How can I manage my practice income tax-efficiently?
Financial adviser Gareth Rose answers some common GP questions on drawings, savings and tax
In the current economic climate, everyone is looking closely at their own finances, from income to expenditure on utility bills. With income tax at 40% for higher-rate taxpayers and 50% for those with taxable income above £150,000, even relatively simple steps can provide significant savings.
How are GP partners taxed on their income?
GP partners are taxed on their overall income – not, as many tend to believe, on how much they choose to draw from the practice. Drawings are payments made to each partner, usually on a regular monthly basis, on account of their final share of the net income – or profit – of the practice. They are not wages or salary and are not subject to tax. Income tax is the individual liability of each partner. It is the liability arising on the partner's profit share for a relevant tax year, plus any other income sources such as rent from additional property or interest on bank savings. Whether you draw all or none of the profit out of your practice, your tax liability is the same.
Each partner must submit a self-assessment tax return by 31 January following the end of the tax year (for example, for the 2010/11 tax year by 31 January 2012, the 2011/12 year by 31 January 2013). The return should contain details of all sources of taxable income and allowable reliefs.
How do different ways of taking drawings affect the options available for offsetting tax and interest?
The amount partners draw from the practice and the pattern these funds are drawn in has a significant effect on a GP's available funds and how they can be used to mitigate the tax burden.
There are three main methods different practices use to allocate drawings. The simplest method is to distribute all profit in the practice account at the end of the month among the partners, though this can leave the practice vulnerable to being overdrawn. For a more complex solution, partners can draw a fixed amount based on net income per quarter, topped up by a bonus – although the bonus payments can fluctuate widely.
A yet more complex solution is to draw payments monthly based on a full year's projection of income, which provides a steady income but needs complex accounting systems. A more detailed analysis of the three methods and their pros and cons is found in the box on the following page.
Should GP partners pay tax individually or as a practice?
Some practices save for their tax bills within the practice so individual partners do not have any concerns or responsibilities in saving for these themselves, or making payments over to HMRC.
Alternatively, partners can save for their own tax liabilities personally. This gives the individual flexibility in managing their own affairs.
The advantage to paying the tax by practice is that partners have safety as a group. Although tax liabilities are an individual responsibility – in other words, there is no joint and several liability for the other partners – if a partner does get behind with their tax payments it can cause stress on that particular partner, potentially causing problems within the partnership. In extreme cases, it can lead to bankruptcy of the partner and their removal from the partnership.
Where work of a personal nature is undertaken and paid through the practice, partners need to decide whether this will be paid out in full. It normally makes sense to pay partners net – that is, in full with a deduction made for tax – if the practice will handle the overall tax bill. An exception to this rule would be if the partner wants the amount in full – for instance, to invest in an offset account – and will make good the liability in full when it is due.
How can savings accounts be used to offset tax and interest?
The use of fixed-term cash deposits and notice accounts to maximise the rate of interest paid on savings is particularly useful. Taking as much of your profits as possible out of the practice via drawings has become very popular over recent years, as partners are then free to use the money as they see fit. Taking the money out of the practice also opens up the options available with regard to holding the funds until payment to HMRC is due.
If you take the maximum level of drawings available and hold these personally until such time as the tax is due in an offset account, this can provide significant savings on borrowings.
With an offset mortgage, you use the money in your savings and current accounts to help reduce monthly mortgage repayments or the mortgage term.
You won't pay tax on your savings as they won't be earning interest and you can still access them when you need to – for example, when the income tax payment is due to HMRC. In general, you know when payments are due to HMRC, and approximately how much. It is therefore possible to hold the required level of funds in term or notice accounts until the funds are needed to pay over to HMRC. While interest rates are relatively low, this strategy will maximise the interest you receive.
Maximisation of cash ISA allowances also provides tax savings while the funds are held personally, as the interest is paid gross. The maximum cash ISA deposit for the 2011/12 tax year is £5,340 per person. Funds can also be held in the name of a spouse or partner, doubling the amount of savings you can hold that get tax-free interest.
What other investments are available?
Other savings and investment options are of course available, but these must be considered carefully – especially where there is any level of investment risk – before proceeding. Investments such as venture capital trusts and enterprise investment schemes do provide income tax relief, but are subject to minimum holding periods of five and three years respectively and carry a high degree of investment risk.
The Annual Allowance is the maximum amount of pension savings that can be made each year with tax relief applying. From April 2011, it is £50,000.
For members of the NHS scheme the contribution towards the limit is calculated as 16 times the increase in value of the pension, plus the increase in the lump sum, from the start of the tax year to the end (allowing for an inflationary increase on the starting figure).
Any further contributions, free-standing additional voluntary contributions, or personal pensions are included in the allowance in addition to the NHS scheme. Many GPs are close to the new allowance, and additional pension savings must be considered carefully.
Projections of available drawings and tax liabilities are essential. This allows the maximisation of saving rates and ensures no nasty surprises.
Gareth Rose is a financial planning consultant at Moore and Smalley Healthcare Services and a member of the Association of Independent Specialist Medical Accountants