To incorporate or not to incorporate?

In recent years the question of incorporation has been weighted in favour of companies due to the low rates of tax for companies and for dividend income. However, following the Chancellor’s announcement in the Spring Budget of 2021, will this still be the case?

At the moment, the corporation tax rate is 19% on all profits but from 1 April 2023 the main rate of corporation tax will increase to 25% and we will see a return to different rates of corporation tax as follows:

  • 25% on profits over £250,000
  • 19% on profits up to £50,000
  • 26.5% (effective rate) on profits between £50,000 and £250,000

The table below shows the net income after tax at different levels of profit for a sole trader, a company at the old rates (19%) and a company at the new rates from 1 April 2023. These figures are based on the full amount of profits being extracted from the company (one shareholder) by taking a minimum salary with the balance in dividends.

Net income after tax (full extraction of profit)
Profit levelSole TradeCompany 19%Company rates from April 2023
££ETR*£ETR*£ETR*
50,00038,85122.3%40,23719.5%40,23719.5%
75,00053,41028.8%55,89425.5%55,11226.5%
100,00067,91032.1%69,56230.4%67,51532.5%
250,000144,88242.1%148,68640.5%134,32246.3%

*ETR = Effective Tax Rate

The figures above show that from 1 April 2023, it remains beneficial to incorporate up to profit levels of £100,000 but that for higher profit levels, the effect of the increased rates of corporation tax mean that net income after tax will actually be lower than it would be if operating as a sole trader.

However, let us now consider the position if you were only to extract £50,000 of profits from the company.

Company 19%Company rates from April 2023
Profit levelSole Trade(£50,000 net of tax)Profits still to extractTotal(£50,000 net of tax)Profits still to extractTotal
££ETR*£ETR**£££ETR**££
50,00038,85122.3%40,23719.5%040,23740,23719.5%040,237
75,00053,41028.8%47,34320.1%12,58659,92947,34321.7%11,41158,754
100,00067,91032.1%47,34319.8%32,81880,16147,34322.8%27,78677,129
250,000144,88242.1%47,34319.3%154,318201,66147,34325.1%139,892187,235

**ETR = Effective Tax Rate (Corporation tax + income tax on extracted profits)

As can be seen from the above it can be financially advantageous to operate as a limited company rather than a sole trader, at all profit levels, if you do not extract the full amount of profit from the company. The balance of the profits can be left in the company thereby deferring any personal tax liability on those profits until a later date or used to invest in the business as and when required.

It is important to remember that there is not a one size fits all calculation that can be made, and each business will be different depending on its circumstances and requirements. Careful consideration needs to be given to many factors, including but not limited to the following:

  • Profit level
  • Income requirement of the business owners
  • Pension contributions
  • Associated companies
  • Availability of a director’s loan account that can be drawn on
  • Additional costs of operating as a limited company

A limited company can still make sense as a business medium for a sole trader or a buy to let landlord, but good advice is now more important than ever so please get in touch if you would like to discuss what this means for your business.

You can view a recording of our recent webinar on the changes to corporation tax below:

Contact us

For further advice, please contact Dorothy Johnston at dorothy.johnston@taitwalker.co.uk.