Financial measures put in place during the pandemic made it inevitable the Government would make changes to the tax system to reduce its debt by seeking higher taxes from individuals and companies. With private medicine now seeing a surge in demand, Partner, Ian Tongue believes it is a good time to consider whether your current trading structure is still tax-efficient.
The main changes
For political reasons, the headline rates of income tax were left alone, but National Insurance (NI) rates for individuals and employers are increasing from 1 April 2022.
Politically, NI is portrayed as money which pays for health and social care, but clearly those services cost more than the NI paid and it is a tax in all but name.
The increased NI will be paid on both employment earnings and the profits of the self-employed. Additionally, an employer also pays more. The increase is 1.25% across the board.
Recognising that many choose to extract funds by way of dividends (investment income) rather than employment or trading income, from 1 April 2022 the income tax rates on dividends also increase by 1.25%.
The biggest tax changes relate to limited companies, as corporation tax rates will see a significant increase from 1 April 2023.
Instead of there being a flat rate of 19% payable on all earnings, the tax rate payable will be 19% on the first £50,000 of taxable profits increasing to 25% for those earnings more than £250,000.
The jump in these rates creates a zone between £50,000 and £250,000 where the effective tax rate is 26.5%.
This seems excessive, but the principle here is to gradually increase overall tax paid such that you approach a rate of 25% as you near £250,000 of earnings.
For example, earnings of £200,000 would attract £50,000 of tax at 19% and £150,000 at 26.5% which is £49,250 of tax on £200,000 of earnings – an effective rate of 24.6%.
These earning bands are shared between ‘associated’ companies such that if you have two businesses which are associated, the rate would be 19% on the first £25,000 and 25% from £125,000 applicable to both businesses regardless of the size of earnings in each.
Determining whether you have associated companies can be complicated and therefore if you run more than one limited company, you should speak with your accountant.
The impact of the corporation tax changes depends on the level of profit after tax. The following table provides an indication of the additional tax due at differing levels of earnings:
Impact of changes
For the self-employed – from 1 April 2022
The impact for the self-employed, whether as a sole trader or in partnership, is straightforward: it is 1.25% more paid on the profits earned.
Where you have employees, the NI rate payable by the employer will increase by 1.25%, but as this additional cost is tax-deductible, the effective increase for a higher-rate taxpayer is around 0.73%.
The effective rate of tax including NI for a higher-rate taxpayer becomes 43.25%.
For those trading as a limited company – from 1 April 2022
Where dividends are extracted, the rate of income tax payable increases by 1.25% across the board, ranging from 8.75% to 39.35% depending on your tax rate.
The effective rate of tax to extract profits after the initial £2,000 tax-free dividend allowance is used up becomes 46.4%.
For those trading as a limited company – from 1 April 2023
Due to the increase in corporation tax rates applicable from 1 April 2023, the effective rate of tax payable will increase considerably if you are extracting significant levels of dividends from your firm.
This variation in dividend extraction policy between taxpayers and the proportion of profits extracted from company profits will result in the impact on you personally being unique and therefore is best discussed with your accountant.
However, as an example for a private practice earning £100,000 before tax with the profits fully extracted and all shareholders being higher-rate taxpayers, the following would be payable:
The position now is the company would pay £19,000 and the individual would pay £25,675, assuming that they had their £2,000 dividend tax-free allowance available in full. This would be an effective rate of tax of 44.68%.
From 1 April 2022, the same example would give rise to a further 1.25% of tax on the dividends, making the effective rate of tax 45.66%.
From 1 April 2022, the corporation tax rates also increase and this will increase the marginal rate of tax to 48.8% in this example.
Additional to the above rates of tax, factors such as lost personal allowances and pension annual allowance charges also come into play.
It was inevitable that tax rates would be reviewed following the Covid financial measures undertaken by the government.
Increased taxes will be payable by most, but considering your trading status and reviewing matters with your accountant should ensure that you are tax-efficient and not overpaying.
Tax Planning Considerations
Clearly, the tax rate hikes for companies are significant and it may be time to consider changing your strategy of profit extraction from your company or even revert to an alternative structure such as a sole trader or partnership.
For those extracting all their profits from their private practice, it is worth asking your accountant to quantify the additional tax that will be payable from 1 April 2023.
Armed with this, you ask them how this will now compare to other structures that are available to your circumstances.
It may be that partnerships or self-employed businesses are now more appropriate particularly, as the earnings threshold for pension annual allowance tapering has increased to £200,000.
For all companies, the higher tax rates also mean higher tax relief on business expenditures, so as you approach 2023 it may be worth delaying capital expenditure to obtain more tax relief.
This delaying tactic must be balanced against the current higher capital allowances available, which may not be available later.
For those not extracting the funds, you may be building up retained profits. It is important to speak with your accountant regarding the ultimate extraction strategy, as changes to capital gains tax are rumoured and alternative strategies may be required.
Written for the Independent Practitioner Today, the full issue can be found here.