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A COMPLAINT OF the Federation of Small Businesses has for some time been that this Government, in aiming to help small business, has concentrated much too heavily on the corporate sector. The argument is that this concentration is beginning to create significant distortions as a particular vehicle is chosen for its tax efficiency rather than its market suitability.
While it is well known that a trader (as long as he is safe from IR35) can save tax by incorporation, we may be in danger of forgetting that this is almost entirely this Government's doing. In 1996-97 the amount of tax that any small trader could save by incorporating and paying himself in dividends was small, probably less than the added expense of administration. See Example 1. Furthermore, because it meant forgoing pension payments, it was probably not even tax efficient.
The differences now, however, are startling. As illustrated in Example 2, a trader making £20,000 a year profit could save £2,187 in tax by incorporating his business. A trader making £42,000 a year can save more than £3,000 (see Example 3). There are three reasons for this:
Movements in tax rates
The small companies corporation tax rate in 1996-97 was 24 per cent and is now 20 per cent, with the addition of the ten per cent starting rate, whereas the basic rate of income tax has only fallen from 24 per cent to 22 per cent, and the ten per cent band is going to be extended next year.
Advance corporation tax
The abolition of advance corporation tax has changed the position substantially in favour of the higher rate shareholder.
National Insurance
Increases in National Insurance, in particular the substantial increase in Class 4 National Insurance, have added to the incentive to incorporate and take dividends.
Finally, the new regulations for stakeholder pensions mean that it is necessary only to take a salary one year in five and still make pension payments if wished.
There are of course issues resulting from the national minimum wage which might have marginal impact on the planning but the Examples illustrate the broad possibilities.
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Example 1 |
