For many years, working out whether tax savings could be achieved by incorporation was relatively straightforward. Once profits reached a particular level, transferring the trade to a limited company and using profit extraction strategies would save a lot of money; the larger the profits, the bigger the saving. This all changed in 2016 with notional tax credits for dividends being abolished such that the question of whether to incorporate depended on a combination of factors. Now with the increase in dividend tax rates as from April 2022 the question as to whether to incorporate (or disincorporate) has even more relevance as in certain instances it is more tax efficient to operate as a sole trader or in a partnership. However, tax savings can still be achieved particularly if there is more than one director-owner and if not all profits are withdrawn. As ever it all depends on the calculations.
Tax Savings on Incorporation
Example 1 – Income gains on incorporation
Other Considerations
There are various reasons why the above figures should be used as a guide only. The main one being that they assume all the profit is withdrawn which is not the case with many companies. Pension contributions can be a valuable method of extracting profits with no personal tax implications for the director-owner and tax relief for the company.
In addition, the calculations assume a sole director-shareholder but if the company could be set up with a spouse or civil partner then including two personal allowances, two basic rate bands and two dividend allowances in the mix could still yield large savings.
When deciding whether to incorporate it should not be forgotten that there are other vehicles of operation that may produce higher tax savings in comparison. A partnership could be a more tax-efficient option for those who are married or civil partners because of the availability of double personal allowance and double basic rate band (assuming that there is no other income). However, bearing in mind the protections offered as a company may lead the owner to look at setting up a limited liability partnership.
Finally, it must be said that the above figures could all change in the next few weeks as whoever is the new incumbent of Number 10 may reduce tax rates or National Insurance contributions in the next ’emergency budget’.