An alternative perspective on Budget 2004
I’m sure that, like me, many freelancers subscribed to various newsletters from accountants and web sites for news about the budget. The message that some were sending out last night was along the lines of ‘nothing for freelancers to worry about’. Well I suppose that rather depends on your perspective!
After last December’s Pre Budget Report and its now infamous IR591 fears were high that Budget 2004 would see sweeping changes in the freelancer world.
There was widespread concern that Budget 2004 would see the introduction of punishing new taxes or NIC charges on close company dividends.
Others also saw IR591 as meaning that IR35 would be repealed. There were comments that IR591 would spell the end of the IR35 industry – the schemes and insurance products and related services all designed to help freelancers deal with or work around IR35.
On UKTECH we were concerned at the implications that IR591 would have for freelancers. It seemed to me that new NIC charges were a distinct possibility. However, we were cautious about the timetable, as any sweeping changes would have been hard to introduce in April 2004. We also made it quite clear that, in our view, whatever IR591 brought it would not mean the end of IR35.
Overall it seems that we were reasonably realistic in our expectations.
We have a new tax for small companies that are paying corporation tax at an overall rate of less than 19% and which pay dividends out to non-corporate shareholders. This is probably less punitive than we feared. But we need to be cautious because there is more to come.
The Government have made it clear that this is only the start and they will be issuing new proposals at the time of the next Pre Budget Report that will look at “wider issues raised by the interaction with the tax system of definitions of income of self employment, and the remuneration paid to owner managers”
It is understandable that some commentators consider that the Budget has not done much to affect freelancers – but only in comparison to what might have happened. There is no increase in NIC rates and NIC is not being charged on dividends from close companies.
There are no provisions that attack profits retained in the company. The new 19% tax on dividends seems to have come almost as a relief compared to what might have happened!
However, had we approached this Budget with no preconceptions then I suspect headlines might have been rather different! Here is my suggestion as to how some issues in this Budget could have been greeted had we not feared something very much worse!
Small company dividend shock!
The Government is attacking small businesses whose taxable profits are less than £50,000 (the level at which they suffer Corporation Tax at 19% on the profit made). It is introducing, from 1 April 2004, a measure that
” will ensure that a minimum rate of corporation tax of 19% is charged when a company makes distributions to non-company shareholders.”
This means that companies making less than £50,000 profit a year – who pay an effective rate of CT that is below 19% - will have to pay an additional corporation tax charge to bring their overall CT charge up to 19% of their pre tax profit. For example, a small trader who makes, say, £10,000 profit a year currently pays no CT because of the nil tax rate on profits up to £10K. If that profit is paid out as a dividend to basic rate tax payers there is no income tax payable. From 1 April 2004 the company will now have to pay 19% corporation tax on the dividend.
In the above example if the company only has £10,000 in profit to use for the dividend then it will only be able to pay a dividend of £8403, which will attract a CT charge of 19% = £1597, making £10,000 in total.
This new tax only affects businesses with profits of less than £50,000. Because of the way that corporation tax is charged on small company profits, at this point a company will have paid CT at an overall rate of 19% on these profits. This is because between £10,000 and £50,000 the marginal rate of small company tax is 23.75%. Hence, at £50K profit, a company pays nil CT on the first £10K of profit and 23.75% CT on the balance of £40K – making £9500 CT in total – an effective rate of 19% on £50K.
The Chancellor has said on breakfast television this morning that this 19% dividend tax is to close a loophole whereby people who are really employees are avoiding tax. Clearly he is either badly briefed by his officials or he is deliberately trying to avoid acknowledging that this “loophole” is one entirely of his own making. When he introduced the nil rate CT band for the first £10K he was told that this would encourage the self-employed to incorporate.
The “loophole” has nothing to do with issues of disguised employment – he introduced IR35 in the 2000 budget to deal with that. The flood of workers who have incorporated over the last two years are not disguised employees but self employed tradesmen who were self employed before and are now employees of their own company. They were not caught by IR35 because they were clearly self-employed or because they do not provide personal services.
This 19% “dividend” tax punishes the same very small businesses that the Chancellor said he was trying to help with the nil percent tax rate. A cynic would say that this has been his plan all along.
First lure the self-employed into a nice, easy to regulate corporate structure, then hit them with a new punitive tax structure that does not apply to larger businesses.
Until more details are available it is difficult to know what the mechanics will be. But it appears that the new charges could penalize a business that has income, after other costs of, say, £60,000 and pays its two working directors, salaries of £25,000 each, leaving £10,000 profit to pay to them by way of dividends. They might decide it is better not to pay higher salaries but to draw low salaries of say £4500 each, leaving profit of £51000 to pay by way of dividends.
