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is that the proprietors are taxed on the total of their business profits irrespective of how much is actually withdrawn from the business.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 £7,696 pa (for 2013/14 tax year) from the company to avoid any national insurance liabilities. This salary is of course tax deductible against the company’s profits
- corporation tax payable at only 20% on company taxable profits up to £300,000 pa
- tax efficient low income tax 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
- funds accumulated within the company can be extracted on a sale of the shares via a capital gain qualifying for Entrepreneurs Relief at the 10% special rate of CGT
Indication of potential tax savings:
The following example provides an indication of the annual tax savings (to the nearest £100) which are currently achievable for 2013/14 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 |
£4,800 |
£3,500 |
£1,300 |
|
£50,000 |
£13,200 |
£9,300 |
£3,900 |
|
£100,000 |
£34,200 |
£29,300 |
£4,900 |
|
£150,000 |
£59,000 |
£53,000 |
£6,000 |
*Assuming sole director/shareholder is paid a salary of £7,696 pa and that all of the 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 annual profits are currently shared equally within a husband and wife partnership, the overall tax saving potentially increases to around £7,700 per annum by using a limited company structure.
Avoiding penal marginal rates by using a limited company
The potential for director/shareholders to have flexibility over the amount and timing of salaries and dividends extracted from their company can also be very tax efficient in terms of:
- Reducing total income below £60,000 thereby minimising the new High Income Child Benefit charge.
- Reducing total income between £100,000 and £118,880 thereby minimising the amount of lost personal allowance.
- Reducing total income to below £150,000 thereby eliminating the special higher rate applicable to dividends of 37.5%.
