Corporation Tax Rate

Corporation Tax Rate Reduced: Good News for Company Owners!

THERE was good news for company owners in the Budget.

It was confirmed that the main rate of corporation tax is to be reduced by 1% per year from 1st April 2011 to 1st April 2014. At the end of this period the rate will have fallen from 28% to 24%.

The planned increase in the small companies corporation tax rate from 21% to 22%, which was due to take place on 1st April 2011, has not only been abolished: it’s been reversed. This rate will now be reduced to 20% next April.

Owners of small companies (profits under £300,000) will pay almost 10% less corporation tax under the new Government. Bigger companies will pay up to 15% less tax.

The current and future corporation tax rates can be summarised as follows:

Profits                                           Year Commencing 1st April
                                         2010       2011      2012      2013      2014
Up to £300k                         21           20           20           20           20          
£300k to £1.5M                   29.75      28.75      27.5        26.25       25
Over £1.5M                          28           27           26           25           24

Incorporation
The reductions in the corporation tax rates combined with increases in personal tax rates on both income and capital gains mean that many more business owners could stand to benefit by incorporating their businesses.

Example
Georgia makes an annual profit of £50,000. As a sole trader in 2011/12, she would pay income tax of £9,730, class 4 national insurance of £3,538 and class 2 NI of £130. This would give her a total tax burden of £13,398.

If Georgia had put her business into a company instead, she could pay herself an estimated tax-free salary of £5,925 during 2011/12, leaving a taxable profit of £44,075. The company would pay corporation tax at just 20%, or £8,815, leaving after-tax profits of £35,260. Georgia could then take a tax-free dividend of up to £34,155 (£43,875 - £5,925 = £37,950 x 9/10 = £34,155).

By using a company, Georgia could thus save £4,583 by using a company if she retained £1,105 or more of her after tax profit in the company. She would even still save £4,307 if she distributed all her after tax profits as a dividend.

The potential savings for other unincorporated trading business owners who transfer their businesses into a company are as follows:

Profits	Personal Tax	Using a Company	Saving
£10,000	£1,002	£815	£187
£20,000	£3,902	£2,815	£1,087
£30,000	£6,802	£4,815	£1,987
£40,000	£9,702	£6,815	£2,887
£50,000	£13,398	£9,091	£4,307
£75,000	£23,898	£19,091	£4,807
£100,000	£34,398	£29,091	£5,307
£150,000	£58,388	£49,091	£9,297
£200,000	£84,388	£69,091	£15,297

These illustrative savings are again based on the assumptions set out above and also on the assumption that the owner takes the maximum tax-free salary (i.e. equivalent to the NI earnings threshold) and extracts all remaining after tax profits as a dividend.

Before everyone rushes into forming a company, however, it is worth remembering that there was another very beneficial Corporation Tax regime between 2002 and 2004. Many people rushed into forming companies at that time only to see steady increases in the tax on small companies and their owners over the following years. It could happen again!

Company Capital Gains
Using a company to hold investment properties could become increasingly popular following the latest changes to corporation tax and capital gains tax.

Companies pay corporation tax on their capital gains as well as their income, which means most will pay just 20% tax on up to £300,000 of capital gains from April next year.

By contrast individual investors who are higher-rate taxpayers will pay up to 28% tax on their capital gains.

Companies do not receive the £10,100 annual CGT exemption but they do enjoy one very valuable tax relief that individual investors no longer receive: indexation relief.

Indexation relief eliminates the purely inflationary element of capital gains. The relief is based on the increase in the retail prices index over the period of the company’s ownership of the asset.

Example
Some time in the future Sandy sells an investment property he holds inside his property company, Built on Sand Ltd. The property was purchased 15 years previously for £200,000 and sold for £450,000.

This gain of £250,000 is reduced by indexation relief. Let’s say the retail prices index has risen by 50% between the purchase date and the date of disposal. This means indexation relief will be £100,000 (£200,000 purchase price x 50%).

Sandy’s taxable gain will therefore be reduced from £250,000 to £150,000. Corporation tax at 20% comes to £30,000.

If Sandy had held the property outside a company the tax could have been as much as £70,000 if he is subject to the maximum 28% tax rate on the entire gain and has already used up his annual CGT exemption for the year.

Even if Sandy owns the property with a wife or partner and they manage to free up two CGT exemptions and two basic-rate tax bands (paying CGT at 18%) the tax bill will still be in the region of £57,000 based on current tax rates.

So Sandy has saved between £27,000 and £40,000 by using a company.

Companies can, of course, also save you tax on your rental profits. A tax rate of 20% is of course, far more attractive than a tax rate of 40% or 50%.

The one problem with using a company is taking money out. Withdrawals can be taxed as dividends, resulting in an additional 25% tax becoming payable if you are a higher-rate taxpayer (36.1% tax if you have income over £150,000).

This additional corporation tax can, however, be avoided by using your company as a long-term investment vehicle and only extracting funds at certain times, for example when you have very little other taxable income for the year.