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Budget: Impact on incorporation decisions - updated

16th Mar 2017
Partner Rebecca Benneyworth Training Consultants
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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, says Rebecca Benneyworth.

[NB: This article has been updated from the original published on 10 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.

AccountingWEB's Spring Budget coverage is brought to you in association with TaxCalc. Visit our Budget page to keep up with all the predictions, debates and post-Budget analysis.

Replies (38)

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By Matrix
10th Mar 2017 14:37

Thanks Rebecca this is very helpful. It looks as if in future years the profit level where incorporation becomes an option falls to £30k whereas it is currently £40k. This is after taking off accounting fees and assuming there are no more significant changes such as the abolition of the dividend allowance.

Thanks (3)
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By ohgoodgodno
10th Mar 2017 15:49

Brilliant article, just what Aweb needs more of

Thanks (10)
Hallerud at Easter
By DJKL
10th Mar 2017 16:34

If I were a pessimistic individual (and I am) I might consider what would happen if say the now reduced dividend allowance/band was not to be available in future years to be set against dividends from close companies or was scrapped altogether.

It just seems to me only a matter of time before this particular stable door gets bolted again- like the £10,000 nil rate band re CT it shines brightly but only for a short time then either a supernova or eventual white dwarf.

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By Ranse
10th Mar 2017 18:14

Thumbs up to Rebecca. Great article!

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Jennifer Adams
By Jennifer Adams
11th Mar 2017 14:00

Thank you Rebecca. I wonder if the number crunchers at No 11 have done this calculation? My guess is not.

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By rushmere
12th Mar 2017 14:31

Thanks for this excellent and very useful article. Shouldn't the increase in tax liability because of the reduction in Dividend Allowance be 7.5% x £3,000 = £225, as the Dividend Allowance has been reduced by £3,000? or am I wrong?

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Replying to rushmere:
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By frankscotreid
13th Mar 2017 11:09

The same thought occurred to me as Rushmere

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Replying to rushmere:
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By Peter Bromiley
13th Mar 2017 11:33

You are right - Rebecca's wording is wrong. But I think her calculations are right.

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Accountants & Business Advisers
By Gladstone
12th Mar 2017 16:49

Thank you very much for your informative article with comprehensive tax implications in future years.

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accountant in london
By Accountant in London
13th Mar 2017 10:23

Many thanks for this article. Just what the accountants need at the moment. A client emailed me to ask if he should become a sole trader again..... and this article will help me to respond to him.

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By [email protected]
13th Mar 2017 10:49

Hi

I'm trying to replicate this calculation myself to make sure I understand it but I'm getting the wrong numbers could anybody explain how the figures in table 1 have been arrived at?

Thanks

Adam

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By [email protected]
13th Mar 2017 10:49

Hi

I'm trying to replicate this calculation myself to make sure I understand it but I'm getting the wrong numbers could anybody explain how the figures in table 1 have been arrived at?

Thanks

Adam

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Replying to [email protected]:
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By Peter Bromiley
13th Mar 2017 11:52

Good question, Adam. You inspired me to check the figures - and I got stuck on the first line - £20,000 income in 2016/17.
I'm getting about £2,628 for the Company (using £8,060 as the salary) and £2,874.60 for the sole trader. Can anyone help?

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Replying to Peter Bromiley:
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By StevenT
13th Mar 2017 12:04

I agree the sole trade figures as follows:
IT = £20,000 - £11,000 = £9,000 x 20% = £1,800
Class 4 = £20,000 - £8,060 = £11,940 x 9% = £1,075
Class 2 = £2.80 x 52 = £146
To give £1,800 + £1,075 + £146 = £3,021.

For the company I get:
CT = £20,000 - £8,060 = £11,940 x 20% = £2,388
IT = £11,940 - (£11,000 - £8,060) = £9000
£5,000 x 0% = 0
£4,000 x 7.5% = £300
Overall cost = (£2,388 + £300) = £2,688

Can anyone explain the difference in the Company from the articles figures to mine?

Thanks
Steven

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Replying to StevenT:
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By gordonb
13th Mar 2017 12:13

With a salary of £8060 and a PA of £11000 you need to deduct the balance of £2940 from the dividend income before applying the 7.5%,

Regards,
Gordon

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Replying to gordonb:
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By StevenT
13th Mar 2017 12:16

I have deducted the balance of £2,940 from the dividends received of £11,940 to give taxable dividends of £9,000.
This is then taxed at 0% for the initial £5,000 and 7.5% for the remaining £4,000 to give £300 as per my workings?

