The first point to note is that there is more to consider than tax on profits when considering the optimum business structure. Inheritance Tax, Capital Gains Tax, and family plans for the future should all be taken into account.
Changes to Corporation Tax and Dividends
At present, all companies pay 19% Corporation Tax on all their profits. This changes in April 2023, when the rate of tax will depend on the level of profit and whether you own any other companies. For a farming family with no other associated companies, the position will be as follows:
The first £50,000 of profit taxed at 19%
The next £200,000 of profit is taxed at a marginal rate of 26.5%.
Any balance over £250,000 is taxed at 25%.
This means that a company making £100,000 of profit will pay £3,750 more Corporation Tax in future. However, this is still less than 40% Income Tax paid by a higher rate taxpayer if the business was operated as a partnership.
The key point when operating a partnership is how much is required to be withdrawn to cover living expenses or service personal loans and mortgages. It has been more tax-efficient to withdraw money by way of a dividend, but the tax rate payable on dividends increased by 1.25% in April 2022, meaning the position is now not clear-cut. The new rates will be 8.75% for a basic rate taxpayer, 33.75% for a higher rate taxpayer, and 39.35% for an additional rate taxpayer. The result of these changes is that if a company is paying 25% or 26.5% Corporation Tax on part of its profits, and the balance is withdrawn as a dividend by a higher rate taxpayer, the effective rate of tax will be more than 50%.
This can be more than the tax paid by an individual on partnership profits. The rate of National Insurance payable by a self-employed person needs to be taken into account, but is no more than 9%, and drops to 2% on profits over £50,270. It is also important to note that National insurance is not payable once a person reaches State Pension age.
Should I operate my business as a partnership or company?
This does not mean that incorporation is no longer the right option for farmers. Where a farmer is expanding their business and does not need to withdraw all their profit by way of a dividend, the payment of Corporation Tax at 25% or 26.5% is preferable to Income Tax and National Insurance of 42%.
As always it is essential to base a decision on your personal circumstances as there is certainly no one answer that applies to all farming businesses.
If you would like support and advice about the best way to operate your farm business please contact us.
