The existing system of grossing-up dividends will be abolished and replaced with a simple rate of tax on net dividends. The tax bands will be 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers. The current Dividend Tax Credit will be replaced by a new tax-free Dividend Allowance of £5,000.

The way that dividends are taxed will completely change. Using the existing rules, a contractor declares a dividend and then grosses-up that net dividend by ten ninths to arrive at a gross dividend, including tax credit of 10%.

So currently, for every £100 of profit earned, a contractor’s company pays 20%, or £20, in corporation tax, leaving £80 to be paid as a dividend. That is then grossed up to £88.89 to find out which personal tax band the dividend falls into. Basic rate taxpayers pay no additional income tax on dividends, while higher rate taxpayers pay 25% of the £80 and additional rate taxpayers pay 30.55% of the £80.

From April that will change. The new Dividend Tax rates will be applied to all net dividends after deducting an individual’s personal allowance not used by salary or other income. The new rates are 0% for the first £5,000 (called the Dividend Allowance), 7.5% for a basic rate taxpayer, 32.5% for a higher rate taxpayer and 38.1% for an additional rate taxpayer.

On a positive note, the new rules say that for every £100 profit, 20% or £20 of corporation tax is deducted and then the Dividend Tax applies to the remaining £80. What this does is actually delay the point when a contractor starts to pay higher rate tax, because the net dividends are no longer grossed up.

There is little that can be done for contractors to avoid the new tax on dividends, however with good advice from Cogent and careful planning, such as diverting profits into a pension scheme, much can be done to mitigate the increase.

Contractors working under constant fear of changing tax rules can relax – for a while at least. The government has announced IR35 rules will not change until April 2017 at the earliest after months of rumours about the tax law. HMRC confirmed at the most recent IR35 Forum meeting on 15 December 2015 that no measures will be implemented during the 2016/17 tax year.

IR35 was introduced a decade ago by Labour with the intention of levelling the playing field between contractors working for their own companies and employees, as contractor companies provided opportunities for tax breaks that are unavailable to other workers. Many of contracting’s stakeholders were at the meeting of the IR35 Forum when HMRC announced it’s decision, including the Association for Independent Professionals and the Self Employed (IPSE).

“We’re pleased that our efforts, alongside those of numerous other groups and hundreds of thousands of contractors, have helped to convince the Government to go back into listening mode. Clearly the message got across that the approach HMRC was considering wasn’t the most appropriate one.” an IPSE spokesman told Contractor Calculator.

Proposals to force clients to take responsibility for IR35 compliance were also widely criticised. The ambiguity over the ‘supervision, direction or control’ (SDC) test was also highlighted. There has been concern amongst contractors since the Summer Budget that IR35 was going to be overhauled and fears were compounded when media outlets reported details of a rumoured one month contract limit prior to the Autumn statement. HMRC has also confirmed that it is set to look into improving it’s Employment Status Indicator (ESI) tool to provide the public with a much more reliable way of assessing their employment status.