Keep the rewards of your hard work
What is the best way for independent practitioners to pay themselves? Richard Norbury explains the different tax-efficient strategies.
For various reasons, many doctors have structured their affairs so that they trade via a limited company. The benefits include being tax-efficient and keeping them under thresholds for tapering of the pension annual allowance.
But, due to tax legislation changes, regular reviews should be done to ensure this is still the best trading structure – and, if so, how best to extract the funds.
Corporation tax rates have recently increased, meaning the first £50,000 of profit is taxed at 19% and the next £200,000 of profit is then taxed at the effective marginal rate of 26.5%.
We must remember that companies are a separate legal entity and often individuals will be both a director (officer) of the company and a shareholder.
The two separate distinctions are important, as this allows different methods of payment.
Directors & employees
Salaries
Paying a salary to yourself and family members may now be more tax-efficient than it was in the past due to the corporation tax rate changes.
In addition, employees’ National Insurance is not payable up to £1,048 per month and can be a tax-efficient way to extract funds from a company. For those consultants who are fully private, this option is often the most tax-efficient.
In the past, most consultants did not pay themselves a salary due to already having an NHS salary, but recent changes in the National Insurance limits and corporation tax mean this should be reviewed.
Remember that the company may be required to operate a Pay As You Earn (PAYE) scheme and report to HM Revenue and Customs (HMRC) the amounts that are paid over each period – usually monthly.
Failure to do this may result in penalties and interest payable. The amount of salary paid, especially to family members, should be justified and at a market rate for the work being done within the company.
Benefit in kind
Electric cars have been very popular in recent years, as this allows payments directly from the company and attracts tax relief at source.
This means directors do not have to pay a lease or hire purchase from their own taxed earnings, which can effectively boost net disposable income without having to extract profit from the firm.
Bear in mind that this may become more attractive now the corporation tax rates have increased, as the tax relief on the lease payments may be higher depending on your profit level.
HMRC views this as if the individual has been provided with an asset in lieu of a salary, so it is taxed under the benefit-in-kind rules.
Currently electric cars are taxed at 2% of the original list price of the vehicle, so, for a car originally costing £50,000, individuals are taxed as if they have received £1,000 in salary.
There is also class 1a National Insurance charge to pay via the company, but the amounts are usually quite low. The 2% benefit- in-kind rate is set to increase by 1% a year after 2024-25, reaching 5% by 2027-28.
Loans
A company can provide a loan to a director. If this loan is £10,000 or under, then it can be interest-free, otherwise interest can be charged at the approved HMRC rate which is currently 2.25%.
If the loan is over £10,000 and is provided interest-free, a taxable benefit is calculated under the benefit-in-kind rules.
If the loan is still outstanding at the point that corporation tax is payable – usually nine months and one day after the company year end – then a further tax is levied known as section 455 tax at 33.75% of the outstanding amount. This additional tax is effectively a deposit with HMRC until the loan is repaid.
With interest rates rising, this may be an attractive option for a short-term loan from the company, given the low rates imposed by HMRC and the fact that this is going back to your company rather than to a lender.
If you are considering this, then please discuss carefully with an accountant, as regular and repeated loans can attract attention from HMRC and anti-tax avoidance measures are applied.
Staff benefits and entertaining
Each officer or employee of the company can receive up to £150 per head for social functions such as staff Christmas parties. This is a tax-deductible cost in the company accounts.
Often companies will also pay for social functions to individuals who are not employed directly but may be employed by the trust or a private hospital. In these circumstances, this can be paid from a company and, while it is not tax- deductible, it is not paid from your own taxed earnings, which is often beneficial.
There may also be an opportunity to pay gifts to employees and directors and as long as the limits are under the exemption limits for trivial benefits, it is not cash or a cash voucher and is not a reward for the their work or performance.
Pension
Much the same way as a salary, a pension contribution can be paid from the company directly.
As with the salary, any payment needs to be justified as part of the overall package paid to an individual. For individuals who want to save additional money towards retirement, this may be an option and becomes more attractive if you are paying the higher rates of corporation tax.
The payment itself does not need to be declared on the individual’s tax return but does need to be considered when tracking the tax on pension annual allowance, especially for individuals who are active members of the NHS Pension Scheme.
The annual allowance threshold has been increased from £40,000 to £60,000 from April 2023, so it may be the case that some individuals have some scope to top up their private pension pot without suffering a tax charge.
Despite the increase in pension annual allowance, this amount may be reduced if your total income exceeds £200,000. This is a complex area and professional advice should be taken if you are considering this option.
Shareholders
Dividends
The shareholders own the shares in the company and, assuming the company has sufficient reserves, the directors can vote dividends on the shares and sometimes on different classes of shares.
In 2023-24, the first £1,000 of dividends paid is tax-free. This tax-free amount falls to £500 in future years. The individual then pays tax on the dividend income at the following prevailing rates:
- Basic rate taxpayer 8.75%;
- Higher rate taxpayer 33.75%;
- Additional rate taxpayer 39.35%.
Bear in mind that sometimes voting the tax-free dividend can itself cause a tax charge if you are in the band between £100,000 and £125,140, where your personal tax-free allowance is reduced.
Often the advantage of paying dividends is that it does allow an element of control, as it may be beneficial to vote the dividends in certain tax years.
For example, if you have a large salary in one particular year due to additional waiting list initiative work, you may decide not to vote as many dividends, because doing so would take you over certain tax thresholds, such as the thresholds for tapering of the pension annual allowance.
Sole traders and partnerships
With the recent tax legislation changes and the rise in the cost of living, individuals may find that they are in the position where they need to extract all or almost all of the available funds from a company in some way, shape or form. In these circumstances, consider whether a sole trader or a partnership model is a better fit.
Previously, the threshold for tapering of the pension annual allowance was restrictive at £110,000, but this has since risen to £200,000.
Extracting profits from companies is challenging, with lots of moving parts. There are numerous flexible strategies depending on the circumstances of the individual, which is why you should discuss your options with a specialist medical accountant who can tailor the plan accordingly.
Richard Norbury (right) is a partner at Sandison Easson & Co, specialist medical accountants