IN previous articles I have
explained how operating your
practice through a company, rather
than as a partnership, can have
advantages when it comes to
managing your tax bill.
Just to recap, the key advantage is
that although the profits of a company
are taxed when earned
and taxed again when
they are paid out to
the owners, there is
considerable flexibility
in how and when
profits are extracted
and this can help to
keep down the owner’s
overall tax bill.
In a partnership, all
partners are taxed on
their share of practice
profits as their
personal income: this
means that the tax rate
applied will often now
be 51% [52% in 2011-
12 when the additional
rate of national insurance contributions
(NIC) goes up to 2%].
Veterinary companies
In small companies, individuals can manage their personal income by using
a combination of the extraction routes
available to them. Some might choose
to receive a small salary which just
exceeds the NIC limit for the second
state pension as this will enable them to
have the appropriate pension credits.
The balance of profit could then be
paid as dividends. It is worth noting that
dividends are treated
as an appropriation of
the taxed profit and
are, therefore, not a
deduction for
corporation tax
purposes. There has
not been any
movement in the rules
on taxing the way
profits are shared
between the owners of
a family business.
After announcing its
initial proposals on
“income shifting” following the Jones v.
Garnett case, the Government then deferred them and the new
Government has yet to announce any
concrete proposals on this. So, for the
time being, extracting profits from your family company by way of dividends
remains a highly tax-efficient option.
If you have already incorporated
your practice, you may have sold the goodwill in the practice to the company.
Typically, the company will purchase
the goodwill from you, leaving the
money outstanding as a loan to be
repaid as and when funds permit. You
will have paid capital gains tax on the
disposal of the goodwill so the loan
repayment is tax free when it is paid out
of the company.
Anyone extracting income in excess
of £150,000 will face paying income tax
at 50% on salary or rental payments
(where you let the practice premises to
the company) or an effective rate of
36.11% on dividends.
Clearly, structuring a mix of
dividend payments and loan repayments
(where available) can help to keep your
taxable income below this threshold.
Similarly, if you are extracting income
of over £100,000, you will lose the
personal allowance (giving a maximum
additional tax charge of £2,590) so,
again, keeping your taxable income
below this threshold may be prudent.
In the longer term, another way to
extract profits from your company is
for the company to make pension
contributions on your behalf. Recently
published Government proposals for
changes to the pension rules for 2011-
12 mean that there will be significantly
less scope for contributions to be made
tax efficiently in future.
Therefore, it may be sensible for the
company to make a large contribution
this year for individuals whose current
pension input periods end on or before
5th April 2011.
There are technically no restrictions
on the amount of pension
contributions paid by the company that
can qualify for corporation tax relief
each year (although HMRC may query
payments that appear “uncommercial”
in relation to the duties undertaken and
“spreading” may apply in some
circumstances).
If, however, payments by the
company exceed the annual limit
(£255,000 for 2010-11) a penalty will be
incurred (for individuals, the limit is the
lower of relevant earnings and
£255,000). If you earn more than
£130,000 a year, the anti-forestalling
rules which apply from 22nd April 2009
to 5th April 2011 may affect the
amount of tax relief obtained. As
always, you should seek advice from a
suitable qualified independent financial
adviser on such issues.
It is important to bear in mind that,
if you do not draw a salary but you
wish to retain a personal pension and
make individual contributions rather
than the company paying these, dividends do not count as earned
income so your pension contributions
would be restricted to the limits for
stakeholder pensions, currently £3,600
per annum.
Those close to retirement might
also consider leaving profits within the
company if they are not required to
meet their current spending needs.
Then, on sale of the business on
retirement, provided the cash in the
company is not excessive and
entrepreneurs’ relief is available, capital
gains tax is paid at only 10% on the
first £5 million of lifetime gains.
Partnerships
If you don’t want to incorporate the
practice completely, then there are other
options for including a corporate
vehicle in the practice. For example, the
current partners and their family
members could form a company that
becomes one of the partners in the
practice and takes a share of the profit.
If all the current partners are 50%
taxpayers, this could achieve an
immediate 22% tax saving on the
profits received by the company.
Of course, there would be further
tax charges when the company pays out
its profits to its shareholders but this
does, again, give considerable flexibility
over timing and the shares could be
owned by members of the partners’
families who pay income tax at lower
rates: remember, where a gross
dividend falls within the individual’s
basic rate band, no further tax is
payable.
As with veterinary companies,
partners should also consider making
significant personal pension
contributions before the rules change in
2011-12. The annual contributions limit
will reduce from £255,000 (or 100% of
earnings if less) to £50,000 so this
could be the last year in which it is
possible to make a large contribution to
store funds in the tax-free haven of a
pension fund.
Although there are complex anti-
forestalling rules that may apply to such
a one-off contribution, some
individuals will still be able to get net
tax relief at 20% on the amount paid in
– giving a maximum possible
government subsidy for this year of
£51,000 (£255,000 x 20%).
Unfortunately, new transitional rules
introduced from 14th October 2010
already impose the £50,000 limit on
pension schemes whose current
pension input period ends after 5th
April 2011.
