Kevin Read explains the impact of recent tax changes on profit withdrawal from small companies.
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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, or lower National Insurance contributions (NICs) rates), the ability to choose when to 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.
A shift in the tax landscape
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.
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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.
Although you only need to go back to 2017 for the last time we had differential corporation tax rates, the threshold at which the small profits rate was payable was much higher at £300,000, so many more companies than in the past are affected by the increase.
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Employers’ NICs are to increase significantly from 6 April 2025. The threshold at which contributions start decreases from £9,100 per annum to £5,000 per annum, and the rate increases to 15% (from 13.8%).
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The potential tax savings by taking dividends rather than salary have been greatly eroded due to:
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the four-percentage point reduction in the main rate of employees’ NICs that has happened (in two phases) from January 2024; and
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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, of course, are not deductible for corporation tax purposes, unlike salary.
The practical impact
For the owner of an owner-managed business (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 rents), what other income you have, the availability of the employment allowance to mitigate employers’ NICs and the company’s level of profits.
The table below is based on the following assumptions:
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The employment allowance is not available (e.g., it is a sole director company).
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The owner has no other income.
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A salary equal to the personal allowance is taken, with the post-corporation tax profits being fully distributed.
The table also gives figures for a sole trader with equivalent profits.
|
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 |
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.
Disincorporation
Some OMBs may want to consider disincorporation. There are no special reliefs when disincorporating, so how this is done will need careful consideration.
Practical tip
Many OMBs should consider whether a limited company is still the most appropriate structure for their business.
