SHOULD CORPORATION TAX BE DEVOLVED TO NORTHERN IRELAND AND SCOTLAND?

Posted on October 12, 2011 by Robin Taylor

by JOHN CHOWN AND BINNE VRIES

Generally, lowering taxes on companies should increase activity, but from what source? If new business (including diverted foreign business) is at the expense of England & Wales,
then given that most of the votes are there, the UK government is unlikely to agree. They may be more relaxed about business that would otherwise have gone to the Republic where tax reductions have proved to have a dramatic impact on the economy (the 12.5% rate, introduced under EU pressure, was preceded by substantial specific exemptions from tax).

A simple reduction in the rate of tax which appears to be envisaged would be a great headline catching measure, particularly for foreign investors, but will raise two problems. First, existing businesses will seek to arrange that more of the profits will arise in
the favoured location without actually changing the substance of their operations. This will raise problems of transfer pricing and the whole battery of complex anti-avoidance legislation, only too familiar to international practitioners, would have to be applied.

What good would the change do?  As has been demonstrated many times, up to
a point, reducing tax rates can actually increase revenue. Certainly, measures to slash rates (from around 50%) and broaden the base, such as were taken by Geoffrey Howe, proved very successful, but most of the easy benefits have now been obtained and present UK
rates seem very near optimum levels in terms of pure revenue raising.

Based on international evidence, we are sceptical about whether  broad-brush regional incentives are economically efficient. If we may make a positive suggestion, , what we really need in both Northern Ireland and Scotland (and arguably in the UK as a whole) are carefully designed and targeted, simple to understand, specific incentives for small businesses (remember that many of these are unincorporated) starting up or recruiting new employees. This would be less controversial at both domestic and EU level than competing for foreign investment. The reduction in tax take from the business should then, we hope, be more than balanced by the very substantial revenue turnaround when an increase in employment turns Social Security beneficiaries into taxpayers. The newly employed  will also have more to spend, increasing the yield of Value Added Tax.

This brings us to the second problem. Neither country really has an independent budget. Scotland enjoys a Treasury block grant of £30 billion per annum and any reduction in the
corporation tax take from either would automatically cause a reduction in its grant. Scotland business is said to pay £5 billion of corporation tax (ignoring the sensitive subject of North Sea oil) and it has been calculated that a reduction rate to 12.5% would cost Scotland £2.6 billion while it is not clear that they would get back the secondary benefits just referred to.  A report by the NI Economic Group suggests (tentatively) that the cost of a change in Northern Ireland would be £2-300 million.

These figures take no account of the income tax, social security and VAT consequences of any changes and these would have to be taken into account very carefully. However, as neither country can afford to lose net revenue, we need a much more careful analysis of which revenue benefits accrue to the UK and which would actually benefit the particular territory. If this were merely a domestic problem, it could be solved with mutual good will backed by very careful calculations but we have to take into account European Union rules on State aid and the non-legal binding Code of Conduct for business taxation.

If we apply European Court of Justice criteria (the Azores judgment) it would seem that we would first have to ensure that the relevant decisions were taken by the separate governments of Northern Ireland and Scotland rather than London. More significantly, though, the loss of revenue would have to be borne by the territory concerned and could
not be compensated for by central government subsidies. This leaves an interesting question would the grant simply be reduced by the loss of corporation tax revenue or would the calculation take into account increases in the take from employment and value added taxes? In any case, to comply with these conditions, there would have to be a substantial reshaping of the budget arrangements and a probably a significant delegation of overall budgetary powers to the government concerned.

To conclude, the idea is an interesting one, but will have to clear many hurdles. As to the EU issues. Attitudes may be change (and we fear not for the better) as even more complex
issues about the relationship between monetary, fiscal and political union develop within the eurozone.

THE AUTHORS

John Chown, an economist and international tax adviser, a co-founder of the Institute for Fiscal Studies and Secretary to the International Tax Specialist Group, has done extensive
Ministerial level work on tax policy and financial markets in the EU,  Russia, Thailand and elsewhere. His colleague Binne Vries is a Dutch international tax lawyer who has worked for many years in the United Kingdom and now lives in Belfast. www.chowndewhurst.com

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LIMITED TAX BILLS VIA LIMITED COMPANIES?

Posted on October 12, 2011 by Robin Taylor

WHY THE NEW CORPORATION TAX RATES MEAN LLP IS NO LONGER THE “DEFAULT CHOICE” FOR PROFESSIONAL FIRMS.

This article was prepared by Donald Parbrook, Head of Tax at Milne Craig, Chartered Accountants and Chartered Tax Advisers. Readers are advised to take appropriate individual advice on their circumstances regarding the article below. www.milnecraig.co.uk

In recent years, many professional firms have taken the opportunity to incorporate their partnerships into “LLPs”. Some aspects of such a move were explored in issue 11.

However, smaller partnerships (from all sectors) have sometimes chosen to incorporate as a company instead, and have then been able to benefit from the low corporation tax rates for small companies.

