In the first of a two part series Anne Hutchings a specialist accountant and tax consultant for retail pharmacists examines some of the methods by which pharmacists can reduce their tax liabilities.
 

Tax evasion or avoidance?

What is the difference between tax evasion and tax avoidance? Put simply tax evasion is illegal and I would never recommend this. An example of evasion is where someone deliberately under declares their profits to the Inland Revenue. A more subtle form, but nevertheless still evasion can be where someone discloses a transaction but disguises or misleads the Revenue regarding the true and accurate circumstances involved. Tax avoidance on the other hand is perfectly legal using the full boundaries of the tax legislation to mitigate tax liabilities, with details fully disclosed to the Inland Revenue.

Out of the many tax avoidance methods available I have chosen a selection which are particularly relevant for pharmacists.

Employee Benefit Trust (EBT)

For pharmacists trading through a limited company an EBT is worth consideration. In his pre Budget speech in November the Chancellor announced some changes in the legislation regarding the claiming of corporation tax relief for payments into EBT's. The bottom line is that there will no longer be a corporation tax deduction until the EBT pays the company employees and the payments will be liable to income tax and national insurance contributions. Companies who were using EBT's largely to provide the company directors with loans etc will no longer receive the corporation tax deduction.

However EBT's can still be used as an efficient method of providing funds to directors. This is best illustrated through an example:

A Pharmacy Ltd has cash of £250,000, which has accumulated from profits after corporation tax during recent years. The company pays £250,000 into an EBT and the trustees of the EBT decide to lend Mr Shah who is the director of the company £200,000. The tax position for the company is neutral i.e. no tax deduction for the EBT payment and no tax liability on the payment.

Mr Shah has received £200,000 to use as he wishes. The only tax charge which Mr Shah would be liable to, is tax on the notional interest on the loan, between £2,000 and £4,000 per annum depending on tax and interest rates. However, even this can be avoided with a little careful planning which Mr Shah would do. Therefore Mr Shah can receive £200,000 tax free. Without the EBT, to extract funds from the company Mr Shah (assuming he owns the company shares) is likely to take a dividend.

Conclusion - In the right circumstances EBT's can still be very tax effective.

Spouse's tax efficient car

Because of the tax rules this will only work for a pharmacist who is a sole trader or a pharmacist trading through a partnership. If your spouse or any other family member is employed in your business on a modest salary of say £4,500 per annum, typically just under the tax and national insurance threshold, you could provide them with a car. As long as that persons total remuneration package is under £8,500 per annum including the car benefit they will not have to pay tax on this benefit. To summarise they can be provided with a salary of £4,500 plus a car totally free of tax. In addition the pharmacist will obtain tax allowances for the car and running costs.

 
Points to be aware of - The car benefit must be calculated accurately to ensure that the overall package does not exceed £8,500, it is worth taking professional advice on this. It may be possible with a bit of number crunching on the overall package of salary plus car benefit to purchase quite an expensive car of say £20,000 or more. The person in receipt of the salary/car must do sufficient work in your business to justify their remuneration package.

Tax efficient cars for the children

This one is for pharmacists operating through a limited company. Typically if you have a child who is a student and you want to help them out by providing a car you can do so quite cheaply through your company. Your son or daughter doesn't need to work for your business. You will be taxed on the benefit of the car, however, if the car is carefully chosen this can be quite cheap. Car benefits are based on CO2 emissions, so if you bought a car for say £8,000 with low emissions the tax charge would be 15% of the cost. You would be taxed on a benefit of £1,200 which in terms of tax would actually cost you a maximum of £480 per annum. All car expenses would be tax deductible through your company.

Making maximum use of your spouse's allowances

Many pharmacists have a spouse who has little or no income whilst the pharmacist is paying tax at 40%. The question is what can be done to address the balance?

Sole traders should consider incorporating their business into a limited company, which provides the opportunity for giving the spouse shares. If a spouse has shares funds can be extracted very tax effectively through the payment of dividends. You cannot achieve this as a sole trader. Your other option is to make your spouse a partner, to do this the spouse must be a pharmacist.

If you are already trading through a company or thinking of incorporating but you are reluctant to give your spouse a significant shareholding in your company there may be a way around this. Consider holding the shares in your company jointly with your spouse. However, you retain a beneficial interest of 99% and your spouse 1%. Because of a quirk in the tax legislation any dividends voted can be apportioned on a 50/50 basis between you both.

Use your annual capital gains exemption

If you own investments producing capital gains, such as a share portfolio make sure that you and your spouse are both using your annual capital gains exemptions which are currently £7,700 per annum per person. This may mean transferring some assets to your spouse.
 

Tax effective school fees planning

The question is how to get money out of your pharmacy to pay school fees. You can simply pay the fees out of your after tax profits which if you are paying tax at 40% is very expensive. However, if you operate through a limited company there is another possibility.

