Incorporation.....is it too late?.....or too early?

Whether or not to transfer your business into a limited company has been a hot topic on our desks for a couple of years now. Changes in the taxation treatment of dividends opened up a whole bunch of exciting opportunities for the forward thinking business. It largely meant that significant tax savings could be made between the trading styles of a sole trader and a limited company.

Needless to say the Revenue have been hot on our heals and outlawed some of our most innovative ideas to distribute profits in highly tax effective ways. And as the shadow of Europe looms ever closer, who is to say we may have to fall in line with neighbours and then all the benefits are gone. Or are they?

Firstly, let's be clear about what is going on here. If you chose to transfer your business into a limited company then you are bound by all the pomp and ceremony that surrounds incorporated businesses. Amongst other things you will need to submit annual returns to the Registrar of Companies; you must prepare accounts in a long winded and boring statutory format; you may need a shareholders agreement. All rather tedious and with costs involved, but if your accountant is smart he will be using technology to make this exercise as painless and efficient as possible.

So what do we gain? At the moment there are some subtle differences, and here I shall only deal with the ones that you are probably interested in, those relating to tax. In the case of most chiropractors, if you are a sole trader your top rate of tax is 40%, as a limited company it's 19%. Sounds good so far.

What else? Well, when it comes to taking money from your limited company things are not so straight forward. As a sole trader, if you have money in the bank at the end of the week you draw it out - put some in the tax account like your accountant told you and the rest straight in your back pocket.

It can be like that in your limited company too, but only if your accountant is on your side, not Gordon's. In the first instance you can take a small, (tax deductible!) salary from the company. We recommend a salary up to the national insurance limit so that the company gets full tax relief on the payment to you, and you pay minimal tax/NI whilst still maintaining your NI contributions (win, win!).

Next, you have your dividend paid into your directors' (loan) account up to the top of your basic rate band. That will be a further £30k. So long as your gross income at this point does not exceed the top rate of tax (£38,335) then your personal tax bill will be..wait for it..nil!

But what if your profits, even after allowing for the 19% tax paid by the company, allow you to draw more? Well, this is where the really smart accountant can earn his money. At the time of incorporation, so long as you had already traded for two years or more and you were making reasonable profits (that is at least £50k+) then he would have capitalised your goodwill in your own business and sold it to the limited company! The tax cost of this sale would normally be between 6 and 10% so you could stuff the net amount in your directors' account for you to draw down over the next couple of years. And we are not talking Mickey Mouse amounts of goodwill here, we are looking at £100 -150k +. But of course, your accountant has to know his onions. He may be challenged by the Revenue and will have to substantiate precisely how he arrived at that figure He can't just pull it out of thin air, and ideally he should be able to demonstrate similar practices with similar profits/turnover/patient lists etc have sold in the real world for that amount.

All too often we have seen this opportunity missed entirely, or even worse, (and here cometh the warning) businesses incorporated too early. Well-meaning advice from colleagues is no substitute for professional taxation advice in these circumstances. The danger is that the costs of selling the goodwill can far outweigh the benefits if full tax relief's (due after 2 full years of trading as a sole trader or partnership) are not available. See your accountant for more details.

So that is mostly it. If you make profits of £100k, then the company pays tax at 19%, and given you have followed the above advice you can draw out the remaining £81k without a further penny payment of income tax.

Would that be of any interest to you?

Queries/calls/emails/advice

Mike Hutchinson  BA(Hons) ACA CNLP

support@finance4chiropractors.com

01872 242800