In recent weeks it has become apparent that Revenue are becoming particularly interested in the way in which certain medical consultants have structured their affairs by transferring all/part of their business previously carried on as a sole trader into a company.
This is based largely on limited evidence that has come to light in relation to certain transactions which Revenue view as possibly having little bona fide commercial substance.
Examples of areas of concern to Revenue
1. A legitimate reason for any business person establishing a company has always been the concept of limited liability which provides a certain level of comfort at a personal level in the case of a claim against the business. In general, there is a view that Doctors cannot trade though an entity that purports to limit their personal liability in providing a duty of care to a patient and therefore they must, when incorporating, use an unlimited liability company. This automatically means that the normal reason cited for incorporating a company does not apply in the case of Doctors.
2. On a transfer of a medical business to a company, valuations of goodwill have been used which in the opinion of Revenue are excessive. While a transfer of goodwill is of course subject to capital gains tax, on first principals this historically was at a much lower tax rate than if the same value was released as income liable to tax at marginal rates as high as 55% in some cases. Also, where such a transaction took place, any resulting funds owed to the sole trader by the company may be reflected in a Directors Loan Account balance higher than would otherwise be the case, which Revenue are concerned could be drawn down tax free in lieu of salary over time
3. In some cases, Revenue consider that a claim for relief from capital gains tax on transfer of the goodwill under Retirement Relief or judicious use of capital losses may not be genuine and they have a concern also that in some cases it is very unclear as to whether or when a legal or beneficial transfer of a business to a company has in fact taken place.
Some background and what Revenue plan to do
It should be remembered that many of these incorporations took place primarily to achieve the following objectives:
i. Ensure that profits of the medical practice are taxed at the corporate 12.5% rate rather than at marginal income tax rates – this really only applies when there is a significant difference between earned income of the business and what a particular practitioner “requires” as income and draws down from the company as salary taxed at source.
ii. Pension planning – a 60 year old self-employed doctor earning €300,000 per annum can only claim a deduction for pension contributions to a maximum of €46,000 per annum (being 40% of a deemed income ceiling of €115,000) while the same Doctor trading through a company could set up a self-administered pension scheme and arrange for the company to make almost unlimited tax effective contributions in some cases.
Clearly, therefore, the attraction to follow the incorporation route was quite apparent to many professionals in this sector and it is perhaps not surprising that Revenue are paying some attention to the bona fides of such transactions and how they were effected in practice.
It is understood that in coming months Revenue will engage with the medical profession and their advisors initially, probably through non audit interventions to determine if any practices are being adopted either currently or historically which give rise to a significant loss of Tax Revenues.
Where timely replies are not received, it is quite likely that full tax audits may take place which may well give rise to significant penalties where Revenue views as to the lack of bona fides in certain cases can be substantiated.
It is therefore possibly an opportune time to review past transactions that accountants in practice may have engaged in with clients in this area.