UK Tax Planning

by | Oct 21, 2016 |

INTRODUCTION
There are several financial advantages to using a UK company. Some of the greatest benefits include:

  • A UK company is an independent legal entity. This is important because, in the event that your business is sued or takes actions to sue another entity, your personal assets will be protected.
  • Companies are subject to significantly lower tax rates than person income tax rates. While the highest bracket of person income tax was 45% in 2015, the maximum rate of company tax was just 20%. Business owners who earn profits within their company can especially benefit from this lower tax rate.
  • The government continues to create corporate tax cuts that make it easy for businesses to prosper. Since April 2015, corporate tax rates have been cut from 30% to 20%. Tax rates will be reduced even further, with the rate going to 19% in 2017 and 17% by 2020.
    While companies can already benefit from the declining corporate tax rates, there are a variety of additional actions that business owners can take to minimise their company and person tax liability even further.

In this guide, we discuss the main aspects of tax planning for both companies and company owners.

Why use a limited company for Tax Planning?

This section focuses on the main benefits of using a company.

When you use a company, your business is considered an independent legal entity, meaning that your company is taxed separately from your personal income tax—but at significantly lower rates.

If you were to trade in your own name, your personal income tax would range from 20-40% depending on your income. On the other hand, if you trade as a limited liability company (LLC), your tax obligation would be reduced to a maximum rate of 20%. This savings in taxes is especially financially advantageous as your business grows and your profit margin increases.

However, corporate tax is not the only tax expense business owners need to consider. Income tax, due to the extraction of profits from a company by a shareholder, can reduce the attractiveness of using a company for tax purposes, especially when high levels of profits are extracted from the business.

These shareholder payments are typically allocated in the form of dividends since dividends now result in higher levels of take-home pay than salary payments. Unfortunately, dividend tax rates remain high, currently estimated at a 32.5% rate for higher rate taxpayers and a 38.1% rate for additional rate taxpayers. Even with the advantage of low corporate tax rates, dividend tax liabilities could cancel out the tax benefits of using a company.

On the other hand, when businesses are able to retain profits within the company, even if it is just a portion of profits, they can capitalise on the financial advantages of using a company. One advantage of this profit retention is when businesses are able to reinvest profits, it becomes possible to defer tax payable. Of course, the company could become liable for income tax payments in the future if profits are extracted, but there are ways to liquidate the company and extract funds as capital distribution or extract tax-free as non-residents, in order to limit liability (potentially even reducing the rate to only 10% CGT).

SHOULD YOU EVEN USE COMPANY?

Determining whether or not you should be using a company is an important decision that carries financial consequences. As we have discussed in Section 2, reinvesting profits in your company can significantly reduce your total tax payable. However, there are certain circumstances where this is not the case, and using a UK company could actually increase your total tax payable instead.

Some of these special circumstances include:

If you’re planning on moving overseas

The tax consequences of moving overseas are often overlooked by those deciding whether to use a UK company, but it is an important consideration due to the tax complications involved.

For example, imagine that you sell eBooks online and you transfer the rights to your books to your UK company because of the many tax benefits.

Now imagine that five years later, your eBooks have become widely successful, and you can finally afford your lifelong wish to move to a hot climate, like Cyprus.

If you were trading in your own name, you could move to Cyprus without complications and you could just continue trading from overseas. As long as you do not make any UK trades, then there will be no UK tax charges incurred, and you could benefit from the minimal royalty tax rates in Cyprus. In addition, unlike many other countries, when you cease to be a resident in the UK you are not charged with disposal of assets.

Unfortunately, since your eBook profits and rights are locked into a UK company, there are several tax complications involved with moving overseas.

In order to transfer the eBooks out of your UK company, you would have to crystallise a gain in the company which is determined by the nominal acquisition cost and the current market value of your books (which could be substantial if you are generating high royalties per annum). This means that even if you never return to the UK, you are still obligated to a 20% corporate tax fee.

In addition, when you establish a UK company, your business is permanently linked to the UK since you would still be receiving UK dividends. One way that companies try to circumvent these additional charges is by incorporating overseas so that the new company could hold shares, but this would cost you more in incorporation and reporting fees.

Occupying property
Using a UK company could pose several disadvantages to those intending to purchase and occupy residential property.

The main downsides of using a company under these circumstances include:

  • The property will be locked in the company.

This means that any disposal or sale of the property would crystallise a gain in the company, and cause additional tax charges related to the extraction of the profits.

  • There are far fewer reliefs available to a company than to an individual.

