Should I incorporate my business?
For commercial reasons, you may prefer to operate as a company rather than as a sole trader. These might include:
Limited liability (although you may need to give personal guarantees).
Companies may find it easier to raise finance and have greater credibility with creditors.
Companies have business continuity even after a transfer of ownership.
But will incorporation save you money?
Below is a graph that shows the potential tax saving of incorporation (after taking account of the new corporation tax rate described above), on the assumption that you want to distribute all your profits each year as dividend, and pay yourself a nominal salary of £5,000.
The tax benefits will increase if you do not withdraw all the profit out of the company. There is a tax disadvantage for companies which make very high profits (say £400k).
The tax saving may be eroded by the additional costs of incorporation, for example:
one-off costs such as company formation and new stationery;
cash flow disadvantages in the year of incorporation due to the timing of tax payments under the various rules.
ongoing costs. For example company accounts are more complex and must be prepared in a prescribed format, a PAYE scheme must be operated, bank accounts and insurance may be more expensive.
There are other factors which should be considered, including:
The tax benefits depend on paying dividends rather than salary and a low salary may cause problems with mortgage applications and, after 2006, may restrict the amount of pension contributions you can make.
The formalities of company law. For example, if you draw surplus funds out of the company bank account without declaring a dividend then there will be adverse tax consequences.
If you change your mind it may be expensive to disincorporate
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New tax rate on small profits
The Budget introduced a new rate of corporation tax that will apply to companies that distribute their profits as dividend.
There are new rules which generally affect companies with profits up to £50,000. There will now be an additional corporation tax cost when these companies pay a dividend to individuals. Under the old rules a company with profits of £10,000 could pay it all out in dividends. Now it can only pay dividends of £8,403, the remaining £1,597 being the tax.
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Protecting your business - and yourself
What will happen when you die? Will your business collapse, leaving your dependants with nothing? If you have partners or fellow shareholders, will they be able to pay out your dependants?
Alternatively, suppose it’s one of your partners or fellow shareholders that dies. Will the business suffer without them? Will you be able to pay out their dependants? Or will you be stuck with those dependants as colleagues in your business?
Of course, there may be other key people in your business. For example, the death of a sales manager, a production manager, or a financial controller may devastate your business. It is often said that people are a business’ most important asset. But, if that’s the case, why is it that only a small number of businesses are insured against the loss of a key person? A national survey concluded the following:
94% of companies identified that they had one or more irreplaceable employees
68% of these companies had no form of key person cover
79% of the companies with no cover said that they had never considered it because it had never been explained to them.
Business protection insurance can be a vital part of your business and financial planning. Unfortunately the concept, benefits and costs of such insurance have not been properly explained to most business people.
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In brief...
High value dealers
Businesses which accept payment in cash of more than €15,000 (around £10,000) for a single transaction are now subject to strict money laundering regulations. Examples may include not only jewellers and car dealers but also wholesalers trading low value goods in high volumes.
Stakeholder pensions
April brought news that the Regulators had fined the first employer for not offering a suitable Stakeholder Pension Scheme. Further prosecutions are now inevitable. Make sure that your scheme satisfies the current legislation.
Stamp duty charges for partnerships
Beware - where a partnership owns land or property, there may now be a stamp duty land tax charge when partners join or leave the partnership, or if there are changes to the partnership shares of existing partners.
VAT Registration
If you are starting a new business or otherwise need to be registered for VAT there will be a long delay before your application is processed. The “normal” 2 or 3 weeks wait for a VAT number is now more like 6 to 8 weeks. Customs & Excise are concerned at the increase in fraudulent registrations and have been implementing additional security checks. You now need to provide evidence that you are a genuine registration (e.g. copies of invoices) to help speed up your application.
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Trusts - complicated and only for the wealthy?
Do you think that trusts are:
Too complicated?
Too expensive?
Only for the very rich?
If so, think again. Even after increases in the rates of tax paid by some trusts in the recent Budget, and the raft of tax avoidance legislation aimed at trusts, they still have a valuable part to play in asset and tax planning.
The creation of a trust can enable you to:
Give away assets whilst retaining an element of control over what happens to them.
