Incorporation Decisions (I) - How Does The Spring Budget 2017 Affect The Decision To Incorporate?

Lindsey Wicks examines how the reduction in the dividend allowance will affect the decision to incorporate.

When the idea for this article was conceived on Budget Day, I assumed that I would be examining the dynamics between two key Budget changes:

the reduction in the dividend allowance from £5,000 to £2,000 from April 2018; and
the increase in the rate of Class 4 National Insurance contributions (NIC) in April 2018 and April 2019.

We already knew that Class 2 NIC is being abolished from April 2018, so an increase in Class 4 NIC was anticipated, if not welcomed.

The reduction in the dividend allowance would inevitably make operating through a company less attractive from April 2018, whereas the Class 4 NIC increases would make it more expensive to operate as a sole trader – particularly if the additional Class 4 NIC exceeded the amount of Class 2 NIC that would currently be paid.

A quick U-turn

After the public outcry about broken manifesto promises, just a week after announcing the Class 4 NIC rate increases, Chancellor Philip Hammond announced that the rates of NIC would remain unchanged during this Parliament. At the same time, he confirmed that the abolition of Class 2 NIC would go ahead as planned next April. However, given that the Class 4 NIC rate increases were set to raise more than £2 billion over a four-year period, he warned that we can expect tax raising announcements at the autumn Budget to plug the hole that this U-turn has created.

What will change in April 2018?

Apart from the reduction in the dividend allowance from £5,000 to £2,000 and the abolition of Class 2 NIC from April 2018, we don’t, as yet, know what other tax changes we can expect from next April. As I have already alluded to, there will be a tax raising announcement at the autumn Budget. We do know that the tax locks legislated for in Finance (No. 2) Act 2015 and the National Insurance Contributions (Rate Ceilings) Act 2015 enshrine the following in law for the duration of the current Parliament:

the basic rate of income tax shall not exceed 20%;
the higher rate of income tax shall not exceed 40%;
the additional rate of income tax shall not exceed 45%;
the standard rate of VAT shall not exceed 20%;
the reduced rate of VAT shall not exceed 5%;
no supplies may be removed from the lists qualifying for the reduced rate of VAT or the zero rate of VAT;
the rate of Class 1, Class 1A, and Class 1B NIC paid by employees, employers, and third parties shall not be increased; and
the NIC upper earnings limit shall not exceed the higher rate threshold for income tax.

These have now been extended in spirit, if not in law, to pledge that no other NIC rates will increase during the current Parliament.

It should be noted, therefore, that assumptions will be made about the 2018/19 tax year that may well change as a result of the autumn Budget.

The tax differences between operating as a sole trader or via a company

The decision to operate via a company should always be a commercial one and not tax driven. However, it is inevitable that tax costs will form part of any decision making over the most appropriate business vehicle.

In the current tax year, if we make a comparison between a sole trader and a one-man company, with the assumption of equal profit levels and that profits are extracted from the company via a salary of £8,164 and the balance as dividends, the total tax bill is less for a company at all profit levels, although the amount of the saving does fluctuate. The other key assumption is that the individual taxpayer has no other income.

For 2018/19, as we do not yet know the income tax personal allowances, income tax thresholds, and NIC thresholds, or indeed what the income tax dividend rates will be, the numbers have been calculated as if those stay the same as the current tax year. A company is still cheaper from a tax perspective, but the combination of the lower dividend allowance and the abolition of Class 2 NIC narrows the gap by £373.

Profit	2017/18			2018/19
Profit	Sole trader net after tax	Company owner net after tax	Saving	Sole trader net after tax	Company owner net after tax	Saving
£ 20,000	£ 17,087	£ 17,657	£ 570	£ 17,235	£ 17,432	£ 197
£ 25,000	£ 20,637	£ 21,404	£ 767	£ 20,785	£ 21,179	£ 394
£ 30,000	£ 24,187	£ 25,150	£ 963	£ 24,335	£ 24,925	£ 590
£ 35,000	£ 27,737	£ 28,896	£ 1,159	£ 27,885	£ 28,671	£ 786
£ 40,000	£ 31,287	£ 32,642	£ 1,355	£ 31,435	£ 32,417	£ 982
£ 45,000	£ 34,837	£ 36,389	£ 1,552	£ 34,985	£ 36,164	£ 1,179
£ 50,000	£ 37,737	£ 40,135	£ 2,398	£ 37,885	£ 39,910	£ 2,025
£ 60,000	£ 43,537	£ 46,340	£ 2,803	£ 43,685	£ 46,115	£ 2,430
£ 70,000	£ 49,337	£ 51,807	£ 2,470	£ 49,485	£ 51,582	£ 2,097
£ 80,000	£ 55,137	£ 57,275	£ 2,138	£ 55,285	£ 57,050	£ 1,765
£ 90,000	£ 60,937	£ 62,742	£ 1,805	£ 61,085	£ 62,517	£ 1,432
£ 100,000	£ 66,737	£ 68,210	£ 1,473	£ 66,885	£ 67,985	£ 1,100

The costs and benefits of incorporation

Where there is an existing business, there will inevitably be tax costs associated with incorporation, such as capital gains tax (CGT) and stamp duty land tax (SDLT) (or land and buildings transaction tax in Scotland) on the transfer of assets. Reliefs may be available to mitigate or defer any CGT, but there is no incorporation relief for SDLT.

A company is, of course, a separate legal person and provides limited liability. That said, in an owner-manager situation, protection may be reduced if monies are lent or guarantees given. Operating via a company may open doors for attracting new business, as it gives the impression of a business of a certain size.

There are, of course, increased administrative costs associated with running a company. These include operating a payroll and the associated real time information reporting to HMRC, filing accounts and annual returns at Companies House, and online corporation tax filing with HMRC. The decision to pay dividends should also be properly recorded and the correct paperwork completed.

Companies won’t be within the quarterly reporting cycle for making tax digital for business until April 2020 (compared to April 2018 or April 2019 for the self-employed), although if VAT registered, they will start using HMRC’s new digital services for the quarterly reporting of VAT from April 2019. Therefore, any benefit of delaying quarterly reporting to HMRC by incorporating a business will be minimal.

It should be remembered that for many contractors, however, there is no choice but to operate via a company where the engager will only engage a company.

The future

In his spring Budget speech, the Chancellor alluded to the fact that the ‘Taylor Review of Employment Practices in the Modern Economy’ is aware that tax is a key driver in trends between employment, self-employment, and incorporation. While tax and NIC were not within the original scope of the Taylor review, it will be interesting to see what the final report has to say on this matter, and what bearing this might have on future tax policy.

As for other tax changes, Brexit may add some uncertainty to the picture. A further reduction in the corporation tax rate to 17% in April 2020 has already been legislated for in Finance Act 2016. Other manifesto pledges include raising the income tax personal allowance to £12,500 and the higher rate threshold to £50,000.

Practical Tip:

Where there is a choice of business vehicle, the decision should be influenced by all costs and benefits, only one of which should be tax.