For example, if you live in your property as your main home, you could qualify for principal private resident relief (PPR) as an individual when you dispose of, or sell, your home. Additionally, if the property is sold for a profit, individuals can benefit from an annual exemption amount on their Capital Gain Tax (CGT) liability. In contrast, companies do not qualify for these reliefs and exemptions, and tax fees could actually eliminate any gains on property disposal. Companies are only entitled to a small of relief intended to compensate for inflation.

  • If you claim the property under your company but you occupy it as your primary home, you could also be charged income tax on the market rental income that your company could have earned.

This is because if you do not pay market rental to the company, then, for tax purposes, this is viewed as a type of personal compensation that falls under personal income.

  • Company properties are subject to Annual Tax on Enveloped Dwellings (ATED) in addition to Stamp Duty and Land Tax (SDLT) and ATED-related Capital Gain Tax (CGT).

These high-rate tax charges apply to company-owned residential properties that are valued at or over a certain amount. The thresholds for these taxes have significantly increased since their establishment in April of 2013. For example, when ATED was first enacted, the threshold began at properties valued at £2 million and over; now properties valued as low as £500,000 and over are obligated to pay £3,500 in ATED charges for the period 1 April 2016 to 31 March 2017. In addition, companies are responsible for SDLT charges relating to residential properties valued at just £125,000.

For these reasons, it is typically not financially advantageous to own a residential property via a company.

If you’re a non-UK domiciliary

If you are a resident of another country outside of the UK, it may not be advisable to use a UK company because you will generally be charged taxes for all overseas profits and assets.

Typically, UK companies are classified as residing in the UK and are responsible for corporate taxes on all global profits and incomes.

Provided that you can retain income at your country of residence, it may be more advantageous to establish your company overseas and avoid UK tax charges.

Incorporation followed by a quick sale

Sole traders or business partners of unincorporated businesses can benefit from Entrepreneurs relief, a 10% CGT rate on gains of up to £10,000,000) when they sell all or part of their business in shares.

In contrast, once your company is established you cannot benefit from Entrepreneurs Relief on any shares sold within the first 12 months. This is because when you transfer your business rights to a company, a new period of share ownership starts. Even if you incorporate your company and then leave it dormant for years, you still need to meet 12 months of active ownership before qualifying for this Entrepreneurs Relief.

This can be a frustrating stipulation for company owners who receive great offers for their shares shortly after incorporating.

Assets held long term

If you plan to retain assets long term, such as property or other investments, it may not be in your interest to buy through a company because you miss out on the lower rate of Capital Gain Tax (28% for residential assets, or 20% for non-residential property assets).

When companies hold assets long term, they have access to very limited reliefs. They are also liable for 20% corporate tax, in addition to income tax charges on any extraction profits (typically at a 32.5% or 38.1% rate).

Some companies choose to sell shares instead of the assets within the company because this qualifies them for the 10% or 20% CGT on gains, and possibly even Entrepreneurs Relief. However, this strategy leaves the company with unrealised tax liabilities which could depreciate the value of the company in the eyes of potential buyers.

As a result, companies tend to receive less for their share than if the assets were sold personally.

If you can’t retain profits in the company

The main reason to use a company is that you qualify for a lower rate of tax than you would personally. This benefit is significantly minimised if you continue to extract profits from the company, as these extractions incur personal tax charges that could outweigh the financial benefits of the lower corporate tax rate.

If you are a high rate tax payer, personal tax liability could be as high as 40-45% in addition to National Insurance for trading. In contrast, your corporate tax would be 20% in addition to a 32.5% tax rate on extractions of dividends.

In addition to these fees, you have to consider other costs of operating a company, including higher accounting fees, filing fees, and extra admin.

When you factor all of these expenses, it may not be beneficial to incorporate if you are unable to retain profits within the company.

If you need to make significant pension contributions
It may be more advantageous to trade personally if you need to make significant pension contributions.

Tax relief for pension contributions depends on your income level. This means that as a personal trader, you could make a pension contribution up to your net profit or the annual and lifetime pension limit.

Though you would be taxed at a 40%-45% rate, pension contributions would qualify for relief.

If you use a company, however, you would need to generate significant earned income in order to account for the tax on the company’s profits.

You may find it better to trade personally if you need to make large pension contributions.

It is also important to keep in mind that dividend income does not count as earned income—meaning that you would need to extract from your company in the form of bonuses/salaries to use as the base of your pension contribution.

If you take this route, you are liable for NIC charges on yourself (currently 2% above the upper earning limit) and the company (a tax deductible rate of 13.8% on the full amount of the bonus).

When you add these charges together, the benefits of using a company are significantly decreased. Depending on your circumstances, your company’s profits, and the pension contribution that you are making, the downsides of using a company may or may not outweigh the advantages.

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