Impact of the dividend tax on company vs sole trader choice for small businesses

As discussed in my Budget summary post last month the changes to the personal taxation of dividends from April next year was entirely unexpected and caused concern amongst contractor and small business groups. The Chancellor stated at the time that the aim of the changes was to deter tax motivated incorporations and it will certainly reduce the difference in tax paid overall by an individual operating through a company vs the same business operating as a sole trader.  There are of course a number of other very good reasons why you might want to incorporate, for example limited liability, access to financing via equity investment, and greater overall tax planning and flexibility. However let’s ignore those reasons for now and focus solely on the tax issue as I suspect in most cases this is going to be the over-riding one particularly for contractors.

In order to make a comparison it is necessary to make some basic assumptions, the main one being that in the case of the company the owner/director will be taking out of the company as a mix of salary and dividends all of the profits made each year. I’ve summarised in a table below the tax saving of being a company rather than a sole trader at various profit levels, first at current tax rates, then from next year when the dividend tax comes in, and finally from 2017 when corporation tax drops to 19%, which to some extent reduces the impact of the dividend tax charge.

Estimated tax saving of trading as a company compared to a sole trader

                                       2015/16                                2016/17                          2017/18

£20,000                         £700                                     £500                                   £600

£30,000                         £1,600                                  £800                                  £1,000

£40,000                        £2,500                                  £1,100                                £1,400

£50,000                        £3,200                                  £2,300                               £2,700

£75,000                        £4,300                                  £1,700                               £2,350

My gut feeling from reviewing these figures is that the threshold at which the tax savings alone become sufficient to offset the additional costs of running a company will move from around £20-25,000 to £30-35,000, though as mentioned earlier there are a number of other benefits to operating a business through a company.