Is this really what the Chancellor wants?
It is not clear yet what happens regarding dividends paid out of accumulated profits. We will need to review the options before 1 April to be able to advise whether it is better to draw out profits before 1 April 2004, but there are clearly going to be many detailed issues that need to be considered.
BN35 Shock!– new Revenue clampdown on tax avoidance
In Revenue Budget Notice 35 (echoes of IR35) they announce plans to attack those:
” who are not paying their share of tax or contributions, in particular those:
• who fail to comply with their legal obligations such as by trying to stay hidden from the Inland Revenue or don’t file accurate returns; or
• who seek to avoid tax by exploiting loopholes in the law.
“
The measures include:
” new data systems to improve analysis of tax compliance issues and support the better deployment of staff to areas of significant Exchequer risk;
• more specialist staff to deal with high risk issues involving large businesses and individuals whose tax affairs are substantial and complex; and
“
There will be extra funding to enable the Revenue to invest in additional specialist staff and new systems so they can deploy resources better and better target high-risk areas.
Alongside this development is the new requirement, set out in BN 28, that promoters of tax avoidance schemes will have to register the details with the Revenue and that tax-payers will have to disclose when they are using such a scheme. We do not have any details yet as to how the tax schemes to be registered will be defined.
It is clearly an area of concern for freelancers, especially those contemplating working through some of the more exotic arrangements that some companies have set up with foreign loans, offshore payments, complex structures etc, all of which would appear, on the face of it, to be a ‘scheme’ designed to minimise tax and potentially a target for these new requirements.
However, there will be many freelancers working via various composite company arrangements and schemes whose position is far less clear. They will be anxious to learn more about how this provision in the budget will work in practice.
Section 660A Shock!
In Budget notice 22 the Government has announced an attack on those couples who jointly hold shares in a close company. The BN says:
”Distributions (usually dividends) from jointly owned shares in close companies will no longer be automatically split 50/50 between husband and wife but will be taxed according to the actual proportions of ownership and entitlement to the income.“
This measure, effective from 6 April 2004, is aimed at those who thought they could use jointly held shares to avoid the Section 660A settlements issue. This stems from the provisions of Section 282A of the Income and Corporation Taxes Act 1988, which says that income from jointly held assets should be shared equally between husband and wife.
However, in my view, the Revenue are merely playing safe here as Section 282A(5) already provides the Revenue with the ability to override 282A, where the income is “treated by virtue of any other provision of the Income Tax Acts as income of the other of them” - which is the case under Section 660A.
Nevertheless, this measure and the fact that nothing else was done under IR591, indicates that the Revenue believes that its position on Section 660A is strong and does not need any additional strengthening. We will have to wait for the first test case (Arctic Systems) to see whether they are correct.
The good news
The Budget was not all bad news for freelancers. First year capital allowances on qualifying fixed assets for small companies rise from 40% to 50% - but the 100% allowance on IT equipment and software seems to be coming to an end at the end of March 2004.
The current loophole for those who use a double cab pickup as their company car remains open until 6 April 2007 when employer provided vans will start to be taxed more heavily with a single scale charge of £3000 if they have any private use.
Those involved in the Construction Industry will probably be relieved to know that the CIS revisions, first set out two years ago have been delayed until 6 April 2006.
Amongst the changes that will come in at that time are the introduction of an employment status declaration which will see the main contractor having to verify the identity and tax status of their subcontractors.
Freelancers who also let out properties will also be pleased to know that from 6 April 2004 they will be able to claim up to £1500 pa for the costs of installing loft and wall insulation!
Conclusion
Clearly we have not yet seen all that was envisaged when the Chancellor announced IR591 last December. I think what we have so far is a piece of political compromise.
Having announced that they were going to address the issue it was unacceptable not to do anything in this Budget. But I think it is also clear that the many representations from the accounting professionals and tax bodies served as a warning that anything introduced too hastily would result in more problems.
Hence the Revenue has gone for a fairly simple quick fix (but one that may have more issues than is apparent at first), while confirming that the deeper seated issues will be considered and – hopefully – consulted upon in time for next year’s Budget. In the meantime IR35 will remain of concern to all freelancers as will Section 660A.
Those of us who work in areas relating to freelancer issues also know that our advice and services remain as relevant and necessary as ever – perhaps even more so as the Revenue gears up its resources in a way that can only mean that more businesses and more arrangements and schemes will come under their scrutiny.
We will continue to analyse the detail - hopefully by the time of our seminars next week we will have more answers than questions.