The rate of corporation tax looks set to drift downwards to 19% and then to 18% over the next couple of years, making incorporation look increasingly attractive for many small businesses. Apart from the saving on tax, there is also a substantial saving on Class 4 National Insurance. Against this, a new tax on dividends is being proposed, perhaps to “compensate” the State for the loss of Class 4 NIC. It is a little early to judge where this is heading, but we will remind you about dividends.
In order to get any tax benefit from setting up a company, you need to declare dividends regularly. We can help you with the paperwork and the management accounting that you will need, but please just remember to consider a dividend every year. After you have declared the dividend, you don’t actually have to pay anything. Small owner-managed companies can just leave the dividend as a credit on a director’s current account. You should therefore be declaring a dividend every year optimised by reference to the tax rules, let a balance build up on the director’s current account, and then withdraw cash in future years as you need it.
What to avoid is only declaring a dividend for cash you actually withdraw, and then withdrawing so much in one year that you are paying surtax. This defeats the point of incorporation. You should have been declaring dividends in previous years in anticipation of the day when you would need lots of cash.
One side effect of declaring a dividend is that the balance sheet becomes a bit weaker since the director’s current account appears on the balance sheet as an external creditor rather than part of the ownership interest. If this is an issue, then we can partly remedy this by declaring some part of the director’s current account as a subordinated creditor by a note in the accounts (which the director signs) and showing this subordinated creditor as a long-term liability.
The tax rules change every year, and the attractiveness of incorporation is one of those areas which are most subject to change. Looking back over a longer timescale, incorporation is attractive when otherwise you would be paying income tax at a higher rate. Once you have a company, it makes sense to divorce the activity of declaring tax-optimised dividends from the activity of actually paying them.
David Porthouse & Co are Carlisle accountants serving clients in Cumbria and North West England. They have a substantial interest in new technology and are developing an optical number recognition/datepoint system for scanning bank statements, with the intention of controlling the costs of accounts preparation. They also have a spreadsheet system which can be e-mailed back and forth between the accountant and clients. In addition, they have now developed an online quotation system for transparent pricing.