Forget the spin – it’s a tax and spend budget!

In this issue we comment on the key feature of the recent Budget – National Insurance changes – and offer reminders of the ways in which this swingeing tax increase can be avoided by certain individuals and companies.

As most will realise, the Budget headline was the proposal to spend significantly more on the National Health Service, with this extra expenditure being funded by huge increases to National Insurance Contributions. It was implied that the payment of National Insurance Contributions and the receipt of benefits, treatment etc from the NHS are somehow linked. That is not the case whatsoever; the NHS is funded out of general taxation and National Insurance Contributions are just another tax (even though the receipt of certain state benefits is dependent upon the right contributions having been paid at the right time).
When does the pain start?
The tax increase takes effect from 6 April 2003 on which date the rate of contributions payable by employers will increase by 1%, and for employees and the self-employed the rate will also increase by 1%. Importantly the extra 1% will also be paid on earnings above the upper earnings limit, thus, the actual increase for higher earners will be significantly more than for lower earners.
So how can this tax increase be avoided?
The good news is that there was no attempt to put National Insurance Contributions on dividends, even though a number of commentators had suggested this might happen. So, for those who both work in the business and own shares in it the solution is simple. By taking dividends in respect of their shares, rather than salary or bonuses, the tax increase is avoided. The Inland Revenue cannot force working shareholders to take salary, although minimum wage legislation may apply.

This approach can be widened and made very flexible e.g. shareholders can have different classes of share so that different levels of dividend can be targeted at different shareholders to match their income requirements. Also, senior employees might be given a small number of non-voting shares to enable them to receive income by way of dividend.

There are some pitfalls. To be tax efficient, the dividends should be paid out of profits that have been taxed at the small companies’ rate of corporation tax, otherwise the loss of corporation tax relief will outweigh the saving of National Insurance Contributions. Also, dividends are not pensionable income – this can sometimes be problematic if large pension contributions are paid.

Barnes Roffe Topical Tips

• For small companies, dividend payments are generally an extremely tax efficient way of extracting income. The position will be even more attractive from April 2003.
• Dividends tend to be unattractive for large and marginal rate companies.
• Different classes of share, particularly when employees are involved, will help make the arrangements very flexible.