Happy New Year from HMRC?

Posted: 16th Jan

Many, hopefully most, readers will already have completed and filed their 2015-16 tax returns and might be forgiven for thinking that tax is “done” for another year.

However it is worth publicising three big upcoming tax rises which between them will affect most readers.

Dividend taxation – The first, which took effect in April 2016, is an increase in the tax charged on dividend income. Although the opportunity for planning around the tax increase has long since passed, many are yet to fully realise its practical implications.

An example of someone for whom this change is particularly painful is Ed, a business owner who has historically taken dividends from his company sufficient to take his personal taxable income up to a level just below the higher rate threshold. Ed, although required to file self assessment tax returns, has not needed to pay any tax. However going forward, he should expect a personal tax bill of around £2,000 each year which will normally be payable in two instalments in January and July of each year. But, due to the way in payments on account are calculated, he will pay nothing in January or July 2017, leaving Ed with around £3,000 to pay in January 2018.

In practice, the unprepared and uninformed couple owning a company between them could be facing an unexpected tax bill of as much as £6,000 next Christmas. It may still be possible for them to mitigate their liabilities as dividends may no longer be the most efficient way to extract funds.

Flat rate VAT – The Chancellor’s Autumn statement in November included a significant change to the flat rate VAT scheme which will affect many businesses.

From 1 April 2017, the flat rate VAT scheme will include a new 16.5% rate for “labour only” businesses. These businesses have previously paid the maximum rate of 14.5%. Although the definition of a “labour only” business remains draft, it is expected that any business which spends less than 2% of its turnover on goods each year will fall within the definition.

In addition the draft rules indicate that the definition of goods for this purpose will exclude capital expenditure, food and drink, and most motoring expenses. We therefore expect that many, if not most, consultancy businesses will be within the scope of the new 16.5% rate from 1 April 2017. Businesses in other sectors may also be caught.

For a business with a VAT inclusive turnover of £180,000 – at the upper end of eligibility for the flat rate scheme – an increase in the flat rate percentage from 14.5% to 16.5% represents an additional annual cost to the business of £3,600. The new 16.5% rate is very close to the 16.67% of VAT inclusive turnover which a business with no input VAT to recover would pay. Most businesses within the new rules will be better leaving the flat rate scheme and accounting for VAT in the normal manner, or deregistering completely if below the VAT registration threshold.

Interest on residential buy to lets – The wider media has ensured that there is a broad appreciation that restrictions on the deductibility of interest on residential buy-to-let mortgages are being phased in from April 2017. However what has not been realised is that the restrictions will affect many basic rate taxpayers as well as the higher rate taxpayers who are the public target. Once fully implemented in 2020, interest will cease to be a tax deductible expense, greatly increasing an individual’s taxable income and pushing many who are currently basic rate taxpayers into higher rate (40%) tax. Although landlords will instead be able to claim a reduction in their tax bill equal to 20% of interest paid, pushing them into higher rate tax means many who are currently basic rate taxpayers will face significant increases in their tax bills.

Among those most likely to be affected (and not to have realised it) are those who have one or two buy-to-let properties and whose taxable income is currently between around £35,000 and the higher rate threshold (£43,000 in 2017/18), and the semi-professional landlord who has a larger portfolio but little income as all properties are highly geared to minimise income tax and maximise capital growth. We have discussed mitigation of the impact of the changes with a number of our landlord clients. It is worth saying that incorporation, sometimes touted in the press as a solution, is a “magic bullet” only
in an extremely limited number of cases – for most landlords moving one or more properties into a limited company gives rise to significant Capital Gains Tax and / or Stamp Duty Land Tax charges. However in many cases, the tax changes are a prompt to take a holistic review of the portfolio, to restructure borrowings to mitigate the impact of the changes as far as possible, and maybe to take the opportunity to tactically and tax efficiently realise investments.

Please feel free to contact Chris Bentley if you would like to discuss further on 01625 669669 or CBentley@harts-ltd.com