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The 2017 Budget's impact on the tax position of a sole trader vs. a company

  1. Incorporation
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    ChrisGoodfellow

    ChrisGoodfellow Editor Staff Member

    Posts: 130 Likes: 36
    1 |

    Just as we had started to get used to the new dividend tax rules, the Chancellor has made changes that impact the tax position of both the self-employed small business owner and similar businesses run through limited companies. Rebecca Benneyworth, a partner at Rebecca Benneyworth Training Consultants, looks at the tax implications

    [This article has been updated from the original published on 14 March, following the Chancellor's decision to scrap the NIC Class 4 rate increases in 2018 and 2019 on 15 March]

    Add in the promised reductions in corporation tax and you have a complex picture, varying from year-to-year over the next three years or so.

    So here are the changes we know about over the next few years, looking only at those that are likely to affect decisions about business structure. This means that I am regarding the tax and NIC thresholds as frozen at 2017/18 amounts, despite the fact that we know they will rise, and in the case of the tax figures, rise fairly substantially.

    Each of the sets of figures have been prepared on the following basis:

    • For the sole trader, tax and NIC payable have been based on 2017/18 rates and thresholds, except for the known abolition of Class 2 NIC in 2018; Class 4 NIC has been regarded as stable at 9% throughout the period
    • For the company tax liability, I have assumed that a salary equal to the NIC start point (£8,164 for 2017/18 onwards) is paid, and the balance of post tax profits are distributed by way of dividend. This provides a like for like comparison, as the company profits are then available to spend on living expenses
    • There are other factors which will bear on this decision, as indeed there are ways of reducing the tax liability in the company still further by paying interest on a loan to the company from the owner/director, but as not all businesses are in a position to take advantage of this, it has been excluded. The main issue to bear in mind is the additional costs of running the business through the limited company – mainly in administrative costs, but also potentially through issues arising in relation to business motoring.

    Table 1 – for comparison – 2016/17 position

    Profit

    Sole trader

    Company

    Saving

    £20,000

    £3,020

    £2,509

    £511

    £30,000

    £5,920

    £5,109

    £811

    £40,000

    £8,820

    £7,709

    £1,111

    £50,000

    £12,630

    £10,309

    £2,321

    £75,000

    £23,130

    £21,462

    £1,668

    £100,000

    £33,630

    £32,962

    £668

    This rather complex picture indicates that advice about incorporation is not driven by the tax outcomes, as these are uncertain. While there is a consistent tax saving at all profit levels shown, this saving ebbs and flows through the income range. Providing advice about the likely tax implications of incorporation (or remaining incorporated) probably demands an understanding of the likely profit levels and the amount of profit that the client is likely to extract. Retaining profits in the company will save tax at the higher levels of profit as the dividends forgone are taxed at 32.5%.

    The marginal rates of tax borne on profits are:

     

    Self-employed

    Company

    Basic rate

    29%

    26%

    Higher rate

    42%

    46%

     

    The marginal rate calculations (here and below) ignore the personal allowance and the dividend nil rate band and look only at income squarely within each band.
     

    Table 2 – 2017/18

    The changes that are coming through for 2017/18 are:

    • Increase in personal allowance to £11,500
    • Increase in higher rate threshold to £45,000
    • Increase in NIC threshold to £8,164 per annum
    • Increase in the Class 2 rate of NIC to £2.85 per week
    • Reduction in corporation tax to 19%

    Profit

    Sole trader

    Company

    Saving

    £20,000

    £2,913

    £2,343

    £570

    £30,000

    £5,813

    £4,850

    £963

    £40,000

    £8,713

    £7,358

    £1,355

    £50,000

    £12,263

    £9,865

    £2,398

    £75,000

    £22,763

    £20,459

    £2,304

    £100,000

    £33,263

    £31,790

    £1,473

    This shows a slight increase in the benefit of incorporation against 2016/17 at all levels of profit, and the reduction in the tax savings at £75,000 and £100,000 of profit is less marked. This is because the marginal rates in the higher rate tax band have drawn slightly closer together.

