Tax policies introduced during the first decade of the 21st century encouraged the use of companies as a trading vehicle. The result was that many traditionally self-employed people incorporated their businesses, took salaries equal to the income tax personal allowance or lower national insurance threshold and then withdrew other remuneration by way of dividend.
Often the goodwill of the unincorporated business was sold to the new company to create a loan account that was drawn down by the director/shareholder having suffered only 10% tax as a result of entrepreneurs’ relief. Overall, incorporation was quite a tax efficient route for the small business owner, other things being equal.
However, major changes in the last two budgets have effectively removed the 10% tax rate on incorporation and changed the way dividends are taxed, removing some of the income tax and national insurance advantage of incorporation.
The changes for dividends will be effective from 6 April 2016 and though there is no detailed legislation at the time of writing, we do have a broad idea of how it will work. The notional tax credit of 10% attached to dividends will be abolished and a new £5,000 band introduced where dividends will be taxed at 0%. This will, however, use up part of the basic or higher rate bands.
The new rates will be basic rate 7.5% (currently 0%), higher rate 32.5% (currently 25%) and additional rate 38.1% (currently 30.6% as mentioned in my blog post of 17th August.
For business owners taking remuneration through dividends, there is almost certainly going to be a tax increase though, generally, dividends remain more tax efficient than salary. There is a clear incentive to ensure that shareholdings are held by both husbands and wives, as well as, perhaps, adult children so long as the altered ownership is correctly executed and is consistent with longer term business, family and succession concerns . There are many legal as well as tax issues to consider here, but a review of the current ownership position is recommended.
There are other ways of mitigating the increased tax liability for business owners, including extracting value by charging interest on directors’ loan accounts or reviewing the rents on property let to the company. Again, my post of 17th August may be worth revisiting. There is no doubt that the new measures on dividend tax and goodwill limit the attractiveness of incorporation from a tax point of view. However, despite what the Government, indeed any Government, appear to believe, incorporations are not always predicated upon income tax savings, but for other sound commercial reasons. Careful planning will certainly need to be undertaken prior to April 2016 and many large dividends will be paid before then to take advantage of the current lower rates. Going forward, business owners should ensure that they review their remuneration strategies to ensure that these are still tax efficient under the new regime