With the introduction of the 50% income tax rate on 6 April 2010, many high earners found themselves far worse off and looked for ways to mitigate their exposure. In addition to this, tax relief on pension savings was heavily restricted for taxpayers with high incomes.
Our clients Alison & Nick are successful Architects running a Limited Liability Partnership (LLP) with annual profits in excess of £500,000. As the only Partners they would have been exposed to the 50% income tax rate on profit shares in excess of £150,000 each. Alison & Nick are keen pension savers and so were also unhappy to hear that their pension contributions would not be protected from the so called anti-forestalling regime and would for a couple of years be subject to special income tax charges.
Alison and Nick own their offices through a family company. Rather than the LLP continuing to pay rent to the company it was decided that the company should become a partner in the LLP itself. The company would also provide other services to the LLP in return for an annual share of profits.
The allocation of profits to the new corporate partner enabled Alison & Nick to ensure their income fell below the thresholds for both the 50% income tax rate and also outside of the anti-forestalling regime for pension contributions. Allocating profits to the company in this way also ensured that it was regarded as trading and not an investment company; accordingly profits within the company would be taxed at the lower rate of corporation tax.
Income can be withdrawn from the company by the shareholders in years when other income is not so high (e.g. when profits are lower or on retirement) so that the 50% rate does not apply. The company can also be of benefit for family wealth planning such as by Alison & Nick’s children holding shares in the company and being allocated dividends to pay for university fees. There is also the possibility of course that the era of austerity might end one day and tax rates reduce.
In considering the overall impact and key tax issues from this planning we also had to consider other aspects such as Capital Gains Tax, Stamp Duty Land Tax and VAT, but with careful consideration all potential obstacles were overcome with a successful result.
The large differential between corporation and income tax rates is relatively new but likely to be sustained as a result of the need to be competitive internationally on corporate tax rates. It provides a changed landscape for planning how businesses should be structured.