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.