Small firms shouldn't rush to delist

WHEN the Chancellor announced in the Budget his intentions to "close a loophole" by introducing an "additional tax on dividends" payable by small companies, many thought this would end, or at least stem, the tide of small business incorporations.

It seemed the tax advantages of incorporation had been removed, but this is far from the truth. First, there was never a loophole to close - it was Gordon Brown who introduced, among other incentives, the 0 per cent tax rate on the first 10,000 of a company’s profits. Although the intention was to encourage enterprise and investment, Brown clearly underestimated the attractiveness of the 0 per cent rate. Many advisers suspected it would only be a matter of time beforehe saw the error of his ways and the more prudent advisers will no doubt have told their clients that while one should never look a gift horse in the mouth, it does no harm to inspect the other end: horses can have the propensity to provide a nasty kick.

Second, there is to be no additional tax on dividends. It is important to understand that the new rules will simply ensure a minimum charge of 19 per cent on profits that are distributed. The new rules will, contrary to the impression given by some commentators, have no effect on the tax position of the recipient.

Companies generating profits of 50,000 and above are already paying tax at 19 per cent and, therefore, the changes will have no effect on them. Unfortunately, low profit companies will be most affected: a company with profits of 10,000 will see an increase in its annual tax bill of almost 2,000. But the overall tax burden will still be less than that of the equivalent sole trader.

The reduced saving, however, when considered with the financial and other aspects of managing a limited company may be insufficient to encourage such businesses to incorporate in the same numbers as previously. On the other hand, there should be no need for a small company to rush into disincorporation - with set-up costs having already been incurred, the ongoing savings may be almost enough to justify continuing as a limited firm.

Businesses with taxable profits of 20,000 and above should certainly continue to consider incorporation. At 20,000 a company will pay 1,400 less in tax and national insurance per year than the corresponding sole trader. At 50,000 (the point at which the new rules cease to have effect), the overall tax and NI savings can be as high as 6,000 per year. Generally, tax savings continue to increase as profits increase.

No decisions should be based on tax-considerations alone. As well as the positive aspects of limited liability status, running a company involves a significant degree of responsibility, statutory compliance and is generally more expensive than trading as the unincorporated equivalent.

Any decision on incorporation must also take into account the future plans of the participator(s) - there would be little benefit in incorporation with planned retirement only, say, a year away. Furthermore, incorporation is unavailable to some businesses.

In summary, while the computational aspects of the new rules would appear to be complex, much of the criticism has been exaggerated. For those enterprises that are able to, all but the smallest should continue to consider incorporation as a viable, tax-efficient business vehicle.

David Lochhead is a tax manager in the Edinburgh office of accountants Haines Watts. Contact: 0131 625 5151 or [email protected]