By Vanessa Parnell, partner, Thomas Westcott Chartered Accountants
We are often asked to consider what the best trading structure for a business might be, and with that the tax benefits of trading through a limited company can be a major influencing factor.
While incorporation is still beneficial, with changes in dividend taxation over recent years the tax benefits of trading through a limited company have slowly been eroded. And, from April 6, 2018, the benefits will be eroded further as the £5,000 tax-free dividend allowance is reducing to £2,000.
This reduction in the tax-free threshold will cost individuals in receipt of £5,000 of dividends an additional £225 (or £975 if a higher rate tax payer) for the tax year 2018/2019 compared to 2017/2018. However, even with this increased personal tax charge, this does not necessarily mean that it is no longer tax efficient to trade through a limited company.
There are many other factors to take into account when considering the best trading vehicle for your business and we would always advise that full consideration is given to these before making a decision.
A few of the other considerations that should be borne in mind when looking at the best trading vehicle are:
- Will you want to extract all profits from the business each year? Using a limited company can allow profits to be retained within the business, where they are only subject to tax at 19% (reducing to 17% in 2020). If you have taken on debt this can mean that a limited company can repay the debt quicker. For example, for every £10,000 of profit earned a limited company would have £8,100 to repay the capital on debt, whereas a sole trader/partnership would only have £7,100 if a basic rate tax payer or £5,800 if a higher rate tax payer.
- Although the personal tax cost is increasing the rate of corporation tax is gradually falling, which to an extent offsets the increased personal tax cost.
- A limited company may commercially be a much better trading vehicle, as it offers limited liability, whereas in general the risk of trading as a sole trader/partnership is greater, with all your personal assets at risk.
- Some industries or customers will only contract with a limited company from a risk and compliance perspective.
Consideration should also be given to the nature of your business and what enhanced tax reliefs may be available to you. For example, if you are likely to be undertaking significant research & development work then a company structure may be the better trading vehicle to access reliefs only available to limited companies.