THE CHOICE OF BUSINESS FORM SOLE TRADERPARTNERSHIP VERSUS LIMITED LIABILITY COMPANY

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THE CHOICE OF BUSINESS FORMSOLE
TRADER/PARTNERSHIPVERSUSLIMITED LIABILITY
COMPANY
Theory and practice of taxation BModule code
333TB2 Lecture 12
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INCORPORATIONGENERAL FACTORS

• Limited liability status
• Corporate personality
• Finance
• Costs of formation
• Administration
• Filing of accounts

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SOLE TRADER/PARTNERSHIPVERSUSLIMITED LIABILITY
COMPANYTAX CONSIDERATIONS

• 1 Remuneration
• 2 Tax rates
• 3 NIC
• 4 Dividends
• 5 Pensions
• 6 Loss relief
• 7 Date of payment of tax
• 8 Capital gains tax
• 9 Loans

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1 Remuneration

• Sole traderTrading incomeNo deduction for
  salary, fees, bonus, NIC of proprietor Spouse of
  proprietor if employed salary etc must be
  reasonable (ie wholly and exclusively for
  business purposes if a partner can take any
  share.
• Ltd companySalary, employers contribution to
  pension fund, employers NIC etc all
  deductibleShareholder/director assessed as
  Employment Income

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2 Tax rates

• Sole trader10, 22, and, after 32,400, 40
• Ltd company
• (0, 23.75), 19, 32.75 and, after 1.5m, 30

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3 NIC

• Sole traderClass 2 2.10 p weekClass 4 8
  profits between 5,035 and 33,540
  1 profits over 33,540Not deductible from
  profits
• Ltd company Class 1Employee 11 on
  remuneration between 97 and 645 p wk. Plus 1
  earnings over 645Employer 12.8 on
  remuneration 97 and aboveDeductible from profits

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4 Dividends

• Payment from a company by dividend or
  salaryDividends saves NIC (some social security
  benefits will be lost)
  reduces net asset value and hence value of
  shares. This will reduces capital gains on
  disposal of shares not
  deductible from profits (as salary)Pension
  contributions are based on salarySalary will be
  assessed as Employment Income. Dividends may not
  result in extra tax (depends on level of income)
  

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5 Pensions

• Terms and conditions broadly same for employed
  and self employed but note that in an
  occupational scheme the employers contribution
  is a deductible expense.

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6 Loss relief

• Individuals can offset losses of first four years
  against other income of three preceding years.
  Not available to companies.
• Otherwise loss relief similar. More flexibility
  to individuals on relief against other income in
  year of loss and preceding year.

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7 Date of payment of tax

• Corporation tax 9 months after end of accounting
  period (small companies)
• Income Tax Two equal instalments 1Jan in year of
  assessment and 1July following

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8 Capital gains tax

• Individuals get an annual exemption of
  8,800.Pay CGT at IT rates 10, 20, 40
• Companies pay CT on gains. CT rates (0, 23.75),
  19, 32.75, 30
• Companies may pay tax twice on gains CT at time
  of gain. This will increase asset value and then
  there will be a capital gain if the shares are
  sold

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9 Loans

• Tax implications of loans to a participator of a
  Close Company
• These do not apply to loans to proprietors

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10 Raising Finance

• Enterprise investment scheme and venture capital
  scheme give qualifying companies advantage over
  unincorporated businesses

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COMPARING SOLE TRADER AND COMPANY PROFITS OF
60,000 Example 1 Company retains all profit
(Assuming 2006-07 rates of tax taxpayer a
single person with no other sources of income)
SOLE TRADER
COMPANY Profits subject
to IT 60,000 Profit subject to CT
60,000


CT _at_ 19
11,400 Retained profits
48,600 INCOME TAX On first 33,300
7,068 Next 21,665
_at_ 40 8,666 Total
54,965 (pa 5,035) 15,734 Self employed
NI 2,653 IT NI
18,387 Net income
41,613

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COMPANY MAKES MAX DISTRIBUTION AS SALARY


Trading profits
60,000 Less Salary
(53,763)
Employers NI
(6,237) PCTCT

NIL CT

NIL Retained profit

NIL
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PERSONAL TAX POSITION Income

53,763IT on first 33,300

(7,068) Next 15,428 _at_40
(6,171
Total 48,728 (53,763 5,035)
(13,239)Employees
NI contribution
(3,337) Net income
37,187
Total wealth (nil retained in company) Compared
with Sole trader
41,613
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COMPANY MAKES DISTRIBUTION AS DIVIDENDS

• Distribute all after tax profits as dividends
• Profit
  60,000
• Tax _at_ 19
  11,400
• Profit after tax
  49,600
• Dividend
  49,600
• Retained profit
  Nil

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Personal Tax position
Dividends received
49,600 Gross taxable income (49,600 x 10/9)
55,111 Less personal allowance
5,035 Taxable income
50,076 Tax payable IT on first 33,300 _at_10
3,330 Next
16,776 _at_32.5 5,542

Total 50,076
8,872 Tax credit 10
55,111
5,511 Additional tax payable
3,361 NB NO tax is repayable
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Total wealth
Dividend
49,600 Less additional tax payable (slide 18)
3,361 46,239 Retained
profit 0
46,239Compared to distribution as salary (16)
37,187Sole trader (14)
41,613

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OTHER CONSIDERATIONS ADVANTAGES OF
CORPORATE STATUS Limited Liability (Sole
traders and partners are liable jointly and
severally for their firms debts)Raising Finance
etcOutsiders will be more willing to take an
equity stake in a limited companyShares of
different classes may be createdLoan finance
easier to obtain as lenders may take a charge on
company assets. Flexibility when transferring on
business Shares are more easily transferred e.g.
than property Commercial image
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OTHER CONSIDERATIONS ADVANTAGES OF
CORPORATE STATUS

• Retained profits are subject to Corporation Tax
  only - not Income Tax or NI
• More generous pension provision may be made by
  the Employer (the company) for employees
  (directors) than under Personal pension
  provisions
• Benefits for employees can be more tax-efficient
• Value of business is converted into shares which
  could become quoted ( eg on AIM)
• This can provide for succession of ownership (
  and make original owners (very) wealthy)

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DISADVANTAGE OF CORPORATE STATUS Complications
with regards to return of capital Restrictions
on making loans to directors Rules on tax
deductibility of expenses. (Benefits in kind)
Loss relief is more generous for sole trader
e.g.. Set off against all other income of the
taxpayer under S380 and S381.There may be
Capital Gains Tax difficulties on disposal of
widely held shares in a family companyPotential
double charge on capital gains Company
sells as asset - subject to Corporation Tax on
gain Shares of company reflect this
gain When the shares are sold this
increase in value will be subject to
Capital Gains TaxThis may be overcome by
assets such as land and building being held as
private assets of the director/shareholder and
rented or loaned to the company.
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DISADVANTAGE OF CORPORATE STATUS A partners
share of profits will not be challenged by Inland
Revenue (provided they are a genuine
partner)BUTExcessive remuneration to
employee/director may be challengedNI
contributions of company plus employee are
usually higher than those of self-employedThere
may be statutory requirements re books, audit
etcDisclosure requirements may give sensitive
information to employees, competitors etc