When You Should Not Use a Company
By Lee Hadnum BSc ACA CTA
Much has been written on when you should use a UK company. In fact you'll find plenty of websites devoted to using a company and how it could save you thousands. Well in many cases this is correct, however, we like to go one step further so we're going to run through some of the occasions when using a company would not be beneficial.
Where the company would be classed as a close investment company ('CIC').
The tax legislation states that a close company is a CIC unless throughout the accounting period it exists wholly or mainly for one or more of the following purposes
a) the purpose of carrying on a trade or trades on a commercial basis
b) the purpose of making investments in land or estates or interests in land in cases where the land is, or is intended to be, let to persons other than
- i) any person connected with the relevant company, or
- ii) any person who is the wife or husband of an individual connected with the relevant company, or is a relative, or the wife or husband of a relative, of such an individual or of the husband or wife of such an individual
Therefore if you're using a company as a non property investment company the chances are you'll be caught by these provisions. This would include holding an intangible asset or investing in shares via a company.
Investments in land have a specific let out in that providing the property is let to an unconnected party the company would not be a CIC.If though you used a separate property company to hold property that was let to your trading company you could easily fall within the CIC rules.
Where the CIC rules apply the company is charged at (currently) 30% irrespective of the level of profits. When you consider that this is just the company's tax charge and that an additional tax charge would arise on the shareholders/directors on the extraction of funds (potentially at 25% for a higher rate taxpayer extracting dividends) you could easily end up paying more tax by using a company than if you invested personally. When you also add into the equation the fact that individuals would usually be entitled to higher reliefs on disposals of capital assets (eg the annual exemption and taper relief) this swings the balance even more in favour of personal investment.
If you're planning on going overseas
This is something that many people overlook, but given the number of people emigrating and working from overseas (eg telecommuting) it's well worth bearing in mind.
Imagine this. You write a few e-books and decide to sell them over the internet. As you live in the UK you know all about the advantages of a UK company and therefore transfer the rights to the books to the company at start up and trade via the UK company.
Five years later, the company has become profitable, and generates royalties of £75K per annum. You have got sick of life in the UK and want to move to Cyprus.
There is no problem with you personally moving to Cyprus, the downside is that the e-books are locked in the UK company. Any transfer of the e-books out of the UK company would crystallise a gain in the UK company, based on the market value of the books (likely to be substantial if they're generating £75K pa) and the original acquisition cost (nominal).
Therefore the fact that you never set foot in the UK would not stop the UK taxman taking 20% of the profits of the UK royalty company. There would also be a risk that if you stopped trading from the company after leaving the UK (to prevent other income being taxed in the UK) that the UK taxman could class the company as a CIC, and thus tax it at 30%.
The fact that Cyprus is generally regarded as a royalty tax haven wouldn't matter to you as you wouldn't be able to take advantage of it (at least not without incurring a hefty tax cost).
The other downside of retaining a UK company is that you can't comletely sever your ties with the UK, as you'll still be in receipt of UK dividends. You could incorporate an overseas company to hold the shares but this is 'messy' and could anyway lead to an increase in the number of associated companies/tax rate dependent on what the holding company does.
If you're trading personally you won't have any of these problems. There is no deemed disposal of assets when you cease to be UK resident (unlike in many countries) and you could just carry out the trade from overseas. Provided you have no UK trade there will then be no UK tax charges (there may though be UK witholding tax issues if the royalties have a UK source)
If you're looking at purchasing property which you will or even may occupy this should not be owned by a company.
The use of a company in this case has a number of disadvantages including:
- The fact that the property will be locked in the company. Any disposal of the property would crystallise a gain in the company (subject to corporation tax) as well as a further tax charge on the extraction of the proceeds
- The reliefs available to a company are much less than an individual. In particular if you have occupied the property as your main residence you would qualify for principal private residence ('PPR') relief on a disposal. In addition taper relief (before April 2008) and the annual exemption would be due. This will in many cases fully eliminate any gain.
By contrast a company would not be entitled to any of these reliefs and would be fully charged to corporation tax on the gain with only a small amount of relief for the effects of inflation.
- Any occupation of the property by you without you paying the company a market rental would be classed as a benefit in kind from the company to you. The broad effect of this is that you are likely to be subject to an annual income tax charge on approximately the market rental income the company could have obtained.
Therefore owning a personal residence via a company, is obviously a big no,no.
If you're a non UK domiciliary
If you're a non UK domiciliary you are generally taxed on overseas income and gains to the extent that the income or proceeds are remitted to the UK (ie brought into the UK).
In this case, if you own overseas assets or are conducting a trade overseas using a UK company may not be advisable. A UK company would usually be classed as resident in the UK, and as such would be subject to corporation tax on its worldwide income and gains.
Given as a non UK domiciliary you could own personally and avoid UK tax by retaining income or gains overseas, using a UK company would not be advisable (providing you could retain some of the cash overseas). After the 2008 pre budget report though you’d need to ensure that the overseas unremitted income was substantial as you’ll be charged £30,000 each year for the privilege of the remittance basis.
If you can't retain profits in the company
The benefit of the company is that it has a lower rate of tax than you do personally. If you extract cash from the company you then incur a personal tax charge which eliminates much of the benefit of using the company.
So, if you hold personally you may suffer a 40% tax charge (as well as National Insurance if you're a trader). If you hold via a company, the company may suffer a tax charge of 20% (if profits of less than £300K) and you would suffer an effective tax rate at 25% on extraction of dividends.
When you take into account the other drawbacks of using a company, including the higher accounting and filing fees, extra admin etc the benefits may not be worthwhile.
If you need to make significant pension contributions
You may find it better to trade personally if you need to make large pension contributions.
Your ability to make pension contributions and get tax relief on them now depend on the level of your earned income. Therefore if you're trading personally you could potentially make a pension contribution of the amount of your net profit,(subject to the usual rules regarding the annual and lifetime pension limits). You'd be taxed at 40% but the pension would qualify for tax relief.
If you use a company, the company would be taxed on the profits generated. In order to make a large pension contribution you would need to have significant earned income. Dividend income is not classed as earned income, and therefore you would need to extract cash as salary/bonus to use this as a 'base' for your pension contribution. The downside to this is that you'd be looking at NIC charges on you (although only at 1% above the upper earnings limit) and on the company.
The company would pay NIC at 12.8% on the full amount of the bonus,although it would be tax deductible.
In this case the salary payment could in itself reduce the benefit of using a company significantly. The company may still have the edge but it would be more marginal, and when you take other issues into account... well that's up to you.
The purpose of this article is to highlight that there is very rarely a simple strategy that is correct for everyone. For many using a UK company would be advisable, however there are also other people for whom using a UK company would be a serious error. Ensure you carefully consider using a company, as once you have assets locked in the company extracting them can be costly.