Limited company or Partnership?

With the new dividend tax rates from 6 April 2016 a lot of people are asking whether it is still worthwhile running their business as a Limited company rather than an unincorporated sole trader or partnership.

There are benefits from trading as a Limited company such as limited liability and other commercial reasons that need to be considered alongside any potential tax benefit.

However from a tax point of view above a certain profit level (and in most circumstances) the business trading as a Limited company will end up paying less tax.

For example, there are 2 identical husband and wife businesses trading in 2016/17. One is a Limited company and the other is a partnership but both make a pre tax profit of £102,000 before they extract any remuneration. The couple with the partnership pay £5k+ more in tax/NIC than the Limited company.

Limited company

The Limited company husband and wife will take £11k salary each and then dividends of £32k each. There’s no income tax on the salary and a small amount of employers NIC of £353 each (but the Corporation Tax benefit outweighs that). There’s no Employers NIC as this is covered by the Employment allowance.

£5k of dividends are tax free for each of them so they pay tax on the remaining £27k dividends at 7.5% (so £2,025 each)

The company pays Corporation Tax of £16k (£102k profit less £22k salaries x 20%).

The couple end up with a net £81k from the £102k and an effective tax rate of 20.3%.

Partnership

Assuming the same 50/50 split of the £102k profits.

They each pay income tax on £51k (£11k at nil, £32k at 20% and £8k at 40%) so £9,600 each.

They also pay Class 4 NIC each of £3,305 (9% re £43k - £8.060k and 2% re £8k) plus Class 2 NIC each of £145.60 each.

The couple end up with a net £76k from the £102k and an effective tax rate of 25.6%.

The numbers need to be worked through for specific circumstances but here there’s a £5k benefit from operating as a Limited company in this example.