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.

HM Revenue and Customs has been criticised for hailing it’s “most successful year” ever in a report detailing positive results and playing down embarrassments over the past 12 months.In the meantime, the head of HMRC, Lin Homer, was awarded a Damehood in the New Year’s honours list. However, she has since resigned. HMRC has been criticised for a series of failings and “abysmal” levels of customer service and has been accused by senior MPs of being “complacent”. But in it’s report for 2015, published online, HMRC said it had “had it’s most successful and sustained performance in it’s ten-year history”. The department said it had “achieved successive record-breaking revenues, last year alone bringing in more than £517billion”. It added that “all this was achieved at the same time as improving customer service”.

HMRC also hailed it’s success of tax avoidance clampdown on UK banks. It said the amount of money in tax avoidance schemes has fallen from £3.2bn in 2013 to £1bn. Nigel Mills, a Conservative member of the Public Accounts Committee, said: “There are serious questions about how HMRC is performing, it is failing to answer enough calls and collect enough money from large businesses and tax avoiders.

“You would think you would want that sorting out before you gave someone a gong. I don’t understand why we have to have every well-paid civil servant in every department getting a knighthood or damehood.

“Surely these honours should go to captains of industry who have created lots of jobs or people who have done transformational things for charities. It seems wrong to me.”

John Pugh, a Liberal Democrat member of the committee, told The Telegraph: “Frankly the honours system is in enough trouble without Civil Service mandarins using it for self-congratulatory back slapping.

“Lin Homer would certainly not have been nominated by the hordes of unanswered taxpayer callers to the diminishing number of accessible tax offices.

“Perhaps – if they could get through – some of the thousands of identified and unprosecuted tax evaders put in a good word.”

The 8 July Budget contained a number of measures with implications for personal and business finances. Here’s a quick round-up of some of the key announcements.

• The income tax personal allowance will increase from £10,600 in the current financial year to £11,000 in 2016-17 and £11,200 in 2017-18.
• The higher rate threshold, above which income tax is paid at 40 per cent, will increase from £42,385 in 2015-16 to £43,000 in 2016-17 and £43,600 in 2017-18. The levels of the personal allowance and higher rate thresholds are slightly higher than those announced in the March 2015 Budget.
• Child benefit will be frozen for four years from April 2016, along with other working age benefits.
• The amount you can earn tax-free from letting out furnished accommodation in your home will rise from £4,250 per year to £7,500 from April 2016.
• Insurance premium tax (IPT) is charged on insurance premiums and covers most general insurance, such as car and household, although life and most other long-term insurance policies are exempt. From 1 November 2015, the standard rate of IPT will be increased by 3.5 per cent to nine per cent.
• The pensions annual allowance – the amount that can be saved each year into a pension and receive tax relief – is currently £40,000 a year. From April 2016, for every £2 of adjusted income someone has above £150,000 – including their own and employer pension contributions – the annual allowance will be reduced by £1, down to a minimum of £10,000.
• From 2017, a new £175,000 inheritance tax (IHT) allowance will be phased for the estates of people leaving their home to direct descendants. The effect of the new allowance – called the main residence nil rate band, which will sit on top of the existing £325,000 IHT threshold – will be to create an effective IHT threshold of £1 million for spouses and civil partners by 2020-21.
• Dividend tax credit means that non and basic rate taxpayers currently pay no tax on dividend income. From April 2016, the credit will be replaced by a £5,000 annual dividend tax allowance. Tax above the threshold will be levied at 7.5 per cent for basic rate taxpayers, 32.5 per cent for higher rate taxpayers and 38.1 per cent for additional rate taxpayers, those with annual income of more than £150,000. ***See our important note at the foot of this article***
• Residential landlords can currently offset ten per cent of annual rental income against tax as a wear and tear allowance for furnishings. From April 2016, the allowance will be scrapped. Instead, landlords will deduct the annual cost of replacing furnishings.
• Legislation will be introduced to strengthen HM Revenue & Customs’ powers to recover tax debts directly from taxpayers’ bank and building society accounts, including cash ISAs.
• The corporation tax rate will be reduced from 20 per cent to 19 per cent in 2017 and to 18 per cent in 2020.
• The employment allowance – a discount on employers’ national insurance contributions – will rise from £2,000 a year to £3,000 in April 2016. Companies where the director is the sole employee will no longer be able to claim the employment allowance from April 2016.***See note at the foot of this article***

The government will publish a “roadmap” by the end of the year, showing how it will transform tax administration for individuals and small businesses by 2020. It will also publish a business tax roadmap by April 2016, setting out its plans for business taxes in the same period.

***Important note on dividend income***

As we are all aware, over the years, governments together with HMRC have enacted various attacks on the freelance limited company sector such as IR35. The perception is that freelance contractors get an unfair advantage in being able to work through a limited company.

In fact, over the years, we as accountants have been able to advise freelance contractor clients on very advantageous methods of extracting profits from their company.

The changes notified in the Budget will in the first instance increase the tax charge on the traditional method of taking most of the profits out as dividends. Non and basic rate taxpayers currently pay no tax on dividend income, however from April 2016, everyone will receive a £5,000 annual dividend tax allowance.

Once this has been exhausted, even those dividends earned below the higher rate tax threshold will carry an additional 7.5% tax charge. The rule of thumb applied over the years that dividends taken up to the higher rate tax threshold will not incur income tax will no longer apply.

As always, we at Cogent will be analysing all the options available for our clients to see how to mitigate their overall tax liability. It is early days in analysing these options and we will over the coming months be in touch to provide available strategies to help you to retain more of your hard-earned income.

***Note on the employment allowance***

As usual, you can be confident we will provide our clients with the best advice. We will be looking at the options and will guide you accordingly.