On 8 July 2015 George Obsorne presented his first Budget of this Parliament, and the first Conservative-only budget since 1996.
This Budget is aimed to not only balance the books, but remove some of the imbalances within the tax system. Some of these changes were completely unexpected… The Chancellor has definitely thrown a few curve balls!
We will briefly cover the biggest and most radical changes here, plus the main tax proposals from the Summer Budget. However if you would like a more detailed review of the Budget, including proposals already outlined in the March Budget such as the personal savings allowance, our full Budget summary can be found here. While this blog covers the announcements made by the Chancellor, none of this is yet law so may be amended by the Finance Act.
Main Budget Tax Proposals
Brand new taxation system for dividends received by individuals
- Restriction of relief for interest payments on buy to lets
- Extension to the inheritance tax nil rate band for homes
Other Tax Changes
- Changes in the Annual Investment Allowance for businesses
- Removal of tax relief on the acquisition of certain intangible assets
- Increase in the NIC Employment Allowance
As part of the Government’s plan to bring the personal allowance up to £12,500 by the end of this Parliament, a small increase in the personal allowance was announced. For the current year (2015/16) it is £10,600 but will be going up to £11,000 in 2016/17 and £11,200 is 2017/18. The tapered reduction of the personal allowance for individuals with adjusted net income over £100,000 remains.
Dividend Tax Allowance
This was the major surprise of the budget for us as there had been no hint of any changes in this area!
Historically, dividends have attracted a notional tax credit which meant that for basic rate taxpayers, there was no tax to pay on these. Higher rate tax payers would pay 25% on the net dividend and additional rate taxpayers would pay 30.56%. This is in recent years…. if you go further back, the tax on dividends was more than 80% for some!
From 6 April 2016 the Government will abolish the dividend tax credit and replace it with a new Dividend Tax Allowance of £5,000 per year. Dividends will then be taxed in the basic rate band at 7.5%, the higher rate band at 32.5% and in the additional rate at 38.1%.
This makes more sense through an example. Say you operate through a limited company and normally take £8,000 salary and £30,000 dividends – under the current rules you would not pay any income tax (assuming this is your only income) – your “take home pay” would be £38,000. Now contrast this to the new rules from April 2016…. the income tax would be £1,650 and your “take home pay” would be £36,350. If you took an £8,000 salary with a £150,000 dividend, you would pay £8,000 more tax under the new rules!
There are a couple of saving graces to this…… firstly a cut in corporation tax and secondly an extension of the basic rate band so that higher rate tax only kicks in at £43,000, or £48,000 if you include the dividend allowance. Equally, because there will be no grossing up of dividends like there was in the past so the amount being taxed (even though you have drawn the same amount) will be lower, even if the applied rate is higher.
The other bonus is that though these changes are coming, they aren’t effective until April. Therefore we will be speaking to our affected clients so together we can plan around this as much as we can. This may mean taking more dividends in the current year and less next year, but this needs to be reviewed on an individual basis as there are complex factors at play, such as cash flow, payments on account, differing tax rates and tapering away of personal allowances.
The idea with these changes is to remove the preferential tax treatment for this well-established method of profit extraction for small businesses through incorporation. While it is an admirable idea to address imbalances in the system, a little warning would have been nice Mr Chancellor, as this is the go-to remuneration strategy for the majority of small companies! The Treasury’s plan is to reduce “Tax motivated incorporation”. Let’s not forget that it was tax policy that ‘forced’ (note the inverted commas) businesses to incorporate back in 2002 when the first £10,000 of profits were free of tax. To be fair though, that was Gordon Brown, so it’s one thing we can’t blame on George Osborne. Even though this rebalancing act reduces the tax savings from operating as an incorporated entity, it may still save a significant amount of tax, just not as much perhaps. Of course there are more reasons to incorporate, outside of the tax treatment – if you would like to discuss the benefits and drawbacks of incorporation, get in touch.
Restricted Loan Interest Relief on Buy-to-Lets
The basic principles of calculating how much profit to tax, whether it be from a trade or property, has always been that you add up all the income, take off all the expenses, adjust for any tax jiggery-pokery (as required by tax law of course) and that’s the profit you pay tax on. Well, when it comes to residential property, it’s being turned upside down!
From April 2017 higher and additional rate taxpayers will no longer be able to deduct all the finance costs they incur (mortgage interest and fees) against their rental income. There will be gradual reduction over the next 4 years so that the finance costs are only a deduction at basic rate of tax, not higher or additional rate.
People are being taxed on income at one rate and getting relief on expenses at another (lower) rate. In a budget that is supposedly about addressing imbalances, this doesn’t seem fair (I know… life’s not fair!) and seems to specifically insert an imbalance that wasn’t even there in the first place.
Wear and Tear Allowance
There is a bit of a sweetener in store for some property lessors though. In the past, there has been no relief for expenses incurred on fixtures and fittings (including carpets and white goods) on properties that aren’t fully furnished. While fully furnished properties were eligible for an allowance for wear and tear at 10% of rent income, this was not available for partly furnished properties. Well the wear and tear allowance is disappearing and all properties, whether furnished or unfurnished (including partly) will benefit from relief for the actual costs incurred of replacing furnishings.
Currently there is a £40,000 annual allowance for pension contributions (both personal and employer). From April 2016 there will be a taper of this allowance for those with adjusted net income of over £150,000. The allowance will be reduced by £1 for every £2 of income, down to a minimum of £10,000. This is to pay for the increased inheritance tax nil rate band (see later) but the Government are in consultation about pensions in the longer term and are reviewing whether there is a case to be made for widespread changes to pensions relief, so watch this space!
