Companies must assess impact of Darling's changes

Published on Saturday 25 April 2009 15:27

THE Budget was a mixed bag of good and bad news for businesses in Scotland, which are small, often unincorporated or small privately owned companies, and where tax changes are directly linked to the financial wellbeing of the proprietor, writes Valerie Smart.

Changes such as the fuel tax increase fall firmly within the bad news category. Any business which has distribution costs, whether on the goods it buys or on getting its goods to market, will feel the impact of this increase, no more so than in rural Scotland.

More bad news was the confirmation that the current 15% VAT rate would only last until December 31 – increasing the rate just as the January sales start is the last thing retailers want to face. The taxable turnover threshold which determines whether a person has to be registered for VAT also moves to 68,000 from May 1.

On a more positive note, news that the Government has listened to pleas to extend loss relief was welcome. Many viable businesses have incurred losses in the last few months since the downturn began. The extension will enable trading losses to be carried back by up to three years, generating a tax repayment. The measure will apply to accounting periods ending in the period November 24, 2008, to November 23, 2010, or for tax years 2008/09 and 2009/10 for unincorporated businesses.

The amount that can be carried back to the preceding year is unlimited but additional losses up to 50,000 per tax year can be carried back against the profits of the two preceding years.

For unincorporated businesses the previous extension announced in the Pre-Budget Report only looked at losses incurred in 2008/09. This would have been too early for the full impact of the recession to have hit many businesses, so the extension could be of real benefit. At the same time there are proposals to allow taxpayers to enter into voluntary managed payment plans whereby they can pay their tax bills in instalments straddling the normal due date without incurring late payment interest and penalties.

For those businesses with money to invest, the introduction of a temporary 40% first year capital allowance on the purchase of certain types of plant and machinery until April 5, 2010, is also welcome.

The villain of the piece is the increase in tax rates. For small companies with profits under 300,000 the corporation tax rate of 21% will rise to 22% from April 1, 2010.

The top rate of income tax also rises to 50% from April 6, 2010, if income exceeds 150,000. However, the withdrawal of personal allowances for those earning over 100,000 results in a marginal tax rate of 60% for those who just exceed that limit.

This means that the marginal rate on income over 100,000 will be taxed at rates between 45% and 60% until the 150,000 tax band threshold is reached. It follows that those affected need to consider carefully the structure of their business operations if they want to minimise their tax bill.

From April 6, 2010, taking account of national insurance contributions, a self-employed individual earning 200,000 of taxable profits will have an effective tax rate of 41%, up 3.75% from this year. The same profits earned in a limited company and withdrawn by way of salary will attract a total tax bill of 47%, up 2.7% from 2009/10. Leaving profits in a company will attract a 22% tax burden compared with 21% currently, but if the company goes on to pay out the net profits by way of dividend the tax bill rises to 38.5% against the current 35.5%.

Currently, dividends paid to higher rate taxpayers attract an effective tax charge of 25% on the amount received, but from April 6, 2010, dividends which take taxpayers above the 150,000 tax band will attract a 36% effective rate. If shares are held in family trusts where dividends are accumulated, the tax rate will always be an effective 36% regardless of the size of income. Thought should be given to whether this income would be better paid out from the trust. With tax cuts unlikely in the foreseeable future, getting the business structure right for the family is going to be a key part of tax planning.

Pensions have also been hit, and although the Chancellor said the withdrawal of higher rate relief would apply to those earning over 150,000 from April 6, 2011, new rules that apply a special tax charge and neutralise higher rate tax relief apply immediately.

The loss of higher rate relief changes the dynamics of pension fund planning and thought needs to be given to the likely tax rate which will affect withdrawals from the pension fund in due course. If tax relief on contributions is only 20% but pension income is taxed at 50%, it may be that pension saving will become unattractive.

Valerie Smart is tax director at PricewaterhouseCoopers