The headline news, of course, is that the rates of corporation tax are changing. For companies with profits over £1.5 million per year, the “mainstream” rate of CT is to be reduced from 30% to 28% from April 2008.
The bad news, however, is that for small companies (profits under £300,000 per year) the rates are going up, to 20% on 1 April 2007, 21% in April 2008, and 22% in April 2009.
This is Gordon’s response to what he referred to as “Tax-motivated incorporation” – the transfer of small sole trader or partnership businesses into limited companies in order to take advantage of the lower rates of tax on profits. It was, of course, Gordon who started this, with the introduction of the 10% “starting rate” of CT in 2000, and the reduction of that rate to 0% (on profits up to £10,000) in 2002. Having provided this huge incentive to small businesses to incorporate, Gordon is now tightening the screws – but is it really the end of the road for “tax-motivated incorporation”?
As an illustration of the effect of the changes for 2007/08, and of the scenario in 2009 when the rate of CT for a small company will be 22%, compare the tax position of a sole trader making profits of £50,000 with the same business run through a limited company. Assume that:
§ the trader has no other income,
§ that he needs to extract all the company’s profits to fund his living expenses, and
§ that he does this in the most tax-efficient way he can.
When we look at the numbers, it is interesting to compare them with the position as it would have been if Gordon had not put up the rate of CT, so the table includes the tax effect if the 2006 rates of CT had remained unchanged. The comparison with the 2009 rates is of course inaccurate, because it assumes that the rates of income tax and NIC remain unchanged, and we do not yet know what they will be in 2009.
Sole Trader | Ltd Company (2006 rates) | Ltd Company (2007 rates) | Ltd Company (2009 rates) | |
Profits | 50,000 | 50,000 | 50,000 | 50,000 |
Admin cost of company | N/A | (800) | (800) | (800) |
Salary | N/A | (5,200) | (5,200) | (5,200) |
Profit for CT | N/A | 44,000 | 44,000 | 44,000 |
Corporation Tax | N/A | (8,360) | (8,800) | (9,680) |
Dividend payable | N/A | 35,640 | 35,200 | 34,320 |
Income Tax | (11,414) | (1,125) | (1,015) | (795) |
National Insurance | (2,635) | N/A | N/A | N/A |
Cash in hand | 35,951 | 39,715 (includes 5,200 salary) | 39,385 (includes 5,200 salary) | 38,725 (includes 5,200 salary) |
Tax saving | N/A | 3,764 | 3,434 | 2,774 |
Effective rate of tax on profits | 28.10% | 20.57% | 21.23% | 23.45% |
It seems, then, that there may still be a case for incorporation of some small businesses. In the case of a larger business, the savings are still there, though less dramatic:
Sole Trader | Ltd Company (2006 rates) | Ltd Company (2007 rates) | Ltd Company (2009 rates) | |
Profits | 100,000 | 100,000 | 100,000 | 100,000 |
Admin cost of company | N/A | (800) | (800) | (800) |
Salary | N/A | (5,200) | (5,200) | (5,200) |
Profit for CT | N/A | 94,000 | 94,000 | 94,000 |
Corporation Tax | N/A |
