The Barleymows – Incorporation
Henry walks into the kitchen to find George surrounded by paperwork, lunch untouched, head in hands …
Henry: You OK, Dad? It can’t be that bad!
George looks up and groans. David comes into the kitchen, whistling happily. Takes coat off.
George (grumbles): I just can’t understand why we pay so much tax, yet never seem to have any cash available. It’s not as if we take much of the profit out of the business …
Henry sits down next to his dad.
Henry: Tell me all about it! My last tax bill was as high as my blummin’ drawings …
George: Didn’t Ensors recently mention ‘incorporation’ …. I wonder whether we should talk some more with them about this?
David sits down, looking pleased with himself.
David: And where do you think I’ve been this very morning?
Henry (smiles): Ah, so what did Ensors say, Son?
David: We had a really good chat and there are some possibilities we need to talk about. The main point is whether we consider incorporating the whole farm, or just the contracting side of the business.
George: But why would you incorporate only a part of the business?
David: Well … (he pulls his notebook out and glances at notes) Ensors say there may be Capital Gains Tax and Inheritance Tax issues if we incorporate the whole farm due to the non-business assets that we own, like our cottages and rented business units. The immediate and potential long-term tax impact of incorporation would need to be calculated and very carefully considered.
Henry: OK, but you mentioned incorporating only the contracting side of the business. How would that work?
David: Well, Ensors suggested we might ring fence the contracting business and transfer it into a company.
Henry and George look at each other.
David: The shareholding can be in the same ratio as our farm partnership and we can all be directors so that we all have input in how the company is run. Of course, the farm equipment would need to be transferred from the partnership into the company, along with the staff. However, the land and property can stay in the partnership.
Henry: But won’t there be a tax charge if we sell the equipment to a company?
David: Apparently not. Although the equipment can be sold at market value, there is something called a tax election that can be made so that it is transferred to the company at Tax Written Down Value (TWDV), thus creating no taxable profit or loss …
George (snorts): But how does the company pay us for the equipment? It won’t have any rollicking money!
David: I asked Ensors that exact same question and they said that directors’ loan accounts are formed equivalent to the market value of the equipment, and these loans can be paid down to us over time, tax free, as money becomes available in the company.
Henry: Hmm … that makes sense. How will we farm our own partnership land though, if we no longer own the equipment or have any staff?
David: Well, the new company will contract-farm our land, in the same way that it will take on the other farm contracts we have.
George (mulling): So … the profits from all the existing contracting work, together with profit made by the company in contracting our own land, will sit in the company, rather than the partnership? But how does this actually save tax? I heard the corporation tax rate is going up!
David: Yes, Ensors did warn me that corporation tax rates will be increasing to a maximum of 25%, but the first £50,000 profit remains at 19%, and there is a sliding scale rate increase until profits reach £250,000 when the 25% rate then kicks in.
Henry: But I still don’t really see how it’s going to save us tax?
David: Ensors did advise that they’ll need to run some numbers but, in very simple terms, we only suffer income tax on any profits we draw from the company. Whereas in the partnership we suffer income tax on the profits … regardless of our drawings.
George: Well that would be good as I draw very little from the business each year but always seem to end up with a large tax bill!
David: Exactly grandad! If we don’t need to draw profit personally from the company, then we will not suffer any income tax on the profits. If we do need to draw some funds out, we can firstly draw down on our directors’ loans tax free, or otherwise declare dividends, which are at lower income tax rates than self-employment profits, and carry no National Insurance charge – although that won’t exactly help you at your grand old age, Grandad!
George (chuckles): Oy, cheeky beggar – just wait until you are old enough to draw the state pension!
Henry (still processing it all): This all sounds a bit too good to be true, Son. I mean, where is the catch?
David: You are right to be cautious, Dad. Ensors did stress that careful planning is needed and the circumstances need to be right for it to be worth proceeding with. There will also be initial set-up costs, including legal fees, together with ongoing administrative costs of running the company.
George: And that’s not to mention the fact that we will be running two businesses alongside each other – surely that’s going to complicate matters a bit?
Henry: I think we need to consider matters seriously before we decide whether to go ahead, it’s not completely straightforward. Could you arrange another meeting with Ensors, Son? So we can get our heads together with the experts and work out a plan.
David: Will do, Dad. But first of all, I’m hungry …
He reaches for a tomato off George’s untouched plate. George whacks his hand away …
George: Oy! On yer bike!
David (laughs): Blimey grandad! The minute you think there’s a way of saving tax you spring back to life!