Written by Andy Vessey ATT, Larsen Howie's Head of Tax
Hike in Corporation Tax may be on the horizon for PSCs
Those contractors who have been freelancing for the last five years or more may remember that we used to have two separate rates of Corporation Tax.
Up until 1st April 2015, there was a Small Companies Rate which could be claimed by qualifying companies whose profits did not exceed £300,000, and there was a main rate for companies with profits of over £1.5M. To complicate matters, however, profits that fell in between those two limits were subject to marginal rates.
From 1st April 2015, all company profits are charged at a single rate of Corporation Tax, with the exception of profits made by companies within a ring fence trade, i.e. oil-related activities. For the last few years, Corporation Tax has fallen from 20% to 19% and is set to drop to 17% in 2020, as Britain continues in its ambition to have one of the lowest Corporation Tax rates within the major global economies so as to encourage big business to trade here.
However, there are some strong rumours circulating within Whitehall that the Small Companies Rate could come back with a vengeance in the very near future - that spells bad news for contractors.
Why bad news, I hear you say? Surely it’s a good thing isn’t it, because after all in the pre-April 2015 days the rate was lower than the main rate paid by the bigger companies? Most of us have made that mistake, albeit wholly reasonably, of regarding the Small Companies Rate as a smaller rate for smaller companies but that is not right. It is a rate for small companies and the word on the street is that upon reintroduction that rate will be 25%.
There is method behind this madness. The Chancellor of the Exchequer needs to find money and quickly, and raising Corporation Tax Rates for small companies would be one way of doing that as there are 1.9 million limited companies that form part of the population of small and medium-sized enterprises (SMEs) in the UK.
Service station economics
You’ve been driving along the motorway for a few hours and need a drink and a bite to eat, so you pull into a service station. You decide upon a drink and a sandwich (for which you will need to re-mortgage your home) and after a moan about the price, you make the purchase. This is because you have nowhere else to go to sate your appetite and thirst. Service station owners have got you over a barrel; despite your moaning, you will spend money.
It’s the same principle for Corporation Tax. What would the likes of Amazon do if the government hiked up the rate for large businesses? Well, they would simply take their business elsewhere and deprive the Exchequer of much-needed revenue.
Different story for the smaller, one-person company. At first, they will quite understandably moan and groan about an increase in taxation but ultimately they will end up paying it because there is little they can do to alter their position. After all, very few will decide to up sticks and relocate to a more favourable tax jurisdiction.
Small business would once again be squeezed to allow the government to kowtow to big corporations.
It ends the dividend question
April 2016 saw changes to the taxation of dividends in the UK.
A nil-rate band was introduced but only for the first £5,000 of dividend income - and even this was slashed to £2,000 from 6th April 2018. Individuals in receipt of dividends in excess of these limits, then pay tax at 7.5%, 32.5% or 38.1% depending on the level of their taxable income.
The thinly veiled justification for this reform by the government was that there were too many businesses incorporating motivated solely by avoiding tax, chiefly because of the NIC savings to be had on dividends.
By upping the Corporation Tax rate to 25%, the dividend question is finally put to bed, so some in the corridors of power believe.
End of IR35?
So if the level of dividends extracted from a PSC becomes irrelevant because of increased Corporation Tax and dividend taxation, will IR35 still be necessary? It would be nice to think that as a concession for further hammering PSC’s, IR35 would disappear but that is likely to be wishful thinking as the example below demonstrates.
Hardy Ltd’s turnover for the year ending 31st March 2019 is £150,000, all from one engagement with Laurel plc. The company incurs expenditure of £50,000 and therefore has taxable profits of £100,000 which its director, Oliver, extracts by way of dividend. This is Oliver’s only form of remuneration. Unfortunately, HMRC deems the engagement to be caught by IR35.
The IR35 deemed payment is calculated as £126,241 (£150,000 less £7,500 (5% unspecified expenses) & £16,259 Employer’s NIC). Assuming a Corporation Tax rate of 25%, this would result in the following tax position:
PAYE tax on £126,241 = £43,596
Employees NIC on £126,241 = £ 6,152
Employer’s NIC (as above) = £16,259
Less = £66,007
Corporation Tax relief on deemed payment + Employer’s NIC = (25,000)
(limited to tax paid)
Dividend tax paid on £100,000 = (19,874)
Net IR35 liability = 21,133
Had Hardy Ltd not fallen foul of IR35, then the company would have paid Corporation Tax of £25,000 & Oliver would have paid dividend tax of £19,874. The IR35 rules ensure that just over an extra £21,000 is pocketed by the government.
At a time when cash is needed to swell the Exchequer’s coffers, then it is unlikely that IR35 would vanish with the reintroduction of the Small Companies Rate. After all, the government wants to have their cake and eat it.
If the rumours are true and PSCs become subject to a discriminatory rate of Corporation Tax, then this would represent yet another damaging attack on them and whilst it may appear to be some clever wheeze to raise revenue, it would be self-serving and a potential vote-loser come the next General Election.
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