The rationale behind the use of the limited company is the lower rate of corporation tax on any profits which can result and, if dividends are planned correctly, in total profits being extracted from the business at a lower marginal rate of taxation than if the limited company was not used.
Tax planning exists around introducing a new limited company (NewCo) into the business as a partner directly. For example, a new partnership agreement can be drafted allocating the majority of the profits generated to NewCo, with only a residual £8,000 ‘salary’ (i.e. profit share) paid to the remaining partners directly. This will ensure the partners profit share exceeds the ‘lower profits limit’ of £7,605 (for 2012/13), efficiently utilising the partners’ personal income tax allowance, and negating the need to operate a PAYE scheme in the limited company, with only very minimal exposure to 9% Class 4 NIC. This results in the bulk of the profits being assessable on NewCo.
The company would be liable to corporation tax on its share of the profits from the partnership, and these are taxed in exactly the same way as if NewCo had generated these from its own trading activities. Where the limited company makes profits in excess of £300,000 (apportioned as appropriate for a period of less than 12 months, or where there are associated companies) the tax benefit is diluted as the company starts to suffer corporation tax at the higher marginal rate, so a careful review must be undertaken beforehand of the anticipated profit levels.
Usually, a profitable business will have some inherent goodwill that makes the business worth more to a third party purchaser than the sum of the net assets on the balance sheet. Any disposal of goodwill to a newly-formed NewCo would be a chargeable event for CGT purposes (taxable at 10% if entrepreneurs’ relief is available which it may be if ‘part’ of the enterprise, separately identifiable in its own right, is disposed of to a limited company). As NewCo would owe the existing partners for the agreed market valuation of goodwill, the partners can draw down on this debt owed by NewCo with no further tax effect.
Practical Tip :
For partnerships the tax efficiency of the potential for the introduction of a corporate partner should be thoroughly reviewed. Specific professional advice is essential.
Julie Butler F.C.A.