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Replying to StevenT:
Hallerud at Easter
By DJKL
13th Mar 2017 13:11

The dividends received are not £11,940, nor are they net £9,000.

Profit 20,000 less salary £8,060 = taxable 11,940 less CT of 20% being £2388 so gives available to distribute £9552 .

Thereafter

Dividend £9552
Bal pa 2940

and then work through the rest of the calc

Thanks (1)
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By Trethi Teg
13th Mar 2017 10:51

I am a little confused (not unusual) concerning the mandatory date for the commencement of MTD. I thought the original proposal for unincorporated businesses below the VAT threshold was April 2018. This was put back a year in budget - to April 2019 - or so I thought. Also what is the relevance of the year end date. Have not seen any reference to year end dates in the MTD debate so far.

Could someone please clarify?

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Replying to Trethi Teg:
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By raju m
13th Mar 2017 14:42

If the year end is just before 5 April ie 31 March then the MTD start effectively gets delayed by a year.

Raju Mehta

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By Ian McTernan CTA
13th Mar 2017 11:01

Thanks Rebecca.

I'll take issue with one point, which is the admin of running a small company compared to MTD. One can be done on a spreadsheet or after the year end, the other requires 5 sets of figures using some software the client wants nothing to do with...

Apart from that, I suspect we will see a further erosion of the differences in taxation by means of increases in the dividend tax charge, despite the marginal rate already being higher than the self employed. or some attack on the deduction of expenses.

For higher rate taxpayers the true marginal rate is 52.5%, being 20% CT and 32.5% dividend tax charge, and 58.1% if you're into the additional rate.

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By geraldw
13th Mar 2017 11:15

Does incorporation look better if couples ( + family ) are also shareholders and claim their dividend allowance ? Or is there a mechanism to prevent this being used.

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Replying to geraldw:
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By I'msorryIhaven'taclue
13th Mar 2017 12:43

geraldw wrote:

Does incorporation look better if couples ( + family ) are also shareholders and claim their dividend allowance ? Or is there a mechanism to prevent this being used.

Wouldn't using the £3,000 Employment Allowance* be a better option for such family firms with more than one person on the payroll? That way the overall 'tax' leakage would be 12% (EE NI) rather than 20% corporation tax.

EDIT: *paying salaries above the primary threshold up to each employee's £11,500 personal allowance. Apologies that wasn't made clear.

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By NeilW
13th Mar 2017 11:21

A very good article, but surely employer and employees NI is still less than dividend tax + corporation tax.

employee NI is a 22.6% marginal tax rate, whereas dividend tax + corp tax is 25.1% marginal.

Unless my maths is bad there is another £80.19 saving to be had by paying a salary at the personal allowance level and paying the class 1 national insurance.

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By PhilipMunk
13th Mar 2017 11:23

Very good article

I assuem there are also benefits from having, where applicable, married spouses as shareholders.

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By AgileAccountancy
13th Mar 2017 11:50

Nice work good article

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By I'msorryIhaven'taclue
13th Mar 2017 12:51

For clients with different facets to their business, I wonder how long it will be before some operate as BOTH an incorporated business AND as sole-traders?
A self-employed taxable profit of sub £5,965 for example would be NI free (or better still a sub £8,060 taxable profit would attract the rather minimal class 2 NI contributions only.) As a bonus, all bases could be better covered for travelling expenses / subsistence. And those claiming working tax credits could avoid the minimum wage issues that sometimes arise.

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By el simon
13th Mar 2017 14:28

Very useful indeed! One point re MTD though, my reading of the HMRC post-budget guidance says it is now coming in for unincorporated businesses below (and above) the VAT threshold in April 2019 not 2020. See
https://www.gov.uk/government/publications/making-tax-digital-for-busine...
Who is likely to be affected...
- April 2019 if they have profits chargeable to Income Tax and pay Class 4 NICs and their turnovers are below the VAT threshold
- April 2019 if they are registered for and pay VAT
- from April 2020 if they pay Corporation Tax (CT)

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By el simon
13th Mar 2017 14:32

PS ref my previous posting... it is still April next year for unincorporated businesses above the VAT threshold. From the same guidance:
- April 2018 if they have profits chargeable to Income Tax and pay Class 4 National Insurance contributions (NICs) and their turnovers are in excess of the VAT threshold

(and April 2019 if you are below the VAT threshold, whether or not you are VAT registered)

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By raju m
13th Mar 2017 14:48

As usual a very useful article from Rebecca. Thanks.

