Taxing Times

Tax - It's all getting a bit of a drag

At this time of year dentists, being almost exclusively higher rate tax payers, will be eagerly anticipating the Chancellor’s bi-annual raid of their “piggy-banks” at the end of the month. It seems like a treadmill - the harder you work the more you have to hand over. I recall seeing the wording of a bookmark saying “As soon as I make ends meet, somebody moves the ends”. Come January, that somebody is Mr Brown. This ever increasing tax burden is not imaginary. It is real and it’s called “fiscal drag”. Fiscal Drag is the term for describing the increase in tax revenue caused by the tax thresholds not increasing in line with general rates of inflation. A recent article in Taxation Magazine – one of the UK’s leading tax journals, demonstrated the effect of fiscal drag over twenty years. Over this period tax is now higher as a proportion of GDP. One of the most striking statistics was that the personal allowance increased by 128% while average earnings trebled. Income tax as a percentage of GDP had increased by a full percentage point over the same period. This is all done using smoke and mirrors and by creating the illusion that tax rates are going down when in fact the tax take is going up.

What are dentists to do against this apparent never-ending tide and more importantly is there anything that can be done to mitigate the tax bill due on the 31st January – even at this late stage? Sadly, the opportunities are very limited and even more so with the abolition of the carry-back facility for pension contributions on 6th April 2006.

But it might be worth considering applying to reduce your payment on account for 2006/07. This necessitates taking action in the current tax year to reduce your taxable income, or otherwise you’ll face a nasty bill at a future date for interest paid late.

Applying to reduce payments on account

When you make your January tax payment this consists of two elements – one being the balancing payment (or credit where there is an over-payment) for the previous tax year– i.e. 2005/06 and the other being the first payment on account for the current tax year – i.e. tax year 2006/07. I am referring here to the latter element – the payment on account. You can claim to reduce your payments on account at any time up to 31 January after the end of the tax year concerned and can do so either by making the claim within the tax return or by completing a separate claim form. The requirements are:

1. It must be submitted by 31 January.
2. You must give the reasons – i.e. either a) you expect your income will be lower or b) allowances or reliefs will be higher or alternatively c) none of your income will be taxed at source.
   
   Provided that these modest requirements are met the claim will be accepted. Somewhat amusingly, the HMRC internal manuals state “Most claims are likely to ask for a reduction in the payments on account. Claims to increase payments on account will be less frequent”. “.less frequent” is a euphemism for “will never occur”! Be careful however, interest will be charged in the event that your payments on account are less than they should have been. 

What do I have to do next? 

You now have to ensure that the appropriate action is taken in the period up to the end of the tax year - i.e. to 5th of April 2007. This means that you effectively have about three months to act and take the necessary planning steps to either reduce your trading income or increase your allowances or reliefs. Typical steps which produce instant tax relief at the time of making the investment, would include a combination of the following:

1. Making a contribution to a personal pension scheme or SIPP. Be aware that carry-backs of earlier contributions to earlier years are no longer possible.
2. Subscribing to a Venture Capital Trust. Income tax relief is available at 30% of the amount invested – up to a maximum of £200,000. Accordingly, the maximum relief is £60,000 in any one tax year. Such shares are also exempt from capital gains tax. VCT’s are quoted companies which invest in qualifying unquoted companies which can include those listed on the Attentive Investment Market (AIM) which includes some well known names. Although the tax relief is less generous than in the previous year the tax breaks are still fairly generous.
3. Subscribing to an Enterprise Investment Scheme. Income tax relief is given at 20% for investments in a qualifying company. The maximum amount on which one can obtain relief is £400,000 – maximum relief is therefore £80,000 in tax terms. The scheme provides generous income tax and CGT reliefs to encourage outside equity investment in unquoted trading companies.
4. Service Company - This is worthy of an article in its own right. The prime purpose of a service company is to accumulate profits at a lower rate of corporation tax (19%) than the 40% income tax rate paid by most dentists. You may want to call it a “tax-shelter “of sorts. I recently came across a case where the profits of a dentist had increased dramatically in 2006, more than trebling the 2005 profit. This uplift in profits created a big potential problem – a considerably inflated tax bill! By use of a combination of pension contributions and venture capital trust investments my dentist client made substantial inroads on the tax bill. In this particular case the spouse acted as a practice manager and provided substantial financial and consultancy advice but he was also a higher rate tax payer in his own right. A service company was set up and a management fee was charged, thus channelling profits into the service company. As this was set up in tax year 2006 it will significantly reduce the tax liability for 2007. Accordingly, a claim to reduce the payments on account for 2007 has been made. Of course, there has to be a proper basis for charging the management fee and one also has to be careful of the impact of VAT but the end result is a significantly reduced tax bill. This shows the importance of sensible tax planning – preferably well in advance.

Dentists should always be aware of the maxim “never let the tax tail wag the commercial dog”. A sense of proportion has to be maintained throughout any tax planning exercise but tax planning just does not happen of its own accord. It should ideally be done in advance in a cool and rational manner rather than as a last minute exercise in a desperate attempt to reduce tax bills. This is because one is severely limited as to the course of action if one is looking at a situation after the event. Most sensible tax planning is done in advance when all aspects can be fully considered.