Company gains – better than personal gains

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Some years ago the Labour Chancellor encouraged people to form their businesses as limited companies.  The first £10,000 of profits were to be tax-free.  Then people took his advice and set up loads of companies.  Then in his 2004 Budget he made changes to make the whole idea much less attractive again.

I am not dwelling on this aspect today, but I am going to set out another major disadvantage of companies.

It is easy and cheap to set up a limited company.  Indeed some banks and government agencies seem to encourage it.  Getting your money or assets out of the company is a different matter.

Let me give you an example.  Say you set up a company and it acquires a farm in East Anglia for £100,000.  It then farms away at it for 3 years until the local builder comes knocking.  He offers £1,100,000 for the land so he can build quality housing for young families.  What are the tax implications?

The company is about to make a capital gain of a juicy £1,000,000.  (I will ignore the inflation allowance which companies still get.) This gain counts as corporation tax profits in just the same way as farm income did.  This high level of profits will be taxed at 26% – so the company pays tax of £260,000 (2011/12 rates).

Once this sale goes though you have a company with no land and £740,000 in the bank once the tax is paid.  But you, the owner (shareholder) still cannot go on that World cruise you promised to.  To do that you have two choices:

  1. Wind the company up, or
  2. Take the money out over a number of years as dividends.

Option 1 will mean you have a Capital Gains Tax bill.  With your CGT exemption your bill might be close to £205,000. Check out Extra-Statutory Concession C16.  Then you have £535,000 to play with.

Option 2 might be attractive if you can live on about £38,000 per year.  You might not face any higher rate tax on that level of dividends.  But during the 20+ years it takes to get your money out the company becomes an investment company.  This is because it is holding its £740,000 as deposits or investments.  Investment companies pay the full 26% corporation tax on their annual investment income such as bank interest.

Neither of these options looks too attractive to me.  What is the alternative?

Well the alternatives include never going near a company or having the land in your own name and letting it under conacre/annual tenancy to the company.  What then are the tax implications for you?

You personally make a gain of £1 million.  The maximum CGT you personally pay is then just below £280,000 (an effective rate of c28%).  This leaves you with £720,000 to play with, but you have it right from the year of sale, rather than having to drip-feed it out over 20 years.  Under any comparison this is better than if the company owned the land (at least £185,000 better).  And no further constraints on using the money.

This all goes to show the importance of taking advice before setting up as a company and in particular before acquiring valuable assets in the name of a company.

Huston’s Hint

Being a ‘company director’ is important to some people, paying less tax is important to some people – which sort are you?