New dividend tax rules will cost contractors

The new dividend tax rules will have a big impact on the way many people within the contracting sector organise their finances. This is because many self-employed flexible workers will have to pay an extra £2,000 in tax on an £80,000 contract under new rules outlined by George Osborne in the budget.

Contractors who meet their tax obligations through limited companies and other personal service firms will have to pay thousands of pounds more each year because of the new rise in dividend tax which takes effect from April 2016.

The changes are expected to raise an additional £6.8bn for the Treasury, but the story for self employed workers is that almost half this figure is expected to be generated from the 750,000 contractors across the UK.

The new rules mean freelancers will pay an extra 3% in tax when they bill their client for an £80,000 contract. For contracts worth £160,000 this rate will increase to 5% which means contractors will pay almost £8,000 more overall.

The reason for the latest changes is because the government has been trying to clamp down on flexible workers who do not use personal service companies in the correct way for some time now.

Those who continue to source their income through dividends in order to pay a lower rate of income tax and national insurance contributions are the target of the new measures.

However, many workers who organise their finances in this way are not technically contractors and are actually in breach of the tax avoidance rules know as IR35 by acting as ‘disguised employees’. Although HMRC has been enforcing of IR35 more rigorously the latest moves on dividends might end up hitting the wrong target and penalising genuine contractors who have simply been adhering to the rules up to now.