The new business
Part 2 of 2
This is the Finance Act 2023 version of this article. It is relevant for candidates sitting the ATX-UK exam in the period 1 June 2024 to 31 March 2025. Candidates sitting ATX-UK after 31 March 2025 should refer to the Finance Act 2024 version of this article (to be published on the ACCA website in 2025).
In the first part of this article we looked at some fundamental issues relating to unincorporated businesses.
The remaining parts of this article examine the choice of business vehicle and compares trading as an unincorporated business with trading through a company by reference to the relevant taxes.
Taxation of business profits
From a tax point of view, an unincorporated business is a simple structure. The profits of the business, as adjusted for tax purposes, are subject to income tax and class 4 national insurance contributions in the hands of the sole trader or partners who own the business. There will also be a liability to class 2 national insurance contributions.
Where a business is operated via a company, the tax position is more complicated. It is likely that the individual(s) who formed the company, and who are running the business, will extract profits from the company principally in the form of salary and dividends (they may also be paid rent, in respect of a building, or pension contributions may be made on their behalf). The payment of a salary results in a liability to class 1 employer’s and employee’s national insurance contributions and a deduction for the purposes of calculating the company’s taxable profits. Dividends do not give rise to a liability to national insurance contributions and are not tax deductible for the company. Any profits retained in the company are subject to corporation tax only.
When comparing alternative strategies, it will often be necessary to consider the total tax cost (ie including national insurance contributions) of each strategy while recognising that other (non-tax) factors are also relevant. This is covered in more detail in the article ‘Taxation of the unincorporated business – the existing business’.
In addition to affecting the total tax payable, the choice of business vehicle will also affect the timing of the liabilities, with the self-employed making payments on 31 January in the tax year and 31 July and 31 January following the end of the tax year, and employees’ tax being paid monthly. A company’s tax liability will be due nine months and one day after the end of the accounting period, unless it is required to pay its tax in instalments.
Initial losses
Where there is an expectation of losses in the early life of the business, there may be an advantage to operating the business as an unincorporated entity. This is because the losses can then be offset against the other income and/or chargeable gains of the sole trader or partners.
It should be recognised that the relief available here is particularly generous in that, as well as being able to offset the losses in the year of loss and/or the previous year, the losses of the first four tax years can be offset against the income of the previous three years on a first in, first out basis. This means, for example, that where an employee resigns from his job in order to start a new business as an unincorporated trader, any initial losses can be offset against employment income arising prior to the start of the business.
Where losses arise in a new company, the relief available is far less generous. In these circumstances it is likely that the only significant relief available will be against future profits. Relief for the losses is therefore dependent on the company eventually making profits (never a certainty!) and, even then, the relief is delayed until such profits are realised.
Capital gains tax
An unincorporated business and shares in a company are both potentially qualifying assets for the purposes of gift holdover relief and business asset disposal relief. However, the circumstances and precise conditions must always be considered carefully.
Inheritance tax
Business property relief is likely to be available on a future disposal of the business regardless of the choice of business vehicle. However, from a commercial point of view, it is more straightforward to transfer shares in a company than to transfer an interest in an unincorporated business.
Value added tax (VAT)
The main issue from the point of view of VAT is whether or not the business is required to register, together with the advantages and disadvantages of registering voluntarily. It may also be necessary to consider whether it would be advantageous to operate one or more of the flat rate scheme, the cash accounting scheme or the annual accounting scheme.
The choice of business vehicle requires the consideration of commercial and legal issues as well as various tax issues. When writing about the tax issues you should stop and think before you start writing and note down briefly the points you intend to make. Then make sure that you make all of the points in the time available.
Note: The unincorporated trader is considered further in:
Written by a member of the ATX-UK 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.