Below are a set of seminar notes prepared by me for a number of presentations over the next couple of months:
TAX PLANNING AFTER THE 2009 BUDGET
A PRESENTATION BY MARK SIMPSON, DIRECTOR OF TAX SAVING, SIMPSON BURGESS NASH, CHARTERED ACCOUNTANTS
“The avoidance of taxes is the only intellectual pursuit that carries any reward.”
John Maynard Keynes
A. Introduction
This presentation is about tax mitigation. It is not about:
Tax evasion
Illegal
New naming and shaming regime and new penalty regime to deter tax evaders
Offshore disclosure facility to entice them into the open
Tax avoidance
Legal
Uses highly artificial schemes to seek to obtain a tax advantage
Large fees
No guarantee of success
Disclosure regime and constant government blocking action
Two-pronged HMRC attack – on scheme in principle, and on implementation in detail.
Recipe for large scale HMRC enquiry
B. Tax mitigation
Simpler and more straightforward
Less controversial
No likelihood of detailed HMRC scrutiny
Still highly effective
I will talk about 12 ideas for tax mitigation, some based on Budget proposals and some left alone by the Budget, which by and large concentrated on blocking complex avoidance schemes.
All are straightforward and practical enough to consider; not all will be relevant to you, but some will be. None will cost a fortune to implement, and all can yield significant tax savings.
- Income splitting
“I will have such revenges on you both,
That all the world shall -- I will do such things --
What they are, yet I know not: but they shall be
The terrors of the earth!”
King Lear Act 2 Scene 4
Such was the nature of the Government’s reaction, in the form of the comments of (my former schoolmate) the Exchequer Secretary to the Treasury Angela Eagle, to the House of Lords decision in the Arctic Systems case, which found that splitting income from a limited company between spouses by splitting the shareholdings was a valid tax mitigation exercise, even if the spouses did unequal amounts of work for the company.
The threat of counter action produced some unsatisfactory draft legislation, followed by a deferral of action for a year, followed in November by an indefinite deferral of action. This is no doubt a subject to which the Government will return, but not yet.
Thus any taxpayer who has a personal company and a spouse or civil partner has the opportunity to split income from the company with them by giving them shares, and voting dividends on those shares. Do not:
Try this with a partnership
Waive dividends on shares
Issue shares with only dividend rights
In the context of a future tax regime featuring a 50% income tax rate for income above £150,000, the loss of personal allowances on income above £100,000 and the denial of higher rate tax relief on pension contributions for those with income above £150,000, this possibility offers potentially large tax advantages for relevant taxpayers. We do not know for how much longer income splitting will remain possible, but whilst it does it is wise to explore its possibilities.
- Incorporation
“It is an axiomatic principle of English company law that a company is an entity separate and distinct from its members, who are liable only to the extent that they have contributed to the company's capital: Salomon v Salomon [1897].”
Wikipedia
Much the same case can be made for incorporation as for income splitting as a tax mitigation measure. As the quote suggests, historically the attraction of incorporation was limited liability, but increasingly the tax system has pushed taxpayers in that direction also. Apart from specific reliefs such as research and development enhancement or tax credits and enhanced capital allowances on ‘green’ plant and machinery, the interaction of the corporation tax and income tax regimes makes trading through a company a very attractive proposition for a profitable business.
The crux of this matter is the ability for the director / shareholder of a small limited
company to control the level of his or her personal income, and also the nature of that income (salary or dividend). In combination with income splitting for example, this permits spouses to draw just over £80,000 per year from a company (profits permitting) with no personal tax or national insurance charge whatsoever, with credit given for benefits purposes as if NI had been paid. The 21% corporation tax charge on the underlying profits would be around £18,250, which is a saving of £14,750 on the income tax & NI liability that would otherwise be suffered by an individual sole trader with similar profits (£33,000).
Of course the ability to split, and to control, the level of income will only become more important when the proposed tax charges for 2010-11 and 2011-12 (see below) come into effect.
