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To incorporate or not to incorporate?
Capital allowances squeezed but not for a couple of years
 

To incorporate or not to incorporate?

With the reduction in the Corporation Tax rates, particularly the small companies rate from 21% to 20%, and the main corporation tax rate from 28% to 27% with effect from 1 April 2011, together with the current increases in income tax for those with income over £150,000, is there yet another incentive for businesses to incorporate?

In the not so distant past the nil tax rate for companies meant that a number of business sort to incorporate to take advantage of the beneficial nil tax rate but this was subsequently changed by the previous Government to avoid such tax planning.

So is incorporation beneficial? When considering this it should be noted that there is still the issue of the second layer of taxation when it comes to extracting profits from a company by an individual. If profits are extracted via dividends the effective tax rate is 25%, or for those who already exceeds the £150,000 higher threshold they will have an effective dividend tax rate of around 36%.

The facts in each case would need to be considered to obtain an accurate assessment of whether incorporation would be beneficial from a tax perspective but as a rule of thumb the larger the business the more incorporation makes sense.

For instance if an individual was taxed on £175,000 of business profits he would pay tax and NIC of £72,400. Compare this to a company which has taxable income of £175,000. It would pay total tax, including corporation tax, of £62,365 assuming there is no salary paid and hence no NIC costs. Each case should be looked at on its facts and there can be many considerations to take on board, but some simple 'what if' planning can certainly help the decision making process.

Capital allowances squeezed but not for a couple of years

The Chancellor has targeted capital allowances in order to fund the announced reduction in the headline rates of corporation tax. However, businesses have some breathing space as these changes will not take effect until April 2012.

The announcement sees a reduction in the rate of writing down allowances (WDAs) from 20% to 18% for all assets other than those in the special rate pool - this is the second recent cutback in this WDA, following the reduction from 25% to 20% in April 2008. The WDA for assets in the special rate pool (eg integral features, long life assets and cars acquired after 1 April 2009 with carbon emissions of more than 160g/km) will also be reduced from 10% to 8%.

The Annual Investment Allowance, which broadly entitles businesses to claim 100% of the cost of qualifying plant and machinery (except for cars) as a deduction from their profits will be slashed to £25,000 from April 2012. This was only increased from £50,000 to £100,000 in the March 2010 Budget by the previous Chancellor.
Although these changes only defer the tax relief available to businesses, it may prove to be an incentive for them to accelerate their planned capital expenditure in order to take advantage of the current higher rates while they still remain.

The Chancellor also confirmed the introduction of a 100% first year allowance for zero-emission vans, which was originally announced in March 2010 Budget. However, in order to comply with European law, this will not be available to businesses in difficulty.