Running your Business as a Company
What does the future hold?
You may be wondering if the changes announced by Gordon Brown in the Budget mean that you are little better off running your business through a company than if you were running it in an unincorporated form.
What are the changes?
The Chancellor did not restrict himself to changes for the 2007/08 tax year as he normally does, but promised a raft of changes to the income tax, corporation tax and National Insurance (NI) rates and bands up to and including the 2009/10 tax year. Some of these changes come through in different years so it is easier to look at the position once all the changes have taken place in 2009/10.
In summary these changes are:
Year |
Year |
|
Income tax |
|
|
Starting rate on earnings |
10% |
abolished |
Basic rate on earnings |
22% |
20% |
Higher rate on earnings |
40% |
40% |
Corporation tax |
|
|
Small company rate |
20% |
22% |
So, at first sight, a self employed person appears to benefit compared to a company given the rise in corporation tax rates and the reduction in basic rate. However this issue is further complicated by the changes to the NI and tax bandings. In summary, the bands will be (ignoring increases expected due to inflation):
|
Tax |
Year |
Income tax |
|
|
Personal allowance |
5,225 |
5,225 |
Starting rate band |
2,230 |
Nil |
Basic rate band |
32,370 |
35,400 |
Higher rates start at: |
39,825 |
40,625 |
NI |
|
|
Lower earnings limit (no NI) |
5,225 |
5,225 |
Upper earnings limit |
34,840 |
40,625 |
The government is intending to align the upper limit of the basic rate band with the upper earnings limit for NI with the effect that the unincorporated business will pay more NI at 8% rather than 1%.
This alignment of the income tax and NI bands by 2009/10 is a key part of the change. A self employed person pays Class 4 contributions at 8% on the profits falling within the lower and upper limits but only 1% on profits in excess of the upper limit. There is therefore a significant increase in the contributions by 2009/10.
So are you better off as a company or as an unincorporated business?
The answer, of course, is that it depends on your particular circumstances but the examples below give an indication of the savings that are still achievable by a business trading as a company.
Significant advantages of trading as a company are that the owners can decide:
- how much profit is actually paid out to the owners of the business. An unincorporated business may suffer a 41% marginal tax rate (40% income tax and 1% NI) on profits even if the profits are reinvested in the business. A small company will suffer only the small companies rate (22% for 2009/10) and so has a far higher ratio of profits that can be reinvested;
- the balance of the payout between salary and dividends. For many small companies a payment of a small salary and the balance as dividends can be a tax efficient form of profit extraction.
The examples assume that all the profits of the company are distributed by paying a salary equal to the personal allowance and the balance as dividends. They give an indication of the tax savings that may be achievable for 2009/10 once all the proposed changes in the tax system have taken place.
Sole trader compared to ‘one man company’
Profits: |
£30,000 |
£50,000 |
£100,000 |
Tax and NI payable: |
£ |
£ |
£ |
As sole trader |
7,051 |
13,870 |
34,370 |
As company |
5,451 |
10,617 |
31,367 |
Potential saving as a company |
1,600 |
3,253 |
3,003 |
Partnership (two partners) compared to company
Profits: |
£30,000 |
£50,000 |
£100,000 |
Tax and NI payable: |
£ |
£ |
£ |
As partnership |
5,702 |
11,302 |
27,740 |
As company |
4,301 |
8,701 |
21,233 |
Potential saving as a company |
1,401 |
2,601 |
6,507 |
If you would like more detail as to how the figures have been calculated or see some calculations which fit your particular circumstances, please do not hesitate to contact us if you would like further advice.
The tax calculations indicated in this document are based on the government’s tax proposals for 2009/10. It is possible that further changes are made so that the benefits of operating your business as a company are no longer applicable. We will of course keep you informed of future developments.
Download the Running your Business as a Company fact sheet as a pdf
