The price of limited liability

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AccountingWEB have a good article on the tax benefits arising from running a business through a limited company, and how that benefit has changed over the years. I know there's a registration required to read the story - but it doesn't take long.

The assumption is that the owner of a business does not pay themselves a salary but does instead pay out the profit by way of dividend, so effectively avoiding social security contributions otherwise due by the employer and employee in the UK, with a consequent tax saving when compared to an equivalent self employed person.

As the article shows, that saving has reduced somewhat since 2003 and will do so over the next three years, but in 2007/08 £10,000 of profits taxed in this way will save £324 of tax and on £40,000 of profits the tax saving is over £3,400.

Small business is protesting at the decline in the rate of this benefit. But there are two questions to ask. The first is why should the benefit be available? Tax justice requires that a source should be taxed at the same rate whatever structure is used i.e. tax should not be the determinant of the decision to use an entity. Second, since limited liability is a privilege given by society it should, logically command a price, not confer a benefit.

I understand all the issues involved. I wrote one of the first ever articles on how to use limited companies to save tax using these techniques when they first become possible back in 1985, for Accountancy magazine. But even then I suggested that the choice of a limited company should not be made for tax reasons. The obligations of running the business, and complying with the rules to legally pay dividends from a company are onerous. I really do doubt that many who do so strictly comply with them. And if they do many will be diverting effort from a much more serious issue - that of making money.

I recall writing an article for Accountancy Age sometime in the late 80's saying 'Don't limit small buisness' in which I argued that the decision to incorporate was usually taken for all the wrong reasons. I still think that's true. I suspect that many who adopt this option think they make savings but actually earn less as a result. Many of my clients felt that way and steered clear of incorporation for exactly that reason.

To put it another way, those accountants who promote this might understand tax, but they don't understand the bigger picture of profit. As such closing this gap could well be to the benefit of the profitability of the UK small business sector because it would then concentrate on the real issue - which is making money.