Budget 2021: Considerations for incorporation and remuneration planning post 1 April 2023.

The increase in the corporation tax rate announced in the budget from 19% to 25% does not bite until 1 April 2023, but we know only too well that those two years will pass very quickly. So this substantial hike in corporation tax rates needs to be considered now for existing sole traders, partnerships who might consider incorporating, or for new businesses deciding on the best business structure.

The question of whether to operate as a limited company, or in a structure that does not pay corporation tax (be that a sole trade, a traditional partnership, or a limited liability partnership) is not solely a tax question, and it is worth noting that this article does not address issues outside of the tax cost to the business owner and the issues of extracting his or her profits from the trade.   

The chancellor was keen to point out on Wednesday 3rd March that the new rate of 25% only applies to profits in excess of £250k, with the 19% rate applying to profits of less than £50k, but the full detail is not quite that simple.   For example, I have been predicting for a couple of years that a higher corporation tax rate would come into force for companies that hold property or other investments, and this will now be the case, all investment companies, regardless of their level of profit will pay corporation tax at 25% from 1 April 2023. 

For trading companies, the £250k limit before which tax at 25% is charged does apply, but if there is more than one company in a group, this limit will be divided between the companies, and for profits falling in the £50k to £250k band, there is an effective marginal rate of 26.5%. 

So, what does this mean in practice?  Every taxpayer’s position is different and should be reviewed whilst taking into account all relevant personal factors, but in order to get a feel for how these new rates will apply I have looked at two ends of the spectrum.

The smaller trader

In this example my trader makes a profit before taking any monies out of the business of £50k per annum and this is his only source of income. 

As a sole trader (and using rates and allowances for 2021/22) he pays tax of approximately £7,500 and national insurance of approx. £3,800, so his total tax and NIC burden is £11,300. 

If he were to incorporate and take all of the profit out as salary, his tax burden falls to £6,500, but national insurance then rises to approx. £9,200 so overall deductions of £15,700. 

In reality though he would not take all his income as salary and so suppose he instead extracted all of these profits as a dividend.  In this case there are no NIC charges but (working on the 19% tax rate as a small company), he would pay corporation tax of £9,500 before drawing the balance as a dividend, and personal tax of £1,945 so a total tax burden of £11,445, which is pretty similar to the unincorporated position.

Investment company

If I run the same scenario for an investment company however (subject the exact nature of the investments in the company) the tax for an individual taking a salary is similar as it is for a trading company.  The tax burden if the profits are withdrawn as a dividend in this case however rise to just over £14k due to the additional corporation tax from 1 April 2023 so the investment company option becomes more tax costly here than being unincorporated.

The more substantial trader 

I’ve also looked at the same comparisons for a business that has a profit (before any drawings by the owner) of £500k.  Where this is run as an unincorporated business the total tax and NIC burden is about £223k.

As a limited company drawing salary, the tax and NIC goes up to £255k, but even when dividends are taken (which is more tax efficient than salary) the total tax burden only falls to about £250k, still more than the unincorporated business if all profits are taken out of the company.  To the extent that profits are retained in the company and re-invested, a limited company structure will likely reduce the overall tax burden.

Conclusion 

What does this all mean then?

Without a doubt the higher corporation tax rate for any size investment company and for larger trading companies and groups reduces the tax benefits of incorporation, and whilst remuneration to shareholders by way of dividend is still more tax efficient than salary, the margin between the two will become smaller going forward.  Given the restriction in furlough relief to directors who have taken remuneration as dividends in the past year, there may be a future shift towards paying more salary and less dividend now that these tax savings are reduced.  There will be other factors to be taken into account, for example if the directors’ wages are part of an R&D claim, then salary is likely to be the more attractive option. 

As outlined, whether or not to operate as an incorporated business can be determined by many factors outside of tax, but tax considerations will inevitably play their part. How the new CT regime interplays with other tax measures and reliefs is also important. The new super deduction for capital expenditure and other important reliefs e.g. R&D tax credit relief (which is only available for limited companies not unincorporated businesses) are just two examples, and I would also note that succession planning is more easily achieved with a limited company structure.  So, despite these increased corporation tax rates, incorporating a business is likely to remain something well worth considering for many unincorporated sole traders and partnerships.

For more information on how the new CT regime might impact you or your business please call me today on 0345 3303200 or email me at mary.tierney@bennettbrooks.co.uk ?

MARY TIERNEY ACA CTA

Tax Director