When considering the most appropriate and advantageous structure for a business, it is important not to focus purely on the headline direct tax position, although of course this is a significant consideration.

Apart from the annual corporation tax/income tax comparison, other factors to consider may include:

  • Is there a significant business risk meaning that the business should be in a limited company or Limited Liability Partnership in order to protect personal assets as far as possible (note that banks etc will almost certainly take a personal guarantee from the directors on any borrowings though)?
  • Is there a desire to involve third parties in equity ownership now or in the future (employee share options, outside investors)? If so, a limited company is the likely best option.
  • Will customers of the business insist on a certain structure in order to engage, for example in the contracting sector?
  • Are there other businesses which you wish to keep separate from a VAT turnover perspective? A new company or LLP will have its own VAT threshold which may be useful if you wish the new, or existing business to remain under the threshold, or if there would be a partial exemption issue for example.
  • Is there a perception from potential customers and other stakeholders which gives one structure an advantage over another?
  • Is filing documents at Companies House a concern from a privacy perspective?
  • What are the future plans for the business? A third party sale is generally more straight forward when selling company shares than a sole trade or partnership business.
  • Is the business owner prepared to accept the legal responsibilities of being a company director, and happy with the extra record keeping requirements, and in particular able to separate out company funds from personal funds? Note also that accountancy and bookkeeping fees are likely to be higher.
  • Where multiple business owners will be involved, then if flexibility on allocating profits year on year is desired, then a partnership or LLP may be more appropriate than a limited company where dividends are paid out proportionally to shares (although there is the possibility of adding the complication of different classes of shares – be careful to ensure there is a commercial justification for this in case HMRC enquire).
  • Is there scope to provide a spouse with income from the business as salary (commercial rate) or dividends (care with settlements legislation) from the business
  • Consider the tax effect of mixed business and personal cost items, for example car usage, use of home

 

The direct tax comparison

Until the changes to the taxation of dividends in 2016 (see separate factsheet //crmoxford.co.uk/news/changes-taxation-dividends-april-2016/) then in many instances, there was a clear tax advantage in operating a small business through a limited company.  This is not necessarily now the case, particularly if most or all of the profits are withdrawn as income rather than left in the company for retention/investment etc.

The following examples use 2018/19 rates (note that the dividend allowance reduces from £5,000 to £2,000):

Basic rate taxpayer:

Sole trader Company Sole trader Company
Profit          25,000          25,000          40,000          40,000
Salary                   –            8,424                   –            8,424
Corporation tax                   –            3,149                   –            5,999
Dividend                   –          13,427                   –          25,577
Personal tax            2,630                600            5,630            1,511
Personal NIC            1,645                   –            2,995                   –
Net income          20,725          21,251            31,375          32,489

 

Higher rate taxpayer:

Sole trader Company Sole trader Company
Profit          50,000          50,000          80,000      80,000
Salary                   –            8,424                   –         8,424
Corporation tax                   –            7,899                   –      13,599
Dividend                   –          33,677                   –      57,977
Personal tax            8,360            2,119          20,360         8,955
Personal NIC            3,639                   –            4,239                –
Net income          38,001          39,982            55,401      57,446

 

You can see that the differential at most income levels is quite marginal, especially when you take into account the additional compliance and filing costs associated with a limited company.  Therefore, for businesses which intend to withdraw most or all of their profits as income, then the other factors outlined at the start of this document may be the more persuasive ones.

However, where profits are not to be drawn out in whole, but to remain in the business for expansion etc, then this is where a tax advantage occurs for the limited company structure:

Basic rate taxpayer:

Sole trader Company Sole trader Company
Profit          25,000      25,000      40,000      40,000
Salary                   –         8,424                –         8,424
Corporation tax                   –         3,149                –         5,999
Profit retained         5,000      10,000
Dividend                   –         8,427                –      15,577
Personal tax            2,630            225         5,630            761
Personal NIC            1,645                –         2,995                –
Net income/retained profit          20,725      21,626        31,375      33,239

 

Higher rate taxpayer:

Sole trader Company Sole trader Company
Profit           50,000      50,000          80,000        80,000
Salary                     –         8,424                   –           8,424
Corporation tax                     –         7,899                   –        13,599
Profit retained      10,000        25,000
Dividend                     –      23,677                   –        32,977
Personal tax              8,360         1,369          20,360           2,066
Personal NIC              3,639                –            4,239                  –
Net income/retained profit           38,001      40,732            55,401        64,334

 

This means that the capital in the business can build up far quicker by using the company to effectively shelter the profit which is not required as personal income from higher rate tax.  Naturally, the greater the amount of profit to be retained in the company, the greater the tax savings can be made.

 

Summary:

The decision to incorporate or not incorporate can be a complicated issue, with conflicting points on both sides.  In each case, it is ultimately a personal decision for the business owners as to which factors are most important for them in their circumstances, rather than being a pure tax driven decision.

If you would like to discuss your personal circumstances, then please call us on 01865 379272.

 

Disclaimer

This document is prepared as a generic guide and does not constitute tax, financial or any other advice. The applicability of tax and other rules will depend on your individual circumstances.  You should consult a suitably qualified and experienced professional before making decisions. No responsibility can be taken for any loss arising from action, or inaction, taken as a result of the information in this guide.  This factsheet is based on our understanding of the legislation as at September 2018.

© Chapman, Robinson & Moore Ltd 2018.  All rights reserved.

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