After register a business in UK the first duty is to decide whether to carry out the trade in the form of a company, i.e. with the individual as a director liable to tax on earnings or in the form of an unincorporated business, either as partnership or as a sole trader. The practice of some specific professions may not be done through a limited company, despite the fact that limited liability partnerships and unlimited companies may be permitted. The considerations taken into account for making this choice and the appropriate planning of tax once you register your business UK are discussed in this blog, explaining in detail the basic considerations for making a choice, the effect of national insurance and marginal rates of tax, expenses and benefits, rules for the opening years, losses in a business that are not incorporated anymore along with the case of companies for capital gains tax (CGT) and the cash flows of tax. Finally, the case of bad days is considered, answering the question that what if the things go wrong? Then what is the responsibility of the tax planning and what measures should be taken? Then, we will end our discussion on the personal services by the personal service companies, or the PSCs in the case if a person is in fact an employee of the client.
Basic Considerations to Choose a Medium of Business
An individual can make a choice between carrying out a trade as a sole trader or he can choose to register a company name UK for this purpose. Any of these choices and the choice between remuneration and dividends can have a significant effect on the overall tax and the burden of NIC. Another important consideration is that of cash flow.
An incorporation’s attraction is in the fact that a partner or a sole trader is liable for the payment of the debts of business of his personal assets to the full extent. A limited company formation UK liability of shareholders is restricted to any amount that is unpaid on his shares. However, the reduction of limited liability is often done due to the demands of landlords or bankers for personal guarantees from the directors of limited company formation UK. Also, compliance with the statutory obligations such as audits, annual returns etc., that are applicable to a company can be expensive.
Whenever you make a choice to register a company name UK, it is often easier for the company to raise finance as compared to an unincorporated business. Partly, this is because of the misconception that a company has greater permanence and reliability. A company can acquire the equity finance with the help of venture capital institutions and can go for borrowing by giving over its assets, a floating charge as a security while a partnership or a sole trader are not allowed to do this.
A business can be considered creditworthy or more reputable if it is conducted through a company’s medium. However, companies have to comply with the requirements of disclosure and this cannot be attractive to proprietors who intend to keep information from potential competitors, employees etc. The avoidance of this can be done by making use of a company that is not limited but in that scenario, one loses any benefit of limited status. By filling the abbreviated accounts, the requirements of disclosure could be lessened.
Effect of National Insurance and Marginal Rates of Tax
The profits of a trader, whether withdrawn or retained are liable to tax at a marginal rate equivalent to 40% on the income liable to tax between £32,010 and £100,000, at a marginal rate of 60% between £100,000 and £118,880 (because of the personal allowance withdrawal), at a marginal rate of 40% between £118,880 and £150,000 and at a 45% marginal rate on income liable to tax above £150,000. Moreover, class 2 and class 4 National insurance contributions are liable to the payment.
A shareholder or a director who has control can make a decision of the payment of profits that they should be either paid as dividends or as remuneration, or retained within the company.
In case if the retaining of profits is done, the resultant growth in the values of assets will increase the potential gain when shares are sold. Where the payment of remuneration is done, the liability of total insurance is greater than that in the case of proprietor of an unincorporated business.
In case of the spouse’s employment, then the person pay should be justified to be for the purposes of trade, exclusively and in its entirety. The HM Revenue and Customs may not allow an excessive cost of salary. On the contrary, a spouse, in the form of an active partner, can take any share in profits, under the condition that he is active in the business personally and there is a proof of a bona fide partnership. Hence, the personal allowance of a spouse, higher rate and basic rate bands can be used.
In making the choice of a business medium, it should also be remembered that a sole trader will not be allowed the benefits of enhanced state that are available for an employee who makes the payment of class 1 contributions and national insurance. Particularly, it should be noted that the self-employed do not get themselves entitled to the state second pension.
