Incorporating to save tax 1 – Where now?
Well, we always said it couldn’t last.
And, sadly, we were right. Thanks to this year’s Finance Bill, Gordon Brown’s bright new dawn for family companies – the 0% tax rate for companies with modest profits – comes to an ignominious end. With effect from now. (From April, to be precise.)
So where does that leave the millions of businesses that have incorporated over the last four years, encouraged by the Chancellor’s generosity? Should they now go into reverse, and dis-incorporate? We think not.
In this article, we shall look briefly at the continuing advantages for businesses that have already incorporated. Then, more importantly, we shall examine whether businesses that currently remain as sole traderships and partnerships should now consider incorporating. As we shall show, in spite of Gordon Brown’s U-turn, we believe that many attractive advantages still remain for those who now decide to ‘go limited’.
The continuing advantages
Those who incorporated to save tax used to enjoy three slices of savings. Year after year. Now, one has gone – no more profits taxed at 0%. But two remain:
1. There’s a 3% differential in the ‘headline’ rate of tax. A business run as a sole tradership or partnership can expect to pay tax at the rate of (at least) 22%, compared with (at least) 19% for a company.
Put another way, if the business isn’t incorporated, its annual tax bill will be one-sixth more than it need be. Over the years, that will add up to an awful lot of money paid to the Government, needlessly.
2. And that’s just for starters. The annual national insurance bills for the self-employed can easily amount to £2,500 or more. This impost can be eliminated totally if the business is run through a company (provided, of course, that the profits are extracted largely by way of dividend rather than as remuneration).
So, if you’ve incorporated your business in recent years, you’ve still got plenty to be thankful for. Our recommendation here, therefore, is quite simply
- carry on as before.
What, then, of those who are yet to take the plunge? Does the withdrawal of the 0% tax band mean that going to all the trouble and expense of incorporating can no longer be justified?
Again, we think not. We still think that, for very many businesses, incorporation is worthwhile. More than worthwhile.
Here’s why:
‘One-off’ tax perks worth having
We’ve already mentioned two ongoing advantages for those who run their businesses through a company. The tax and national insurance savings we’ve highlighted are available to companies every year.
But that’s not all. In addition, the act of incorporation can itself produce some one-off advantages. These act as a sort of ‘initial bonus’ to encourage those who might be dithering a little, to take a deep breath – and go for it!
- First, there’s the tax holiday. Following incorporation, you might (legitimately) avoid paying tax for nearly 18 months! For example, if you converted your business into a limited company at the beginning of April this year, your last self-employed tax bill will probably have to be paid next month (July 2006). And the first annual tax bill for your new company will not fall due until (early) January 2008! The tax liability all catches up in the end, of course, but in the meantime you’ve had the benefit of the money, not Mr Brown!
- Then there’s the matter of the business goodwill. It is very probable that, assuming your business is making profits, it will have some goodwill value. On incorporation, you could sell that business goodwill to your new company at a fair price. It might even be suggested to you that a fair price could be around £35,000. In that event, assuming you have been trading for at least two years prior to incorporation, you’d pay no capital gains tax on this sale of goodwill. That’s because, after deducting 75% business asset taper relief, your taxable gain would become only £8,750. And, surprise surprise, this amount falls just below your annual capital gains tax exemption of £8,800. The end-result of all this is that you’ll have created a loan account of £35,000 within your new company – a honey pot which will enable you to take money out of the company when it suits, without having to pay any tax. Of course, as we explained last year (in September 2005), the Revenue may not be too happy about this ploy, so care needs to be taken. But if the advice we gave nine months ago is followed and an unrealistically high value is not placed on the goodwill, then a juicy tax-free loan account can often be created.
- In addition to transferring the business goodwill to your company you will, of course, transfer various items of plant and machinery. What can we say?
Yet more tax wrinkles await here. When, as is usual, the transfer of plant and machinery forms part of the incorporation process, some surprising one-off tax savings can often be secured. Very surprising tax savings – worthy of a short article of their own.
So that’s what we shall do, a little later in this issue. Hopefully however, we’ve already said enough to show that, by and large, incorporating a business is still
- a good thing.
So do it!
Conclusion
It’s all very worrying. The Chancellor of the Exchequer has made a complete pig’s breakfast of taxing small company profits. He introduced a tax change – the 0% band of tax – which he’s now had to withdraw. And we won’t even mention the half hearted attempt he made in the middle of it all, to cobble together some sort of solution – the non corporate distribution rate. (That failed too.) The next Prime Minister? As we said, all very worrying.
Alan Rook is a chartered accountant and has been writing on tax matters for the past 15 years.
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