After our feature on shareholder agreements (AJ 10.4.03), we look at tax breaks and the possibility of saving money
Most architectural practices are partnerships or limited companies. A further type of trading entity is also possible under the Limited Liability Partnership Act, which came into effect in 2001, which provided for the following:
The business profits are taxed on the partners just like a normal partnership.
The liability is limited to the assets of the business just like a limited company.
It is possible to convert traditional partnerships to limited liability partnerships without any unpleasant taxation charges arising.
The downside of a partnership is the unlimited personal exposure to liability if the business ultimately fails. The downside of limited liability partnership is likely to be that the regulations concerning the preparation of financial accounts will be similar to those that apply to limited companies - including having to submit copies to Companies House, which are available for inspection by any interested party.
However, many business people prefer the flexibility that partnerships allow, but have been fearful of their exposure to personal debt. A limited liability partnership provides something approaching the best of both worlds (see 'Damage Limitation', AJ 22.3.01).
When a partnership gets to a certain size there is likely to be a decision either to become a limited company or to go the limited liability partnership route. The advantage of remaining a partnership is the freedom. For example, there is greater freedom to borrow. The limited company route, however, has some recent useful tax breaks.
Corporation tax breaks
From a taxation perspective, it is invariably better to be a limited company. Successive budgets have resulted in the Chancellor bringing more and more concessions. In 2002 a zero rate of corporation tax was introduced for the first £10,000 of business profits.
There are five different rates of corporation tax, which currently apply as follows:
zero on the first £10,000 (the Starting Rate);
23.75 per cent on the next £40,000 (the Marginal Starting Rate);
19 per cent on the next £250,000 (the Small companies Rate);
32.75 per cent on the next £1,200,000 (the Marginal Small Companies Rate); and
30 per cent on profits above £1,500,000 (the Full Rate).
Avoiding NI increases
Small limited architectural companies can engineer their affairs to avoid the consequences of this month's increases in National Insurance and can save themselves thousands of pounds.
Many small businesses have few employees, apart from the directors/ shareholders themselves. This means that they can reduce their salaries down to the level at which a National Insurance credit is received but no National Insurance is actually paid (£385 per month).
The difference can be extracted from the business by voting themselves dividends. And, of course, the dividends on the first £10,000 of profits are tax-free, provided there is no overall liability at the 40 per cent higher rate.
Share option Tax Savings
To reward the individual working shareholders in exactly the same rates and ratios that they would have been rewarded in the form of salary, it is possible to designate that each working shareholder has a different class of shares - perhaps called 'A' and 'B' shares (see AJ 10.4.03).
This permits them to each extract different amounts from one another, without one of them having to regularly waive their entitlement to part of the dividends. Such an arrangement is likely to be particularly attractive to small architectural companies where the husband and wife are the only shareholders, and one of them has other income from outside the business, as both basic rate bands can be fully utilised.
VAT cash flow savings
As businesses with relatively little VAT on purchases in comparison with VAT charged on turnover, all architects with a turnover of less than £600,000 should benefit from joining the cash accounting scheme. Under these accounting arrangements, VAT on sales need not be accounted for until payment has been received from the customer.
In addition to providing a cash flow advantage, the scheme also allows for automatic bad debt relief, as no VAT ever becomes due if the customer does not pay. Those already on the cash accounting scheme should note that their eligibility to use it does not cease when their turnover exceeds the £600,000 threshold. There is a built-in 25 per cent tolerance within the scheme, meaning that turnover must exceed £750,000 before the use is obliged to revert to invoice-based accounting for VAT.
The nature of most architects' services is such that a second method of improving cash flow may be available to those with a turnover in excess of the cash accounting threshold. On any contract involving more than one payment date, VAT becomes due either when an invoice is issued or when a payment is received, whichever is the earlier.
By ensuring that an invoice is not issued until payment has been received, it is possible to defer the point at which VAT becomes due.
This is done by issuing a request for payment when the client's liability to pay arises and generating a proper VAT invoice only when then money comes in. The cash flow saving has to be measured against the cost of the extra administration involved, so it may not suit everyone, but it is another arrangement which certainly merits consideration.
Graeme Lovell is a tax partner and Neil Owen is a VAT specialist at Langdowns DFK. Tel 023 8061 3000 or visit www. langdowns. co. uk