Tax planning in light of the 2016 Budget announcements
With the dust settled on the chancellor's March budget announcements, accounting firms have had time to digest the content and look to see how best they can plan ahead for their clients, writes Jennifer Parnell
Every individual is entitled to a personal allowance: the amount a person can earn before they pay tax on their earnings. This saw an increase of £400 from £10,600 to £11,000 in the 2016/17 tax year, and is set to further increase in 2017/18.
The basic rate band, which is the amount of income that is taxed at 20 per cent, saw a minor increase, as did the higher rate band. However, there was no change to the additional rate band, which remains at £150,000.
Class 4 national insurance contributions for self-employed individuals remain at a rate of 9 per cent in respect of profits over £8,060, but the upper band has risen from £42,385 to £43,000 this current tax year.
The chancellor also announced a very small piece of good news: there are intended plans to abolish class 2 national insurance contributions for the self-employed from 6 April 2018. In the current tax year, a self-employed individual will pay a total of £145.60 in class 2 national insurance contributions, so while this will be a modest saving, it is surely welcome news.
Overall, there really wasn't much to get excited about for self-employed individuals, who may not see a vast change in their overall tax liability for the 2016/17 tax year, provided of course that their profit share and other income remains largely constant.
Shareholder and incorporated entities
For those individual shareholders of incorporated entities who are remunerated by way of dividends, the government has now introduced a new 'dividend allowance', which will see the first £5,000 of dividends received taxed at a rate of 0 per cent. This replaces the somewhat confusing dividend tax credit of 10 per cent we have seen in previous years.
Any dividends declared from the 2016/17 tax year onwards will be taxed at a rate of 7.5 per cent for basic rate tax payers, 32.5 per cent for upper rate tax payers, and 38.1 per cent for additional rate tax payers. Tax will not be deducted at source. Therefore, if there is any tax payable, this must be declared via self-assessment.
The introduction of the new dividend allowance and changes to the taxation rates for each income band will mean that a number of basic rate tax payers will now suffer tax on their dividends when previously they would not have paid any because of the 10 per cent tax credit. This will of course increase the administrative burden on these individuals as they may now be required to complete a tax return, or at the very least contact HMRC and pay what they owe.
It is true that some people may be worse off under this new regime, specifically those basic rate taxpayers who receive more than £5,000 in dividends. On the other hand, however, those higher rate tax payers with dividend income of £5,000 or less will suffer tax at a reduced rate of 0 per cent instead of at an effective rate of 25 per cent as would have been under the previous regime.
The introduction of the allowance and the scrapping of the 10 per cent tax credit is not advantageous news for those individuals with various shareholdings or larger investments from which a high amount of dividend income is derived.
For shareholders in incorporated entities, getting the right balance between taking a salary and remunerating oneself through dividends is key. It is important to remember that making contributions under PAYE and national insurance contributions counts towards an individual's future state benefit credit when the time comes to draw a state pension.
Businesses are also at liberty to pay into an approved pension scheme on behalf of their employees, and this can be seen as an attractive, alternative way of remunerating individuals, while providing a tax allowable expense for the business.
In a nutshell, the budget was arguably more exciting for the shareholder than the self-employed, but that doesn't mean that tax planning is not an issue for the latter. With constant changes to tax legislation, it is prudent to continually consider whether your income structure is as tax efficient as it could be.
Jennifer Parnell is a chartered accountant and professional practices supervisor at www.krestonreeves.com www.krestonreeves.com