Lee Sharpe considers what the personal tax freeze and the Corporation Tax hike mean, for people who are considering incorporating their trading businesses (or not).
Introduction
The Chancellor delivered a Budget he described as “unpopular but honest” on 3 March 2021. In broad terms that might be considered a fair assessment, although it will not have taken long for veteran advisers to realise that, far from a novel approach, there was much that basically reversed a good deal of what his recent predecessors had been trying to do since the 2010 Emergency Budget (which, if one recalls, set out to deal with the last “once-in-a-generation” global financial crisis).
This article will concentrate on one of the key announcements in the Budget, being the (re)introduction of a higher main rate of Corporation Tax of 25%, for profits deemed to arise from 1 April 2023. This has been somewhat tempered by the (re)introduction of a “Small Profits Rate” that will retain the current rate of 19% for the first £50,000 of taxable profits.
This also means that:
- There will be a higher Marginal Rate (26.5%) for chargeable profits between £50,000 and £250,000, to “catch up” so that the company will have effectively paid 25% tax on all profits up to £250,000
- The £50,000 and £250,000 thresholds will be split amongst groups, and
- “Associated company” rules will be re-introduced to prevent avoidance by fragmenting a business amongst several companies
- The rules may not be exactly the same as the previous regime
One Minor Detail…
When the then-Chancellor announced in the Summer 2015 Budget that he intended to take the rate of Corporation Tax below 20%, he said that he couldn’t do so while Income Tax rates on dividends were so low – and that they were only so low in the first place because they had been drawn up when Corporation Tax was high. What appeared to have escaped the then-Chancellor’s understanding was that the vast majority of small companies had not yet enjoyed any of the reduction in Corporation Tax rates, because it had previously been aimed almost exclusively at larger companies. So, Corporation Tax rates have been pushed back up again, but has the taxation of dividends also been reduced, to compensate? Of course not.
Should I Run My Trade Through a Company?
The Chancellor has also helpfully set out that the tax-free Personal Allowance and Higher Rate Threshold will remain static for 2021/22 through to 2025/26, so that “fiscal drag” due to wage inflation over the next few years will cause more people to pay tax at higher rates without realising.
This allows us to isolate and to predict what will be the effect of the change in CT rates from April 2023. The following chart compares what will be the net income for a single shareholder who draws a salary of £750pcm (£9,000pa) and then takes all annual profits remaining (after Corporation Tax has been paid) as dividends, for varying levels of pre-salary profit in the company – versus what he or she would expect to get in self-employment. The dashed line is the result for 2022/23, while the solid line is for 2023/24 – “before and after”; just for fun, the dotted line shows 2015/16, before the new dividend regime tanked dividends. The following table shows the “post-tax” income from self-employment, and from operating the trade through a company, on which the chart is based.
Results and Conclusion
Note the calculations assume the trader has no other income, etc. There is no real change from 2022/23 to 2023/24 until the pre-salary profits reach around £60,000 (so that after the £9,000 salary, Corporation Tax starts to be charged at the higher Marginal Rate above £50,000). After that, however, the rate of decline in net benefit of being in a company will be much steeper than under the current regime. The net tax benefit, where dividends taxed at only 7.5% below the Higher Rate Threshold offer a modest net yield, is soon lost once the higher Corporation Tax rates eat away at the amount left from which to actually pay out dividends. While £50,000 of profits may seem reasonable, where they are shared out between several shareholders, the pinch point will be much sooner. As pre-salary profits rise beyond £250, the net cost exceeds the apparent mischief of “tax-motivated incorporation” that the then-Chancellor supposedly sought to address in the Summer 2015 Budget. While “freezing” Income Tax rates is forecast to net around £19billion to the Exchequer by the end of 2025/26, the change to Corporation Tax is projected to return almost £48billion. Many family company owners will have received quite limited pandemic support from the government, in the absence of relatively high salaries; it is arguable that they may feel somewhat disinclined to bear the lion’s share of the cost to replenish the government’s coffers. Note, however, that disincorporation / dissolving a company may also prove an “expensive option” from a practical and capital gains perspective. Note also that there is no “end date” for the incoming Corporation Tax regime – the Budget did not refer to it as a “temporary measure”.
