Question: Two years ago our accountant encouraged us to transfer our farming business into a limited company – the aim being to reduce our tax bills. I am aware that companies pay lower tax rates and we have not paid any tax on the amounts we drew out of the company. However, I understand we will now be paying tax on our withdrawals. Is incorporation still worth it?
Answer: The choice of vehicle for any business is an important one – sole trade, partnership or limited company. Circumstances often change so the choice of vehicle should be revisited and sometimes a transfer from one vehicle to another will be appropriate
There are many factors to consider when making the decision, one of which is the amount of tax payable on the annual profits. For some time companies have paid less tax than unincorporated businesses. The current corporation tax rate is 19% compared to up to 62% for individuals.
Recently there have been a number of changes to the tax rates and rules in this area. For example, from April 2016 we saw the introduction of new rules for taxing dividend income. This has meant that many of those running their businesses through companies will pay more tax, with increased personal tax bills in January 2018. The change means that whereas individuals were able to withdraw cash from a company of over £40,000 with no tax due they will now pay around £2,000 in tax every year.
There are more changes to come:
- The abolition of class 2 national insurance and the reform of class 4 national insurance likely to result in a rise in cost for unincorporated (self-employed) business owners.
- The reduction in tax-free dividend allowance from £5,000 to £2,000.
- The reduction of corporation tax rates from 19% to 17% from April 2020.
Bearing all the above changes in mind there can still be large tax savings by using a limited company, but the savings might be smaller. For example, there are savings of over £2,000 per individual for a business making profits of £50,000 per individual. The savings will rise in 2020 when the corporation tax rate reduces to 17%. The savings are also much higher if the business is one where profits are retained to reduce debt or invested within the business for expansion. In addition, in some circumstances, drawings from the business can still be made tax free, thereby increasing the annual savings further.
A husband and wife partnership making £150,000 profits every year will pay tax of approximately £46,000. Assuming they draw £60,000 a year from the business, their tax bill would reduce to approximately £30,000 if they use a limited company, an annual saving of £16,000.
Another very important reason a company vehicle can be appropriate is a limited liability. Farmers are always taking business risks, whether it is buying stock, planting seeds in the hope they will grow, buying land, or many other actions. Some business risks can be managed, others cannot.
Most farming businesses have historically operated using partnerships or as sole trade businesses. This is simple, but there is an unlimited liability. There is a greater risk of things going wrong in farming today with greater price volatility, globally moving diseases and the prospect of greater swings in weather patterns. Combined with larger farming businesses the risks are now greater. This could be the year to protect your assets using a limited company