The Government has been considering ways to address perceived inequities in the tax system between employed and self-employed individuals and has asked Matthew Taylor, Chief Executive of the RSA to consider the wider implications of this. Philip Hammond said in his speech that “people should have choices about how they work, but those choices should not be driven primarily by differences in tax treatment”.
The attractiveness of self-employment arises due to the fact that National Insurance Contribution (NIC) rates have been lower, at 9% for the self-employed compared to 12% for employees. Historically in addition, the self-employed also paid Class 2 NICs (their ‘stamp’) in order to build up their entitlement to a state pension. Historically, the dissimilar rates reflected the differences in the value of the state pension and contributory welfare benefits.
The lower rates of NIC paid by the self-employed has been forecasted to cost the public finances £5 billion over the next year, although this is arguably not a cost, merely the size of the gap.
With the introduction of the new state pension and the abolition of Class 2 NIC from 6 April 2018, those differences will be substantially reduced. With this in mind the Chancellor announced measures to increase the rate of Class 4 NICs payable by the self-employed by 1% to 10% with effect from 6 April 2018 and a further 1% from 6 April 2019. This will raise significantly greater revenues than simply reversing the abolition of Class 2 NIC.
The Government will consult in summer to address other inequalities between working status, such as parental benefits.
Alongside this, many individuals have legally incorporated their businesses or provide their services through personal companies in order to benefit from lower corporation tax rates and dividend rates on extraction of profits. The dividend ‘allowance’ was never really an allowance, but rather a nil-rate of tax, but it does allow remuneration planning strategies by director shareholders to reduce the overall level of tax on profits extracted from their business.
This allowance was only introduced a little over a year ago alongside a measure to increase the rates of tax on dividends by 7.5% from April 2016; this tax increase was designed to address the differences in the NIC between extraction of funds in the form of dividends as opposed to salary. All of these measures close the gap between the self-employed, employed and director shareholders in terms of tax on income earned.
The dividend allowance, or nil-rate to be more precise, will reduce from £5,000 to £2,000 from 6 April 2018 at a cost of up to £225 for basic rate taxpayers, £975 for higher rate taxpayers and £1,143 for additional rate taxpayers. This will effect director shareholders, but also many private investors with shareholdings outside of ISAs, typically worth more than around £50,000. This will hurt savers already hit by poor interest rates looking for a better return through equity based holdings.
The measures announced will mean a review of employment status for many individuals and careful consideration of profit extraction for incorporated businesses in the following tax years.