I come across interesting things from time to time and rather than start a new thread each time - I thought one to cover Tax would be more interesting.

A comment taken from a Small incorporated companies guide:

The Chancellor's solution is clearly targeted only at the small incorporated businesses with profits of up to 50,000. The proposals should not affect those with taxable profits consistently above that level. Thus, given that he was committed to doing something in this area, these proposals represent probably the least worst solution, although there are still a number of loose ends to tie up. It also seems that he took note of many of the representations made after the pre-budget report.

In essence the measure is intended to ensure that when profits are distributed after 31 March 2004 (to individuals or trustees) the profits out of which they have been paid will be subject to a minimum rate of 19% corporation tax. The maximum additional tax due under the new rules is expected to be 1,900 per year.

There will be rules, not yet specified, to cover situations where:

distributions exceed the profits for the period in which the distribution is paid;

newly incorporated companies; and

to deal with accounting periods that straddle 31 March 2004.

The 0% rate of corporation tax will only apply to retained profits and those distributed to other companies. Thus the new rules will not affect companies with profits wholly taxable at corporation tax rates of 19% or above. The proposals are also intended to incentivise even small companies to reinvest such that if they do so they will still benefit from the 0% rate on the first 10% of retained profits.

We understand that the rules are intended to operate as follows:

Compute corporation tax in the usual way and identify the effective rate on the profits for the period. (If this is 19% or above the new rules will not be relevant.) eg: Assume taxable profits of 30,000. Corporation tax would normally be 4,750, that is 10,000 at 0% and 20,000 at 23.75%. The effective average rate on the profits of 30,000 is 15.83%.

The profits available to distribute under the old rules would therefore be 25,250 (being 30,000 minus 4,750).

Assume that a dividend of 20,000 is to be paid. The company will be liable to 19% corporation tax in respect of this 20,000 and also 15.83% (in this example) on the remaining 10,000.

The total corporation tax payable on the normal due date would thus be 5,383 (being 3,800 plus 1,583). The increased charge is 633 being the difference between 19% and 15.83% tax in respect of the 20,000 dividend.

When will this new tax be payable?

The extra corporation tax payable because of the dividend will be due as part of the company's normal corporation tax liability. Thus the first payments under the new regime will fall due on 1 January 2006 (being 9 months and one day after the end of the 12 month accounting period ending on 31 March 2005).

What will happen with dividends paid out of brought-forward reserves?

Dividends paid after the end of the accounting period will apparently be treated as if they related to the period in which they are paid even if declared to be a final dividend for the previous accounting period. This is presumably to minimise the need for cumulative figures to be computed and means the rules will be less complex than they might otherwise have been.

Related issues

Finally, it is worth noting that the Chancellor's chosen situation means that two related issues are largely unaffected. That is, IR35 and the prospect of challenges under the settlements legislation (s.660A).

Is there more to come?

This may not be the end of the story however as, in a separate Budget press notice there is a related announcement: "To ensure that targeted tax incentives support the Government's objectives for growth, enterprise and productivity, the Government proposes to consider the issues raised by the interaction with the tax system of definitions of income of self-employment, and the remuneration paid to owner-managers, in a discussion paper which will be issued at the time of the 2004 Pre-Budget Report."

This may well mean that there are further changes to come although this time we are being promised a discussion paper beforehand.

Disincorporation

In the meantime any small incorporated companies that no longer consider that incorporation is beneficial should not attempt to simply disincorporate. In the absence of any new reliefs there remain a number of legal, commercial and tax issues to consider whenever a company's trade and business are transferred to a sole trader or partnership. Amongst the tax issues are:

the absence of any capital gains releifs such that corporation tax will be payable on the deemed market value of assets (including goodwill);

the absence of any loss carry-forward releifs; and

the prospect of the market-value of the assets (including stock, WIP and goodwill) being treated as a distribution or a benefit-in-kind.

The danger of overlooking such issues lies in the prospect of tax liabilities being identified and pursued possibly some time after the disincorporation takes place.

19% dividend tax made simpler:

The businesses affected the most are the small businesses with profits of under 10,000 who are subject to the nil starting rate for Corporation Tax and who because of the Chancellors increases in National Insurance extract their money from their businesses by means of a dividend. Such businesses with profits of 10,000 will see an increase in their Corporation Tax liability from nil to 1,900. This represents an extremely large increase for such small companies, who may now need to consult with their accountants to examine if it is still to their advantage to be incorporated.

The next category to be affected is the companies with profits in the marginal rates of between 10,000 and 50,000. Because it is a marginal rate the tax rate increases gradually from nil to 19%. Consequently the companies with profits closer to 10,000 will suffer a greater increase than those closer to 50,000.

For example the increase for a company with profits of 20,000 is 1,425 but the increase for a company with profits of 40,000 is only 475, again an indication of the affect on the smaller company.

The larger companies with profits over 50,000 will not be affected.