Is Incorporating the Right Choice for You?

Posted On May 12, 2017 By mhauk

Hot on the heels of the Budget, the questions being asked by many partners at solicitor practices across the country are, “Should we consider incorporation to obtain limitation to liability or not?” and, “What are the consequences now?”

The majority of the legal practices that we see are predominantly partnerships and partners are looking at how to structure their practice in order to attract and obtain potential future partners.

The big question is, what is the most tax efficient way of extracting funds from the business?

One solution could be to set up a limited company with an alphabet share structure so that different dividends can be declared for each of the different shareholders to replicate the profit sharing ratios of the partnership. Thus, making full use of the shareholders’ tax free allowances.

Prior to the change in taxation of dividends, a significant tax saving could be made, as no national insurance was payable and because of the tax credit received on dividends. The Chancellor is, in effect, closing this route off and getting people to pay more income tax.

Another avenue that could be explored is setting up a Limited Liability Partnership (LLP).

At a glance, an LLP offers similar protection and, in addition, enables members to register charges over their loans to a Limited Company (Ltd). However, they are taxed very differently.

Even though an LLP is a separate entity and does not pay tax itself, the LLP members are taxed as if they are self-employed, subject to certain HMRC criteria, as if they were a member of a partnership. A Ltd pays corporation tax on profits and the shareholders pay income tax on the dividends.

The Chancellor has backtracked on his proposal to increase national insurance contributions for the self-employed. The Chancellor proposed the change on the basis that the difference in national insurance rates between employed and self-employed undermined the fairness of the UK tax system. Will he seek to redress this in a future Budget?

In addition, in the spring Budget, it was announced that the tax free dividend allowance will be reduced from £5,000 to £2,000 from April 2018. What this means is that only the first £2,000 will be declared tax free and any dividends beyond this will be taxed according to your tax banding for 2017/18 tax year according to your total income:

  • Tax free up to £2,000
  • 7.5% within the basic rate band (£2,001 – £33,500)
  • 32.5% on higher rate (£33,501 – £150,000)
  • 38.1% on additional rate band (over £150,001)

Taxation of profits should not be the influencing factor in deciding the structure of the practice, as there are many commercial decisions to be made. In addition, entry to and departure from the entities need to be considered due to potential tax consequences.

Therefore, if you would like to talk to us about incorporating in more detail or if you have any questions, please contact Hannah Farmborough or call on 0207 429 4147 to be put in contact with a member of our Professional Practices team

This article originally appeared on the blog of our member firm, Larking Gowen.