If we assume that a taxpayer is employed on a salary of £50k pa. He then wishes to operate a separate trade making, say, £50k annual profit.
If self employed he would pay tax at 40%. If operated via a limited company he would pay CT of 19% and personal tax on the dividends of 25% (combined effective tax rate of 39%).
Hence there is no significant tax reason to incorporate (leaving aside any commercial/pension reasons).
Is this correct?
Steve
Replies (11)
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of course
the taxpayer is already on a salary of £50k - does this not mean that there would be no class 4 NIC (except for the 1% rate) to pay on his self employed profits
correct
Ask A Silly Question......
Problem is £50k salary & 50k annual (trading) profit albeit from a seperate trade are quite different to us accountants. One is the top line for profit and the other the starting point for taxable profit. No one likes a smart [***]! You pay the same tax & nic as self-employed or an employee at the amount assessable for tax. Source: Inland Revenue
Ambiguous question-not!
I had interpreted question as meaning that individual was switching from employment, rather than adding to it. I missed the words "separate trade". He must be in fortunate position if he has a job paying £50k, yet has the capacity to start a concurrent business making the same!
As an aside, where does the effective rate of tax of 39% come from? I always thought that 25+19=44
Tax rate
Sorry for any ambiguity - it was not intended.
The rate of 39% arises as follows:
initially you have 19% CT to pay on your profits then you have 25% of the balance charged to IT (assuming all profits extracted via dividend), i.e. 25% of the remaining 81% that's left after the CT charge.
25% x 81% = 20%.
20% (calculated above) + 19% (CT) = 39%.
Steve
39%
David, you only pay the dividend out of profits after CT, so it is 81% of the profits that is subjected to the 25% tax charge. The total charge is therefore (81%x 25%) + 19% which is 39.25%. The advantage over self-employment is therefore 1.75% at present, less than £1,000 on the £50,000 quoted, which is probably not enough to make incorporation worthwhle
My mistake!
I was, of course, calculating the effective tax rate on the profits distributed, nto total profits. Thanks to those for putting me right.
Thanks for the comments.
In the question I stated that the taxpayer is already on a salary of £50k - does this not mean that there would be no class 4 NIC (except for the 1% rate) to pay on his self employed profits as he will have paid the maximum already?
Effectively A Tax In Everything But Name
I think you will find that most of the savings are down to NO Class 4 NIC on business profits in a Ltd Co. Hence the Debate on putting NIC on dividends, flat rate taxation on turnover etc, all in the vain hope of creating an artificial, but level, playing field for SME's..
Deferral
The significant advantage of trading as a company is deferral. If you don't need the cash, leave it in the company. Then you don't pay the dividend top-up tax in the year that the money is earned, and if you make less than £10K profit you don't pay any corporation tax either.
The cash can be kept indefinitely within the company shell and used to buy property, reinvest in the business, or simply sit in a deposit account.
If the client decides at some time in the future to call it a day and stops earning, then the retained cash can be used to provide an income.
So it has half the advantages of a pension scheme with none of the downsides.
Cheap Option Not
Everybody, I get confused when commentators talk about the dividend tax being a personal tax. Unless HRT applicable it isn't in the small company environment- distributions being made from already taxed profits. Instead of just taking your perceived cheap option Steve, think about the bigger picture here. You cant save nearly £1,000 and will miss out on all the legal goodies if you dont go Ltd.
Not necessarily correct
You need to consider NI as well as income tax. Assuming all company profits (after basic salary and CT) would be distributed as dividend, there is an overall tax/NI saving of almost £3,900. Whether or not this is significant depends on the individual.