The long-term march towards an overwhelmingly incorporated UK continues unabated.
Only very recently, City AM reported that 4,890 out of 10,400 UK law firms (ie 47%) are now operating as limited companies, up from 32% five years ago. Even in the professions, the traditional partnership and sole trader practice are giving way. This is, in no small part, down to the Tax Merits of the Limited company.
Understanding these merits might help business owners choose their structure wisely and get the best out of what they have……………………
Low revenue tax rates
It is unsafe simply to compare tax rates applicable to companies with rates levied on profits arising outside the corporate sector. Some of those company profits will need to be extracted for personal use, at which point further tax is likely to arise. Nevertheless, it is still highly significant that the UK’s Corporation Tax regime involves a flat rate charge of only 19%.
The UK’s company tax regime has become increasingly benign over a long period of time now. This continues with the planned reduction of the headline rate to 17% from April 2020. Meanwhile, profits earned by the owners of partnerships and sole trade business, have generally seen increasing Income Tax (eg the 45% additional rate) and National Insurance (eg the 2% uncapped “band”).
Practical advantages of that low revenue tax rate
Despite the “second tier” of taxation involved in extracting profit from the company for personal use, a company’s low tax rate does provide a number of clear advantages:
- Cashflow: The cashflow benefit of using a UK company is not just about the much reduced immediate tax exposure. For the vast majority of SME business, Corporation Tax is payable 9 months after the accounting reference date which is materially later than personal tax on unincorporated business profits;
- Handling debt: Capital debt (for example a mortgage on business premises), needs repaying, of course. If the debt is in the company, it gets repaid out of 81 pence in every £1 of profit which the company makes. Repaying out of partnership profits, however, might typically mean it has to be funded out of 58 pence (or less) in every £1 made;
- Other costs and benefits: Just like with debt, wherever we are able to justify non-deductible expenditures as company expenditures, or wherever expenditures are personal but yield little or no taxable “benefit-in-kind” for the individuals who benefit from them, we can save material sums as a result of using cheaper company monies.
Reliefs only available to companies or in respect of companies
Over a sustained period of time we have seen new tax-advantaged initiatives which apply only to business conducted through, and investment made into, limited companies. Examples include:
- R&D Tax Credits and Patent Box are initiatives which provide potentially significant tax advantages to companies only.
- Enterprise Investment Scheme (EIS), its little sister Seed EIS, and the Venture Capital Trust scheme all provide tax breaks to individuals who invest in companies only.
Dividend income and managed extraction
Company owners often enjoy a range of means by which they can take their income from the business. The company vehicle opens up access to dividend income which typically becomes the core of most owners’ extraction policies. Dividend income is not “earnings” and is therefore not subject to National Insurance. Owners also benefit from the £2,000 dividend “nil rate band” each year.
Despite the absence of “earnings” for company owners, their ability to access important tax benefits through a registered pension scheme is not lost. Where the company makes pension contributions on their behalf, they need no “net relevant earnings” to make those contributions eligible.
The company provides owners with the option to turn on (and off) the extraction of dividend income when appropriate. As well as being a facility which can aid cashflow and protection of value, this “tap” is invaluable to the owners’ personal tax planning. It enables them to maximise personal allowances and avoid breaching key thresholds.
Access to the family’s reliefs and allowances
The nature of shares in a limited company and the simplicity with which they can be transferred between parties can make it easy to benefit individuals beyond those who might work full-time in the business. These other individuals might typically be family members whose tax reliefs and allowances can then be accessed.
The company as a quasi trust
We routinely use a company as a form of “quasi trust” in our clients’ estate and Inheritance Tax planning. This is what we call the Family Investment Company (FIC).
The FIC is a limited company. It is typically controlled by the senior generation who act like trustees. It holds assets for family members. It suffers no ten year anniversary IHT charges and no 45% “additional rate” Income Tax (unlike trusts). In common with all UK companies it pays no Corporation Tax on dividend income received on its share investments. The senior generation use the “tap” if and when they decide to pay benefits out to the shareholding family members.
Converting from an unincorporated status and into a limited company is facilitated by certain long-established tax reliefs. Those facilities can yield additional tax advantages beyond the tax-free achievement of company status. They can, for example, serve to uprate the tax base cost(s) of the taxpayer’s principal assets to current market value, as noted in an earlier blog-post.
The above is far from the whole story about the merits and other consequences of operating and investing through a limited company.
Nevertheless, with so many positive tax reasons, it is no wonder that Harold Sharp is routinely designing incorporations of business throughout the year.
If you would like to consider the ownership structure of your business or how to get more tax benefit out of your existing company, please speak to your relationship principal here or send an email to Tax Partner, Chris Barrington.