GEORGE Osborne’s Summer Budget was marketed as being a budget for working people. But was that comment aimed at all working people, or just employees in a certain wage bracket?
Mixed in with the rhetoric and numbers, and the by now familiar promises to crack down on avoidance and evasion, was talk of “addressing imbalances in the system”.
As a tax professional who thinks the tax system should do its job of raising revenue for the government with as light a touch as possible, distorting behaviours only where the intention is deliberate – say with “sin taxes” on tobacco and alcohol, Osborne’s goal sounded quite promising.
But some of the detail, now that the Budget has been analysed, is a bit more concerning. There seems to be a trend more for levelling up the financial burden across the board, so that everyone pays the same taxes as employees on their income, even if they don’t get the same state benefits.
Dividends taxed heavily
For incorporated businesses, the big shock was changes to the dividend regime. No more grossing up and then claiming back a notional credit; instead, you’ll get the first £5,000 tax-free, then pay tax at what look like increased rates on the balance.
In practice, even after the £5,000 tax-free allowance, the loss of the tax credit means that more tax will be paid overall. The actual sums are quite complex, and will be further complicated by the interactions with things like the Employment Allowance and changes to the corporation tax rate.
It’s easy to say, but this is almost certainly an area where you’d need an accountant to work out the precise impact of the changes. As a rule though, the tax changes won’t have any effect on a company making profits of less than £18,000 – although at that level the tax savings from being incorporated will be pretty much wiped out by the extra administration costs.
In fact, that’s pretty much the case on profits up to around £40,000 per year at the moment when the true “costs” of running a company – either paying someone else or doing it properly yourself (accounts, Companies House filings, pensions auto-enrolment, minimum wage compliance, RTI filings, dividend paperwork, minutes, etc.) are totted up.
And with the increases in dividend taxes, that “break even for tax” point is likely to shift up to nearer £70,000. Beyond that though, the combined impact of corporation tax and the new, higher dividend rate actually see the tax benefits starting to fall again – here it might be more tax-efficient to operate as a sole trader.
However, at those sorts of turnover levels, your potential exposures are likely to be such that incorporation is wise, just to limit your liability.
Triple lock, but…
It’s vital to remember though that there are other changes in the pipeline. Although the Chancellor’s “triple lock” should hold VAT, Class 1 national insurance contributions (NICs) and the main income tax rates steady, Class 4 NICs aren’t bound by that.
So if the Chancellor decides to align Class 4 NICs with the Class 1 employee rate then that would move the pendulum slightly back towards incorporation again. And you must remember that every business is different.
If you can transfer significant goodwill into a newly incorporated business then the changes around interest income become relevant, and incorporation looks more fiscally attractive. The interactions are complex though, and will depend entirely on your own circumstances. The one thing you mustn’t do is make changes without taking good professional advice.
If you’ve qualified up until now for the NICs Employment Allowance then you’ll need to check how many employees you’ve got, and whether that’s still going to be available.
Sole director employees won’t qualify any more, and there will be anti-avoidance provisions in place to stop the obvious workarounds like employing additional family members just to beat the numerical limit.
In practice of course, burdens like auto-enrolment, demonstrating national minimum wage compliance and the like already make taking on employees unnecessarily a pretty unattractive prospect for small businesses.
A recent research study estimated that the unpaid work done by friends and family to keep small businesses afloat could be worth as much as £64 million a week to the UK economy, and the continued increase in costs and administrative burdens of formally employing them isn’t going to encourage anyone to make things better.
One area the government has long been worried about is disguised employment. Up until now, the tax burdens on a self-employed labour relationship, or contracts with a company, have been so much lower than on employment relationships as to make it attractive to try to dress employments up as business contracts.
Sometimes that’s a joint decision to share the benefits, sometimes it’s pretty much forced on an independent contractor by big clients demanding a limited company to contract with, and sometimes it’s just straight exploitation of low-paid workers by criminal employers.
In order to make false selfemployment less attractive, one thing the government is going to clamp down on is travel expenses. Although it’s theoretically aimed at agency workers who are claiming their daily commute on a tax return in a way that employees specifically can’t, it’s almost inevitably going to catch a lot of other targets.
Long-distance drivers are going to be among the targets, and are even one of the specific examples given in the relevant HMRC manuals explaining how the taxman is supposed to interpret the rules.
The proposal is that anyone who’s employed through one company but subject to a (theoretical) right of supervision, or direction, or control by another third party will be treated as if employed by the third party for travel expense purposes.
That means a driver carrying someone else’s goods will be their employee if the consignor is able to dictate the order of drop-offs, or change the route – so travel costs to and from the depot won’t be allowable.
The concern is that the bar is set so low, with just a theoretical right to any of supervision, direction or control being enough, that almost any contractual relationship could be caught in the real world. The much hated IR35 – tax legislation designed to catch disguised employment – is finally up for a fundamental review as well, with the government consulting on ways to try to improve it.
While that might be good news, the early indications are that it’s not necessarily going to pan out the way small businesses might want it to.
HMRC is talking to lots of interested parties about how to fix things up at the level of legislation, rather than just trying to improve administration, but one clear message we’re getting is that ministers are standing by the figure of £400 million per year “tax leakage” around IR35, and they (rightly) see it as their responsibility to try to stem that flow.
As always, it’s vital that the fix isn’t rushed, and doesn’t do more harm than good. The worry here is that some of the suggested proposals, which aim to put more of the burden on larger businesses when they trade with smaller ones, could drive big businesses to treat all small companies as a risk to their own tax compliance record, which wouldn’t be to anyone’s advantage.
But it does look as though the disguised employment measures are targeted more at the unscrupulous employers and the mechanisms they use to line their own pockets than at the genuine small business trying to make an honest living.
Small business review
In the longer term, there’s a deeper review of the whole future of tax and NICs which is going to be run by the Office of Tax Simplification.
We can’t even begin to guess yet how that’s going to adjust the balance between employed and self-employed tax burdens, and how it’ll play out against the other changes to company and dividend tax to influence what’s going to be the best legal form for a business.
One thing we must hope they remember is that in 2014 HMRC commissioned research which showed that tax isn’t the key driver in deciding what form a business takes – although it was clear that businesses that had thought about the tax position tended to be more successful.
It’s not just HMRC which is looking at small businesses. The Department of Business Innovation and Skills has launched a review of the whole area of self-employment, looking at what government can and should be doing to support entrepreneurs, traders and all the other individuals who are trying to make it on their own for one reason or another.
Some of the areas they are looking at are the benefits, such as maternity pay, which sole traders currently lose out on. Other target areas will have a benefit for all small businesses, whether sole traders or not, such as a continued focus on trying to deal with late payment issues.
All in all though, it doesn’t look like it’s been a great Budget for small businesses. The changes are complex and fiddly, and there are no great giveaways there that you can access just by filling out a few forms.
On the other hand, there could be elephant traps to drift into if business owners aren’t savvy enough to understand their situation and how the changes will affect them.
It’s not a great endorsement of the Chancellor’s Budget that the best you can hope for is that it doesn’t make things too much worse, and you may well need to pay for advice to be sure of even that.