Taxation of the unincorporated business for P6 (UK)

The existing business (for P6 (UK))
Part 2 of 4

This is the Finance Act 2015 version of this article. It is relevant for candidates sitting the P6 (UK) exam in the period 1 September 2016 to 31 March 2017.
Candidates sitting P6 (UK) after 31 March 2017 should refer to the Finance Act 2016 version of this article (to be published on the ACCA website in 2017).

In the first part of this article we looked at some fundamental issues relating to unincorporated traders.

The remaining parts of this article compare the total tax paid on the profits of a business depending on the business vehicle used, the implications of a change of accounting date and the cessation of a business.

TOTAL TAX – COMPARISON WITH COMPANY

The total tax paid on the profits generated by a business will vary depending on whether the business is unincorporated or is owned by a company. This is a significant issue and will be considered, together with legal and commercial issues, when deciding on a business vehicle prior to commencing to trade and also when considering the desirability of transferring an existing unincorporated business to a company.

The calculations necessary to compare the alternative business structures must be performed with care if they are to be accurate. They require a sound knowledge of income tax, national insurance and corporation tax.

Illustration 1
Sammy’s business has an annual tax adjusted profit of £46,000. This figure is prior to any payments being made to Sammy. Sammy is considering three strategies: Strategy A, where the business is unincorporated, and Strategies B and C, where the business is incorporated.

Under Strategy A, where the business is unincorporated, the net income available to Sammy for the year ended 31 March 2016 is calculated as follows.

 Strategy A
Unincorporated
£
 

Income tax:

  
Trading income

46,000

 
Personal allowance

(10,600)

 

Taxable income

35,400

 
   
£31,785 x 20%6,357 

(£35,400 – £31,785) x 40%

1,446

 

Income tax payable

7,803

 
   

Class 4 National Insurance contributions:

  
(£42,385 – £8,060) x 9%

3,089

 

(£46,000 – £42,385) x 2%

72 
   

Class 2 National Insurance contributions:

  

52 x £2.80         

146 

Total tax payable

11,110

 
   

Net income for Sammy (£46,000 – £11,110)

34,890

 


Under Strategies B and C, the business will be operated via Wilson Ltd, a company owned 100% by Sammy. In these circumstances, the net income available to Sammy will depend on the mix of salary and dividends paid by the company. The calculations set out below show the income available to Sammy where the company’s profit after tax is paid to Sammy as a dividend in addition to a salary of either £34,000 or £11,000.

 Strategy B Salary
£34,000
£
Strategy C
Salary
£11,000
£
 

Wilson Ltd

   

Trading profit pre salary

46,000

46,000

 
Salary

(34,000)

(11,000)

 
Employer’s class 1 national insurance contributions (less employment allowance)

((£34,000 – £8,060)
x 13.8% = £3,580 – £2,000))

((£11,000 – £8,060)
x 13.8% = £406 – £406)







(1,580)











0
 

Taxable total profit

10,420

35,000

 

Corporation tax at 20%

(2,084)

(7,000)

 

Available for dividend         


8,336


28,000

 
    
Sammy   

Employment income

34,000

11,000

 

Dividend income
(£8,336/£28,000) x 100/90)



9,262



31,111

 
Personal allowance

(10,600)

(10,600)

 

Taxable income

32,662

31,511

 
    

((£34,000 – £10,600) = £23,400 x 20%)


4,680

  

((£31,785 – £23,400) = £8,385 x 10%)

838

 

 
((£9,262 – £8,385) = £877 x 32.5%)
285
  

Tax credit on dividend income


(926)

 

 
 

4,877

 

 
    
((£11,000 – £10,600) = £400 x 20%) 
80
 
((£31,111 x 10%) 
3,111
 
Tax credit on dividend income 
(3,111)
 
  80 
    

Salary

34,000

11,000

 

Dividend

8,336

28,000

 

Income tax

(4,877)

(80)

 

Employee’s class 1 National Insurance contributions
(£34,000/£11,000 – £8,060) x 12%





(3,113)





(353)

 

Net income for Sammy

34,346

38,567

 

 

Summary – Net income for Sammy

 
Strategy A
Unincorporated
£
Strategy B
Salary
£34,000
£
Strategy C
Salary
£11,000
£
 

Net income for Sammy


34,890

34,346

38,567
 


The net income available to Sammy is, of course, simply the difference between the profit of the business and the total tax payable under each of the alternatives.

 
Strategy A
Unincorporated
£
Strategy B Salary
£34,000
£
Strategy C Salary
£11,000
£
 

Profit of the business


46,000


46,000


46,000

 

Corporation tax

 

(2,084)

(7,000)

 

Income tax

(7,803)

(4,877)

(80)

 

National Insurance contributions:

    

Employer’s class 1

 

(1,580)

0

 

Employee’s class 1

 

(3,113)

(353)

 

Class 2

(146)

   

Class 4
(£3,089 + £72)


(3,161)


______

______
 

Net income available
to Sammy


34,890


34,346


38,567

 

A comparison of Strategy A with Strategies B and C illustrates that being self-employed does not necessarily result in more income being available to the individual.

A comparison of Strategy B with Strategy C illustrates the tax that can be saved when a dividend is paid in place of salary.

Conclusion

Calculating the total tax paid on the profits of a business is not particularly technically difficult. However, it does require very good knowledge of the Paper F6 syllabus and great care must be taken in order to earn all of the available marks.

Note: The unincorporated trader is also considered in:

  • Taxation of the unincorporated business – the new business


Written by a member of the P6 examining team

The comments in this article do not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content of this article as the basis of any decision. The authors and the ACCA expressly disclaim all liability to any person in respect of any indirect, incidental, consequential or other damages relating to the use of this article.