    The marginal rates of tax borne on profits are:

     

    Self-employed

    Company

    Basic rate

    29%

    25.07%

    Higher rate

    42%

    45.32%

     

    Table 3 – 2018/19 & 2019/20

    The tax changes we shall see from April 2018 are more complex. The U-turn on Class 4 NIC means that the self-employed actually experience a tax reduction, while director shareholders will pay more tax as a result of the reduction in dividend allowance:

    • Abolition of Class 2 NIC
    • The reduction of the dividend allowance to £2,000 per annum

    Profit

    Sole trader

    Company

    Saving

    £20,000

    £2,765

    £2,568

    £198

    £30,000

    £5,665

    £5,075

    £590

    £40,000

    £8,565

    £7,583

    £983

    £50,000

    £12,115

    £10,090

    £2,025

    £75,000

    £22,615

    £20,684

    £1,931

    £100,000

    £33,115

    £32,015

    £1,100

    At lower levels of profit the tax saving on incorporation is eroded. This is because the abolition of Class 2 NIC and the increase in the main rate of Class 4 NIC results in a net reduction in liability for those with low profits. However, the benefit of incorporation at higher levels of profit increases, as those clients are paying more NIC as a result of the changes. As you can see, at £50,000 the changes virtually balance each other out. Note that for this taxpayer, the reduction in dividend allowance has increased his tax liability by 7.5% x £2,000 = £150.

    The marginal rates on profits are unchanged, as I have calculated these based on the income within the band, rather than taking the dividend allowance into account:

     

    Self-employed

    Company

    Basic rate

    29%

    25.07%

    Higher rate

    42%

    45.32%

     

    Table 4 – 2020/21

    In fact, by this point the personal allowance will reach £12,500 and the higher rate threshold £50,000, but as we know nothing about the other variables, I have used the 2017/18 limits. So the change to report is:

    • Reduction of 2% in the rate of corporation tax.

    Profit

    Sole trader

    Company

    Saving

    £20,000

    £2,765

    £2,349

    £416

    £30,000

    £5,665

    £4,671

    £994

    £40,000

    £8,565

    £6,994

    £1,571

    £50,000

    £12,112

    £9,316

    £2,796

    £75,000

    £22,615

    £20,282

    £2,333

    £100,000

    £33,115

    £31,276

    £1,839

    So the final part of the jigsaw is a significant increase in the benefit of trading through a limited company through the two percentage point reduction in corporation tax. This suggests that there may be other action between now and then to reduce the gap which is regarded as “anomalous”.

    The final marginal rates on profits are:

     

    Self-employed

    Company

    Basic rate

    29%

    23.23%

    Higher rate

    42%

    43.98%

     

    Other factors

    There is an emerging suggestion that as companies will not come within MTD until April 2020, it is worth incorporation to avoid MTD. In fact, for an unincorporated business with turnover below £85,000 and an accounting date of 31 March, the commencement date for mandatory MTD would be 1 April 2020, so there is no real benefit in this. In addition, the administrative burden related to running a company is probably a significantly higher one than that posed by MTD which will be implemented for companies in any case in 2020, so as a result of the Budget announcements it is not worth using MTD delay as a prompt to incorporate.

    This article originally appeared on UK Business Forums' sister site AccountingWeb.

    #0
  2. Talay

    Talay UKBF Big Shot Free Member

    Posts: 3,638 Likes: 770
    Timing is everything.

    U-turn on NICs today doesn't help.

    For future analysis, would it be possible to run the profits / salaries up to a reasonable level. The full impact is not even evident at £100k per annum. Perhaps £250/500k ?
     
    Posted: Mar 15, 2017 By: Talay Member since: Mar 12, 2012
    #2
    Clinton likes this.