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April 2004
Q:
What significant tax changes have taken place affecting small businesses, following the announcements in Budget 2004?
A:
At the time of writing, the Finance Bill 2004 has not been published. However, the main changes announced in Budget 2004 potentially affecting small businesses are summarised below. It is surely unsatisfactory for taxpayers and tax advisers to be reduced to having to interpret the relatively scant information that the Government deems fit to release between the Budget and the Finance Bill in order to quantify the likely effects of certain new measures, most notably the new 'dividends tax' outlined below.
'Dividends tax' for small incorporated businesses
A minimum rate of corporation tax of 19% applies to company profits distributed to non-company shareholders from 1 April 2004. Companies already paying tax at a rate of 19% or above are unaffected. Nor do the new rules have any impact on the tax position of the shareholder. The 19% corporation tax rate generally applies to companies with taxable profits between £50,000 and £300,000. The 'dividends tax' is therefore aimed at companies with profits below £50,000.
Example
A company has taxable profits of £20,000. Individual shareholders receive dividends of £10,000.
Without the new 'dividends tax' the corporation tax liability would have been £2,375. The underlying tax rate (i.e. as a percentage of profits) is 11.875%.
With the 'dividends tax' the company's tax liability is:
Distributed profits = £10,000 x 19% = £1,900.00
Retained profits = £10,000 x 11.875% = £1,187.50
The company's total tax liability is £3,087.50, an increase of £712.50.
An unfortunate effect of the new measures is that the smaller the company's profits, the larger the impact of the dividends tax. A small company with profits of £10,000, all of which are paid out to shareholders as dividends, would suffer an additional corporation tax charge of £1,900. In the above Example, had the company's profits of £20,000 been fully distributed, the additional tax would have been £1,425. If dividends exceed profits for the accounting period, the excess dividends are carried forward and matched with future profits for tax purposes. Clearly, the rules add a further complication to an already unduly complex tax system.
Many sole traders and partnerships have incorporated their businesses in recent years to achieve overall savings in view of beneficial corporation tax rates. The 'dividends tax' does make operating the business through a company potentially less attractive. However, the tax advantages of incorporating a small business have not been eliminated. If no dividends are paid, the company tax bill is unaffected. If dividends are paid, tax and National Insurance savings are still achievable by operating through a limited company, compared to a sole trader or partnership. Existing company owners (and their advisers) should think carefully before disincorporating the business (i.e. ceasing to trade through a limited company and reverting back to operating as a sole trader or partnership), not least of all because tax charges can be triggered in the process. Specific professional advice should always be obtained.
First year allowances for small businesses
First year capital allowances for expenditure by small businesses on plant and machinery are increased from 40% to 50% for one year from 1 April 2004 (companies), or from 6 April 2004 (unincorporated businesses).
Company notification requirement
Finance Act 2004 will introduce a requirement for companies to notify the Revenue within three months following the commencement of trading, with penalties for late notification. This notification requirement is broadly similar to the rules for the newly self-employed, as they are required to notify the Inland Revenue within three months following the end of the calendar month in which the self-employment commenced.
Short tax returns
Around one-and-a-half million self-assessment taxpayers with 'simple' tax affairs will automatically receive a shorter, four-page tax return from April 2005. The short tax return will potentially be available for self-employed individuals with turnovers under £15,000, if their tax affairs are otherwise straightforward. There will be no requirement to self-assess the tax liability based on the return, but the Revenue will 'encourage' submission of the return by 30 September following the tax year, so that the tax can be calculated and the taxpayer notified of any tax liability by the next 31 January.
The devil will no doubt be in the detail so far as legislative changes following the Budget are concerned. Precisely how those changes will give effect to the above and other new tax provisions following Budget 2004 remains to be seen.
Mark McLaughlin
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