1 August 1997

Tax cuts raise questions over trading status

By Philip Clarke

CUTS in corporation tax, introduced in the Budget, have lowered the point at which farmers operating as sole traders or partnerships may be better off converting into farming companies.

In his June 27 statement, Chancellor, Gordon Brown, reduced the rate for small busin-esses to 21p in the £. But income tax was left unchanged at a basic rate of 23p in the £, with the higher rate at 40p.

"This differential may, in some cases, encourage producers to look again at the relative merits of corporate status," says Deloitte and Touche accountant Simon Bennett.

His analysis shows that, in purely economic terms, the break-even point comes at £75,000.

A sole trader making profits of this order would pay income tax and National Insurance of £25,172, leaving available cash of £49,828 (see table 1).

But a farming company, earning profits of £75,000 and paying directors fees of, say, £50,000, would also be left with cash of £49,818 (after deducting £5000 employers NI, £4200 corporation tax and £15,982 income tax and employees NI).

On that basis, a farmer who makes more than £75,000 profit would have more total cash available if he formed a company than if he stayed a sole trader, says Mr Bennett.

"But this option only leaves the director with net remuneration of £34,018 – the balance is left in the company.

"If he wanted to take more cash out, then the point at which he would be better off converting would be higher. Conversely, if he wanted to take less out and reinvest more funds in the business, then the threshold would be lower," he says.

In practice many other things will also influence the decision. "Generally speaking, one would not convert straight from a sole trader to a company, as it is more beneficial to form a partnership with ones spouse, doubling the tax allowances and lower rate tax bands," says Mr Bennett.

Working the figures through, he estimates that parity between a farming company and a part- nership would come with a net farm income of £100,500 and directors fees of £50,000. But this assumes there is a spouse to form a partnership with, and that both parties are happy with such an arrangement.

Furthermore, the analysis takes no account of the additional costs of running a company, for example charges for an audit and for company secretarial services.

But while these factors may play against a company structure until a higher level of profit is reached, some farmers – particularly those who are also involved in food processing – may be tempted by the benefits of limited liability. Under this, members of the public with a claim against the business may, generally, only claim on the assets of the company rather than the private wealth of the shareholders involved.

"The decision whether to incorporate or not is still not straightforward," says Mr Bennett. "However, the Chancellor has certainly taken steps to make it more attractive." &#42


Table 1: Sole trader or company?

Sole trader

Profit75,000

Income tax(23,822)

National Insurance(1,350)

Total deductions(25,172)

Cash49,828


Table 2: Sole trader or company?

Company

Profit75,000

Less:

Remuneration(50,000)

Employers NI(5,000)

Net profit20,000

Coporation tax(4,200)

Cash in company15,800

Remuneration50,000

Income tax(13,822)

Employees NI(2,160)

Personal cash34,018

Total cash49,818