Corporate
and business tax
Incorporation
The
issue of whether to run your business as a company or a sole
trade or partnership is an important decision. In tax terms,
due to the cumulative effect of changes to the tax system
over the last five years, there can be significant tax savings
if a business is incorporated.
In this factsheet, we summarise the relevant tax changes and
show the potential tax savings available from operating as
a company. In addition we consider other relevant factors
including potential disadvantages.
Tax
Savings
The
examples below give an indication of the tax savings that
may be achievable for husband and wife who are currently in
partnership.
| Profits:
|
£30,000 |
£50,000 |
£100,000 |
| Tax
and NI payable: |
£ |
£ |
£ |
As
partners
|
5,882
|
11,882
|
29,312 |
| As
company |
3,648
|
7,612
|
21,395 |
| Potential
saving |
2,234
|
4,270
|
7,917 |
The extent of the savings is dependent on the precise circumstances
of the couple’s tax position and may be more or less
than the above figures. The examples are computed on the basis
that the couple:
- share
profits equally
- have
no other sources of income
- both
partners take a salary of £4,745 from the company
with the balance (after corporation tax) paid out as a dividend.
Remember
that the tax savings indicated are based on current tax legislation.
It is possible that the legislation may be changed so that
incorporation is no longer beneficial.
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When
might a company be considered?
A company can be used as a vehicle for:
- a
profitable trade
- buy-to-let
properties.
|
Summary
of Relevant Changes to the Tax System
Rate
of corporation tax for small companies
The corporation tax starting rate was reduced from 10% to
0% with effect from 1 April 2002. Profits between £10,000
and £50,000 benefit from marginal relief, whilst profits
between £50,000 and £300,000 are taxed at 19%.
The small companies corporation tax rate in 1996/97 was 24%.
Since that time the basic rate of income tax has fallen from
24% to 22%, with only a relatively small amount being taxed
at the 10% starting rate.
However, the benefit of corporation tax rates below 19% where
profits are below £50,000 is now only available where
profits are retained within the company. A new regime imposes
a minimum 19% corporation tax rate where profits are taken
out of the company as a dividend.
Advance corporation tax
The abolition of advance corporation tax on dividends has
improved the position in favour of the basic rate shareholder
taking dividends rather than being self-employed and taxed
on the profits directly.
National Insurance
Increases in NI for employers, employees and the self-employed
have added to the incentive to avoid these charges.
The rate of employees' NIC is 11%. In addition, a 1% charge
applies to all earnings over the NIC upper earnings limit
(which is £31,720). The rate of NIC for the self-employed
is 8%, and 1% on profits above £31,720.
All NI contributions can be avoided by incorporating, taking
a small salary up to the threshold at which NI is payable
and then taking the balance of post-tax profits as dividends.
Stakeholder pensions
Finally, the new regulations for stakeholder pensions mean
that it is necessary only to take a salary one year in six.
Pension payments in each of the six years can be based on
the salary paid in the one year. A new pensions regime will
be introduced in April 2006. However it will still be possible
for a company to make significant pension contributions for
a director/shareholder irrespective of the salary level.
Other
Tax Issues
It
is all too easy to focus exclusively on the potential annual
tax savings available by operating as a company. However,
other tax issues can be equally, and in some cases more, significant
and should not be underestimated.
Capital gains
Incorporating your existing business will involve transferring
at least some of your assets (most significantly goodwill)
from your sole trade or partnership into your new company.
This can create significant capital gains although there are
mechanisms for deferring these gains until any later sale
of the company. We will need to discuss in detail with you
the most appropriate mechanism for your business.
Do you want to transfer all of your business assets to the
company? It may be appropriate to retain personally a valuable
property particularly if there is likely future capital appreciation.
Be aware that it may be possible to extract some tax-free
proceeds from the company by transferring assets in a particular
way. Typically the tax-free sum is currently at least £30,000.
Stamp Duty Land Tax (SDLT)
There may be SDLT charges to consider when assets are transferred
to a company. Goodwill and debtors do not give rise to a charge,
but land and buildings may do so.
Income tax
The precise effects of ceasing business in an unincorporated
form including ‘overlap relief’ need to be considered.
Capital allowances
Once again the position needs to be carefully considered.
Other
Advantages
There
may be other non-tax advantages of incorporation and these
are summarised below.
Limited liability
A company normally provides limited liability. If a shareholder’s
shares are fully paid he cannot normally be required to invest
any more in the company. However, banks often require personal
guarantees from the directors for borrowings. The advantage
of limited liability will generally apply in respect of liabilities
to other creditors.
Legal continuity
A company will enjoy legal continuity as it is a legal entity
in its own right, separate from its owners (the shareholders).
It can own property, sue and be sued.
Transfer of ownership
Effective ownership of the business may be more readily transferred,
in comparison to a business which is not trading as a limited
company.
Borrowing
Normally a bank is able to take extra security by means of
a ‘floating charge’ over the assets of the company
and this will increase the extent to which monies may be borrowed
against the assets of the business.
Credibility
The existence of corporate status is sometimes deemed to add
to the credibility or commercial respectability of the business.
Pension schemes
The company could establish an approved pension scheme which
may provide greater benefits than self-employed schemes.
Staff incentives
Employees may, with adequate safeguards, be offered an opportunity
to acquire an interest in the business, reflecting their position
in the company.
Disadvantages
No
analysis of the position would be complete without highlighting
potential disadvantages.
Administration
The annual compliance requirements for a company in terms
of administration and accounting tend to result in costs being
higher with a company than for a sole trader or partnership.
Annual accounts need to be prepared in a format dictated by
the Companies Act and, in certain circumstances, the accounts
need to be audited by a registered auditor.
Details of the directors and shareholders are filed on the
public register held by the Registrar of Companies.
Privacy
The annual accounts have to be made available on public record
- although these can be modified to minimise the information
disclosed.
PAYE/Benefits
If you do not have any employees at present, you do not have
to be concerned with PAYE and returns of benefits forms (P11Ds).
As a company, you will need to keep records of expenses reimbursed
to you by the company and forms P11D may have to be completed.
Dividends
If you will require regular payments from your company, we
will need to set up a system for you to correctly pay dividends.
Transactions with the business owner
A business owner may introduce funds to and withdraw funds
from an unincorporated business without tax implications.
When a company is involved there may be tax implications on
these transactions.
Director’s responsibilities
A company director may be at risk of criminal or civil penalty
proceedings eg for late filing of accounts or for breaking
the insolvency rules.
How
We Can Help
There
may be a number of good reasons currently for considering
use of a company as part of a tax planning strategy. However
as you can see from this factsheet, there are many factors
to consider. We would welcome the opportunity to talk to you
about your own specific circumstances.
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of page
For information of users: This material is published
for the information of clients. It provides only an overview
of the regulations in force at the date of publication, and
no action should be taken without consulting the detailed
legislation or seeking professional advice. Therefore no responsibility
for loss occasioned by any person acting or refraining from
action as a result of the material can be accepted by the
authors or the firm.
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