Trading Vehicles Flashcards
Richard - freelance with client bank c £150k pa goal Consultancy Vs Muhammad - no contacts expects to make initial start-up losses
Q. Compare the Tax and NIC implications if business ventures are set up as:»_space;(i) A sole trader
(i) A Sole Trader
-Trading profits will be assessed to income tax
-All of the sole trader’s profit is taxed at income tax rates, even if it is not withdrawn from the business. Being a sole trader could therefore be less advantageous if either R or M earn substantial profits that they want to reinvestment in the business.
-R’s existing freelance work is already taxed as trading income. The opening year rules for new businesses will not apply because his self-employment commenced four years ago and is merely expanding.
-For M, the opening year rules will apply. For the year of commencement, he will be assessed on his profit from the commencement date to the following 5 April, or a nil figure if he generates a loss.
-As a sole trader, M could set trading losses arising in any of the first four years against his income of the three tax years preceding the loss-making year, taking the earliest of these years first, subject to an annual cap that limits certain tax reliefs.
-M could probably obtain 40% (or 45%) tax relief on any losses carried back against his employment income from Megabank plc.
-Both would benefit from consulting an accountant regarding the accounting period for their businesses; >Richard will face a large increase in his tax liability if his self-employed income rises, first appearing in 31 Jan balancing payment. If Accounting Date is late in the year ie 1Apr he should change year end to delay payment
>Muhammad should choose Acc Date that maximises tax reliefs and optimises cash flow.
-Richard could loose his PA and liable for 45% addl rate tax if income exceeds £150K
-Both liable for Class 2 and Class 4 NICs [subject to relevant earnings limits]
-M unlikely to pay NIC initially [Profits >£8,632 Class4 and >£6,365 Class2
-However, both will be less than when employed (as no Em’ee Conts)
Richard - freelance with client bank c £150k pa goal Consultancy Vs Muhammad - no contacts expects to make initial start-up losses
Q. Compare the Tax and NIC implications if business ventures are set up as: (i) A sole trader,»_space;(ii) A Ltd co.«
(13) and (10) marks
(ii) A limited company
- Advantage of Ltd Co is 19% Corp Tax on profits
- A corporate structure allows entrepreneurs to shelter excess profits from higher and addtl income tax rates. The retained profits suffer only corporation tax and may be withdrawn in the future when, with careful planning, they may be taxed at lower rates. It is also possible to avoid NICs by withdrawing profits in the form of dividends [taxed at dividend rates after £2K 0% DA]
- Could be viable for R, expects to produce more income than he needs, with opp of £40K into a pension free of NIC and tax deductible for the company OR spread income to family members by employing them (provided their salaries are justifiable in relation to the work performed for the trade)
- Drawback of Ltd Co. is: if all profits are withdrawn as remuneration, total emp’r and ‘ee NICs will be higher than self-employed NICs paid by a sole trader on an equivalent level of income
- Dividends are not deductible against company’s profits for corp tax purposes
- Dividends are not earnings for pension purposes, but AA is likely to be the factor restricting tax relief for high earners
- Where intangible fixed assets are disposed of by the company (rather than individual) could lead to double tax charge ie corp tax on gain, then shareholder liable to CGT on disposal (might not be an issue for a consultancy business)
- Entrepreneurs’ relief (10% flat rate CGT) on first £10m lifetime gain realised on the disposal of shares or on a capital distribution if a company is liquidated.
- Based on the info contained, action by HMRC under IR35 would appear unlikely
Richard - freelance with client bank c £150k pa goal Consultancy Vs Muhammad - no contacts expects to make initial start-up losses
Recommend the most appropriate trading vehicles for R and M (5)
R: Limited Co.
