The Chancellor’s shock announcement about dividend taxation left lots of accountants wondering whether this signals the end of tax motivated incorporation. In response to pleas from AccountingWEB members, Rebecca Benneyworth takes an introductory look at the proposals.
In reality, incorporating to save tax has not really been a practical solution for businesses with profits of less than £40,000 for a few years now. The additional administration erodes the few hundred pounds of tax saved quite quickly, and with the abolition of Class 2 NIC next year the savings are smaller still.
Where business owners decide to do their own admin, the risk of significant fines can soon outweigh any benefits, and the CT return and Companies House filing process is not simple for small businesses to navigate unaided, although the new joint Companies House and HMRC product due to be launched very soon will help a little.
Business owners would probably save more tax by paying a partner with minimal other income to do some administrative work in the business than by incorporating.
The point at which incorporation saves enough tax to make sense is probably at around £40,000 profit. At this point, even with some additional costs for company accounts, payroll and corporation tax, there is still some saving left for the owner.
But the big question is what the effect of the change in taxation of dividends will be for these company owners?
There are a lot of assumptions that can vary, but in simple terms, if a business making £40,000 a year in profit incorporates, it saves around £2,500 in tax for the owner, assuming he or she takes a salary of just below the NIC limit and the rest of the profits by way of dividend.
From 2016, that saving will be reduced to around £600, taking into account the increased personal allowance and the abolition of Class 2 NIC. So the savings are lost – and the extra admin costs probably mean that limited company status is not worthwhile.
It is not worth increasing the salary to use up the personal allowance, as the removal of the employment allowance for one man limited companies from 2016 means that such a move would cost significant amounts of NIC.
So company owners are in for a bigger tax bill in the future.
Rebecca trained in London with Kidsons and, on qualifying, spent some time as Chief Accountant of a manufacturing company. She now has her own small practice in Gloucestershire that comprises of owner managed businesses and small companies.
She also lectures extensively for a range of professional bodies, accountancy firms,...