THE VIEW FROM No 50

 

MAY 2002

 

K P Bonney & Co.  Chartered Accountants    50 Cleasby Road    Menston   Ilkley    West Yorkshire    LS29 6JA

Tel: 01943 870933             Fax: 01943 870925                www.kpbonney.co.uk

 

 


 

TAX REDUCTIONS FAVOUR COMPANIES

 

Traditionally, businesses have been carried on either as unincorporated entities (a sole trader or partnership) or as limited companies.  Sole traders and partners are personally liable to the creditors of their businesses whereas the shareholders in a limited company have no further liability if the business fails.

 

This difference in the financial exposure of the owners of the business to their creditors has tended to dominate the decision-making process as to whether a business should be incorporated or not.  However, there are significant differences in tax treatment to be taken into account as well.  A sole trader or partner is taxed on profits earned, irrespective of the level of personal drawings.  This means that in a good year there can be a heavy tax liability on profits over and above what the proprietor needs to draw for personal requirements.  However, when times are hard and there are no profits, the proprietor can continue to take drawings (borrowing money if necessary) without incurring a tax liability.

 

In a limited company excess profits over and above directors’ remuneration are taxed broadly at 20% which is significantly less than personal higher rate tax of 40%.  It is also possible to reduce the exposure to tax and national insurance on remuneration by taking dividends instead. 

 

More recently, a new entity, the limited liability partnership (LLP) has been introduced.  An LLP allows a partnership to limit the commercial liability of its members, but in tax terms the members are treated in the same way as ordinary partners.  Therefore, the alternative choice for tax purposes still remains the limited company. 

 

The April 2002 Budget has drawn renewed attention to the potential tax advantages of limited companies.  From 1 April 2002 the small companies rate of corporation tax is reduced from 20% to 19% and the first £10,000 of company profits are tax free.  As a result, small businesses can achieve worthwhile savings by incorporating.  Take the following examples of a sole trader earning profits of £20,000, £34,515 (at which level he remains a basic rate tax payer) and £50,000.

 

 

Sole Trader

                                           £                 £                 £

 

Profits                            20,000        34,515        50,000

Personal allowance       4,615          4,615          4,615

                                    ______     ______     ______

 

Taxable                          15,385        29,900        45,385

                                    ______     ______     ______

 

Tax                                   3,154          6,348        12,542

Class 2 NIC                        104             104             104

Class 4 NIC                     1,077          1,806          1,806

                                    ______     ______     ______

 

Total tax/NIC                  4,335          8,258        14,452

Profits                            20,000        34,515        50,000

                                    ______     ______     ______

 

Spendable income       15,665        26,257        35,548

                                    ______     ______     ______

 

Now assume that the business is carried on through a limited company.  The owner takes out all available profits by a small salary to preserve state benefits and the balance as dividends:

 

Company position

                                           £                 £                 £

 

Profits                            20,000        34,515        50,000

Salary (No NIC)             4,615          4,615          4,615

                                    ______     ______     ______

 

Taxable profits             15,385        29,900        45,385

Corporation tax              1,279          4,726          8,404

                                    ______     ______     ______

 

Post tax profits             14,106        25,174        36,981

Dividends                     14,106        25,174        36,981

                                    ______     ______     ______

 

Retained in company            -                  -                  -

                                    ______     ______     ______

 

 

Personal position

                                           £                 £                 £

 

Salary (covered by

personal allowance)      4,615          4,615          4,615

Dividends received     14,106        25,174        36,981

Personal tax on

dividends                               -                  -          2,518

                                    ______     ______     ______

 

Spendable income       18,721        29,789        39,078

                                    ______     ______     ______

 

Savings                           3,056          3,532          3,530

                                    ______     ______     ______

 

For partners the savings are not necessarily exactly pro-rata but a two partner firm earning profits of £100,000 would obtain additional spendable income of approximately £7,000 by incorporation.

 

It must be stressed that the above structure would not suit everyone. There are also many other factors to take into account including the extent to which the proprietor wishes to retain profits within the company, pension scheme funding and the impact on working families’ and children’s tax credits.  It will be necessary to prepare specific calculations in every case reflecting the individual’s requirements.  It will also be important in certain cases to ensure that the business will not be caught by the IR35 rules for personal service companies.

 

It is also vitally important for small businesses to appreciate that a greater standard of financial housekeeping is required in a limited company.  Company money must be distinguished from private money.  Care must be taken to ensure that directors’ loan accounts do not become overdrawn.  Thought must also be given to the way in which car ownership and motoring expenses are dealt with as the benefit in kind regime can be harsh within a company structure.  Neither should the additional compliance costs of running a company be ignored although most small businesses will not require an audit.

 

The more detailed regulations which govern a company, coupled with the increased costs of compliance will deter some from operating through a limited company, in spite of the tax savings which can accrue.

 

My advice: The changes in the Budget mean it is now advantageous for more small businesses to incorporate.  Next year the additional 1% NIC levy will hit many businesses hard, but this can be avoided if shareholders extract their profits as dividends. There are a number of pitfalls which must be avoided. For example, the transfer of an existing business to a company must be handled carefully so as not to create capital gains tax liabilities.  It is important to take detailed advice from me before proceeding.

FALSE DOCUMENTS FILED AT COMPANIES HOUSE

 

A number of alarming articles have appeared recently in the financial press relating to false statutory forms being filed at Companies House.  It appears that some companies are being targeted by unscrupulous individuals who submit statutory forms 288a to Companies House appointing themselves as a director of the company.

 

The owners and other directors of the company know nothing about this as there is no official mechanism in existence to tell someone if documents have been filed.  Provided the document has been completed correctly, Companies House will automatically accept the document at face value and place it on the company’s records.

 

By presenting themselves as directors of successful companies, the culprits are able to obtain credit from financial institutions.

 

My advice:   It is always worth checking from time to time just what  documents are on your company’s file. This is a relatively inexpensive procedure and could be carried out a couple of times a year.  Alternatively, there are a number of commercial organisations which will carry out a watching brief over your company’s records and inform you whenever a document has been filed.

 

If you do find that your company has been targeted and there are documents on your company’s records which should not be there, you should contact Companies House immediately and ask for advice.

 

 

STEPHEN PARKS

 

Stephen, who played in midfield for Whitby Town in the Northern League, was exchanged for one of Stockton FC’s turnstiles.  ‘Turnstiles are very hard to come by, so it seemed like a good idea,’ Bob Scaife, the Whitby chairman, explained.  ‘I just hope it turns faster than Stephen ever did.’

 

 

 

 

 

 

 

Copyright  Ó  K P Bonney & Co 2002.  All rights reserved. No part of this publication may be produced, stored in a retrieval system, or transmitted in any form or by any means, electronic mechanical, photocopying, recording or otherwise without prior written permission of the publishers.  Disclaimer  The publishers have taken all due care in the preparation of this publication. No responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication can be accepted by the authors  or the publishers.

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