Local accountants and tax advisers, Trueman Brown, warn SME limited companies that HMRC are changing the taxation of dividends to bring Corporation Tax liabilities in line with those met by sole traders and partnerships.
In the first part of a two-part blog, we looked at how an SME could trade through a limited company and save tax rather than trading as a sole trader or partnership.
In this second part, we look at the flexibility of the tax system could lead to even bigger tax savings. And then we look at how HMRC finally in the July 2015 to bring the tax liabilities of SME limited companies into line with sole traders and partnerships.
FLEXIBILITY
One of the benefits of trading through a limited company is flexibility.
Looking at the example in part one, we have assumed that Tim has to draw out all of the profits from the company as a dividend.
But can Tim arrange his financial affairs so that he can save even more tax?
For 2015/16, Tim can limit his drawings from the company to £38,952.50 so that he pays no tax or national insurance on his drawings from the company.
| Drawn From Company | Shown on Tax Return | Tax & National Insurance Due | |
| Salary | £ 8,060.00 | £ 8,060 | £Nil |
| Dividend | £30,892.50 | £34,325 (£30,892.50 / 0.9) | £Nil |
| Total | £38,952.50 | £42,385 | £Nil |
So, if we assume that Tim can limit his drawings to £38,952.50, by how much would he be limiting the tax the business pays at various profit levels?
ANSWER
The table below shows that once company profits are higher than the basic rate tax band, Tim’s tax would savings increase greatly (i.e., by £2,200 for each £10,000 of profit).
| Profit Level | Tax – Sole Trader | Tax – Limited Company & Director | Difference |
| £20,000 | £3,101 | £2,388 | £713 |
| £30,000 | £6,001 | £4,388 | £1,613 |
| £40,000 | £8,901 | £6,388 | £2,512 |
| £50,000 | £12,791 | £8,388 | £4,403 |
| £60,000 | £16,991 | £10,388 | £6,603 |
| £70,000 | £21,191 | £12,388 | £8,803 |
HMRC Response
HMRC have always seen this tax planning as being very aggressive and have been looking to legislate against it. The problem seemed to be getting the consent of the sitting Chancellor of The Exchequer.
Most commentators expected HMRC would act by applying national insurance to dividends.
However, they could never get the backing of the sitting Chancellor of Exchequer until July 2015.
The Bombshell
In July 2015 Budget, the then Chancellor, George Osborne, announced changes to the way dividends will be taxed.
Osborne believed that many people now work via their own limited companies simply to save tax, i.e., ‘tax motivated incorporation’.
From 6th April 2016, dividends will now be taxed as follows: –
- The 10% tax credit has GONE!
- Each taxpayer will receive £5,000 dividend allowance every year. The allowance was quickly reduced to £2,000 from 6th April 2018.
- Dividends received over and above the allowance will be taxed as follows: –
- 7.5% if basic rate taxpayer (20%). This is now 8.75% for 2022/23.
- 32.5% if higher rate taxpayer (40%). This is now 33.75% for 2022/23.
- 38.1% if additional rate taxpayer (45%). This is now 39.35% for 2022/23.
Increased Tax Liability
To see how this change to the tax code will increase the amount of tax paid by an SME operating via a limited company, let’s use the same example of Ben and Tim.
We will use the same scenario that all after tax profits will be drawn from the business by Ben and Tim and also use the income tax and national insurance rates and bands for 2016/17.
Ben’s tax liability, as a sole trader, will be unaffected by the new legislation.
The tax paid by Tim and his limited company will be as follows: –
Limited company
| Company Income | Amount |
| Profit | £40,000 |
| Less: Salary | £8,060 |
| Net Profit | £31,940 |
| Corporation Tax On Net Profit @ 20% | £6,388.00 |
Tim’s Personal Tax
| Tim’s Income | Amount |
| Salary | £ 8,060 |
| Dividend : Net Profit Of £31,940 Less Corporation Tax Of £6,388 | £25,552 |
| Statutory Total Income | £33,612 |
| Less: Personal Allowance | £11,000 |
| Taxable Income (Only Dividend element) | £22,612 |
| Less: Dividend Allowance | £ 5,000 |
| Dividend Taxable | £17,612 |
| Dividend Taxable @ 7.5% | £1,320.90 |
The new dividend allowance will lead to an increase of £1,320.90 in the amount of tax that Tim will pay personally.
SELF ASSESSMENT PAYMENTS ON ACCOUNT
Taxpayers should also be aware that because Tim’s liability for 2016/17 is greater than £1,000, under the self-assessment regulations, Tim will have to make a payment on accounts of the liability for the fiscal year 2017/18 being two payments of 50% of liability for 2016/17 each.
Tim will have to pay HMRC £1,981.35 (liability of £1,320.90 for 2016/17 and a payment on account of £660.45 for 2017/18) on or before 31st January 2018. A further payment on account of £660.45 for 2017/18 will have to be paid on or before 31st July 2018.
TAX INCREASE OVER VARIOUS PROFIT LEVELS
So what will be the tax increase for limited companies under the new rules: –
| Profit Level | 2015/16 – Old Rules | 2016/17 – New Rules | Tax Increase |
| £20,000 | £ 2,388 | £ 2,508.90 | £ 120.90 |
| £30,000 | £ 4,388 | £ 5,108.90 | £ 720.90 |
| £40,000 | £ 6,388 | £ 7,708.90 | £1,320.90 |
| £50,000 | £ 9,053 | £10,308.90 | £1,255.90 |
| £60,000 | £13,053 | £14,561.90 | £1,508.90 |
| £70,000 | £17,053 | £19,161.90 | £2,108.90 |
In part three of this series of blogs, we look at how SMEs can amend their affairs to reduce their tax bills under the new dividend tax allowance.
Local accountants and tax advisers, Trueman Brown, deliver vital services to small business. Please contact us if you require assistance.
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