The Ticking Time Bomb of Flawed Incorporation

Few dentists would boast that they possessed a detailed knowledge of the intricacies or consequences of incorporating a small business, and the often distressing discovery of improperly or unwisely converted dental practices into limited companies as a result of ‘DIY’, poor accountancy advice or a mixture of both becoming increasingly common.

Legal errors, a lack of foresight, a misunderstanding of the fiscal ramifications or failure to consider the dentists particular circumstances , can all contribute to a faulty or unconsidered incorporation which is in effect a ticking time bomb, with a potentially disadvantageous, or even catastrophic, outcome for the owner(s) should it detonate.

While it has been legal for dental practices to be incorporated since 2006, it wasn’t until 2009/10 that significant numbers began to make the change from sole trader or partnership businesses to incorporation (i.e., to trading as limited companies). 

In the natural course of events practice owners’ family or financial circumstances change, and four years later many of these practices are coming to the market with interested parties on both sides only now discovering that the businesses being offered for sale were not incorporated correctly.

The generic description for this situation, widely recognised within the expert dental legal community, is a ‘flawed incorporation,’ a term which covers a variety of errors which can be compounded over time as practices expand into new areas of activity, take on new partners or associates, or develop different working practices.

One of the most common problems is that practices with an NHS contract will purport to incorporate without referring to NHS England for permission, and so a new, replacement contract is not issued in the name of the limited company; while this may make little immediate difference to the day-to-day treatment of patients, the contract remains in the name of the individual practitioner and eventually problems will arise, most often highlighted in the case of a mooted change of practice ownership within the duration of the contract or a challenge by HMRC to the validity of the incorporation. 

When any business, in this case a dental pratice, is incorporated, its assets, which for a dental practice often include an NHS contract, cease to be owned by an individual and are sold to the limited company; however, all NHS contracts explicitly state that a transfer of ownership is not permitted. It is therefore self-evident that without the consent of the NHS England, the purported transfer of the contract is a fundamental breach of the agreement, which gives NHS England an automatic right to terminate the contract.

At a time of extreme financial restraint across the public sector, the LAT may well take advantage of such a situation by terminating the NHS contract and putting the UDAs out to tender . The result would of course be the loss of the whole of the pra tices NHS goodwill value. 

In reality, for many practices their NHS contract is their principal source of patients, income and business activity, and so constitutes their major asset. If the owner(s) (now the shareholder(s)), should wish to sell their now incorporated practice, its chief asset is still in their name(s) and so does not belong to the company, effectively making the practice of little value and probably unsalable pending the successful negotiation of a new PCT contract, which is extremely unlikely, or face the dis-incorporation of the limited company which can if itself have dire financial consequences. This remains true even if the owner(s) genuinely believed the contract had been transferred, and the tax advantages claimed since incorporation had been accepted by HMRC. 

Another common omission is a failure to notify the lender which enabled the original purchase of the practice, usually a bank, of the intended change in asset ownership, including the goodwill, and of the practice’s proposed altered trading and fiscal status. Incorporation without the lender’s approval, may well be a breach the terms of the loan or mortgage and offer immediate grounds for the loan to be withdrawn. While the tax benefits of incorporation are for many practice principals undeniable, or even irresistible!, in such a scenario they would quickly cease to be relevant. 

It is a truism in every market that articles for sale are only worth what a prospective purchaser is prepared to pay. Whenever a dental practice comes to the market, whether or not it is incorporated, a substantial sum and third party finance are usually involved, and a satisfactory outcome will not be achieved without the purchasing parties’ absolute confidence in what they are buying. Any suggestion that the corporate standing or structure of the business is flawed will in all likelihood adversely affect the price or possibly lead to the sale falling through. At the very least significant delays will occur before completion, and it may be necessary for an incorporation to be effectively reversed before a transfer of ownership is agreed, or even legally possible.

Since incorporation alters the practice’s fiscal status and reduces the principal’s personal and overall tax liabilities any hint of irregularity, however inadvertent, is likely to attract the attention of the Inland Revenue, and so it is vital for the there to be a proper paper trail including written evidence of goodwill valuation and a properly constituted sale agreement to be correct, accurate and unambiguous. At a time when the Government’s overriding concern is to maximise its income to combat the current deficit in its own finances, it’s hardly surprising that HMRC is increasingly active in this area. Tax investigations are notoriously time consuming and expensive even when the outcome is entirely satisfactory for the business concerned, and so documentation regarding the transfer of assets, particularly the goodwill, must be drafted with scrupulous care. Any discrepancies may lead to the authorities failing to recognise the incorporation and demanding repayment of any already received tax benefits.

Dentists naturally regard their primary function to be the delivery of high quality patient care, and in the 21st Century their clinical, performance is subject to more intense scrutiny that ever before as public expectations rise and new treatments and procedures, especially in the area of restorations, enter mainstream practice.

Against this background of demanding regulation, high standards and expanding clinical and financial possibilities in non-NHS, cosmetic dentistry, for many dentists incorporation is a logical step forward for both themselves and their practices. 

However, the importance of engaging industry-focused legal professionals cannot be underestimated when the time comes to incorporate a dental practice. A firm such as Goodman Grant, which practices exclusively in the field of dentistry and is fully cognisant of the specific requirements of a retail health care business, in terms of the need to deliver superior patient care while at the same time maximising business and fiscal efficiency, is the ideal partner to deliver a comprehensive, legally watertight incorporation. Scrupulous attention to detail, and adapting a company model to precisely suit discrete familial or other circumstances, without compromising the absolute legitimacy of the outcome, can only be achieved through the application of specialist knowledge and experience.

For more information call John Grant on 0113 8343705 or email jmg@goodmangrant.co.uk


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