08 November 2022
Historically, dividends paid by a service company have been seen as advantageous because there are no National Insurance Contributions (NICs) payable on a dividend. However, as with most things to do with tax, it is not that simple.
Following the reversal of the short-lived increased NICs rate which was due to become the Health and Social Care Levy, the employer of a higher rate taxpayer will incur 13.8% employer’s NICs. On the 86.2% that makes it to the employee’s payslip, the employee will pay 2% NICs and there will be income tax to pay of 40% on the income subject to higher rate. Of £100 available to pay the employee, £50.97 will typically make it to his pocket for income taxed at the higher rate.
The same higher rate taxpayer ‘employee’ using a service company will from April 2023 pay corporation tax at different rates depending on the level of profits. That rate will be 19% on profits up to £50,000, 26.5% on the next £200,000 and then 25% on profits over £250,000. If the ‘employee’ or their spouse has other companies, those limits may be reduced – if husband and wife each has a service company the 19% rate may only apply to the first £25,000 profit in each company.
If the corporation tax rate is 19%, after tax income from £100 will be £53.66 (this assumes a dividend is paid with income subject to higher rate tax of 33.75%). If the tax rate is 25%, it will be £49.69 – £1.28 less than an employee in a similar position.
Whilst the effective marginal tax rate may no longer be much different for employees than it is for people receiving dividends from their service companies, service companies are likely to remain popular for some time yet. Their main advantages are:
- Profits not required to cover living costs can be retained in a company and possibly extracted on retirement at a tax rate of 10% through liquidation.
- Sometimes, contractors reduce the profits in their company by expenses which would not reduce taxable employment income.
- Service companies can sometimes be used to split income so it is taxed between a couple. If that means individual income can be kept below £50,000, child benefit might not be lost.
The increased tax rates on dividends and increased rates of corporation tax reduce the attractiveness of personal service companies, IR35 or not. There can also be complex double taxation rules to consider when the end-user of the individual’s services assesses them to be a deemed employee, i.e. ‘inside IR35’, and their personal service company bears the cost of PAYE tax and NICs when being paid by that end-user. However, given the other advantages outlined above, we will be seeing personal service companies for some time yet.