Companies also still carry the advantage of limited liability, but are required to file accounts and returns at Companies House.
- Enhanced loss carry back
“If at first you don’t succeed, find out if the loser gets anything”
Bill Lyon
In normal circumstances, a trading loss can only be carried back one tax year, set off against current year income or carried forward against future profits of the same trade.
However, for a limited period, businesses are allowed to carry back up to £50,000 of losses for 3 years. For unincorporated businesses, accounting periods ending in tax years 2008-09 and 2009-10 are eligible. For companies, accounting periods ending between 24 November 2008 and 23 November 2010 are eligible.
Apart from the apparent anomaly of the recession covering different dates for incorporated and unincorporated businesses, there is also an oddity in that the Treasury press release announcing the introduction of the relief said that it would be particularly helpful for start-up businesses struggling in the recession. This is nonsense, as there is a better relief for losses in the first four years of a trade, involving 3-year carry back of an unlimited amount.
It is possible to change the accounting date of a business, and in order to take maximum advantage of enhanced loss carry back this may be necessary. In particular the preparation of accounts for short periods may enable part of a longer period that would not be eligible for the enhanced relief to be made eligible.
Possibly the most extreme planning to maximise the benefits of the new regime would be to incorporate an unincorporated business in early 2010 (prior to 6 April 2010). This would permit either a claim under the new regime or a terminal loss claim (unlimited carry back for losses of last 12 months of trade against previous 3 years’ profits) for the final period loss of the sole trade or partnership, and a potential claim for the new company if a short first period of accounts was chosen to end before 24 November 2010.
- Cars and capital allowances
“Everything in life is somewhere else, and you get there in a car”
E B White
The regime for capital allowances on cars changed dramatically with effect from April 2009.
Features of the old regime
£3,000 annual allowance restriction on cars costing more than £12,000 (expensive cars) and separate pool for each expensive car.
Balancing allowances on sale of expensive cars.
25% writing down allowances, subject to above restriction.
No first year allowances
Private use restrictions on allowances, and separate pool for each private use car.
Formula to disallow a proportion of lease payments on cars with a value when new of over £12,000.
Features of the new regime
No annual allowance restriction on cars costing more than £12,000.
Expensive cars are pooled, so no balancing allowances (unless there is private use).
Writing down allowances at 20% (if CO2 emissions not more than 160 g/km) or otherwise at 10%.
No annual investment allowance or first year allowances
Private use restrictions on allowances, and separate pool for each private use car.
15% disallowance of lease payments for cars emitting more than 160g/km of CO2, otherwise no disallowance.
Implications
Private use becomes very important for cars to be sold after a relatively short period.
Can’t have private use of a company car / car provided as a benefit-in-kind.
Employee cannot get capital allowances on a car used for business travel, but can get tax-free mileage payments at 40p & 25p per mile.
A rare tax incentive for a non-corporate structure, as partner / sole trader cars will invariably have private use.
- VAT rate rise
“Whilst these people may be students in accordance with the dictionary definition, it is by no means clear that they are students in the everyday meaning of the word”
Unnamed senior Customs & Excise official, in a letter to me about a client
The standard rate of VAT will return to 17.5% on 1 January 2010.
The government is acutely conscious of the risk of taxpayers accelerating tax points to take advantage of the 15% rate in respect of supplies not actually made until after 31 December 2009. This can be done by issuing a VAT invoice or taking payment for the supply in advance. Where the customer cannot recover the VAT being charged there would be an advantage to such an acceleration.
In three circumstances the government has introduced forestalling measures to deter the acceleration of tax points:
Where the parties are connected to each other
Where the supplier bears the cost of the accelerated amount between tax point and date of supply
Where the delay between tax point and actual date of supply is at least 6 months.
Where only the third would apply, invoicing in late December 2009 would give until late June 2010 to actually make the supply without any problems.
In fact the forestalling charge is only a 2.5% premium on the VAT charged, so this does not in fact make the situation any worse than charging 17.5% in the first place.
