The 50% top income tax rate against an eventual 24% corporation tax rate is making the company structure desirable once more for sole traders or partnerships seeking tax savings or deferrals. We review the trend and the options…
A few years ago, when there was a zero rate band of corporation tax on the first £10,000 of profits, companies became a popular vehicle for tax planning purposes.
The reason? For individual sole traders, this £10,000 band was approximately twice the personal allowance for income tax, and so it seemed logical in many cases to set up a company through which to operate to leave you with a lower tax bill.
Eventually, HM Revenue & Customs took exception to the abundance of new companies created for this purpose and abolished the zero rate band.
Why companies are back in fashion
Given the recent hike in income tax rates to a top rate of 50% effective from 6 April 2010, and the announcement that the corporation tax rate of 28% is to fall to 24%, there is a tax saving to be made on profits made by a company versus those made by an individual or partnership.
Companies currently pay tax on their profits at rates up to 28%. There is a further tax charge on shareholders extracting profits from the company (either as a dividend or as a salary/bonus), so the company route is generally a means of tax deferral. However, there can be a tax saving with a company and dividend extraction versus operating as a sole trader where the profits of the company are not taxed at the top rate.
Relocation to a low tax jurisdiction
Some individuals may choose to relocate abroad after setting up the company as they may then be able to extract funds from the company at little or no tax cost. In some instances, a tax deferral can become an absolute tax saving.
Introducing corporate partners to partnerships
This is another key area of interest. A corporate partner in this context would be introduced as a member and required to make a capital contribution to the firm. As a partner it will be entitled to profits from the partnership in accordance with the terms in the partnership agreement in return for its services. Careful structuring is needed to decide what ‘services’ the corporate member is to provide.
Partnerships are taxed transparently, ie, individual partners are taxed on their respective profit share as they arise. Again, if structured correctly, the profits allocated to the corporate member should be subject to tax at corporation tax rates (currently 28% or lower), which offers a significant deferral opportunity.
Capital disposal and Entrepreneurs’ Relief
Additionally, where a partner holding shares in the corporate member disposes of their shareholding on leaving the partnership, then it should be possible in many instances to structure this as a capital disposal, subject to 28% capital gains tax – potentially just 10% where entrepreneurs’ relief applies.
As the Government seeks to attract companies to the UK through lower rates of corporation tax, we may see increasing numbers of companies being registered for tax planning purposes.
For further advice and guidance, visit our entrepreneurial services web page.
Image: Jason Dirks/Flickr, 2007