Time to disincorporate?
There are many factors to consider when deciding whether to run a business as a sole trader or via a limited company, but tax has always been a key one. Although there are some tax advantages of being unincorporated (e.g. the ability to carry back losses arising in the first four fiscal years of trade against other income; lower national insurance rates), the ability to choose when you draw income from a company (and are therefore taxable on it) and the option of taking mainly dividends (to avoid employer and employee NICs) has made the company option much more tax efficient, particularly for businesses with high profits.
Almost surreptitiously, this area has evolved over recent years, to the extent that many smaller companies should be considering whether a limited company structure is still appropriate for them.
The reasons are as follows:
- Since 1 April 2023, companies with profits above £50,000 have seen a significant increase in their marginal corporation tax rate, from 19% to 26.5%, until profits reach £250,000, when the main rate of 25% kicks in. These profit limits are reduced where there are associated companies (broadly, companies under common control).
- Employers’ NICs are to increase significantly from 6 April 2025. The threshold at which contributions start decreases from £9,100 p.a. to £5,000 p.a. and the rate increases to 15% (from 13.8%).
- The potential tax savings by taking dividends rather than salary have been greatly eroded, due to:
- the four-percentage point reduction in the main rate of employees’ NICs that has happened in two stages, commencing in January 2024; and
- the effective increase of about 8.75% in dividend tax rates, which began with George Osborne’s abolition of the dividend tax credit system in 2016; dividends are not deductible for corporation tax purposes, unlike salary.
The practical impact
For the owner of an OMB, the exact tax cost of withdrawing profits from a company will depend on several factors, including how it is done (dividend or salary, or perhaps interest or rent), what other income you have, the availability of the Employment Allowance (EA) to mitigate employers’ NICs and the company’s level of profits.
The table below is based on the following assumptions:
- The EA is not available (e.g. it is a sole director company);
- The owner has no other income; and
- A salary equal to the personal allowance is taken, with the post corporation tax profits being fully paid out as dividends.
The table also gives figures for a sole trader with equivalent profits.
As you can see, the sole trader is better off at each profit level. Of course, the director would not need to make a full distribution of profits, but many, particularly at lower profit levels, may need to do so. It is worth adding that there seems to be little likelihood of personal tax rates being cut soon, so delaying distributions until later years may not save much tax anyway.
Some OMBs may want to consider disincorporation. There are no special reliefs when disincorporating, so how this is done will need careful consideration.
We are happy to advise you on whether a limited company is still the most appropriate structure for your business, so please contact us if you want to discuss this area.
| Profit before director draws salary/dividends (£) |
Post tax income for director (£) |
Post tax income for sole trader (£) |
|---|---|---|
| 30,000 | 24,657 | 25,468 |
| 80,000 | 56,804 | 57,711 |
| 150,000 | 87,178 | 92,040 |