Preparing for business with ICAEW and X-Forces
Part 9: Taxation of limited companies
By Clive Lewis, ICAEW, in conjunction with X-Forces
One of the first decisions a start-up business must make is what business format to trade under. There are three basic formats – sole trader, limited company or partnership – although there are some other alternatives.
The decision as to which format to choose has been made more complicated by a change in the way dividends from limited companies are taxed. The change took effect on 6 April 2016. Until then most people forming limited companies paid themselves a salary to use up their personal tax allowance and took the renaming profits as dividends. This was because, previously, dividends were treated as 10% tax paid as well as not making the recipient liable to National Insurance.
So what are the changes?
From 6 April 2016 dividends received attract tax above a dividend tax-free allowance of £5,000. Above this level, dividends will be taxed at 7.5% for standard rate tax payers. Higher rate tax payers will pay tax at 32.5% above earnings of £32,000. For the top rate of tax (earnings above £150,000) dividends will be taxed at 38.1%
How does this work in practice?
Two illustrations will aid understanding.
• Sole trader tax and NIC – £5,920
• Limited company corporation tax and income tax on dividends – £5120
• Saving for limited company – £800
• Sole trader tax and NIC – £23,128
• Limited company corporation tax and income tax on dividends – £21,470
• Saving for limited company – £1,658
Figures for limited companies assume a salary of £8,000 to the owner, to reduce taxable profits and to minimise the NIC contributions and the balance of profits after tax paid as a dividend to the owner.
With profits of £30,000, a saving of £800 for the limited company would be absorbed by the additional costs of administration of a company.
So, from 2016/17 onwards, to make savings in taxation, choosing a limited company is now less tax efficient. To cover the costs of being a limited company and to make significant savings in taxation, a business needs to be making profits approaching £40,000. The savings of forming a limited company start tailing off at around £50,000 and, at £100,000, the tax saving will probably not justify the additional costs.
Ready to go?
Register for X-Forces’ start-up and business planning support today at www.x-forces.com Help for businesses can be obtained from ICAEW’s Business Advice Service, in the form of a free, straightforward discussion with an ICAEW Chartered Accountant. Find out more at www.businessadviceservice.com
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