The building blocks of accountancy

Susan Hutter continues with her A–Z of top tips. This month, she turns to ‘D’…

is for Drawings

The amount consultants and GPs draw from their practice is obviously one of the most important issues for them. 

Whichever trading structure you operate under, the overriding question is: How much you should draw and, in the case of limited companies, how the money should be drawn? 

The trading structures used by doctors cover the whole gamut fom sole trader, partnership, limited liability partnership (LLP) to limited companies. 

Sole traders, partnerships and LLPs

If you are a sole trader, work in a partnership or in a LLP, then your tax status will be self-employed. Whatever you draw, it is not regarded as an expense of the practice. The income tax on the practice profit is calculated on the figure before deducting drawings. 

The drawings themselves are not subject to income tax. Therefore, it is imperative to ensure that you either leave enough money in the practice bank account to pay income tax on the profit or, alternatively, reserve it in a personal account out of the drawings you take from the practice. 

Limited companies

Many consultants and GPs trade as limited companies, where they are both owners and directors. 

One of the most important tax planning points is where the consultant/GP has a non-earning spouse or a lower-earning spouse. In which case, from a tax point of view, it is advisable to pass some of the share capital to the spouse so that they can share in the company income via a dividend. 

This mitigates higher-rate tax, as the spouse will have their own personal allowances and the 20% rate band which takes them to £50,000, before entering the higher tax bands of 40% and 50%. 

Doctors can draw money from their company either as a dividend (also a ‘D’) or a salary or a mixture of the two. If you are going to be able to divide the share capital between yourself and a lower-earning spouse, then it is sensible to take the majority of your drawings as a dividend. 

A small, but useful tax break is that the first £2,000 a year dividend is tax-free. The company does not receive tax relief on the dividends drawn, the corporation tax is charged on profits before the dividend. 

The shareholders will have to pay income tax on the dividends depending on their rate of tax. 

A 20% taxpayer pays 7.5%, a 40% taxpayer pays 32.5% and a 45% taxpayer pays 38.1%.

Keep a reserve 

As with the drawings from a self-employed business, it is vital to ensure that you reserve enough money to pay the tax on the dividend, so be careful not to spend it all.

One would be tempted to assume that due to the fact the tax rates of dividends are lower than tax rates on salaries – which are 20%, 40% and 45% respectively – it is far more tax-efficient to take a dividend than a salary. 

However, unlike a dividend, a salary is deductible from profit before calculating the corporation tax liability. Also, tax is deducted at source under PAYE, so that you do not have to worry about setting money aside from the tax. 

The sting in the tail is the National Insurance liability, paid by the employer, which is 13.8% of the gross salary. This in itself is tax- deductible, but nevertheless is expensive. 

Additionally, there is employees’ National Insurance, also deducted at source. The rates of National Insurance are 12% at the first £50,000 and 2% thereafter. 

Overall, it is usually marginally better to take a dividend. It is advisable to ask your accountant to work out what is best for you. 

In addition to putting aside income tax, take care to reserve for corporation tax, which is at 19% on the company profit. 

Working capital

Whatever the trading structure –   sole trader, partnership, LLP or limited company – it is vital to leave enough money in the practice to cover its working capital requirement. As a rule of thumb, try to make sure there is a least three months’ overheads left in the practice. 

Due diligence is usually only required in the medical profession if one is either buying or selling a practice. If a practice is being bought, then all aspects of the practice will need to be reviewed, not only financial. 

As far as financial due diligence is concerned, you should request the last three years’ practice accounts and if they are out of date – that is to say, more than three months old – you should seek up-to-date figures showing a summary of trading and also assets and liabilities.

At this point, it is wise to show the figures to your accountant, who then may wish to raise further questions. It is also sensible to take legal advice at this juncture. 

The best people to carry out a review of the quality of the practice are the consultants themselves and their practice managers. This would include examining patient lists and practice procedures.

Selling your practice 

If you are selling your practice, the due diligence work carried out on your practice records will be done by the purchaser. 

However, if you are going to get paid by instalments – that is to say, you are not going to receive all the money on completion – then it is often worth doing some financial due diligence on the purchaser to ensure that they are likely to have enough money to pay each instalment. 

Many deals are structured with an agreed consideration, with, say, 50% payable on completion and then something like two further payments a year and two years after completion for 25% each. Sometimes the later payments are dependent on results.

This means that the vendors could be at risk if the purchaser does not have a sufficient financial covenant to be able to make the subsequent instalments. Once again, it is worth enlisting your accountant’s help in this connection.

In all cases, and as always, it is important to take professional advice before proceeding with any of the above suggestions.

Susan Hutter (right) is a partner at Blick Rothenberg and part of the team that advises doctors

• See ‘“C” is for cash’