2010/11 Tax Outlook for Family Business ?

CORPORATION TAX 50% and (effective) 60% personal tax rates are hogging the headlines:

How do companies fare?

How do companies fare under the 2010/11 tax system? Not badly (well not as badly as high income individuals) is the answer.  In the Pre-Budget Report the Chancellor announced that the planned increase in the small companies’ rate (from 21% to 22%) from 1st April 2010 would not take place.  This means that the rate for companies with profits of £300,000 or less will remain at 21%.  Small mercy you may say – especially if the business owners are made to suffer personal tax rates of more than double this level, almost triple in some cases.

So will this influence behaviour, tax planning behaviour, in any way?  It might.

For money that isn’t actually needed by an owner/manager of a company for some specific purpose there would seem to be great financial merit in not withdrawing it immediately by way of dividend or bonus (especially the latter, with its NIC implications).  Even for a company paying the main rate of corporation tax the increase in retained funds will be significant.  As is stated above, where the company pays the small companies’ rate the amount retained will usually be at least 100% more than if paid out.

But that’s one part of the equation; the next is what to do with the retained funds.  Despite the obvious tax advantage of retention of funds within the company, necessary weight needs to be given to the question of investment and current and future utility.  At a relatively simplistic level there’s an even greater degree of ‘no brainerness’ (excuse the inelegant phraseology) in retaining funds, building the company and then realising value on sale while accessing an effective 10% tax rate (through entrepreneurs’ relief) on up to £1m of cumulative gains.  Not bad eh?

Despite this extremely compelling argument, some other factors must be taken into account before this route is pursued.  These will include (or be founded on) the following questions:

 1. Will you build value in the company?

 2. Will you be able to realise any value from sale?

 3. What investment risk is accepted by this extremely undiversified investment strategy?

 4. Will the capital gains tax legislation always be as it is currently?

There may well be positive answers to these questions – but they do need to be asked.

There is a real role for advisers to play here in helping their owner/manager clients appreciate the consequences of apparently sound, tax-driven decisions and, in particular, in encouraging them to consider the longer term impact of whatever decision they take.

If funds are to be extracted from a company for other than immediate need for personal expenditure then the pension/pension alternative conundrum (especially for high earners) needs to be very carefully addressed.  Currently, for this client segment, growing interest is being shown in Employer Financed Retirement Benefits Schemes (EFRBS).  From a tax standpoint their most obvious immediate attraction is that they facilitate the removal of funds from the company net of corporation tax but without any personal tax charge.  Both the corporate tax deduction and the personal tax assessment are deferred until payment out of the EFRBS is made and benefit is received.

So, the amount available for investment in the EFRBS is only diminished by the (lower) rate of corporation tax rather than the (generally) higher income tax rate.