Running Your Business as a Company
Over the years up to April 2004, the tax charge on incorporated entities was considerably lowered. These low rates (compared to income tax rates) coupled with substantial NIC savings, encouraged increasing numbers of traders to incorporate and run their business as a company, extracting most of the profit as dividends.
Due to the tax lost to the Treasury by such incorporations, the 2004 budget introduced an additional requirement that profits which are distributed (dividends) must have suffered corporation tax at 19%. This additional tax charge on distributions claws back some of the tax lost under the previously very benign regime.
However, even with the new 19% rate there could still have been substantial tax and NIC savings available if your business were incorporated, rather than run as a sole trade.
The 2006 Budget has now dispensed with the 0% starting rate and all profits up to £300,000 are now charged at 19%.
[But note that the old adage of not letting the (tax) tail wag the (commercial) dog should always be borne in mind. There may be commercial or practical factors which indicate that incorporation is not for you - despite the tax advantages.]
Rate of Corporation Tax for 2006/07
For a company that does not distribute its profits (pay these out as dividends) but instead retains and invests them in the company, the corporation tax rates are unchanged from 2004/05. Examples of corporation tax payable, after taking a salary equal to the personal allowance, are as follows:
|
Profit |
£15,000 | £30,000 | £45,000 |
| Corporation Tax | £1,893 | £4,743 | £7,593 |
For a company that makes distributions, the tax payable is now as follows:
|
Profit |
£15,000 | £30,000 | £45,000 |
| Salary | £5,035 | £5,035 | £5,035 |
| Corporation Tax | £1,893 | £4,743 | £7,593 |
| Dividend | £8,072 | £20,222 | £32,372 |
[NB Dividends can only be made up to the level of distributable reserves, which takes into account the salary payment and the tax payable. A 'distribution' of the whole of the profit figures above would be an 'over-distribution' and would be illegal, and annullable.] The maximum dividend payable is shown in each case.
Compare these figures with the profits from trading as a sole trader:
|
Profit |
£15,000 | £30,000 | £45,000 |
| Tax and NIC | £2,840 | £7,340 | £12,129 |
So it can be seen that even if the distributions are made there are still substantial savings to be made (albeit not as substantial as previously). On the above level of distribution the savings made by incorporating a sole trade are:
|
Profit |
£15,000 | £30,000 | £45,000 |
| Saving | £947 | £2,597 | £3,936 |
National Insurance
There are currently no NICs on dividends. All NICs can be avoided by incorporation, taking a small salary up to the threshold at which NI is payable and taking any balance as dividends.
Stakeholder Pensions
New regulations for stakeholder pensions mean that if you wish to make substantial pension contributions 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.
Partnerships
The savings made by individual partners when a partnership is incorporated will depend on the circumstances of those partners.
If you currently trade as a husband and wife partnership, the savings at higher profit levels are likely to be greater, due to the availability of two personal allowances and lower and basic tax bandings (but please note that availability may be restricted in cases where one director/employee/shareholder spouse is less active in the company).
Exceptions
There are, of course, other factors to be considered in deciding whether or not to incorporate. For example, you may be caught by the IR35 legislation for personal service companies (see our Quick Guide to IR35).
You may find the additional paperwork involved in running a limited company too much of a burden.
There may be issues concerning the cessation of your sole tradership which need to be considered.
And, of course, having reversed some of the previous tax benefits, there may be further developments in the future such that the tax suffered by incorporated entities is again increased.
Please note: This guide is intended to provide basic information only. Where specific advice is required, we recommend that you seek proper professional help; either from Just Tax or other suitably qualified person or practice.
Post to del.icio.us
