There was a lot of media coverage over the Chancellor’s summer budget with the usual discussion over average households, who will benefit and who will lose. Flying pretty much under the radar, almost unnoticed through all of this, were some budget changes that will have significant impact on small businesses in the UK. These budget secrets will affect the multitude of micro limited companies as well as sole traders considering incorporation. Here are the top budget secrets you may not have picked up on.
Tax on dividends
If you are a company director then you will likely take your company profit through a mixture of salary and dividends, often with the dividends making up the larger share of the money.
Currently there is a complex and convoluted system involving dividend tax credits which effectively means that basic rate tax payers are not taxed on their dividends. This has made it an effective way for company directors to take money out of their company up to the higher tax rate.
From April 2016 this system will be replaced with a divided allowance of £5,000 per year so that only the first £5,000 of dividends will be tax free. Above this level basic rate taxpayers will get taxed at 7.5%, higher rate taxpayers at 32.5% and additional rate taxpayers at 38.1%. Dividends in pension funds and ISAs remain exempt.
Employment Allowance – good news and bad news
Since 2013-14 there has been an employment allowance covering the first £2,000 of employer’s national insurance contributions, which has really benefited many small businesses.
From April 2016 the employment allowance increases to £3,000. This is good news for businesses with a number of staff on their payroll.
The bad news comes for the many sole director limited companies. If you are the sole employee of your own company then from April 2016 the employment allowance no longer applies to you. This results in a loss of up to £3,000 potential tax savings. It is unclear whether employing a spouse, family member or other connected person would allow you to access the allowance.
Double whammy for sole directors
The employment allowance change, in combination with the tax on dividends, will have a significant effect on the sole director. It will narrow the gap between the amount of tax due as a company director and that due as a self employed sole trader, reducing the tax benefit of incorporation.
Goodbye to Amortisation
The final area that may have an impact on small businesses is that tax relief on purchased goodwill and certain customer related intangible assets will no longer be available after 8 July 2015. But what does this actually mean?
Intangible assets are items which generate money for your business, but don’t physically exist. The most common ones are intellectual property, such as patents and goodwill on the sale of a business.
When you purchase an existing business, goodwill is the difference between the value of all the physical assets that the business owns and what you pay for it. It represents the past reputation and future potential of the business, over and above the physical assets that it owns.
Goodwill not only applies when a business changes hands but also when a sole trader incorporates because in that case the business is being purchased by the limited company.
Goodwill decreases in value over time; just as physical assets spread their cost using depreciation, intangible assets such as goodwill, spread their cost with amortisation. Depreciation is not allowed for tax purposes, because there are tax capital allowances instead. Capital allowances only apply to physical assets, not to intangible assets, so in the past amortisation has been allowed as an expense for tax.
After 8 July 2015 you can no longer include amortisation of any intangible assets bought after that date as an allowable expense for tax (although it can still be included in the business accounts). You can continue to include the amortisation of intangible assets purchased before that date.
In the past, one of the benefits of incorporation for sole traders has been the generation of goodwill, which can then be amortised as a business expense over the subsequent years, saving what can be significant amounts of corporation tax. This benefit is not longer available from 8 July 2015 as amortisation can no longer be included.
The end of the micro limited company?
These budget secrets mean a big re-think about the best way for directors to take profit from their company and also whether a limited company is the best structure for all small businesses. Previously there have been very clear benefits incorporating a sole trader business or starting a limited company, but these are rapidly being eroded by ongoing tax changes as the government seeks to even things out.
Limited companies theoretically provide extra protection by limiting the director’s personal liability, however in practice loans, leases and sometimes supplier credit may have to be guaranteed personally for many micro-businesses, so director’s remain personally liable for debts or defaults.
Limited companies come with an extra administrative burden and often a higher accounting cost. For many business the gains to be had from incorporation are starting to become fairly marginal, particularly when these additional financial and time costs are taken into account.
So, does this herald the end of the reign of the micro limited company? It may certainly make business think twice, but tax savings are not the only reason to incorporate. There are very may other factors to consider including potential for growth, reputation and flexibility, so each business needs to consider it’s own individual situation. However, for businesses where tax saving is the main motivation for incorporating, the prospect may not longer be so attractive.
Tax on dividends over £5,000
No more Employers Allowance on NIC where the director is the only employee
No more amortisation (apart from existing intangible assets)