News and Views
Incorporation and tax savings

The main benefits of becoming incorporated or 'going limited' is the lower rate of Corporation Tax when compared to the rate of Income Tax that sole traders and partnerships profits are charged. The first £10,000 of companies profits are tax-free, and between £50,000 and £300,000 are taxed at 19%. An additional factor is that, from 6th April 2003, sole traders and partners will bear the burden of an additional 1% National Insurance Contribution (NIC) on all profits over the personal allowance of £4,615.

For a director of limited company the remuneration package can be structured to be paid in the most tax efficient way. A salary equal to the tax-free personal allowance is paid, without attracting income tax or NIC liability and the balance of the company's profits is drawn as dividend. There is the potential to withdraw approximately £30,000 in dividends without paying further tax.

If the company has profits of more than £10,000 it will have Corporation Tax liability but tax will be payable at a rate lower that income tax rates.

The low salary could cause problems if you or the company contribute to a pension scheme as the levels of premiums are generally linked to the level of salary payments only and not dividends. However, there is a special five-year rule that allows for the pension contributions to be based on a particular base salary year. That figure can be used for a further five years during which salary is swapped for a dividend.

In addition to extracting income by way of salary and dividends, tax free withdrawals can be made from the directors loan account, which will have been credited on incorporation with the payment for Goodwill transferred from the sole trader/ partnership to the company.

Illustration of tax savings that can be achieved on incorporation

There are several other factors that should be taken into account when considering incorporation, perhaps the most important of which is that the companyís money is not your own. This means that you can only take money out of the company by it being properly recorded and subjected to taxation, although if this is properly planned the tax advantages above will still apply. Companies are also subjected to a more rigorous reporting regime with formal accounts required to be prepared within 10 months of the year-end. However the additional costs are small compared to the tax savings available.

If you would like further information on Incorporation please contact Chris Wright on 01242 548600.