Mark McLaughlin points out that the proposed new dividend tax regime should not necessarily be seen as a stumbling block for unincorporated business owners seeking to incorporate, but that any planning must be considered very carefully.
The government has an apparent fixation with ‘tax-motivated incorporations’. This has resulted in the introduction of measures to reduce possible tax advantages of incorporation, including restrictions on both the availability of entrepreneurs’ relief on the disposal of goodwill upon incorporation, and corporation tax relief on the amortisation of goodwill under the intangible fixed assets regime.
Dividends following incorporation
In practice, the vast majority of incorporations are driven by commercial issues, such as the protection generally afforded by limited liability. However, tax considerations obviously need to be taken into account when deciding whether to incorporate.
A possible advantage of incorporation is the potential ability of the company owner(s) to take dividends (subject to company law considerations, and the company’s cash flow). A popular approach to remuneration planning has traditionally been the payment of low salaries and high dividends, mainly due to the National Insurance contributions savings achievable by paying dividends as opposed to salaries.
The proposed reform of dividend taxation (to be included in the Finance Bill 2016) is not aimed directly at discouraging incorporations. However, the changes are likely to have that general effect, because the tax rates on dividends are set to increase. For 2015/16, the effective tax rates on dividends for basic, higher and additional rate taxpayers are 0%, 25% and 30.55% respectively. By contrast, for 2016/17, dividend tax rates of 7.5%, 32.5% and 38.1% are to apply instead.
Whilst tax savings may still be achievable in many cases, including for incorporated business owners applying a ‘low salary, high dividends’ policy in 2016/17, such savings will generally be smaller than in previous years. It will be a matter of crunching the numbers in each case, with a view to achieving the optimum tax position based on the particular circumstances.
Planning with the 0% dividend tax rate
However, some owners of small businesses in particular may still see potential tax advantages in operating through a company. For example, a significant feature of the proposed new dividend tax regime from 2016/17 is the introduction of a 0% tax rate on the first £5,000 of dividend income. Future tax planning for company owners is therefore likely to involve the payment of sufficient dividends to at least utilise this ‘dividend allowance’ for each individual shareholder, where possible.
The proposed £5,000 dividend nil rate has obvious attractions. For some owner-managed businesses in particular, following incorporation there may be an opportunity to introduce family members as shareholders. This could allow the family member to take advantage of their own dividend allowance and (for example) any unused personal allowances and basic rate income tax band.
Beware the pitfalls
Of course, there are numerous tax and non-tax issues to carefully consider before transferring any shares, which are beyond the scope of this short article. The tax implications of transferring shares are likely to include capital gains tax and inheritance tax considerations for the transferor of the shares, and possible employment income considerations for the recipient if the spouse or family member is an officer or employee of the business.
Furthermore, following such share transfers, dividend payments to family members could be open to challenge by HM Revenue and Customs, particularly if the dividends are effectively disguised remuneration. The ‘settlements’ income tax anti-avoidance provisions may also need to be carefully navigated.
As with virtually all tax planning these days, tax practitioners should give those clients who are considering planning of this nature a suitable ‘health warning’.
For clear, detailed and practical guidance on the tax issues, planning points and pitfalls which may be encountered when incorporating a sole trade or partnership business, or when transferring a company's business to a sole trader or partnership, see the newly published edition of Incorporating and Disincorporating a Business at: http://www.bloomsburyprofessional.com/uk/incorporating-and-disincorporating-a-business-9781780439044/
Mark McLaughlin CTA (Fellow) ATT (Fellow) TEP is a co-author of Incorporating and Disincorporating a Business. Mark is a consultant to professional firms with Mark McLaughlin Associates Ltd (www.markmclaughlin.co.uk). He is also Managing Editor of TaxationWeb (www.taxationweb.co.uk). Mark can be contacted via Twitter https://twitter.com/charteredtax and LinkedIn http://www.linkedin.com/pub/mark-mclaughlin/11/811/12.