Contractors are not the only types of business employing dividend-based remuneration strategies, as many unlisted UK companies are reportedly paying dividends to directors and shareholders as a more tax-efficient means of distributing profits
This is according to Profit Distribution and Investment Patterns of Unlisted Companies, a study carried out by Ipsos MORI on behalf of HMRC, which prompts questions as to why contractors are demonised for opting for low salary/high dividend pay schemes, when these tax strategies are is clearly widespread.
The report, which surveyed just over 1,500 unlisted companies, also indirectly highlights that while a large portion of businesses pay staff through dividend remuneration strategies, it is contractors and small businesses that are set to be hit hardest by the dividend tax changes due to take effect from April 2016.
Is paying dividends as director remuneration unusual?
The study found that more than half (58%) of companies reported using dividends as part of their directors’ remuneration strategy, many of which claimed to do so in a bid to maximise tax efficiency. This method of distribution came in second only to salaries on 67%. Meanwhile, 46% reported to utilise salaries and dividends together. The report reads:
“Company remuneration strategies were commonly chosen to maximise tax efficiencies. Around a quarter (26%) of companies whose company directors were remunerated cited tax as a factor in their decisions.”
Tax considerations were identified as having a greater impact on decisions regarding director remuneration than on any other use of company profits.
Found to be in particularly common use was the low salary/high dividend choice that many contractors choose to apply, proving that it is normal as opposed to some kind of ‘deviant’ behaviour that is frequently demonised by the media and politicians as some form of tax avoidance.
“Where paid, salaries tended to be of low monetary value. Two in five (41%) of these companies stated that their main directors’ salary was between £1 and £10,000. A further 21% paid between £10,000 and £20,000,” continues the report.
Companies operating in core contracting sectors, such as professional, scientific and technical activities industries, were found to be most likely to say that remuneration strategies were geared to maximise tax efficiency. Meanwhile, 23% of companies operating a remuneration scheme reported to do so following external advice from accountants or tax agents.
Why do contractors get the bad press?
With the study highlighting the frequency at which unlisted companies pay staff through remuneration schemes, it begs the question; why are contractors vilified for operating in such a way?
“Contractors who choose to pay themselves through dividends out of their hard-earned profits have long come under scrutiny, but as the survey shows, this sort of arrangement spans far beyond the contractor workforce,” highlights ContractorCalculator CEO Dave Chaplin. “Contractors have nothing to apologise for here. They take a risk every year as their income is entirely dependent on how well their business performs.”
It is the reward for this risk that is set to be largely reduced once the Dividend Tax changes come into effect in April 2016. With the new rules coming into play, contractors will have to pay 7.5% tax on dividend income up to £32,000, 32.5% on dividends up to £43,000 and 38.1% for anything within the additional rate band.
What does this mean for contractors and the economy?
Of all the unlisted companies surveyed, almost two out of five (39%) were registered as sole traders, while another 35% employed four or fewer staff. This combination of contractors and micro-enterprises accounts for a significant majority of 74% of unlisted companies, the importance of which is emphasised within the survey itself:
“Unlisted companies lie at the heart of the UK economy. They account for a significant proportion of its GDP and employment. Furthermore, they are a key source of entrepreneurship.”
Taking into consideration the contribution of contractors to the country’s economy, dividend tax hikes could have consequences that reach far further than simply the contingent workforce.
“Stifling contractors and microbusinesses with tax changes, such as dividend tax and IR35, is not only putting the workforce at risk, but it is threatening the UK’s future source of employment and economic growth,” concludes Chaplin.
“The value of the contracting sector to the economy has been highlighted within this HMRC-issued study, yet the Government still remains intent on punishing contractors for being an economic success story.”