Accountants should still warn the clients that limited companies have to file annual accounts that anybody can look at on the Companies House website as opposed to non incorporated private accounts.

Raju M

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By moneymanager
13th Mar 2017 18:51

Very detailed, but will it come to pass? I'm unconvinced that a decision on incorporation (or not) should be based on such narrow points of advantage.

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Replying to moneymanager:
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By Matrix
13th Mar 2017 19:42

HMRC will be thrilled when they read this then, since they assume that all incorporations are tax geared. With such a narrow advantage doesn't this demonstrate that there are other factors such as limited liability, flexibility of profit extraction, exit strategy, perception.....?

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Replying to Matrix:
Hallerud at Easter
By DJKL
14th Mar 2017 10:06

Precisely, incorporating for a very small tax edge that a Chancellor can extinguish at will is imho pretty poor business planning

At the end of the day my clients appear to just want to get on running their business as they see fit, playing musical chairs re incorporation/ disincorporation just takes time away from the more important consideration, earning money.

I can see the point where the differential is enormous but frankly might be concerned for say for a smaller business with possibly a lease on premises and staff, the frictional costs dealing with the lease and the staff notifications re TUPE etc could easily outweigh the benefits and in 18 months it may be volte-face as a Chancellor gets another bee in his bonnet.

It can also be difficult to train the client brought up operating as a sole trader or partnership re asset ownership within a company, so risks re s455 need considered when incorporation is being considered.

I certainly see it as our role to review the position, and mention to the client, but possibly like doctors we should also very fully explain the risks inherent re the treatment, the additional costs inherent , the changes in practices that will arise and the recovery time if implemented.

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Northumberland flag
By MJShone
15th Mar 2017 09:57

What always scares me about incorporation is that clients who've been sole traders/partners for years forget that the company is a separate entity and that it's money's not their money. Cue overdrawn directors' loan accounts/ failure to operate PAYE etc.

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By javickers
15th Mar 2017 11:28

Unmentioned here appear to be the other pitfalls of incorporation that the Government has kindly introduced - the mandatory pension scheme (which, if I've read correctly, an employee - including a sole director - must be automatically enrolled before they can opt-out: So does that mean you have to run a scheme anyway, even if you then intend to opt out of it)? Not to mention the ever-increasing complexity of the VAT system, the tax system in general....

I've run a Ltd Co. since 1997, just me, and used it for various money-making pursuits (all legal & above board I hasten to add!), now for the first time I'm thinking it'll be easier to just jack it all in & become a wage slave.

This is not what I expected from a Tory government.

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Replying to javickers:
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By kfh
20th Mar 2017 10:29

I also have run a Ltd Co for many years mainly for limited liability purposes and because many customers want to trade with a Ltd Co.

Now it is all too much hassle as I HATE unnecessary paperwork (in which I include incompetently written computer software). So I am packing it all in and retiring to spend my pitiful pension which has been decimated by years of Government policies.

An excellent article.

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By tearforfears
15th Mar 2017 11:55

breaking news - NI rises scrapped

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By JimH
15th Mar 2017 15:05

Whoops! Some spreadsheet tweaking for Rebecca and the rest of us now.

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By ChrisKM
30th Mar 2017 11:45

Brilliant article.

Sorry to bump it but just wondered if someone could check where I am going wrong on the company tax numbers for 2020/21 for salary levels of £75k and above.

Taking £75,000, the article states that annual taxation on the company basis falls from £20,684 in 2019/20 to £20,232 in 2020/21 as a result of the 2% cut in corporation tax. This is an increased saving of £452.

But I work out that the tax saved from 2019/20 to 2022/21 as £902, being:

Corporation tax charge savings on company profits of £66,836 @2% = £1,337
Less:
Additional income tax on higher dividend received of £1,337 @ 32.5% = (£435)

What am I missing?

I realise this is hardly a critical issue given the numerous other changes that will be introduced between now and 20/21 (and then no doubt reversed and then re-introduced again), but it was driving me slightly crazy.

Thanks

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