Tax can be lesser of two evils

Peter Harrup, tax partner at the Ipswich office of accountants PKF, explains why trading through a company remains attractive for many businesses.

Peter Harrup, tax partner at the Ipswich office of accountants PKF, explains why trading through a company remains attractive for many businesses.

IN many years advising businesses on their tax affairs, I have seen several waves of sole traders and partnerships incorporating their businesses so that they can take advantage of the tax rules for companies.

First it was sub-contractors seeking to hire themselves out through service companies. The Government sought to limit the attractions of this structure by introducing the IR35 legislation.

Then, to encourage small companies, Gordon Brown introduced a 10% starting rate of Corporation Tax, later reduced to 0%. Unsurprisingly, this triggered another wave of incorporations that only slowed when the starting rate was finally abolished.

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Now, I suspect we will soon see another high tide for the use of corporate structures by family businesses. The simple reason for this is that trading through a company can save you tax.

Individuals operating as sole traders or in partnership are taxed on all the net profits of their business at Income Tax rates - 20%, 40% and soon up to 50%. Small companies currently only suffer tax on their profits at 21% (expected to increase to 22% for 2010/11).

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There are, of course, additional tax charges when profits are extracted from a company by way of salary or dividends, but the owner can choose when such funds are extracted and, therefore, when the tax on them is payable.

A further plus is that where a company makes pension contributions for owner-managers, or other employees, these are usually tax free although, where substantial new contributions to a pension scheme are contemplated, flexing your income is unlikely be effective in mitigating a Special Annual Allowance Charge under the new anti-forestalling rules.

Enabling other family members to share in the profits of your business is also possible with a company. Government proposals to legislate against “income shifting” have been sidelined and while new proposals may emerge in due course married couples, for now, still have significant freedom to allocate business profits between them tax efficiently.

In addition, the tax disadvantages to keeping surplus funds in your company have been considerably reduced by the changes to Capital Gains Tax introduced in April 2008. It is possible to achieve an effective rate of CGT of 10% on the first �1million of gains made on the sale of a qualifying business thanks to the new entrepreneur's relief.

The continuing differences in the tax treatment of different business structures mean that it is still vital to take advice on the most tax-efficient structure for your business: in many circumstances, trading through a company remains the most attractive option.

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