April 22nd, 2014 / Insight posted in The Sunday Times Business Doctor

Set up a company to cut the tax bill

GC writes: My husband and I run a partnership that generates a profit of about £120,000 a year, which we pay full tax on. We have reinvested much of the profit back into the business so the amount we withdraw is much lower. How can we reduce our tax bill?

You may be better off incorporating the business into a limited company, writes Jon Dawson, partner at Kingston Smith LLP. Assuming you split the profits equally, your current higher income tax rate is 42%, including 2% national insurance. As a limited company, the rate of tax on profits will be 20% and you will also have limited liability protection. Any amounts you take out of the company can be withdrawn efficiently using a combination of salary and dividends.

There are two main ways in which you could incorporate. The first is to transfer the business to a new limited company in exchange for shares. This approach should benefit from incorporation relief, meaning the market value of the business at the point of transfer would be calculated and any capital gain arising at that date would be deferred until the shares in the new company are eventually sold.

The second option is to sell the business to a limited company. In this case a capital gain would crystalise at the date of sale.

The main rate of capital gains tax is 28% but, if certain qualifying conditions are met, Entrepreneurs’ Relief could be available.

This reduces the rate to 10%. While the new company would not be able to pay for the business on day one, it could buy you out over time from retained profits until it has paid off the balance in full.

You should note that under the second approach you might have to pay capital gains tax before the company has paid for the business.