Taxation consultant David Price believes any doctor who is considering medical incorporation should tread carefully before taking up this as yet unproven option.
There has been a flurry of talk and activity among medics and their advisors over the past 18 months or so in relation to ‘incorporation’; i.e. the transfer of part of a practice into a company.
There are three main catalysts behind the increased level of interest in this area. These are:
The Medical Council: The Council issued the seventh edition of its ‘Guide to Professional Conduct and Ethics for Registered Medical Practitioners’ during 2009. This edition omitted the prohibition on practising through a company, which had been contained in earlier editions. Separately, the Council confirmed that, provided doctors do not use incorporation in order to attempt to “try and avoid their professional responsibilities”, that the Council does not believe that the doctor’s use of a company is of relevance to it.
Changes in tax law: The assault on tax shelters over the past three years started for doctors with the changes in both law and practice in relation to the amount of private practice income that could be sheltered from tax by investment in pensions. The cumulative effect of the various changes has effectively removed pensions from the tax planning toolkit of most doctors.
The introduction of the ‘High-earners Restriction’ in 2007 and its subsequent extension for 2010 et seq removed many other tax sheltering opportunities.
The final nail in the coffin of tax planning for doctors came in the Finance Act 2011, which abolished virtually all of the remaining reliefs, as well as restricting deductibility of professional memberships and introducing the universal social charge, both of which will affect doctors particularly.
Marketing of incorporation products: Over the past couple of years, a small number of advisors have become very active in marketing incorporation products to doctors, particularly hospital consultants. One such ‘one-size-fits-all’ product that achieved a good deal of traction involved the use of an unlimited company.
Initially this product was brought to Ireland by an offshore firm, which had experience of providing it to medical practices in the UK. In my view, that firm failed to recognise the differences between Irish and UK law in a number of relevant areas.
Some of these early incorporation structures have now started to crumble under the scrutiny of the Irish tax authorities.
So, for any doctor considering incorporation, what are the pitfalls? Well, unfortunately, the short answer is that they are many and varied. The principal reason for the large number of possible slip-ups is the large number of interested parties. Take, for example, a hospital consultant who sees private patients in a number of locations. The parties interested in the legal structure which the consultant adopts will include:
- The Revenue Commissioners;
- The Department of Health;
- The Medical Council;
- The management of any public hospital in which the consultant sees private patients;
- The management of any private hospital in which the consultant sees private patients;
- The consultant’s liability insurers;
- The liability insurers of each affected hospital;
- Vhi, Quinn, POMAS, St Paul’s, etc;
- The consultants themselves; and
- Any employees of the consultant.
Many of these interested parties will have different, often directly opposing, concerns in relation to any proposed incorporation. It is the lack of advance consideration of these concerns, inherent in any off-the-shelf product, which has given rise to most of the failed incorporations to date.
The purpose of this article is to highlight a number of the tax issues that are now starting to come to light. Before doing so, it is worth considering why these issues are only now being considered.
The reason is that, in terms of tax return timelines, medical incorporations are very new. The earliest incorporations (in mainstream medical practices) took place about three years ago. Take, for example, the position of a practice incorporated in June 2008. The new company would probably have prepared its first set of accounts for 12 months to 31 May 2009.
These accounts would have been submitted to the tax inspector around April 21, 2010, and so the tax aspects of the transaction would only start to be examined, at the earliest, 21 months after the incorporation was effected.
In practice, of course, the tax inspector may not advise the doctor that his return is being reviewed as the inspector will want first to build his case and gather as much information as possible from his colleagues in other tax districts. This will be a slow process, as medical incorporations are new to all tax districts. The inspectors, however, are in no rush, as interest will be payable on any settlement by the doctor. With interest on underpayments of tax accruing daily at circa 8 per cent per annum, there is only one winner here.
The often previously unconsidered taxation issues now starting to surface include:
Some advocates of productised incorporation have been advising doctors to ‘sell’ the goodwill attaching to their medical practice to the newly-formed company in order to access capital gains tax treatment, rather than income tax treatment on future profits. This has given rise to a number of issues. First among these are the provisions of section 37 of the Medical Practitioners Act of 2007, which prohibits the practice of medicine by any person (or entity) which is not registered under the Act.