Expenses and Benefits
The limitations on subtracting expenses against the earnings may result in rendering self-employment more attractive than employment at the post of a company director. Despite the fact that the same expense subtraction rules are applicable to both a company and a sole trader, the deductible business expenses of a company may give rise to benefits liable to tax as earnings for directors.
On the contrary, an incorporation can benefit from the provision of fringe benefits. The use of benefits exempt from tax can be done to maximize the net income to be spent of the directors, although special care should be taken because all the benefits are not tax-efficient.
Opening Year Rules
For the rules of opening year that are applicable for the purposes of income tax, the companies have no equivalent. For a partnership or a sole trader, an earning of profits can be done when the basis periods overlap is taxed two times. For such overlap profits, relief is available but that cannot continue for several years, by which inflation of time may have lessened the relief’s value for overlap profits.
In the case if a partnership is envisaged, it may be worth it to start trading with the prospective partner as an employee at salary for a year or more, thereby obtaining relief for tax twice on his wage during the period of overlap.
Losses in an Unincorporated Business
In the case of an unincorporated business, the losses in the duration of first four years can be utilized to acquire repayments of tax (making use of the relief for early trade losses). In these years or the years to come, a claim for relief of loss against general income allows relief for the losses of trade against other income and capital gains of either or both of the two years of tax.
Although there is some great flexibility for the company itself, with the help of corporation tax, the losses of a company are not able to lessen the taxable income of shareholders.
Capital Gains Tax (CGT)
One difference that exists between the individuals and the companies is that, companies do not get an advantage from an exempt amount of the first £10,900 of net gains for the years 2013 and 2014.
The charge of the chargeable gains of an individual is applied to capital gains tax at a rate of 10%, 18% or 28%. The gains of the companies are charged at normal rates of corporation tax, main rate being 23%, small profits rate being 20% or an effective marginal rate being 23.75%.
The main disadvantage of incorporation is the double charge to tax that occurs whenever a company makes the sale of a chargeable asset. First, the company may make the payment of corporation tax on the chargeable gain. Second, the taxation of shareholders may be done when they come to realization that these proceeds, either when the shares are sold, or in the form of dividends, suffering a further charge on the capital gains.
If there are no advantages in taxation for the company when it owns an asset, then the asset should be kept outside the company probably being leased to the company. The lessor may acquire rent without having to restrict the IHT relief for business asset. However, the rent acquired will restrain the relief of entrepreneur for the capital gains tax (CGT).
Cash Flows of Tax
A partner or a sole trader is assessable to NICs and income tax on the basis of a present year, but will make use of preceding year basis to make the computation of two due payments on account on January 31st and July 31st directly after the year of tax. The tax balance is due on January 31st 2015 and July 31st 2015. This lag provides a considerable benefit in the case of rising profits. The drawings of a sole trader or a partner do not themselves accelerate or attract a charge of tax.
As a usual manner, a company makes the payment of a corporation tax nine months after the termination of its period of accounts. Companies that make the payment of tax at a main rate need to make payments in quarterly manner on account based on the estimated liability of the ongoing year. As an employer, it will have to be accountable for NICs and PAYE 14 days after the termination of each month of tax in which the date of pay falls.
Hence, in general, a company that holds a business will make the payment of tax earlier the case when a sole trader or a partnership holds a business.
Planning for the Dark Days
There may be a case when things go wrong for a business or a company. In such a change in circumstances, sound planning of tax should always be there for accountability. A struggling concern may eventually become profitable or even a successful business may fail.
Serious problems mostly do not occur by running down an unincorporated business. The balancing charges with relief of loss may be covered by the proprietor.
Disincorporation or taking a business out of a company, or winding up a corporate trade all at once, is more complicated and covers both tax and legal issues. The following points should be considered:
Provision of Personal Services by the Personal Service Companies (PSCs)
The provisions of IR 35 are the rules of anti-avoidance that attack the provision of personal services by the personal services companies (PSCs). If an individual was an employee if he had been working for a company directly for a client, then generally, he will be subject to NIC and tax on income from the personal service company if he was an employee of the client in reality.