- due to current level of profits
- allow R to smooth his personal taxable income between tax years to avoid high tax charges in a ‘good’ year
- but the reccs should come with a warning that 1) incorporation would bring his existing business to an end which COULD accelerate income tax liabilities - timing of cessation/incorporation should be discussed with Accountant for least damaging income tax impact. 2) IR35 anti-avoidance rules unlikely to apply due to variety of work
M: Sole Trader
- due to his expectation of an initial loss
- losses can be offset against his previous employment income
- due to losses, he will not initially face income tax and NIC charges as a Sole Trader
Richard - freelance with client bank c £150k pa goal Consultancy Vs Muhammad - no contacts expects to make initial start-up losses
Identify and briefly explain the non-tax factors that should be considered in making the choice of trading vehicle (12)
PRIVACY; COSTS; STATUS; PROTECTION FROM CREDITORS; PENSION ARRANGEMENTS; SUCCESSION/OWNERSHIP PLANNING; BENEFITS;
PRIVACY; Limited Co. accounts must be published but not those of a Sole Trader
COSTS; Limited Co. ‘set up’ and ‘running’ costs are marginally more
STATUS; Limited Co. tend to have more status, although smaller cos. can be view as a credit risk putting them in similar position as a Sole Trader
PROTECTION FROM CREDITORS; Cos provided ‘limited liability’ although many Directors have to give personal guarantees for corporate borrowing
PENSION ARRANGEMENTS; Employed directors and self-employed sole traders are subject to the same pension regime
SUCCESSION/OWNERSHIP PLANNING; A company can continue indefinitely and the ownership can be spread easily through different shareholding
BENEFITS; There are a number of tax-free fringe benefits that may be paid to employees, but these are not available to the self-employed
Early Trade Losses Relief
If you have just started your business and you make a loss in the first 4 years of trading then there is the possibility of carrying the loss back 3 years. There is a restriction of the amount of loss you can claim. The maximum offset is the greater of: 25% of adjusted total income; or £50,000
You must start with the earliest year e.g. you start a business in January 2020 (in the 19/20 tax year). If you make a loss in the 21/22-tax year, you can set this loss off against your income in the tax years in the following order:
Year 18/19
Year 19/20
Year 20/21
Loss relief provisions available for M
The loss relief provisions will permit M to set losses arising in any of his first 4 years against his income of the previous 3 TAX YEARS taking the earliest first. So he should be able to receive 40% (or even 45%) tax relief on any losses by setting them against his employment income from Megabank plc. M and his Accountant would need to choose the business year end carefully so as to maximise RELIEFS and optimise CASH FLOW.
The main tax drawback of Sole Trader
In the LONGER TERM the major tax drawback is that all of their profits will be fully taxable on them personally, even if they leave money undrawn in the business.
- ie. on high profits a slice of income (which may not be required immediately) could be subject to 40% tax / 45%(£150K+)
- 2% NICs (addtl Class4 >50K)
- Personal Allowance could be tapered / lost(£125K+)
- Tapered AA down from £40K to £10K at a rate of £1 for every £2 of income over £150K
The main drawback of a Limited Company
Incorporation involves higher costs, more administration and greater disclosure
Company Accounts are available for the public to view online
Limited Cos. and IR35 rules
IR35 is designed to prevent de facto employees changing what would otherwise be ‘employment earnings’ into corporate income via a company. It seems unlikely the two individuals would be regarded as being in deemed employment; their work is originated from a variety of different sources and they would not be under the control of any of their clients.
Ltd co and Corporation Tax
A limited co can be used to shelter income on retained profits after corp tax at 19% which would otherwise (for HRT payers) have been subject to 40% Income tax and 2% NICs where a Sole Trader
- where £150,000 profit, and annual tax saving of £75K x (40%+2%)-19% = £17,250
- more when you factor in the retention of his Personal Allowance (£12,500x40%) = £5,000
Ltd co and NICs
- higher than the NIC on Sole Traders
- Dividends can be to save on NICs but subject to Income Tax at Div rates [divs are not ‘relevant earnings’ for Pension purposes
Ltd co and Pension Arrangements
- Where contributions are made by a Ltd co as an employer they are not restricted by the level of earnings but still count towards the employee’s annual allowance.
- Contributions are a deductible expense for the company (unless a director’s overall remuneration package is commercially excessive)
- where earned income >£150,000 inc.pension conts (unless adj income minus pension conts was