Some advisors had misinterpreted the Medical Council’s change of opinion in relation to the ethical position as a carte blanche for using a company for any purpose.
However, it was never the intention of the Medical Council to imply that the law had changed. It has not.
As a company cannot be registered under the Act, Revenue has questioned how a company could in fact acquire the goodwill of a medical practitioner. If the payment received by the doctor was not for ‘goodwill’ then, Revenue argue, it is a ‘distribution’ from the company and thus liable to income tax.
On the other hand, if the payment was for goodwill (which he was prohibited by law from transferring) then it was an illegal payment and thus liable to income tax under Case 4 of Schedule D and not capital gains tax.
One of the major difficulties facing doctors who encounter this two-pronged argument from their tax inspector is that the inspector is not seeking to unwind the transaction, merely to tax it. In such cases, doctors are faced with having to pay both income tax and corporation tax and professional services surcharge on the same income. Together with penalties and interest, the total cost can exceed 100 per cent of the profits in question.
The Irish tax code contains a number of specific anti-avoidance provisions that are relevant to medical incorporations. In addition, it contains a general anti-avoidance provision, section 811. Both the specific and the general provisions contain references to ‘motive’.
Essentially, the thrust of the legislation is, ‘if one of the main motives behind a particular transaction is avoidance of tax, then any tax avoided by the transaction remains payable’. In order to achieve the promised tax advantages of incorporation, therefore, a doctor has to demonstrate that tax avoidance was not even one of the motives behind his decision to incorporate.
In deciding what motivated an incorporation, Revenue has recourse to the websites and marketing materials of the incorporation provider. In the case of the productised incorporation providers, these marketing materials and websites have concentrated predominantly on the taxation advantages — ironically, thus managing to defeat their client’s ability to obtain the promised advantages.
Lack of purpose:
At the other end of the spectrum are those medics who incorporated their practices purely because they heard that others were doing it, and thus that it must be ‘the thing to do’. Rather than failing because of their motive, this group has failed because they had no motive. Incorporation only has benefits if used as a means to an end. Otherwise, all it produces are unnecessary costs and, most likely, increased taxation.
A number of consultants have recently discovered one of the practical pitfalls of implementing in Ireland an incorporation process designed for the UK. These doctors have discovered that they cannot obtain credit for the withholding tax deducted by the health insurance companies (Vhi etc.)
This is because the tax was withheld and paid over to Revenue under the doctor’s personal tax reference, while the income was portrayed as belonging to the new company.
It is Revenue’s view that the consultant can’t claim the credit as it did not arise on his income. And the company can’t claim the credit as it is not under its tax reference. The problem is compounded because, in general, Vhi will not make payments to companies (as they are not registered practitioners) and in many cases the doctor had therefore concealed the company’s existence from Vhi. How (indeed if) this mess might be resolved remains to be seen.
This new addition to Irish tax law has really thrown the whole area of incorporation into question. In particular, it spells the end of the productised ‘one-size-fits-all’ unlimited company-type solutions.
The new provisions require disclosure to Revenue of any productised tax-avoidance transaction entered into. The responsibility for making the report is imposed primarily on the product promoter, but in certain circumstances also on any advisor involved in preparing or implementing the product and on the taxpayer.
Although the legislation was originally published in the Finance Act 2010 the requirement to report only took effect from January 17, 2011.
While incorporations which were fully implemented prior to that date do not need to be reported, they are still likely to come under scrutiny once Revenue receives its first report in respect of a more recent implementation.
Until greater clarity is available on the law and practice governing medical incorporations, any doctor considering such a move should tread carefully. There are clear advantages to an ‘informed’ incorporation but, for the unwary, there are many potential traps.
As any medic should know, if a product is marketed to cure all your ills with no chance of side effects, it is probably snake oil.
- David Price, Taxation Consultant, TAIN 72518V. Email: firstname.lastname@example.org