Changes to the tax regime are driving more and more people to incorporate their businesses.
For the self-employed and landlords who will be impacted by Making Tax Digital (MTD) in April 2018, the easiest way to obtain a two-year deferment is to incorporate, as MTD does not come into effect for a Limited Company until 2020.
Indeed, for landlords affected by the changes to mortgage interest relief that start to come into effect from this April, the imperative is more acute.
As we outlined in our submission to the HMRC consultation on MTD last summer, the effect of the ludicrous revenue threshold of £10,000 for mandatory quarterly reporting would be to reduce tax revenue.
Clearly, the Office for Budget Responsibility concurs as in the 2016 Autumn Statement Philip Hammond stated “…the OBR has today highlighted the growing cost to the Exchequer of incorporation”.
Mr Hammond went on to say “So the government will consider how we can ensure that the taxation of different ways of working is fair between different individuals, and sustains the tax-base as the economy undergoes rapid change. We will consult in due course on any proposed changes.” This has been interpreted to mean that money-boxing in a Limited Company and the differential rates of National Insurance contributions are under scrutiny.
This newsletter looks why now is the time to incorporate if you are self-employed. For the landlord, there are additional tax complexities around Stamp Duty, Capital Gains Tax and, potentially, the Annual Tax on Enveloped Dwellings. As a result, we will be publishing a separate newsletter on The Landlord and Incorporation next week.
For investors, incorporation is also an attractive option and the rise of Personal Investment Companies is growing. Offering a tax-efficient mechanism to grow your capital base, the opportunity to extract income as dividends and with the investment growth outside the scope of Inheritance Tax, this will feature in a third newsletter.
At the heart of the drive to incorporate is the declining rate of Corporation Tax. Currently at 20%, this reduces to 19% from April, then 18% from April 2019 and 17% from April 2020.
Even now, there are significant tax savings to be made from incorporation. In the 2016-17 tax year, a sole trader with taxable income of £30,000 would have an Income Tax and National Insurance bill of roughly £5,900.
On a basic model, under a company structure of a £18,000 PAYE salary, £7,000 additional allowable expenses and a £5,000 Dividend, the overall Corporation Tax, Income Tax and National Insurance liability would be just over £4,900.
Given that the differential rates of National Insurance contributions between the employed and self-employed of 12% and 9% respectively on income up to £43,000 are under review and the reducing rate of Corporation Tax, this gap can only widen.
This is before looking some of the other potential benefits a Limited Company can offer. For instance, in our scenario above, if your partner does not work and was employed by the business on a part-time basis for £6,000 a year thereby reducing your salary to £12,000, the overall tax burden would reduce to a little more than £2,200.
Other advantages include a wider basket of allowable business expenses, the ability for the company to contribute into a pension scheme which in itself is an allowable business expense, and the ability to lend money to the company.
Taking the last point, from the current tax year, a standard rate tax payer has a tax-free annual allowance of £1,000 for interest income. This reduces to £500 for a higher rate tax payer. As long as the loan into the company is structured with a commercial rate of interest, the resulting interest payments count towards this allowance.
For example, if you are a standard rate tax payer with £20,000 in an ISA earning 0.5%, this could be loaned to the company at an interest rate of 5.0% increasing the interest earned from £100 to £1,000. The interest is another allowable expense for the company reducing the Corporation Tax by £200 as well as adding £1,000 to the money available to extract from the company without tax.
Finally, although the Corporation Tax payment deadline of nine months and a day after the financial year-end is broadly similar to the Self-Assessment payment term, there are no advance payments for the current year.
Whilst there is an additional cost involved in running a Limited Company, the current and prospective tax and compliance benefits far outweigh this.
We await to see if Philip Hammond elaborates on his comments in the Autumn Statement in the upcoming Budget in March.
In the meantime, if you would like to discuss your circumstances, please email us at firstname.lastname@example.org.