Incorporation of all, or part of a profitable farming business is regularly used as part of a strategic tax planning exercise when considering the overall business structure. Proposed changes to the filing requirements, and the corporation tax rate suggest the incorporation position should be carefully reviewed.
CHANGES TO FILING REQUIREMENTS
The Government is in the process of implementing a reform to increase the financial information available to the public. A profit and loss account will be required in the annual accounts filed at Companies House for all companies. In addition, a statement from the directors confirming the company meets the qualifying criteria to claim the audit exemption will be required.
The rationale behind the changes is to improve transparency, allow third parties, such as creditors and consumers to make better informed decisions, and make it easier to spot fraud. It will, of course, also allow competitors and nosy neighbours to access financial information such as turnover, gross margin percentage and profitability.
CHANGING OF TAX RATES
From 1 April 2023, the main rate of corporation tax increases to 25%. This increase raises the question of how beneficial using a company to shelter profits from higher rates will become.
Typically, many businesses commence trading as an unincorporated entity. This works well where there is a significant investment being made in plant, machinery, and equipment, especially where 100% capital allowances are available. The capital allowances tend to keep the taxable profit below the higher rates of income tax, or even produce a taxable loss which can be used to reduce other taxable income.
A significant tax increase arises where the business starts to make considerable profits at a time where capital investment in machinery and equipment reduces. As a result, these unincorporated businesses can start to hit marginal tax rates of up to 62%, making corporation tax rates at 25% still seem quite attractive.
WHAT ARE YOU GOING TO DO WITH THOSE PROFITS?
It is relatively easy to transfer a profitable income stream into a company; the important question you need to consider is what will you do with the profits once they are in the company?
Generally, for an incorporation to work well, the company needs to be able to:
- Grow the business more quickly, this can be done net of corporation tax at 25% as opposed to income tax at up to 62%. Growth being either repayment of debt, or continued expansion. There just needs to be a use for the cash within the company.
- Extract cash from the company for personal use without having to declare dividends at higher rates of tax.
WHAT HAPPENS ON INCORPORATION?
Often assets are transferred into the company at market value; as the company has no cash, the value is left as a loan from the owners. When doing this, it is important to understand and minimise the tax consequences. The owners are free to draw the loan back tax free from future profits of the company.
The types of assets which work particularly well include:
- A dairy herd held under a herd election.
- Plant and machinery subject to capital allowances.
The transfer of the land and buildings, and related borrowing is also an option, but the tax implications are complicated and should be fully understood before proceeding.
In summary, even with increasing corporation tax rates, there is still a role for incorporation to play. When considering incorporating, it is important to understand the tax implications, and also have a plan for the utilisation of the cash generated from a profitable income stream.