Paying too much tax?

Posted: 31st Jan
Chris Bentley, Tax Accountant

You along with many of our clients may think this is the case, particularly at this time of year when presented with last year’s self-assessment tax return.

If you are already of this mindset, the bad news is that there are big tax rises coming in April 2022 and then again in April 2023. A further “reform” of the basis period rules will create increased tax bills for many of those who operate as sole traders or as partnerships in 2023-24. These tax rises are part of the government’s efforts to repair the public finances after the destruction wrought by Covid-19. They may change how your business is structured going forward, and how you take money out.

Tax rises and profit extraction

For reasons of tax efficiency, most business owners have long been advised to operate through a limited company, taking a small salary of around £10,000pa and the remainder of their drawings in the form of dividends. The upcoming tax rises mean this may not be the case in the future.

All rates of income tax on dividends rise by 1.25% from April 2022 and the rate of corporation tax for businesses making profits of more than £250,000 per year will rise by 6% to 25% from April 2023. Taken together these tax increases will mean that the total tax burden (corporation tax, income tax, national insurance) on dividends will be almost identical to that on salaries drawn through the PAYE system. For some business owners, this means the tax benefits of being the owner-manager will come to an end.

By contrast, those operating as a sole trader or as part of a partnership will see a total tax increase of just 1.25% meaning they face a much lighter tax burden than those operating through companies from April 2023. Similarly, the owners of the smallest limited companies, particularly those making profits of under around £100,000 will not see a significant increase in the amount of corporation tax payable.

The changes mean that going forward there are additional tax considerations when structuring a business. Many will still be advised to operate through a limited company and make drawings in the form of dividends because it provides an opportunity to divert income to a lesser earning spouse or to retain surplus funds in the company and defer the personal tax liability. But others may decide to put themselves on payroll so that all tax is paid at source. Others will be advised to set up a new business venture as a sole trader or as an LLP. We would be pleased to advise!

Changes to basis periods

Those who operate their businesses as sole traders, as a partnership or as an LLP currently have their tax liabilities determined by a complex set of rules which refer to the date the business draws its accounts up to. By way of example, the profits of a business for the accounting period 1 May 2020 to 30 April 2021 are taxable in the 2021/22 tax year.

The government is changing this so that all sole traders and members of partnerships and LLPs will be taxable on their profits for a period from 6 April to 5 April (or 1 April to 31 March) from the 2024/25 tax year. This will apply regardless of the date the business draws its accounts up to. It is a major change and means that for the 30 April year-end business in the example above, profits for the period 1 May 2022 to 30 April 2023 and profits for the period 1 May 2023 to 31 March 2024 (ie profits for 23 months) will be taxable in the 2023/24 tax year.

Affected businesses will receive “overlap relief” (credit for profits taxed twice when the business was set up), and there will be provisions to allow the extra tax payable to be spread over a number of years. Despite this we expect a number of business owners to receive unusually, and possibly unexpectedly, large tax bills for the 2023-24 tax year.

In some cases, depending on the wider circumstances, it may be possible to mitigate the impact, but doing so would require early and detailed discussions. In other cases, early consideration will at least give advance notice of the upcoming tax liabilities. Again we would be pleased to advise.

Chris Bentley heads up the specialist Tax and Forensic departments at Harts Accountants. For further information contact Chris on 01625 669669 or email CBentley@harts-ltd.com