The Government’s move to lower the main corporation tax for larger companies now makes “going Limited” (or Unlimited!) significantly cheaper than “going LLP” for most firms.

Tax Basics – the Company or the Partnership?

Note, firstly, that for tax purposes the LLP is generally the same as a “normal” partnership. So, all profits are to be found on the personal tax returns of the partners whether drawn or credit to capital account for another day (you pay tax on the paper profit not what you take out personally!). Historically this meant 40% tax was paid on the top slice for higher earners in an LLP or partnership.

Secondly, the rates are up – the top rate is now 52% (tax and national insurance (“NI”)), if we leave aside the rather scary 62% marginal rate for income between £100,000 and £115,000 approximately, per annum, due to the way the personal allowance is withdrawn at that income point.

A particular tax downside for an LLP/partnership is that the entire profit is taxable whether the partner takes the money or not. So, in a growing business, where profits are perhaps left in the business (and often found locked up in work in progress!), paying tax at these rates can be painful – with the payments on account tax system making that pain excruciating.

So, what is to be done about these horrible tax rates?

In recent years smaller partnerships have often incorporated into companies not LLPs because the corporation tax rate for smaller companies has hovered around the 19%-22% range for some years but, as larger companies paid 28%-30%, they often favoured LLP. After allowing for corporation tax, the profits can be paid out as dividends. Dividends are then taxed on the individual (to the extent they pay higher rate tax). The combined tax on the dividend plus the corporation tax was still less than 40% tax if the corporation tax rate was at the lower end above, but not at the higher end of corporation tax rates.

Leaving aside the fact that a company can operate with its working capital being corporation tax paid at 26% (current main Corporation Tax Rate) against 52% (worst case) tax for a partnership, there is now a change in that there is an absolute tax saving regardless of the size of company.

At Budget 2011, the Chancellor decreased the main corporation tax rate to 26%, with a commitment to reduce it further by 1% per annum to 23% by 2014.

What does the new, lower corporation tax regime mean?

In short, the new lower rates of corporation tax provide a lower tax cost for a company compared with a partnership or LLP for most businesses.

Indeed, if your partnership has significant working capital, the saving on the effective tax cost of money tied up in capital accounts / directors loans is worth it alone.

The additional quirk here is the probability that 50% the tax rate may not be here forever so you can, perhaps, defer drawing the top slice of company profits as a dividend until the personal tax rates are slightly kinder.

After incorporation, you can declare a modest salary along with some dividends (typically up to the top of the basic rate tax band in total) and, if you need more funds, live on your director’s loan account (being your old capital account in the prior practice) to escape 50% and 60% tax rates. As your capital account represents tax paid money, you make an enormous short term saving. However, most partners don’t have capital accounts that are so very generous that this helps you avoid higher rate taxes for long (it varies!)….

…..The icing on the cake

The further “trick” is that many partnerships that have become companies have sold their goodwill to their new company for a full third party market valuation. Where this is possible it can significantly enhance the opening director’s loan balances owed to the former partners – at a tax cost of 10% capital gains tax in most cases. This can enhance the tax benefits of incorporation significantly.

But…the downsides

There are a few complications, but rarely any that can’t be overcome with some careful thought. And whilst an LLP has its place for some sectors, many partnerships, including professional services firms such as accountants, lawyers and the like would be well advised to look again at their tax bills and their options for incorporation. It is useful to note that Jordans and Oswalds have styles of Articles and documentation that is generally pre-approved with the relevant regulatory Institutes including solicitors, surveyors, dentists, accountants, architects and vets.

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Shares or guarantee – getting it right from the start

Posted on September 22, 2011 by Robin Taylor

Kathleen O’Reilly, our Head of Internal Legal Services highlights the importance of getting the right corporate structure from the outset.

Clients often ask if it’s possible to change from a guarantee company to a company limited by shares and vice versa. Unfortunately it is not and this highlights the importance of getting the right company structure for your needs from the start.

Whether your company structure is shares or guarantee is an irreversible decision once the company is incorporated.

“I think people sometimes get confused about this issue because it is possible to play around with share companies to a considerable extent – private companies can become public and vice versa. Also, private limited companies can become unlimited, ” commented Kathleen “so it’s easy to see how this might be seen as a straightforward change too. Unfortunately, company law does not see it that way!”

If you realise your company should have been limited by guarantee e.g.

  • it is not being set up to make a profit
  • it is being set up to regularise arrangements e.g. it is a rugby club or golf club and as such the company needs to have the ability to remove members if necessary
  • membership is intended to be personal and not easily transferable

but the company was set up as limited by shares then there is sometimes little you can do but start again.

If that is the case, the organisation would have to set up another company (this time limited by guarantee), transfer the business from the company limited by shares across to the guarantee company and then set up the register of members etc.

“Sometimes, it may simply be a question of speaking to our experts to see if anything can be done in terms of changing the share rights in the limited company. If the company is one set up to make a profit then it really should be set up limited by shares. It might be that solutions to a problem could be achieved by providing enhanced voting rights for some members compared to others.”

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