The child's grandparent(s) buy some shares in your company at the current market value. With careful planning this may not necessarily involve a huge cost. The grandparent(s) later decide to give the shares to the child or put them into a trust for the child. The dividends paid on those shares are treated as the child's income against which they can set their personal allowances etc. The money can then be used for school fees.

Points to watch - This type of transaction must be seen to be an arms length commercial transaction. If there is any kind of reciprocal arrangement between parents and grandparents it will not be effective for tax purposes.

In my next article, below, I examine issues such as domicile, capital gains avoidance devices, how to make pension contributions even more tax effective and enterprise investment schemes.

Capital gains tax is a big issue for many pharmacists. If you are intending to dispose of an asset the first step is to ascertain what the potential capital gains tax liability is likely to be. This will involve consultation with your accountant or tax advisor who should be able to provide you with an estimate of the tax. The next stage is to find a way of reducing the tax.

Selling the pharmacy business

Sole traders facing a large capital gains tax bill on the sale of the business may wish to consider incorporating their business into a limited company, as I have said many times before there are lots of tax planning opportunities with a limited company structure. The incorporation of the business can be carried out without any capital gains tax arising.

Option 1

Transfer the entire pharmacy business to a new company, which you have set up in exchange for shares in that company. The company then sells the business assets, including the goodwill without any tax liability because the company is treated as having acquired the sole trader business at full market value. This will leave cash in the company. To extract this cash will involve tax liabilities unless it is carefully planned. For example, you could go overseas for a complete tax year and during that period pay the cash to yourself as a substantial dividend tax free. Another possibility is to keep the company and draw cash in the form of dividends over a period of years. Providing your total income from all sources is under the higher rate threshold you should not have to pay tax on the dividends.

Option 2

This is a possible solution for pharmacists who are regarded as non-domiciled. Sole traders can transfer the business into a limited company using gift relief so that no tax is payable on the transfer. The company shares are then converted to bearer shares. These shares are treated as being located wherever they are physically kept. So if they are taken offshore to say the Isle of Man and then sold the capital gain will arise overseas. For non domiciled individuals no tax will be payable as long as the gain is not remitted to the UK. If you wish to bring the money into the UK this can also be possible with proper tax planning, usually involving the use of a trust.

For simplicity in the above examples I have only looked at the capital gains issue on the transfer of the business to a company. For example there may be stamp duty on the transfer of certain assets to the limited company. There are many variations on the above themes, which emphasises the need to consult an expert who will examine all aspects of your particular circumstances and find the plan which is most suitable for you.

Enterprise Investment scheme (EIS)

Investment in a qualifying EIS company can be very tax effective. However, the legislation is complex. If you can find a qualifying company which you are happy to invest in the benefits are:

Income tax relief at 20% on the amount subscribed for shares in a qualifying company up to £150,000. Husbands and wives can each subscribe doubling the limit to £300,000. In addition there is no capital gains tax on disposal of the shares. Among the many conditions which must be met for these tax relief's to be effective is ownership of the shares for at least three years.

The icing on the cake

If you have made a substantial capital gain on the disposal of any asset (business or investment) investment in an EIS company can be used as a way of deferring the capital gains tax which would otherwise have been payable. This means you can get up to 60% tax relief on the EIS investment i.e. 20% income tax relief and 40% capital gains tax relief on the deferred gains. These capital gains may be triggered eventually when the EIS shares are sold but further deferral can be considered at that time.
 

Domicile

Even though you live in the UK and may have done so for many years do you know where you are domiciled? I meet many pharmacists who originally came from overseas. At birth you will have acquired the domicile of your Father. So for example if your Fathers domicile was in India you will have acquired this. It is actually quite difficult for someone to change their domicile which works to our advantage. There are many factors the Inland Revenue look at when deciding on someone's domicile, but the most important is your future intentions. If you are able to convince the Revenue that you intend to move overseas permanently at some future date you will be well on the way to establishing an overseas domicile.

The benefits of overseas domicile:

To make the domicile planning effective you must not directly remit your offshore income or gains to the UK. However, with proper tax planning this can be overcome.

Using stakeholder pensions to your advantage

Under the new stakeholder rules anyone can contribute up to £3,600 per annum into a pension scheme even if they have no earnings. These contributions qualify for tax relief. In practice this new legislation is being used in the following ways:

Harry is a 50 year old pharmacist paying tax at 40% on his income. He pays £3,600 into a pension scheme which after tax relief costs him only £2,160. He elects to take the pension benefits immediately.

An annuity is purchased with £2,700 (initial investment £3,600 less lump sum cash payment £900). Annuity rates vary but let us assume for the purpose of this illustration the rate is 6% this will provide Harry with an annual income of £162 which based on his net cost of £1,260 is the equivalent of a 12.8% return. Harry can repeat this each year up to age 75.

All these tax planning ideas only work if carried out in accordance with the prevailing tax legislation, so do take professional advice.