Firstly I hope you all well whilst reading this, the world is constantly changing, and whilst we cannot predict what is going to happen we can plan and structure for our futures and those we care about futures! It does not matter if your starting out or a well-established clinic we all have a future and within this article, I hope to get the thought process moving on these futures as now is the perfect time to structure or restructure.
Everyone knows that when starting a business, it can be pretty straightforward. Partnership (more than 1 person), Sole Trader (1 person), or Limited Company. Whichever one you choose, to get started can be straightforward by either starting Monday (unincorporated) or searching online to find who has a £9.99 deal to form a company, pick a name, pay the £10, and off you go.
The problem that’s been created with this quick formation is when your clinic/practice is inevitably successful, how do you get the money out?
Unfortunately, at this point, you start to think about legacy planning and tax efficiency, and in many cases, it’s now too late. It’s possible that at this stage you will now pay 32.5% tax on dividends, 40% tax on the Director’s salary (even before the consideration for National Insurance), or a combination of the two.
When starting a business, I always compare it to building a block of flats. If your long term plan is to go up 10 floors – even if you only initially plan 5, then 6-10 are simple because you’ve planned for it. However, if you want to change the foundation for a 5 storey building to make it suitable for 10, it’s going to be extremely expensive – even to the point, it’s just not financially viable.
Did you know that even if you decide to gift shares to your children for free, it is potentially going to land you with a Capital Gains Tax charge of up to 28% on the “deemed value”. A simple example of a business that is worth £1m, to give away 10% of the company to your child for free can attract a CGT liability of up to £28,000!
This can all be dealt with at the formation of the business and whilst it might cost a little more than £9.99, it could save that £28,000 in a few year’s time.
The common terminology used for this is to create “Alphabet Shares”. This is now more and more common in new formations and basically allows you to create different rules for different shares. For example, you could have a share class (A) which is linked to voting (1 vote per 1 share) and a second share class (B) which doesn’t give any entitlement to voting rights but can pay dividends on this. Therefore, you could effectively give your children shares in your business, which whilst doesn’t carry any voting rights, does enable dividends to be paid and to utilize their tax allowances.
In addition to the above, in the unfortunate event of the owners passing, the children will already own part of the company, which will minimize any inheritance tax obligations.
Whilst every business is different, and the scenarios are always different in business to business, to be aware of the possibility of doing this is a massive bonus.
In addition to the above potential in regards to Inheritance Tax / Capital Gains Tax, the next consideration is the ongoing possibility of Dividends once an additional share class is created. On the basis that you comply with HMRC guidelines, you could potentially payout 50% of the profits to a lower rate taxpayer who has shares in the company (even if they only own 10% of the business), resulting in a tax liability of only 7.5% on getting the money out of the company, as opposed to you taking the money at 32.5%, and you could do this for the life of the business.
For another example, assume your business is generating post-tax profits of £100k per annum. If you have already earnt £50k in the year, all future profits are taxed at 32.5%, but if you included your partner in the business, they could potentially earn £50k from the business and not pay tax at any more than 7.5%, which ultimately means more money to your joint bank account, and less to the big bad tax man – and in the best scenario above, that could be as much as £13,500 per annum for the duration of the business.
With all of the examples above, a common question we get asked in our accountancy business is “that’s all well and good, but I don’t want to make my partner/children liable should anything bad happen to the business”. This is where we are able to smile broadly and let them know that the shareholder’s risk of loss is limited to the amount they’ve paid for the shares, which can be as little as £1! Not a bad risk – £1 vs £13,500 per annum + Capital Gains Tax benefits + Inheritance Tax benefits!
If you’ve read this far but are thinking “that all sounds wonderful, but my company has been trading for 4 years and I didn’t know about any of this which means it’s too late”. This isn’t always the case – firstly, transfers of assets (including shares) between husband and wife are exempt from Capital Gains Tax, and secondly, if there was ever a time to re-organize your shares in your business, it’s now. Remember I mentioned that HMRC will tax based on the “deemed value” of the gifts. Right now with the global pandemic, takings are down, profits are down, which ultimately means the value of your business is going to be down. If there was ever a time to do this re-organization, other than before the commencement of trading, it’s now.
It is certainly worth discussing this with your accountant – we regularly have these discussions with our clients so they can consider their options. Unfortunately, many accountants are either unaware of these benefits, or simply don’t want the hassle of the work, because ultimately it wont make much difference to them, but for you and your future, this could be worth tens of thousands. I am a social guy and always up for a chat so if you want to discuss anything just connect with me on social media.