There has historically been a tax benefit of trading through a limited company rather than as a sole trader or partnership.
The tax case for incorporating is now much less clear cut after the various recent tax changes than it used to be.
The ability to sell the goodwill of a business into a company, pay tax at the entrepreneur’s relief rate of 10% on the gain, enabling tax free withdrawals from the company through the director’s loan account and for the company to claim amortisation on the goodwill so acquired has disappeared.
Following the changes to the taxation of dividends from April 2016 it will be necessary to evaluate in each case whether there is a tax benefit in incorporating taking into account forecast levels of profitability, the need for profits to be withdrawn from the company, the number of participators in the company, etc.
So what were the changes? The Chancellor, in his July Summer Budget announced a massive change to the taxation of dividends in the UK, to take effect from 6th April 2016, i.e. for the next fiscal year 2016/17.
Each individual will have an annual tax free dividend allowance of £5,000 per fiscal year.
Dividends received in excess of the personal allowance (£11,000 for 2016/17) and in excess of the £5,000 exemption, will be taxed at 7.5% for the dividends taxable at the 20% basic rate band, 32.5% for the part of the dividends taxed at the 40% higher rate band, and 38.1% for the part of the dividends taxes at the 45% additional rate band.
The £5,000 dividend allowance takes up part of the 20% basic rate or higher rate bands, as appropriate, depending on the level of non-dividend income the individual receives in the year.
From 2016/17, for dividends above £5,000, there will always be more tax to pay on the dividend under the new rules, compared to the current regime.
It is clear that the savings of incorporation are severely diminished in 2016/17 compared with 2015/16 by additional tax on the dividend.
Incorporation may however be an attractive option for the owners of residential property businesses, given the changes to the deductibility of interest that will be phased in over four years from 6 April.
It would also be beneficial to use of the dividend allowance and potentially any unused personal allowance or basic rate tax band of a spouse.
Whatever your situation it is more important than ever to seek professional tax advice.