The Conservative government committed to no rises in income tax, national insurance or VAT during the current parliament in their election manifesto. This was welcome news for care operators and workers and provides some certainty for the next five years, or so we thought...
What the Tories didn’t share, however, was that from April 2016 they would be introducing a new National Living Wage (NLW) for all workers aged over 25 and overhauling the taxation of dividends.
Both of these announcements could adversely impact care operators as salary costs are likely to significantly increase with the introduction of the NLW and extraction of profits for owner managed care businesses will come at a higher tax cost.Below, we look at how the changes to the dividend regime in particular could impact care operators and what action needs to be taken prior to April 2016, when the new rules come in.
Out with the old…
Under the current regime, the effective rate of tax for dividends is 0% for basic rate taxpayers, 25% for higher rate taxpayers and 30.56% for additional tax rate payers. This takes into account a notional 10% dividend tax credit applied against the headline rates of 10%, 32.5% and 37.5% respectively. Under this regime, it is currently possible to receive gross dividends of up to £42,385 (based on 2014/15 allowances and assuming no other taxable income) before being subject to income tax.
...And in with the new
From April 2016 the dividend tax credit will be abolished and all individuals will be able to receive £5,000 dividend income tax free under the new Dividend Allowance. As each person will be entitled to the allowance, regardless of whether they are basic, higher or additional rate taxpayers, owner managed businesses should look to utilise both spouse’s £5,000 allowance. HMRC have recently confirmed that this allowance will be taken into account when calculating taxable income and that it will still utilise the basic/higher rate bands.
The tax rates on dividends in excess of this amount will be 7.5% for basic rate tax payers, 32.5% for higher rate taxpayers and 38.1% for additional rate tax payers.
Salary or dividends
Dividends should still be more tax efficient for owner managed care operators than paying a large salary although there will be an increased tax cost from next year.
For example, a director previously receiving a small salary of, say, £8,000 and dividends up to the basic rate band (just over £34,000 net) would not have been subject to income tax or national insurance. However, from April 2016, tax of approximately £2,000 would be due if that director was to continue to receive the same level of net cash.
Sole trade or incorporation
With recent changes to the taxation of goodwill, the tax benefits associated with incorporating a care business have reduced somewhat. When also factoring in the impact of the new dividends regime, many people are asking whether this could be the final nail in the coffin for incorporation.
After running some initial calculations, and based on our understanding of the new rules, we can conclude that incorporation should not be discounted altogether by care businesses; however, the potential tax benefits are likely to be increasingly marginal.
Incorporating a care business could continue to be a viable way to save or defer tax, especially when profits are retained in the business to fund growth or to pay down any bank debt. Reducing corporation tax rates to 18% by 2020 may also tip the balance in favour of a company structure. Of course, other non-tax commercial factors should also be considered, including the limited liability of a company structure.
Do I need to take any action now?
As the new regime will only affect dividends paid after 5 April 2016, and with detailed rules yet to be released, there may be no reason to immediately alter your remuneration for the 2015/16 tax year. Before the start of the new tax year, however, you should give some consideration to the following:
- acceleration of dividend payments into the current tax year;
- a full review of your remuneration strategy for the 2016/17 tax year to determine whether your tax liability could be reduced by altering your existing approach;
- a review of your business operating structure.
If you would like any advice on how these changes could affect you and/or assistance with a review of your remuneration strategy or operating structure please do get in touch with us.