The existing business
Part 2 of 4
This is the Finance Act 2017 version of this article. It is relevant for candidates sitting the Advanced Taxation – United Kingdom (ATX-UK) (P6) exam in the period 1 June 2018 to 31 March 2019. Candidates sitting ATX-UK (P6) after 31 March 2019 should refer to the Finance Act 2018 version of this article (to be published on the ACCA website in 2019).
From the September 2018 session, a new naming convention is being introduced for all of the exams in the ACCA Qualification, so from that session, the name of the exam will be Advanced Taxation – United Kingdom (ATX-UK). June 2018 is the first session of a new exam year for tax, when the exam name continues to be P6 Advanced Taxation (UK). Since this name change takes place during the validity of this article, ATX-UK (P6) has been used throughout. In the first part of this article we looked at some fundamental issues relating to unincorporated traders.
The remaining parts of this article compare the total tax paid on the profits of a business depending on the business vehicle used, the implications of a change of accounting date and the cessation of a business.
The total tax paid on the profits generated by a business will depend on whether the business is unincorporated or is owned by a company. This is a significant issue and will be considered, together with legal and commercial issues, when deciding on a business vehicle prior to commencing to trade and also when considering the desirability of transferring an existing unincorporated business to a company.
The calculations necessary to compare the alternative business structures must be performed with care if they are to be accurate. They require a sound knowledge of income tax, national insurance and corporation tax.
Illustration 1
Sammy’s business has an annual tax adjusted profit of £46,000. This figure is prior to any payments being made to Sammy. Sammy is considering three strategies: Strategy A, where the business is unincorporated, and Strategies B and C, where the business is incorporated.
Under Strategy A, where the business is unincorporated, the net income available to Sammy for the year ended 31 March 2018 is calculated as follows.
| Strategy A Unincorporated £ | ||
|---|---|---|
Income tax: | ||
| Trading income | 46,000 | |
| Personal allowance | (11,500) | |
Taxable income | 34,500 | |
| £33,500 x 20% | 6,700 | |
(£34,500 – £33,500) x 40% | 400 | |
Income tax payable | 7,100 | |
Class 4 National Insurance contributions: | ||
| (£45,000 – £8,164) x 9% | 3,315 | |
(£46,000 – £45,000) x 2% | 20 | |
Class 2 National Insurance contributions: | ||
52 x £2.85 | 148 | |
Total tax payable | 10,583 | |
Net income for Sammy |
|
Under Strategies B and C, the business will be operated via Wilson Ltd, a company owned 100% by Sammy. Sammy will be the only employee of Wilson Ltd, such that the National insurance contributions employment allowance will not be available. Sammy will not receive any dividends other than those received from Wilson Ltd.
In these circumstances, the net income available to Sammy will depend on the mix of salary and dividends paid by the company. The calculations set out below show the income available to Sammy where the company’s profit after tax is paid to Sammy as a dividend in addition to a salary of either £34,000 or £12,000.
| Strategy B Salary £34,000 £ | Strategy C Salary £12,000 £ | ||
|---|---|---|---|
Wilson Ltd | |||
Trading profit pre salary | 46,000 | 46,000 | |
| Salary | (34,000) | (12,000) | |
Employer’s class 1 national insurance contributions ((£12,000 – £8,164) x 13.8%) | (3,565) | (529) | |
Taxable total profit | 8,435 | 33,471 | |
Corporation tax at 19% | (1,603) | (6,359) | |
Available for dividend | 6,832 | 27,112 | |
| Sammy | |||
Employment income | 34,000 | 12,000 | |
Dividend income | 6,832 | 27,112 | |
| Personal allowance | (11,500) | (11,500) | |
Taxable income | 29,332 | 27,612 | |
((£34,000 – £11,500) = |
| ||
(5,000 x 0%) | 0 |
| |
| (£1,832 x 7.5%) | 137 | ||
| 4,637 |
| |
|
| ||
| ((£12,000 – £11,500) = £500 x 20%) | 100 | ||
| (£5,000 x 0%) | 0 | ||
| (£22,112 x 7.5%) | 1,658 | ||
| 1,758 | |||
Salary | 34,000 | 12,000 | |
Dividend | 6,832 | 27,112 | |
Income tax | (4,637) | (1,758) | |
Employee’s class 1 National Insurance contributions |
|
| |
Net income for Sammy | 33,095 | 36,894 |
Summary – Net income for Sammy
Strategy A Unincorporated £ | Strategy B Salary £34,000 £ | Strategy C Salary £12,000 £ | ||
|---|---|---|---|---|
Net income for Sammy | 35,417 | 33,095 | 36,894 |
The net income available to Sammy is, of course, simply the difference between the profit of the business and the total tax payable under each of the alternatives.
Strategy A Unincorporated £ | Strategy B Salary £34,000 £ | Strategy C Salary £12,000 £ | ||
|---|---|---|---|---|
Profit of the business |
|
|
| |
Corporation tax | (1,603) | (6,359) | ||
Income tax | (7,100) | (4,637) | (1,758) | |
National Insurance contributions: | ||||
Employer’s class 1 | (3,565) | (529) | ||
Employee’s class 1 | (3,100) | (460) | ||
Class 2 | (148) | |||
Class 4 |
| ______ | ______ | |
Net income available |
|
|
|
A comparison of Strategy A with Strategies B and C illustrates that being self-employed does not necessarily result in more income being available to the individual.
A comparison of Strategy B with Strategy C illustrates the tax that can be saved when a dividend is paid in place of salary.
Calculating the total tax paid on the profits of a business is not particularly technically difficult. However, it does require very good knowledge of the TX-UK (F6) syllabus and great care must be taken in order to earn all of the available marks.
Note: The unincorporated trader is also considered in:
Written by a member of the ATX-UK (P6) examining team
The comments in this article do not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content of this article as the basis of any decision. The authors and ACCA expressly disclaim all liability to any person in respect of any indirect, incidental, consequential or other damages relating to the use of this article.