Corporation Tax Rates
You would be forgiven for thinking “Hang on, didn’t corporation tax rates just go down?!”. The reason you would be forgiven is that you would be totally correct! The large company and small company rates were as recently as April 2015 aligned at 20% and yesterday the Chancellor announced a further reduction to 19% from April 2017 and 18% from April 2020. For the next few years the rates will be in line with the small company rate from 10 years ago, although you may remember that the large company rate was 30% then, so there is a significant saving for larger companies. This reduction in the rate is likely (call me cynical) a peace offering over the minimum wage changes which will be detailed later.
Annual Investment Allowance
You’re probably aware of the Annual Investment Allowance which was introduced in 2008 which allows businesses to write off the cost of most plant and machinery (not cars) against profits, up to a total annual limit. Well since then we have been riding the AIA wave (figuratively, of course) as the rates have gone up and down, and up, and up, and then threatened to come crashing down… Currently it is set at £500,000 however it was originally planned to plummet (yes, it’s dramatic isn’t it!) down to £25,000 in January 2016. Fear not! From January 2016 the level is set permanently at £200,000 p.a. (I say permanently, is anything ever permanent in tax?!). This will apply to all purchases after 1 January 2016 and as you would expect, the transition rules are pretty complicated! If you are thinking of purchasing any large equipment, please do get in touch because the timing may be critical to how much accelerated tax relief you can get.
Corporation Tax Relief for Goodwill
George Osborne seems to have a thing about goodwill! You might remember that in the Autumn Statement of 2014 he removed corporation tax relief on goodwill acquired from a related business, such as when a sole trader ore partnership incorporated into a limited company. Well this time he’s gone one step further and withdrawn relief for all goodwill and customer related intangible asset purchases, being from a related party or a third party, even in an arm’s length transaction. Previously, the write off the asset in accordance with the company’s accounting policy was deductible for tax purposes but no more! Relief will continue to be allowed for historical purchases of these intangible assets, but the new rules will prohibit release for any acquired after 8 July 2015.
Capital Gains Tax
Despite widespread speculation, capital gains tax has escaped from the Budget unscathed! There had been concerns about the possible withdrawal or reduction in Entrepreneur’s relief, whereby sale of business investments are taxed at the low rate of 10% but there was no announcement of this. Perhaps the announcements on dividends and goodwill were enough for small, owner-managed businesses to cope with in one Budget!
Inheritance Tax Nil Rate Band
This was the shock of the Budget….. no actually, it wasn’t as it’s been circulating in the media for weeks. An additional nil-rate band will be introduced where a residence is passed onto direct descendants, such as children or grandchildren. This will be initially £100,000 (on top of the standard £325,000 nil-rate band) from April 2017, rising to £175,000 from April 2020. This effectively means that an individual with over £175,000 of their estate value being their residence will have a nil-rate band of £500,000. Subject to a technical consultation (which roughly translates to: ‘we haven’t quite thought this through yet’) the allowance will still be available when a person downsizes or ceases to own a home from 8 July 2015 and assets of the equivalent value (such as cash) are transferred to descendants instead.
As one of the key manifesto promises of the Conservatives, this was always going to be introduced pretty quickly. While critics will complain that this benefits the super-rich, the measures are expected to keep the same amount of estates within inheritance tax at the same levels as in 2014/15 of around 37,000. House price rises have meant that without the introduction of this additional allowance, 63,000 estates would be expected to fall into inheritance tax by 2020/21. Plus, the extra allowance will be withdrawn on a sliding scale for all estates over £2m.
A very political area of tax…. crackdowns are being made in this area to prevent the likes of Roman Abramovich avoiding (not evading, that would be illegal and we wouldn’t allege such a thing) tax. Individuals who have been resident in the UK for 15 out of the last 20 years will not be able to use the “domicile” rules which affect capital gains tax, inheritance tax and income tax. Historically, they have been able to pay tax on the “remittance basis” i.e. only pay UK tax on foreign income and gains, the proceeds of which are brought into the UK. Going forward, worldwide income and gains for these people will be taxable in the UK, even if not remitted into the UK, and they will be subject the UK inheritance tax.
National Living Wage
This is not a new concept, as it has been reported in the media and by opposition politicians for a while. It would appear the Government has accepted that the minimum wage isn’t really enough for most people to live on and for April 2016 there will be a National Living Wage (NLW), which will be 50p higher than the National Minimum Wage (NMW) at that point. It will operate as a premium on top of the NMW and will only be applicable to those aged over 25. Apparently, people over 25 working 35 hours a week will see their gross pay increase by around a third compared to 2015/16 (over £5,200 in cash terms). While great news for employees, this will no doubt mean additional costs for employers, large and small, but there is a silver lining….
In order to absorb some of the additional costs that the NLW will be incurred by employers, the Employment Allowance will be increased from April 2016 to £3,000 per year. You may remember the £2,000 allowance being introduced in April 2014 which can be used against Employers’ National Insurance (NI) contributions as due through the payroll. It’s free money, so we’re not complaining! Remember that related businesses may only be entitled to one allowance between them, so do get in touch if you think this might apply to you. Also from April 2016 companies where the director is the sole employee will not be eligible to claim the allowance, however many probably aren’t anyway as they are likely taking a wage that is below the NI threshold, and topping up with dividends…. (if this is you, you may wish to read the “Dividend Tax Allowance” section above).
That’s a pretty thorough roundup of the key points of the budget, but if you want more detail, please head to our full summary here.
If you have any queries, please get in touch on 0116 242 3400
Katie Kettle – Technical Manger