self-employed still face increases from? Before celebrating this NIC backtrack too fervently, we must consider that there is surely going to be some further action in this area if the government’s sums are to add up.
Those firms which operate a service company will already face a tax increase due to the reduction in the dividend allowance to £2,000 – which comes down from £5,000. Might it be reduced even further? The reduction to £2,000 will already be causing those firms still with service companies to review whether the tax efficiency equation has changed, such that even more firms close down their service company.
The chancellor confirmed in his Budget speech that he is seriously concerned by the amount of tax lost through the different tax treatment of employees and the self-employed. The government promised a review in the summer, with potential fresh legislation looking to restrict the tax benefit of incorporation applying from April 2018. Might this result in an increase in the rate of tax on dividend income? Politically, the government seem to believe this is not an increase in the rate of income tax.
Those using a ‘personal service company’ in the public sector are already facing changes in their tax treatment from 6 April 2017, and higher taxes from that date as a result. It may well be that this legislation is expanded to the private sector in a year’s time as well. If such legislation was adopted, this would affect those retired partners who continue to provide consultancy services to their old firm through the personal service company. It would also affect any one-man-band contractors the firms use – in their IT department, for example.
In overview, the chancellor’s climbdown will initially be welcomed by partners in law firms as well as by the self-employed generally. What we need to watch out for is the chancellor’s next move, as he surely must look to make one, and the higher paid will likely be those where any fresh tax attack will be made.
Louis Baker is head of professional practices at Crowe Clark Whitehill