What tax cuts mean for business owners

As highlighted in a recent Weekly Tax Brief article, the number of entrepreneurs appears to be on the rise and a key decision they will face is whether to incorporate their business or carry on their activity as sole traders or in partnership. This decision is often influenced by the legal protection offered by the ‘corporate veil’ but the tax implications of the different business structures can be a vital factor.

In her recent leadership campaign, Liz Truss has pledged that she will reverse the decision to raise the main rate of corporation tax (due to rise to 25% from April 2023) and keep the current rate of 19% if she becomes the next Prime Minister. She has also pledged to scrap the planned health and social care levy, due to be introduced from 6 April 2023. As of yet, Rishi Sunak has not announced any substantial deviation to the tax measures that he introduced and announced during his time as Chancellor.

Uncertainty of business and employment taxes makes it extremely challenging for business owners to plan ahead and make crucial decisions as to how to structure their business.  For example, could the proposed tax changes mean that it is better for a small, family-run business to be structured as a company, rather than a general partnership?

The answer will depend on a number of factors, in particular the size and profits of the business and whether the owners need to extract cash from the business for living costs. At 19%, the corporation tax rate is low when compared prima facie with the income tax rates, currently between 20% and 45%. That might lead a business owner to conclude that they would be better off structuring the business as a company, but they should not look at one tax in isolation. It is their business, so they need to take into account of all the taxes that might impact it, both corporate and personal.

One common factor to consider when deciding the appropriate business structure is the effective tax rate that will apply on the individual business owner extracting £100 of income. If we assume that the main corporation tax rate will not increase in April 2023 and the national insurance contributions (NICs) and health and social care levy measures that have been introduced will be reversed, the effective rates of tax would be as follows:

Compared to if the 25% main rate of corporation tax and health and social care levy remains:

The figures above highlight that, when the increased 25% main rate of corporation tax kicks in, it appears to be more tax effective for a self-employed person to extract cash from their business than it is for someone operating via a company. This is perhaps an unintended consequence of the changes brought in by the former Chancellor and for many, a company remains the most appropriate structure for wider reasons beyond tax.

The tax changes proposed by Liz Truss could dramatically swing the conclusion, so that for the majority of business owners who operate via a company, there is again a much clearer differential in tax cost between extracting cash by dividend compared to salary. Whilst the uncertainty over taxes may be unwelcome for business owners, they may be amongst those with the most to gain from the tax changes proposed.