Manse Capital Limited Financial Planners - Financial Planners, Wealth Managers, Tax Planners

The Incorporation of Dental and Veterinary Partnerships and a note of Caution Re its Impact on Existing Income Protection Contracts

 Many accountants are currently advising their Dental and Veterinary practices to incorporate in order to gain substantial tax advantages in terms of extracting profits. On the whole this advice is usually good and can certainly be used to create a significant “tax free” income stream for a number of years after incorporation. It works like this:-

 The traditional Partnership or Sole Trader sets up a Ltd Company and incorporates their business by in effect “selling” the assets (namely Goodwill) of the existing Partnership to the Ltd Company. Thus if the Goodwill was valued at £300,000 then we have created a situation whereby the new Ltd Company “owes” the old Partner or Sole Trader £300,000. This £300,000 debt resides in what is known as the Directors Loan Account.  On this sale a capital gains tax charge is triggered but the tax is only paid at 10% because entrepreneur’s relief can be claimed. So in the example above if the overall gain after personal CGT allowances have been taken in to account was £200,000 the old Partner or Sole Trader would face a CGT bill for £20,000. The Partner or Sole Trader is now a Director and shareholder in the new Ltd Company.

The tax advantages now start to become clear when profits are extracted from the Ltd Company. Under the old Partnership Profits structure the Partner or Sole Trader would pay tax and NI on all the net profit using personal tax rates and allowances. Under the Ltd Company structure the Company pays Corporation Tax on the profits and the income is drawn from the Company by the Directors as a modest salary, some dividends and some capital as part repayment of the £300,000 the Company owes them for the Goodwill. Let’s deal with each of these income streams and identify the difference in tax between the two positions.

 Corporate Remuneration Structure

• The salary is paid free of tax as it is within the personal allowance. It is also paid free of NI as it is below the lower earnings limit.
• Dividends can be drawn up to the higher rate (40%) tax threshold without further liability to personal income tax as the company has paid corporation tax on the profits of the business. Dividends are also drawn free of all NI payments.
• Repayments from the directors loan account are paid free of all tax and NI as it is deemed simply to be a repayment of the capital owed by the company to the old Sole Trader or Partner.

Below is the overall effect of this:-

 As the Directors Loan Account has a balance of £300,000 this situation can continue for over 8 years (ignoring rises to the personal allowances and any loan interest charged to the loan account). Thus the saving to the Director in personal tax over this 8 year period will be in excess of £90,000 (8 x £13,873 – £20,000 initial CGT).

As can be seen the savings are significant and it is quite understandable that many businesses are incorporating for these tax savings reasons.

 How does this all fit in with my Income Protection?

 As a Sole Trader or Partner your Income protection was calculated based on your pre tax profits. Thus in the example above where the profits were £100,000 and taking that you can insure typically 50% of this figure, if you fell incapacitated you would receive £50,000 tax free every year until the ceasing age on the contract typically 55 60 or 65. However, under the incorporated structure detailed above the Income Protection insurer will typically only include salary and dividend income as “assessable income” in calculating the benefits you could receive from the plan if you fell ill. Most insurers will not include repayments made from a Directors loan Account. As such in the incorporated position described above the new Director would only receive 50% of £43,875 or £21,937pa tax free. Thus if their long term financial planning and family security was based on the assumption they would receive £50,000 they are going to be significantly disadvantaged.

Our concern is that many incorporations are ocurring without full consideration being given to the wider financial planning issues as a whole and the “tax tail” is sometimes wagging the dog with potentially disastrous consequences.

 What can be done about it?

As specialists in the Dental and Veterinary fields we are in discussion with a number of Income Protection  providers who are looking at the problem and some degree of compromise or alternative structure can usually be put in to place depending on the insurer, the size of the incorporated business, the number of directors and the profits involved. However the position is far more complex than income protection for straight forward partners and sole traders and needs specialist advice to ensure that all aspects of the incorporation are considered.

Incorporation can be an excellent tax saving strategy but it needs to be considered within the context of your overall financial plan so you can weigh up the advantages, disadvantages risks and rewards.

Nick Crabbe is Certified Financial Planner and Wealth Manager working as a Director with Baxter Fensham ltd. If you have any questions about this article please phone the Leeds office and ask to speak to Nick.

Tags: Dental, Dentists, income protection, incorporation, vet, Veterinary