Separate the right to income from the assets, for example so children or grandchildren can enjoy the income (or some of it) but cannot squander the capital.
Put assets beyond the reach of creditors or divorcing spouses in some circumstances.
Disguise the ownership of a business for commercial reasons.
Specify now how assets are to be shared out at a future date.
Trusts can be particularly useful for inheritance tax planning, in ensuring that assets are passed down through the generations in a tax efficient manner.
Once set up, a trust will usually require annual accounts and an annual tax return so there is an ongoing administrative cost. This cost is however likely to be small relative to the benefits of the trust.
It is important to know what you want the trust to achieve and to ensure you have the right kind of trust to achieve it. Before any trust is created, appropriate tax advice is crucial.
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Tax shelters with a difference
The Enterprise Investment Scheme and Venture Capital Trusts are two long-running schemes which provide tax incentives for individuals to invest in trading companies. In the 2004 Budget, the Chancellor has made major changes to these schemes.
Enterprise Investment Scheme (EIS)
The EIS continues to provide 20% income tax relief on investment in an EIS company, and exemption from capital gains tax (CGT) when the investment is sold. The Chancellor has increased the annual investment limit from £150,000 to £200,000.
Up to 40% CGT deferral is also available if capital gains on other assets are reinvested in an EIS company within 3 years after a gain is realised or within the previous 1 year. Perhaps surprisingly, there is no limit on the amount that may qualify for CGT deferral.
Venture Capital Trusts (VCTs)
The most significant changes which the Chancellor has made are to VCTs.
For the tax years 2004/05 and 2005/06, the income tax relief has been doubled, from 20% to 40%. At the same time, CGT deferral relief has been withdrawn. Overnight the Chancellor has turned VCTs from a CGT shelter into an income tax shelter. The annual limit has also been doubled, from £100,000 to £200,000.
The income from VCTs remains exempt from income tax; and, although there is no longer any CGT relief on investing in VCTs, gains on the disposal of VCTs remain exempt from CGT.
Risk and reward
Investing in trading companies carries risk. Investors should always take professional advice before investing in EIS companies or VCTs.
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It's a wrap
The term “wrap” is short for wrapper account, a concept created in Australia in the late 1980s and recently introduced into the UK. Very few UK investors are aware of wraps, and in a recent industry survey only 68% of independent financial advisers had heard of them!
What is a wrap? Quite simply, it is a wrapper that presents all your investment products within one framework. Traditionally, investors and advisers have treated investment products such as pensions, PEPs, ISAs, unit trusts, investment bonds and savings accounts as completely separate products. By not looking at the big picture, advisers have failed to advise on a client’s overall investment portfolio. By contrast, a wrap presents all investment products as part of a single portfolio.
Wraps are also marketed as a way to switch investments cheaply. Whilst that is true, there are already many “multifund” investment products that offer the same facility, generally with a wider choice of investment funds.
At Cassons we have always looked at the big picture. We design a client-specific investment asset allocation model, to choose, say, between property, equities, fixed interest & cash. We then select individual investment funds. The final stage is to allocate the investments to product types such as pensions and ISAs.
Wraps suit the Cassons approach very well. They are still new to the UK and many are still being developed. It is too soon to rush into wraps but we are monitoring their progress and welcome them as another weapon in our financial planning armoury.
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In brief...
Annuity rates
Did you know that pension annuity rates – the amount of income each £1,000 of pension fund will buy – can vary dramatically between providers? For a non-smoking 65 year-old man with a pension fund of £100,000 it currently varies between £6,402 and £7,490 per annum. That’s a difference of 20%! Why not speak to us If you are looking to take an annuity and would like to know more?
Changes to ISAs
A major change to the tax benefits of ISAs came into effect on 6 April 2004. Until then the 10% tax payable on dividend income could be reclaimed by the ISA manager. This is no longer the case. This change will adversely affect the investment performance of those ISAs which earn dividend income, such as Equity Income funds.
Where does all the money go?
Working out the household budget should be a prerequisite to any personal financial planning exercise, but how many of us actually do it? To help you, we’ve developed a computerised, simple to use, Family Budget Planner. This will tell you how much you can put aside to save each month or, conversely, whether you need to make some sacrifices. Why not give it a go?
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