Heritage Financial Advisers - Newbury Berkshire

Accountants look at the pros and cons of incorporation from a business viewpoint – highlighting the benefits of establishing a limited company to achieve tax savings from salary and dividend payments. Yet there are ramifications for dentists’ personal financial planning that must be considered.

In this article we look at some of the challenges and how to best take advantage of them.

Self-employed dentists can invest the lower of 100% of profits or £245,000 into pensions in the 2009 - 2010 tax year, potentially lowering large amounts of higher rate tax.

In theory, there is also significant scope for directors of limited companies to reduce tax liabilities by transferring funds into pensions, but while many directors pay themselves tax-efficient low salaries and take dividend income instead, dividends are not pensionable.

A way around this is to make ‘employer’ rather than ‘personal’ pension contributions of up to £245k in the 2009 - 2010 tax year, which can be paid irrespective of earnings. On the face of it, this seems very attractive to dentists who can maintain a low salary, avoid National Insurance, and make significant savings in corporation tax via pension investments.

Also, by equalising profits between spouses, this creates an opportunity to equalise pensions - something that is not normally possible if the non-dentist spouse is an employee of the principal.

A problem is that we have moved from a complicated pensions regime, but with very clearly defined rules, to a new system that can be open to interpretation and uncertainty. What we do know is that directors’ pension contributions, like any employers’ pension contributions, must be seen to be 'wholly and exclusively for the purpose of trade' and not be excessive.

This leaves dentists potentially exposed to the whims of their local tax office and could result in different allowable contributions depending on where an investor’s tax affairs are handled. Additionally, we would expect Her Majesty’s Revenue and Customs (HMRC) to look closely at any arrangement that brings the earnings of non-dentist director spouses near to the level of their dental partners!

The following example highlights the pension contribution limits for a dentist and his or her spouse, before and after incorporation.

The dentist made profits of £100,000 before incorporation, after paying a spouse’s salary of £30,000. As a limited company, the profits are £120,000 after paying a modest salary to each director of £5,000 per annum.

	Maximum annual pension contributions

	Dentist	Spouse

Before incorporation	£100,000	£30,000

Following incorporation:
Contributions paid personally	£5,000	£5,000
or
Contributions paid by the business	£245,000	£245,000

Somehow, we don’t see HMRC being very comfortable with the company making contributions of up to £490,000, even if the funds were available!

We would strongly advise you to take advice from your accountant regarding the level of payment that would be considered acceptable to HMRC in your own circumstances, to avoid a possible tax investigation.

As a dentist, your income is totally dependent on you turning up for work each day. You lack the employer safety net of 'sick pay' that is enjoyed by employees in the NHS, but these benefits can be replaced through private provision called ‘income protection insurance’ (IPI), historically known as ‘permanent health insurance’ (PHI).

The attractions of a low salary and high dividends can create real issues for income protection purposes. Some companies still exclude any dividends when calculating the maximum level of cover you may take out.

Dentists often hold income protection cover with more than one company, creating possible problems in the event of a claim. Even if one company is willing to take dividends into account, another may not.

The former company may only then pay a proportion of the insured amount, quite reasonably taking the view that as the cover is spread between more than one provider, they are only going to pay a pro rata share of a claim. At best, it can be extremely messy and time consuming sorting out a claim and at worst, the full level of benefits will not be paid.

Incorporation aside, because insurance companies have different definitions of maximum cover, we believe that every dentist should review their income protection policies to ensure total benefits are paid in the event of a claim.

Equalisation of income is another issue that can affect cover. Currently, a principal dentist with profits of £100,000 per annum could take out a policy that provides cover of up to £72,000 per annum. If, following incorporation, the income is divided more equally and the dentist takes salary and dividends totalling say £75,000 per annum, the amount of permitted cover could reduce to just £42,000 per annum.

The good news is that one leading dental insurer has taken the view that if only one spouse is responsible for generating the profits, it is happy to consider 100% of the total profits when assessing the maximum cover that the dentist can take out.

So in this case, if the profits are apportioned £70,000 to the dentist and £50,000 to the spouse, the combined profits of £120,000 are treated as solely the dentist’s income when assessing the maximum level of cover regardless of the profit distribution split. In this scenario, incorporation has a definite advantage.

A mortgage company would generally lend a self-employed principal dentist, who has been trading profitably for many years, up to four times the average of the last two to three years’ profits.

Recently, a client was looking to move house and approached his existing, long-standing lender. On notifying them that he’d recently changed status from self-employed to company director, his borrowing facility was considerably reduced as he no longer had up-to-date accounts, being in his first year as an ‘employee’, without current proof of income.

Even after one or two years of trading as a limited company, it can still be more difficult to obtain the same level of mortgage as many lenders will only take into account basic salary and not dividends, or will only consider a percentage of dividends.

In the past this been overcome by using specialist mortgage lenders who offer self-certification mortgages that do not require proof of income. But the recent tightening of credit has effectively ended this option and we strongly advise dentists to review their personal mortgages before incorporating their practices.

Incorporation can offer excellent tax savings and other benefits to dentists but it is vital every dentist seeks expert advice for any impact it could have on their personal financial planning when deciding whether incorporation is the right road to go down.