How To Pay Less Tax

The following article is reprinted courtesy of "biiBUSINESS, the membership journal of The British Institute of Innkeeping" and appeared in the issue dated February 2003.

Self-employed licensees could be better off forming limited companies thanks to a highly favourable tax regime for small businesses.

Many self-employed licensees run their businesses as sole traders or husband and wife partnerships, and probably haven’t thought seriously about changing to a limited company status.

Now is the time to give serious consideration to the idea. The Chancellor announced significant changes in April Budget 2002, for the small business particularly, relating to National Insurance (NI) and tax on company profits.

Much publicity was given to the extra one percent NI to be paid by companies for each employee from next April. Rather less attention was paid to the hike in NI contributions for the self-employed. These will rise next year from seven to eight percent of profits between £4,615 and £30,420 and above this level the nil rate becomes one percent with no upper limit.

Continuing the trend in recent years, the Chancellor announced a nil rate of tax on profits up to £10,000 with 23.75 percent on the next £40,000 and 19 percent on the next £250,000.

When seen in the context of previously announced changes, they add up to a highly favourable tax regime for small companies. Earlier Gordon Brown had abolished advance corporation tax on companies paying dividends with the recipient still receiving the credit for basic rate tax.

Personal pension contributions can now be paid not only from earnings, but also from dividend income, and the self-employed receive 22 percent tax relief at source.

As shown in the examples, there are potential savings ranging from around £1,500 to more than £3,500 through switching from sole trader status to running the business as a company.

The savings are helped by the ability to take dividends rather than salary for part of the income. Dividends do not attract NI and attract a maximum tax rate of 25 percent of the amount received.

Even greater savings are possible when a company is owned by husband and wife. A sole trader pays £14,452 in tax and NI on a £50.000 profit. A jointly owned company can reduce this bill by almost half to £7,308.

If you are going to run your business as a company, when should you make the change? It all depends on when the business started, your accounting date and the profit profile. The good news is that potentially there is something of a tax holiday in the early stages.

Based on a £50,000 profit and changing to a company last autumn, there is a saving of £754 in both January and July next year and a massive £6,819 in January 2004 with an extra £3,489 to pay in July that year.

You will have to consider how the business is transferred to a company. Currently there is both retirement relief on gains until next April for those aged 50 and over and also the new taper relief making 75 percent of gains exempt.

Basically, there are two elements to consider. If you own your own premises, should these be part of the new company or retained as private assets and leased to the business? Secondly, there is the goodwill of the business which is what it is worth over and above the asset value. In an established licensed business the goodwill may be worth say £120,000: if you sell the goodwill to the company, leaving the proceeds on loan, there may be a tax-free fund available to draw on.

As you will appreciate, these are not entirely simply matters plotting the best route for each business. There will be initial costs, paying an accountant and possibly also a lawyer setting up the company, and producing any new stationery etc as is required. Then a somewhat higher accountancy bill each year.

The cost of setting up a company can start from £3,500. The average cost for a publican is likely to be around £1000.

One potential problem could be the reluctance of the pub company to grant a tenancy to a limited company, as opposed to a sole trader or partnership where there is unlimited liability. Talk to your landlord first and see what reaction you get.

The answer could well be forming an unlimited company. This is treated in the same way as limited companies without the requirement to file accounts at Companies House. There is however, unlimited liability as with a sole trader: which should satisfy the property landlord.

Businesses are all different, and undoubtedly the best course is to seek professional advice. It could save you many thousands of pounds.

Why savings?

Savings are due to:

• Self-employed income tax paid is paid on profit whether drawn or not,
• Self-employed tax rates up to 40% - starting at £34,515 profit,
• Self-employed will pay NIC on all profit from April 2003,
• Companies tax rates are only 19% or less up to £300,000,
• Dividends don’t attract NIC,
• Dividends – highest rate of tax is 25%.

Savings are greater if the company is owned by husband and wife. A sole trader pays £14,452 in tax and NI on a £50,000 profit. However, a company jointly owned by husband and wife can reduce this bill by almost half to £7,308 – savings will be greater from April 2003 because of NIC increases.

Table A: Annual tax savings comparison