Taxation of the unincorporated business for Paper P6 (UK)

THE EXISTING BUSINESS
Part (b)

This is the Finance Act 2013 version of this article. It is relevant for candidates sitting the Paper P6 (UK) exam in 2014. Candidates sitting Paper P6 (UK) in 2015 should refer to the Finance Act 2014 version of this article (to be published on the ACCA website in 2015).

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 £45,000. 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 2014 is calculated as follows.

 Strategy A
Unincorporated
£
 

Income tax:

  
Trading income

45,000

 
Personal allowance

(9,440)

 

Taxable income

35,560

 
   
£32,010 x 20%6,402 

(£35,560 – £32,010) x 40%

1,420

 

Income tax payable

7,822

 
   

Class 4 National Insurance contributions:

  
(£41,450 – £7,755) x 9%

3,033

 

(£45,000 – £41,450) x 2%

71 
   

Class 2 National Insurance contributions:

  

52 x £2.70          

140 

Total tax payable

11,066

 
   

Net income for Sammy (£45,000 – £11,066)

33,934

 


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 £35,000 or £11,000.

 Strategy B Salary
£35,000
£
Strategy C
Salary
£11,000
£
 

Wilson Ltd

   

Trading profit pre salary

45,000

45,000

 
Salary

(35,000)

(11,000)

 

Employer’s class 1 national insurance contributions
(£35,000/£11,000 – £7,696) x 13.8%



(3,768)


(456)
 

Taxable total profit

6,232

33,544

 

Corporation tax at 20%

(1,246)

(6,709)

 

Available for dividend         

4,986

26,835

 
    
Sammy   

Employment income

35,000

11,000

 

Dividend income
(£4,986/£26,835) x 100/90)


5,540


29,817

 
Personal allowance

(9,440)

(9,440)

 

Taxable income (all in the basic rate band)

31,100

31,377

 
    

(£31,100/£31,377 – £5,540/£29,817) x 20%

5,112

312 

£5,540/£29,817 x 10%

554

2,982

 

Tax credit on dividend income

(554)

(2,982)

 
 

5,112

312

 
    

Salary

35,000

11,000

 

Dividend

4,986

26,835

 

Income tax

(5,112)

(312)

 

Employee’s class 1 National Insurance contributions
(£35,000/£11,000 – £7,755) x 12%



(3,269)



(389)

 

Net income for Sammy

31,605

37,134

 

 

Summary – Net income for Sammy

 Strategy A
Unincorporated
£
Strategy B
Salary
£36,000
£
Strategy C
Salary
£11,000
£
 

Net income for Sammy


33,934

31,605

37,134
 


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
£35,000
£
Strategy C Salary
£11,000
£
 

Profit of the business

45,000

45,000

45,000

 

Corporation tax

 

(1,246)

(6,709)

 

Income tax

(7,822)

(5,112)

(312)

 

National Insurance contributions:

    

Employer’s class 1

 

(3,768)

(456)

 

Employee’s class 1

 

(3,269)

(389)

 

Class 2

(140)

   

Class 4
(£3,033 + £71)


(3,104)


______

______
 

Net income available
to Sammy


33,934


31,605


37,134

 

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 Paper 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 author and the ACCA expressly disclaims all liability to any person in respect of any indirect, incidental, consequential or other damages relating to the use of this article.