Small Companies Tax Rate May Cost UK Treasury Big Bucks

by Jason Gorringe, Tax-News.com, London

16 May 2002

The UK's Institute for Fiscal Studies says that if many self-employed people take advantage of the new zero tax rate for company profits up to £10,000, forming themselves into small companies, up to £2.5bn in tax revenue could be lost.

A self-employed person paying income tax at the basic rate could save several thousand pounds from their annual tax bill by setting up as a small company and taking most of their income as a dividend, which is not charged lower rate or basic rate tax. For instance, a self-employed person earning £15,000 a year would have to pay about £3,800 in tax next year, but if they incorporate they could pay no tax at all. There could be further savings on National Insurance contributions (income tax in all but name).

Julian McCrae of the IFS said: "The potential savings to individuals are quite large, so there is an incentive to do it, and there are a lot of people who could benefit, so there is a big market for accountants to go for in offering people advice on how to do it."

The Treasury, which estimated the cost of the zero per cent tax rate as £450m by 2004-05, described the calculation as "rubbish", saying that it did not expect most self-employed people to call themselves companies.

The Treasury may be relying on its hated IR35 legislation, which has prevented many people becoming self-employed through deeming them to be employed if they contract to provide services to a previous employer. But IR35 doesn't apply to companies, and it could be that individuals who in the past would have looked at self-employment will now migrate direct to incorporation, giving tax advantages both to themselves and to their ex-employers.

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