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The April dividend tax change, business entity choice & business financial protection considerations

by Johnny Timpson 11/02/16 Category: Blog

Chancellor of the Exchequer George Osborne’s summer  Budget was pitched as a  Budget for working people. But does that mean all working people, or just employees in a certain wage bracket?  The biggest shock came from changes to the dividend regime. From April, there will be no more grossing up of dividends and  offsetting a notional credit; instead, taxpayers get the first £5,000 tax-free, then pay tax at increased rates on the balance. In practice, even after the £5,000 tax-free allowance, the loss of the tax credit means more tax will be paid overall with directors paying 7.5% more tax on any dividend payments. The  Chancellor’s changes have moved the “break-even point for tax” to nearer £70,000 of profit, beyond this, the combined potential impact of corporation tax changes and the new, higher dividend rate actually see the tax benefits of incorporation starting to fall again. Here it might be more tax-efficient to operate as a sole trader having said this, the cut in corporation tax to 19% in 2017, with a further cut to 18% by 2020 is positive news for those operating a limited company. Many clients operate as a single person businesses. Their business structure can have implications  for the shape of business protection advice and cover needs, let’s explore these ….

A single person business can be established on a sole trader, limited company or even a partnership basis. It's possible for a single owner business using any of these structures to have employees who are not the business owner, but these tips look at purely single person businesses.

The main protection needs are likely to be:

·       Business loan protection.

·       Family protection, where it might be possible to use relevant life cover, depending on the business structure.

Sole trader

Sole traders are in business on their own behalf on a self-employed basis.

Limited company

A one-person limited company is a separate legal entity. It's a legal person in the same way as a living individual.

In their capacity as sole shareholder, the individual is the sole owner of the limited company.

In their capacity as sole director, the individual is an employee of the limited company.

Partnership

It's possible to set up a partnership made up of an individual and a limited company with just one underlying business owner.

This structure is used for tax planning purposes.  Any queries about the type and tax treatment of earnings/ profits  should normally be referred to the business's accountant.

Example: Chris Bloggs Fitness

Chris Bloggs Fitness is simply Chris Bloggs' trading name. The business isn't a separate legal entity that can be distinguished from him/her. 

Chris Bloggs is the sole owner of this business.

Chris Bloggs is self employed. The profits of the business are his/her self employed earnings.

Example: Chris Bloggs Fitness Ltd

Chris Bloggs Fitness Ltd is a limited company.

It's a separate legal entity from Chris Bloggs (the individual).

Chris Bloggs is the sole shareholder and therefore the sole owner of Chris Bloggs Fitness Ltd. As a shareholder, he/she can receive dividends.

Chris Bloggs is the sole director of Chris Bloggs Fitness Ltd. Therefore, he/she is an employee and can receive a salary.

Example: Chris Bloggs & Partner Fitness

The two partners are Chris Bloggs and Chris Bloggs Ltd, a limited company where Chris is the sole shareholding director.

Chris Bloggs is the sole owner of this business.

Business loan protection

If a lender requires life cover, this will always be set up on an own life basis.

The lender may insist on a mortgage assignment over the policy. The lender will provide the documents. 

Business loan protection

Depending on any lender specifications, life cover can be set up on an own life basis, or a life of another basis with the company as the applicant.

The lender may insist on a mortgage assignment over the policy. The lender will provide the documents. 

Business loan protection

Depending on any lender specifications, life cover can be set up on an own life basis, or a life of another basis, with the company (corporate partner) as applicant.

If there are no lender requirements,  it's worth  checking  with the accountant to make sure the way the cover is set up doesn’t conflict with any tax planning.

The lender may insist on a mortgage assignment over the policy. The lender will provide the documents.  

Relevant life cover

It's not possible for sole traders to have relevant life cover, because they are self-employed.

Relevant life cover

It is possible to set up relevant life cover for the director of a limited company, as they have employee status.

Example:

Chris Bloggs Fitness Ltd would be the applicant for the relevant life policy and the settlor of the relevant life policy trust. (Chris Bloggs must not be the applicant or the settlor, because he /she  is the employee.)

Chris Bloggs would be the life assured.

Relevant life cover

It might be possible to set up a relevant life policy given the employer/employee relationship via the limited company.  It's worth checking with the accountant in case this conflicts with any tax planning.

Example:

Chris Bloggs Ltd would be the applicant for the relevant life policy and the settlor of the relevant life policy trust. (Chris Bloggs must not be the applicant or the settlor, because he /she  is the employee.)

Chris Bloggs would be the life assured.

Family protection – other

The sole owner of a business is likely to have significant personal and family protection needs. A family trust can be used where relevant.  

Business trust

A business trust is not suitable as there are no shareholder or partnership protection needs  because there are no co-owners in any of these business structures.

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