One of the most important considerations that business taxpayers are likely to face is the question of whether or not they should operate their business as a sole trader/partnership or through a limited company. This could be on start-up of the business or once an unincorporated business has been trading for a few years and has become established.
One of the main tax disadvantages of a sole trader/partnership is that the proprietors are taxed on the total of the business profits irrespective of how much is actually withdraw from the business. Having to pay income tax and national insurance on relatively healthy profits can put an enormous strain on cash flow where that business is attempting to expand.
Some of the key benefits of incorporation are:
- personal tax is only payable on profits actually extracted from the company via salary and dividends ~ compare this with a sole trader where the proprietor is taxed on the total profits arising
- option to withdraw a ‘low’ salary up to £7,488 pa (for 2012/13) from the company to avoid any national insurance
- corporation tax payable at only 20% on company profits up to £300,000 pa
- tax efficient low rates on dividends extracted from the company
- limited liability ~ subject to personal guarantees
- flexibility over timing of income extracted from the company
- business premises can remain in personal ownership
Indication of potential tax savings:
The following example provides an indication of the annual tax savings which are currently achievable at various profit levels by a sole trader incorporating a business:
Profits |
Total Tax and National Insurance |
Potential annual saving |
|
|
SOLE TRADER |
COMPANY* |
||
|
£25,000 |
£5,082 |
£3,502 |
£1,580 |
|
£50,000 |
£13,311 |
£9,133 |
£4,178 |
|
£100,000 |
£34,311 |
£29,133 |
£5,178 |
|
£150,000 |
£58,553 |
£52,454 |
£6,099 |
=*Assuming sole director/shareholder with a salary of £7,488 pa and remaining post-tax profits are extracted as dividends.
Greater tax savings
Even further tax savings are of course possible where some of the post-tax profits are retained within the company or where a husband and wife are both directors and shareholders. For example, where £100,000 profits are currently shared equally within a husband and wife partnership, the overall tax saving potentially increases to £8,355 per annum by using a limited company structure.
