Lee Sharpe considers the effect of the health and social care levy on owner-managed businesses in light of the scheduled rise in corporation tax rates.
Owner-managed business (OMB) taxation is set for some quite significant changes over the next year or so, with the March 2021 Budget announcing changes to corporation tax from 1 April 2023, and the new health and social care levy (HSCL) planned from April 2022.
Looking at corporation tax first:
|
Profits £0 - £50,000 |
19.0% |
|
Profits £50,001 - £250,000 |
26.5% (marginal rate) |
|
Profits £250,000+ |
25.0% |
Note in particular that while the Chancellor undertook to keep taxable profits of up to £50,000 taxable at just 19%, the effect of this is that the next £200,000 of profits from £50,001 up to £250,000 are taxable at 26.5%, effectively to ‘catch up’ to the main rate of 25%.
April 2023 will also see the reintroduction of the regime for associated companies under common control, so that if there is more than one such company, those bands are apportioned accordingly.
Example: One individual, two companies
Ashley 100% owns two companies: one holds his main IT consultancy business, which makes £60,000 in profits annually; the other runs an eBay account trading collectible comics and illustrated novels, which makes around £10,000 in profits.
The initial £50,000 19% rate band is halved between Ashley’s two companies in the year to 31 March 2024, so his more profitable consulting business becomes more exposed to the new marginal 26.5% rate. The eBay trading company is effectively wasting some of its 19% rate allocation, costing £1,125 overall (the balance of £1,500 additional corporation tax is unavoidable, given that aggregate profits exceed the £50,000 bracket by £20,000).
Where both companies’ profits exceed £25,000, there will be no such waste but people in Ashley’s position should consider aggregating their business into one company, or other measures to reduce exposure to the higher marginal rate.
What are the implications?
Before the announcement of the new HSCL, the hike in corporation tax rates meant that in some cases, where the effective rate of corporation tax was 26.5% or 25% and the director/shareholder was already a higher-rate or additional-rate taxpayer, he or she might actually be better taking a bonus instead of a dividend (because salary is generally allowable for corporation tax purposes, so the company could afford to pay a larger bonus by saving more corporation tax).
While this would depend on the individual’s peculiar mix of incomes, it is surprising how few practitioners appear to have remarked that one can no longer simply assume dividends will always be more efficient.
HSCL and associated dividend rate increase
The new HSCL announced in September 2021 will initially take the form of an increase in the main rates of NICs from April 2022, as follows:
- +1.25% to employees’ NICs (so it will not apply above state pension age)
- +1.25% to employers’ NICs
- +1.25% to self-employed NICs (Class 4) (ceases at state pension age)
-
Note that there will be similar increases to Class 1A and Class 1B NICs
Then from April 2023:
- NICs revert to ‘old’ pre-2022 rates
- HSCL moves to standalone levy (so it can then apply above state pension age as well, where relevant):
- +1.25% on earnings (using existing NICs framework, etc.) deducted from employee
- +1.25% on earnings (using existing NICs framework, etc.) applied to employer
- +1.25% on self-employed profits (using existing NICs framework, thresholds, etc.)
- Note that the employment allowance will also cover new HSCL
-
The new Levy will continue to apply to Class 1A NICs, etc.
There will also be a corresponding increase in dividend income tax rates, from April 2022:
Implications of the levy/dividend hike
Unsurprisingly, post-tax income yields will fall, whether from self-employment, salary, or dividends. Landlords in business on their own account – unincorporated – are unaffected by the levy, but many have already been badly stung by the progressive residential letting finance cost restriction, so they are hardly ‘sitting pretty’.
The effect is similar whether we are talking about the temporary NICs measures for 2022/23, or the levy proper, from 2023/24 onwards, with the only notable difference being that the temporary NICs rates will not apply to those who are excepted from NICs generally, having reached state pension age.
One thing we can say is that from 2023/24, once the corporation tax hike starts, everyone who is a director/shareholder of a company paying either the main rate of 25% or the effective marginal rate of 26.5%, and who is a higher rate taxpayer or above, will be losing more than half of the ‘top slice’ of their gross reward to a mixture of corporation tax, income tax, NICs, levy, etc. – and this regardless of whether the income is taken as salary or as a dividend.
For example, someone who is:
- Director/shareholder of a company paying corporation tax at 26.5%, and is
- An additional rate taxpayer (basically, £150k+ of income), and
-
Who wants an extra dividend of £1,000,
will see only £446 after all applicable taxes – an effective combined tax rate of 55.4%. A bonus might yield slightly more at £450, depending on the composition of his or her base income.
One effect of the HSCL is that, despite the increase in dividend taxation, the needle has crept slightly back in favour of incorporation over self-employment, and dividends in favour of salary (there will also be fewer scenarios where bonuses could be more tax-efficient overall than dividends). But this is a nudge back against the larger shift following corporation tax rate changes from April 2023.
Another side-effect, this time of the dividend rate hike, is that the temporary tax charge on loans to participators (‘section 455 tax’) will also increase, to 33.75% from 6 April 2022.
Conclusion
The hike in corporation tax rates has effectively reversed George Osborne’s progressive reduction in corporation tax rates over the previous decade – but there has been no reversal of the corresponding hike in dividend taxation that he argued at the time was essential to subsidise those reductions. Mr Sunak has in turn justified the impending changes to corporation tax as being necessary to help pay for the significant government spending during the pandemic. Many director/shareholders will actually have seen very little pandemic-related financial assistance, however.
The new HSCL, and the temporary increase in NICs that will precede it, will act to increase the effective tax cost of salaries and dividends. Profit recognition/extraction prior to the introduction of the HSCL (effectively 6 April 2022) may be marginally advantageous; more so for companies prior to April 2023, when corporation tax rates rise significantly; director/shareholders may want to take more dividends before those rate changes take effect.
There will also be a number of scenarios where running a business through a company will become markedly less attractive. While a singleton trading company may not feel the pinch until profits approach the £100,000+ mark, companies with more than one shareholder, or that are ‘associated’ so start to pay punitive rates of corporation tax well before profits exceed £50,000, will want to take the next year or so to work out if they should disincorporate – and, if so, then how.
