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The recent budget had a significant impact on contractors. The main budget changes were:
1, Replacement of dividend tax credits with £5k tax-free dividend allowance and changes to the dividend tax rates.
This is a blow for contractors using a limited company. At the moment, if you have basic rate earnings then the 10% dividend tax is cancelled out by the 10% dividend tax credit so there is no personal tax to pay.
However, the changes will mean that while the dividend tax drops from 10% to 7.5%, the 10% dividend tax credit has been scrapped and replaced by a £5k allowance.
So, whereas previously there was no tax to pay on basic rate dividends, there will now be 7.5% to pay on all dividends over £5k per tax year. For contractors taking the maximum basic rate earnings of £43K next year this will mean around an extra £2k in dividend tax. This is a big change for contractors who currently pay nothing or very little through personal tax returns.
2, Planned reduction of corporation tax from 20% to 19% then 18%.
This will obviously reduce the amount of corporation tax due from limited companies. Good news but the reduction to 19% does not kick in until 2017 and the drop to 18% will not take effect until 2020.
3, Removal of £2k Employers NI break for personal service companies.
This stops the opportunity for contractors using limited companies to up the salary to take advantage of the £2k break in Employers NI. Contractors classed as personal service companies who previously increased their tax efficient salary from £8k to £10k will now have to reduce it back to £8k. However, the financial impact of this is relatively small.
4, Commitment to review IR35 rules.
This has been ongoing for a while now. It has been made clear that this is an area that will continue to be looked at. If you have concerns as a contractor, then the recent introduction of new IR35 tests by HMRC have helped clear up whether contractors fall foul of IR35. If you would like to check your status then this CEJ blog tells you exactly how to do this.
All in all, not a great budget for contractors who operate through a limited company!
So, is it now best to use an umbrella company or to operate through your own limited company? I have done the number crunching in my next post...
If you would like to discuss any of the above then please leave your comments below or get in touch.
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