The question of whether to incorporate a legal practice is rarely off the agenda, but following a number of changes to the tax system aimed at tax-motivated incorporations it may be slipping from favour as practices start to question whether it is now worthwhile.
From December 2014, goodwill acquired by a company related to the seller ceased to qualify for Entrepreneurs’ Relief, which took away much of the benefit of incorporation for many practices.
At the same time, corporation tax relief on the amortisation of goodwill was withdrawn where a company acquires goodwill from any related party, although that change affects only relatively new practices (only those which commenced after 1 April 2002 previously qualified for corporation tax relief on the amortisation anyway).
It was then announced in the 8 July Budget that, from 6 April 2016, the tax regime for dividends would be changed. Draft legislation has not yet been released, but we know that the dividend tax credit is being scrapped, a ‘Dividend Allowance’ of £5,000 per annum will be introduced, and dividends will then be taxed at 7.5%, 32.5% and 38.1% for basic rate, higher rate and additional rate taxpayers respectively.
This is an effective 7.5% increase in the tax payable on dividend income at all three levels, and is seen by some as the start of an attack on those who draw income from their private companies primarily by way of dividends.
There is a ray of light in the Chancellor’s announcement that the corporation tax rate would be reduced from the current rate of 20% to 19% from 1 April 2017 and then to 18% from 1 April 2020.
Taking the impact of the loss of Entrepreneurs’ Relief on goodwill and the increased tax on dividends together, one could be forgiven for thinking incorporation is dead in the water.
But is that really the case? The quick answer is no. Incorporation has never been a “one size fits all” solution, and there will still be many practices that can benefit, particularly if they do not or cannot extract all of the profits made each year, for example because of a need to repay debt, invest, or build work in progress levels.