We are commonly asked by dental practice owners whether changing their business structure from a sole trader or partnership to a limited company would save them tax. Limited companies have typically yielded tax savings for businesses in the past, no matter the level of profits generated by the business.
However, in the last couple of years, there has been a rise in dividend income tax rates, followed by corporation tax rates rising for companies from 1st April 2023. The dividend tax free allowance has also reduced from 6th April 2023 from £2,000 to £1,000 and is planned to decrease again from 6th April 2024 to £500.
With companies and shareholders facing increased tax costs, should dental practices still consider incorporation to save tax? We’ve asked Tom Slevin, Dental Client Services Director, for his thoughts on incorporation, and to outline what we look for when considering whether incorporation is the right choice for a dental practice.
Over to Tom…
When looking at the incorporation option, we have a checklist that we go through, in order to determine whether incorporation is the right strategy for the dental practice owner.
This includes the following:
- What is the current debt of the dental practice and what are the current terms of the lending?
- Does the dentist have a spouse who could be a minority shareholder in the company?
- What are the plans of the dental practice owner in the short term (less than 2 years) and the longer term?
- Are there plans to purchase another dental practice?
- Does the dental practice owner require all of the income generated by the dental practice for their personal living expenses?
- Are their other tax planning opportunities available within a company that are not available under the current business structure, such as school fee planning (our partners at DJH Mitten Clarke have written a useful article on the subject) and limiting your personal income to qualify for tax free childcare?
- If incorporation is the right option, how will we structure the sale of the dental practice to the company for tax purposes?
The list above isn’t exhaustive, and each dental practice will be considered individually on whether incorporation is the right choice for them.
So, let’s go into some more detail on a few of the points above.
Current lending for the dental practice
Many dental practice owners will have some form of debt for the business, which may consist of funding for the purchase of the goodwill and property and hire purchase loans for the purchase of equipment. If the dental practice is to be incorporated into a company, the dentist will want the company to take on these debts. This may result in the bank issuing new loans in the company name, but this may incur additional fees such as an arrangement fee, and the lender may change the rate of interest you are paying.
This can be an opportunity for some dental practices to re-organise their lending at a lower rate. Our Head of Commercial Funding Solutions, David Wright, has recently assisted a client with re-financing on incorporation of their dental practice and following consolidation of various loans. He secured an overall reduction in their interest rate with a new lender and monthly finance costs were reduced.
A dental practice with a high level of debt is likely to see a cash benefit to incorporation, such as a dental practice that makes profits of £250,000 but has annual loan capital repayments of £80,000. This dental practice operating as a sole trader will have cash remaining after tax and loans of just under £64,000 for the year. With the dental practice operating through a company and the dentist taking all available post corporation tax cash as a dividend, the available cash after personal tax rises to above £85,000.
This difference arises due to the difference between profit and cash. As a sole trader, the profit is £250,000 (which income tax and national insurance is payable on), but as loan capital repayments are not an allowable deduction against profits, the cash available to the dentist before paying tax on profits is £170,000.
In the company, the same applies with the corporation tax due (this is payable on profits but the cash available to the company is lower). However, as the dentist is then paid dividends from the company, the dividends are paid from available cash, which is lower than post corporation tax profits and income tax is due only on the dividends paid to the dentist.
This is one area that can yield a significant amount of tax savings for some dental practices.
Spouse as a shareholder
If the dental practice is currently being operated as a sole trader, all of the profits of the business will be taxed on the dentist personally. The dentist may have a spouse that earns less income, but family tax planning as a couple is limited.
With the practice trading through a limited company, the dentist’s spouse can be issued a minority number of shares in the company and dividends can be paid to them instead of being paid to the dentist. This can save a significant amount of income tax each year if your spouse earns less than £50,270 and/or the principal dentist would have more than £100,000 of personal income without dividends being paid to another shareholder.
We will always consider your family circumstances when looking at incorporation of your dental practice as this can result in significant tax savings.
Personal income required for the principal dentist
Profits generated by the dental practice as a sole trader are subject to income tax and national insurance. With the additional rate of income tax being 45% (where profits are more than £125,140), the income tax liabilities can be significant for a principal dentist. However, the remaining profit after tax is then available to the dentist for their own personal expenditure.
If the dental practice is trading through a company, the profits are subject to corporation tax. The remaining profits after tax then form the available reserves of the company. Dividends can be paid to shareholders from the available reserves. As the director and shareholder of the company, the principal dentist can then decide what dividends are payable from the company to its shareholders.
If the principal dentist does not require all of the available reserves for their own personal expenditure, they can decide to retain profit (and cash) within the company. This has the benefit of the company accumulating cash (which can be used for investing in the practice, investing in shares, pension contributions, building a deposit for future practice purchases etc) but as the principal dentist’s personal income is lower, the income tax liability is also reduced.
For example, a principal dentist with profits of £200,000 would have an effective tax rate as a sole trader of over 41%. The same practice operating through a company where the principal dentist requires £80,000 of income from the company to cover their personal expenditure and tax liabilities would have an effective tax rate of just over 31%.
With cash building in the company, this can be a tax planning tool for a dentist looking to sell their dental practice in the near future, which we will cover in a future article.
Is a company the right business structure for your dental practice?
As we have highlighted, there are plenty of tax planning opportunities available if you are considering incorporating your dental practice. It won’t be the right decision for every dental practice but many dental practices could save a significant amount of tax annually when incorporating if planned correctly.
If you are considering incorporating your dental practice, speak to one of our specialist team and we can look at all aspects of the incorporation, from annual tax planning, lending requirements and how to structure the incorporation for your personal needs.
To speak to our team on how we can assist, give us a call on 0151 348 8400.
