Becoming a limited company can lead to greater freedom and new opportunities but what does it mean for surgery finances and GPs’ pensions?
One of the questions that is getting asked more often by medical practitioners is: “Should we be forming a limited company to reduce our tax liability?”
There is no doubt that general practice is under constant pressure in terms of reduced levels of income and increases in costs/expenses resulting from inflationary rises. Add to this employee superannuation contributions that have increased by more than 140% over the last seven years and changes to taxation legislation removing the tax free personal allowance when taxable earnings exceed £100k, there is no doubt GPs’ disposable income has declined over the last few years. This is a very different landscape from the years following the contract changes introduced in 2004. It is therefore no surprise that GPs and other primary healthcare staff are questioning what can be done to minimise their liability to taxation and thus increase their take home pay.
You cannot fail to notice that many successful businesses operate through a limited company and there is a simple reason for this: taxation. As rates of income tax and national insurance contributions (NIC) have increased, the rate of corporation tax has been reduced. This means that business owners pay less taxation as shareholders than they would as sole traders or partners.
That is not to say that trading through a limited company is for everyone. A major factor that GPs and other relevant primary healthcare staff need to take into account is the potential impact upon their NHS pension, as earnings channelled through a company may not be classed as superannuable earnings and may therefore not increase their pension on retirement. We can look at five areas operating through a limited company: liability, administration, flexibility, tax relief and pensions.
A limited company is a separate legal entity to its directors and shareholders. This means that, in most cases, the liabilities are not those of the directors and shareholders. This gives the limited company a significant advantage over a partnership as all partners are jointly and severally liable for the debts of the partnership.
A number of administrative requirements are imposed on a limited company including the requirement to file an annual return, to prepare and file annual financial statements in a statutory format, and to hold various meetings and maintain statutory records. All of these requirements come at a cost and the professional fees for a company will be higher than those of the sole trader or partnership.
In a limited company the general rule is that each share holds an equal right to assets and profits. This can create problems when trying to achieve the desired allocation of profits compared to a partnership. Changes can be made in a limited company, but it is not as easy as varying the profit sharing arrangements in a partnership. It will require the involvements of other professionals (accountants and solicitors) and therefore lead to additional costs. In addition, it is far easier for partners to join and leave a partnership than it is for an individual to buy and sell shares in a limited company.
Partners are liable to income tax (top rate 45%) and class 4 national insurance contributions (top rate 9%) on their profits. A company is liable to corporation tax on its profits but at a rate of only 20%, there is, however, additional tax payable when funds are taken from the company as either salary or dividends. If not all profits generated by the company are required by the shareholders the tax savings could be increased through careful planning. The possible tax savings are set out in the following example.
Dr A and Dr B are partners sharing profits of £250,000 on a 50:50 split and they need all their earnings to meet their personal financial commitments.
As a partner their combined tax, NIC and superannuation liability for the current tax year (2015/16) will be £65,745 each. If Dr A and Dr B operated through a limited company that was not an employing authority (EA) for NHS pension purposes, their liability to tax and NIC is £43,929. By operating through a company the savings to superannuation, tax and NIC amounts to £21,816, which is a significant increase in net disposable income and at first glance this is very attractive.
The annual tax savings certainly put more cash in the GP’s pocket, however, what is the impact upon the doctor’s pension?
In a partnership, each doctor’s superannuable earnings would depend upon the levels of any non-NHS income in the practice and their personal expenses. The pension attracted by those earnings at an accrual rate of 1.4% (assuming they are a member of the 1995 pension scheme) is £1,750 per annum, and this is before dynamisation and any applicable of regulation 72 uplift. Over a 20 year period the total pension lost as a result of operating through a limited company will certainly be in excess of £45,000 per annum, plus three times that amount as a tax free lump sum. So while more cash is available now, how this is used in the limited company model could have massive implications for future retirement plans.
If the limited company obtained EA status then the GP’s superannuation would be assessed on the combination of salary and dividends earned. Their superannuation contributions payable would increase the liabilities including tax and NIC to £59,133. This is a reduction in the total liabilities payable of operating as a partnership of £6,612 but the example does not take account of the company administration costs that would reduce the level of savings.
Also, the superannuable earnings through the company are approximately £9,000 per annum lower, which will obviously have a negative impact upon the pension accrued at retirement.
So do you incorporate?
There are savings available if the corporate model is followed but operating a general medical services (GMS)/personal medical services (PMS)/alternative provider medical services (APMS) contract through a limited company has serious repercussions on a GP’s pension. In addition, a GMS/PMS/APMS contract cannot be simply transferred to the new company and will require NHS England approval, which could result in the contract being put out to tender.
It may be that some of a GP’s private earnings, for example out-of-hours could be channelled through a limited company, thus reducing superannuable earnings, but if all income is drawn the savings are marginal. Twenty thousand pounds of out-of-hours earnings as a sole trader would produce £10,000 of disposable income and via a company £10,900 before taking into consideration lost pension upon retirement – hardly a life changing increase.
Decisions like incorporation should not be taken lightly and you need to involve your accountant and an independent financial advisor in this process – both professionals must be knowledgeable in the healthcare sector and in particular the practitioner’s pension scheme. Every individual’s circumstances are different in terms of where they are on their career path, financial requirements, plus what plans they are making for retirement. The importance of qualified specialist advice cannot be understated.
Keith Taylor, head of medical services, BW Medical Accountants.