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ACCA Strategic Professional · Advanced Taxation (UK) · Alternative ways of achieving personal or business outcomes and their tax consequences

Elena, an additional-rate sole trader, is comparing remaining unincorporated with incorporating. She needs to extract only modest funds each year and wants to leave most profits in the business. Which statement best supports incorporation for her?

Incorporation helps because retained profits are taxed only at corporation tax rates, not at Elena's higher personal rates, and personal tax arises only when funds are extracted. A sole trader is taxed on all profits whether or not drawn, so retention gives deferral.

  1. ARetained profits are taxed in the company at corporation tax rates rather than at Elena's personal income tax rates, so tax is deferred until profits are extractedCorrect
  2. BRetained profits are exempt from all tax inside a company
  3. CProfits of an unincorporated business are taxed only when drawn, so incorporation gives no advantage
  4. DIncorporation removes all national insurance on profits extracted as dividends and salary

Explanation

A sole trader is taxed on all profits arising, whether or not drawn. A company pays corporation tax on profits, and personal tax arises only when funds are extracted, so retention gives deferral and possibly a lower rate. Option B is wrong because corporation tax is payable. Option C is wrong because sole traders are taxed on profits arising, not drawings. Option D is wrong because salary attracts employee and employer NIC.

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