With income tax and VAT both raising considerably more revenue for the Exchequer than Company tax it is highly likely that the Chancellor’s budget on 17th March will concentrate on redressing the balance but it is the small fry that are likely to get truly clobbered.
Gordon Brown’s intentions may have been hidden in the pre-budget report published in December 2003. He hinted at the end of the zero rated £10,000 threshold on small company profits which had been put in place in 2002 to encourage entrepreneurs. It has encouraged literally thousands of self-employed people to convert to Limited Company status but the size of the stampede has taken the government by surprise. In 2002-03 nearly 100,000 applications were received by Companies House and they are still coming at the rate of about 7000 per week. The government had expected it to cost £20m in lost tax revenue in 2002-03 and £256m in the following year but a figure of £1bn is probably closer the mark.
The situation for the Exchequer is exacerbated by the fact that many companies draw the £10,000 tax free profit as a dividend which is free of national insurance contributions (NIC) as well. Thus the owner of a small company with £15,000 profit can take just under £5,000 as salary which is beneath the income tax and NIC threshold and £10,000 as dividend and effectively pay no tax at all.
The temptation for the Chancellor to claw back some of this lost income must be compelling but he may shy away from abolishing the zero rated profit threshold altogether because it would look like too much of a u-turn only two years after it was introduced and at a time when he talks enthusiastically about encouraging entrepreneurs. He could, however, levy NICs on dividends for closed companies with fewer than 30 shareholders.
For many one-man businesses that converted to take advantage of the tax free threshold the price to pay was the considerable increase in red-tape and paperwork that Limited companies have to complete. While it is fairly straightforward to convert to Limited status it is complicated to “dis-incorporate”.
Small business thinking of converting to Limited Company status should do nothing before the budget and those that have already converted should consider voting themselves as much of a dividend as they can afford before the budget. But they will have to make sure that they have made enough profit to cover the dividend. Taking a dividend without the profit in place to support it will not be acceptable to the Inland Revenue.
Monday morning might be a good time to chat to your accountant.
For the BBC prediction of the Chancellor's Budget click on the following link: - http://news.bbc.co.uk/2/hi/business/3509966.stm
Read related items on: