So, here we are, with just a few weeks to go until the big day! Unfortunately, I’m not talking about Christmas, I’m referring to the Budget. What surprises will be in store for us, and how will they impact?
There has been speculation for months about what the chancellor will reveal on 26th November. The early fears focused on inheritance tax and capital gains tax – and those will probably not escape Rachel Reeves’ wrath. However, over the past week or so, attention has turned to income tax.
Despite a manifesto pledge to not increase income tax, national insurance or VAT ‘for working people’, the government is planning what we believe to be a 2p in the £1 tax raid, which would push up the basic rate of income tax from 20% to 22% – the first increase in the basic rate of income tax since the one announced in Dennis Healy’s 1975 Budget.
However, it has been speculated that such an increase in the rate of income tax would be matched by a compensating (2p, perhaps) reduction in the rate of employee’s national insurance; that would take it down from 8% to 6%. As employee’s start paying national insurance at the same threshold as they start to pay tax (£12,570), the chancellor could then use the argument that, for ‘working people’ who have salaried income only, there will be no net impact of a 2p increase in income tax combined with a 2p reduction in employee’s national insurance.
For those of us owning business, as directors and shareholders, what might we expect? I’d expect the higher rate of income tax to be hiked to 42% if the basic rate goes to 22%. And what about dividends? Because dividends are paid out of profits that have already been subject to corporation tax, they attract a more favourable rate of income tax – 8.75% for basic rate taxpayers and 33.75% for those in the higher rate bracket. Might we expect these rates to be increase too?
I’m hoping that the worst-case scenario, in terms of income tax, will be that the same 2p increase will be applied to the dividend rates, possibly taking them to 10.75% and 35.75% respectively. That’s just logical speculation on my part, however. So, what if that does happen? The question I’ve been asking myself is, with increases of 2p in the pound across the board in income tax rates and, on a positive note, a 2p reduction in the employee’s national insurance rate, would we all be better off switching our incomes from dividends to salary?
It has been common practice for many years for director-shareholders to take a modest salary at around the personal allowance level and then top that up with dividends from the company. With thresholds where they have been for the past few years, the typical ‘efficient’ structure has been to take a salary of £12,570 combined with dividends of £37,700. This provides the director-shareholder with an annual income of £50,270. The director-shareholder will have an annual income tax liability of £3,255 on their £50,270 package. Meanwhile, their company has to pay employer’s national insurance of £1,136 on their £12,570 salary but saves corporation tax of at least £2,604 because of the salary cost (£3,632 if the company is paying corporation tax at 26.5% rather than 19%). So, the company actually wins as a result of their remuneration package by between £1,468 and £2,496. This means that the combination of the £3,255 income tax cost for the director-shareholder and the ‘win’ for the company leads to a combined overall tax and national insurance cost of between £759 and £1,786. Not a bad result. And the director-shareholder has a net income of £47,015 after paying the self-assessment bill (£50,270 minus £3,255).
Here’s a summary of the position for a company making a profit of £50,000 before deducting director’s salary.
Net tax and NI cost or benefit to company | 1,469 | |
Net tax and NI cost to director-shareholder | -3,255 | |
Net tax and NI cost to director and company combined | -1,786 | |
Net income for director-shareholder | 47,015 |
And here’s what it looks like for a company making a profit of £100,000 before deducting the director’s salary.
Net tax and NI cost or benefit to company | 2,496 | |
Net tax and NI cost to director-shareholder | -3,255 | |
Net tax and NI cost to director and company combined | -759 | |
Net income for director-shareholder | 47,015 |
So, I have tested what this model would look like with the 2p increase to income tax, across both salary and dividends and the 2p reduction in employee’s national insurance. Here’s the result.
Firstly, for a company making £50,000.
Net tax and NI cost or benefit to company | 1,469 | |
Net tax and NI cost to director-shareholder | -3,999 | |
Net tax and NI cost to director and company combined | -2,530 | |
Net income for director-shareholder | 46,271 |
The company’s position doesn’t change. But the director-shareholder suffers as the income tax burden rises from £3,255 to £3,999. There’s an additional £744 of income tax for the director-shareholder, the equivalent of £62 per month.
And, secondly, for a company making £100,000.
Net tax and NI cost or benefit to company | 2,496 | |
Net tax and NI cost to director-shareholder | -3,999 | |
Net tax and NI cost to director and company combined | -1,503 | |
Net income for director-shareholder | 46,271 |
Again, there’s no change to the company’s position. And, again, the director-shareholder’s income tax burden rises by £744. So, it’s the same additional cost to the individual.
You’ll notice how the net income for the director-shareholder drops by £744 due to the higher income tax (self-assessment) cost. So, what if the director-shareholder took the decision to put themselves on a big salary and dispense with dividends? What salary would they need to be on, after the assumed 2p changes to income tax and national insurance, to come out ‘net’ with 46,271?
The answer is that they’d need a salary of £57,227 – pushing them into higher rate tax. The combined tax and national insurance cost to the company and the director-shareholder rises to £6,429 for a company making £50,000 profit (from £2,530) and to £2,679 for a company making £100,000 (up from £1,503).
So, what have we learned from all of this? Well, although the self-assessment tax burden might increase on the director-shareholder, the combination of a small salary and large dividend still works in the post-Budget world. It’s still better than the alternative of a big salary. But it’s interesting to note that, for companies making larger profits and paying corporation tax at 26.5% (which they do on profits of between £50k and £250k), the ‘gap’ is quite narrow. And that’s because the company is getting 26.5% tax relief on the big salary – whereas smaller companies only ‘save’ tax of 19% on salaries.
After the big day, we might have to tear all of the above up, as it might never happen. Or other thresholds and rates may change. I will, of course, let you know. And we’ll cover all of what does happen at our Budget Breakfast Seminar on 2nd December.
In the meantime, as you hear the rumours over the weekend about the potential 2p income tax and national insurance changes, bear in mind that if they happen as I’ve described, it may cost you around £62 per month.