If you make continuous supplies of services, you can determine the tax point by raising an invoice, so the forestalling charge is unlikely to be a problem anyway.
6. 50% top rate of income tax and personal allowance withdrawal (from 6 April 2010)
“Unquestionably, there is progress. The average American now pays out twice as much in taxes as he formerly got in wages.”
H. L. Mencken
From 2010-11, those with income above £150,000 will pay a 50% top rate of income tax. Also, those with income in excess of £100,000 will lose their income tax personal allowance, at a rate of £1 for every £2 of income above £100,000.
I have dealt above with two of the likeliest effective measures of dealing with these changes, namely income splitting and incorporation. The latter is likely to be particularly attractive to highly profitable partnerships and sole trades.
Taxpayers may also choose to invest for growth rather than income, given a capital gains tax rate of 18% compared to a 50% top rate of income tax.
Taxpayers may also consider salary sacrifice arrangements for employer pension contributions or tax-efficient benefits (see below in each case).
Some have already threatened to emigrate, but may like to consider that HMRC are becoming much more difficult to convince that non-resident status has in fact been achieved.
7. Furnished holiday lettings
“When I was kidnapped, my parents snapped into action. They rented out my room.”
Woody Allen
The favourable tax regime applicable to FHL’s includes the following:
Treatment of losses as trading losses
Ability to treat profits as earnings for pension contribution purposes
Capital allowances despite the fact that the let property is a dwelling house
Capital gains tax entrepreneurs’ relief and holdover relief
Inheritance tax business property relief? A recent court case has cast doubt on whether this was ever due on the majority of FHL properties, as it suggests that a significant level of services needs to be provided by the landlord to make the lettings eligible for relief.
Traditionally the reliefs have been limited to UK properties only. However, the government is concerned that this restriction breaches EU law, and thus for 2009-10 has extended the relief to cover all properties in the European Economic Area (the EU plus Iceland, Liechtenstein and Norway). However, from April 2010 the favourable regime will be terminated completely.
It has to be said that the reasons for abolishing the relief do not stack up. Every EEA country retains the right, under its tax treaty with the UK, to tax income from the letting of property within its borders, and to tax gains on the sale of such property. Thus the potential tax cost to the UK of extending the relief to cover the EEA would be minimal.
So what should the FHL owner do to prepare for the change in April 2010?
· Accelerate any major works on the property to ensure that capital allowances are available on any plant and machinery installed, particularly given that there is a 100% Annual Investment Allowance available on the first £50,000 of such expenditure.
· Similarly, incur any necessary repair etc. expenditure before the change of regime, in order to potentially generate losses (see below).
· Possibly trigger a capital gains tax disposal (not to spouse or civil partner) to crystallise entrepreneurs’ relief (and thus tax at an effective rate below 10%) whilst the values of property are relatively low? This would give an enhanced base cost for future disposal. A trust could usefully be used in this respect.
· Change the accounting date to ensure that maximum loss relief is obtained against general income, particularly given the enhanced carry back provisions.
· Establish residence in the property to allow an election for main residence exemption in respect of the property. This can establish both a claim to main residence exemption for the last 3 years of ownership of the property (regardless of actual residence) and to letting relief, worth up to £40,000 per owner of the property.
· Trigger a cessation of the business to use any available overlap relief for tax purposes. This might fit in neatly with a CGT disposal, but is only relevant if accounts are made up other than for the tax year.
- Pension contributions
“If I'd known how old I was going to be
I'd have taken better care of myself”
Adolph Zukor, on approaching his hundredth birthday
From April 2011, those with taxable income over £150,000 per year will have tax relief on their pension contributions restricted to the basic rate of income tax.
Of more immediate concern are the forestalling rules that came into effect on Budget day. These introduce a tax charge designed to reduce the effective rate of income tax relief on pension contributions to 20%. These will apply to taxpayers who have income of more than £150,000 for the relevant tax year or either of the two previous tax years. They will only apply to taxpayers who make contributions in excess of £20,000 and in excess of their ‘normal ongoing, regular contributions’, which are broadly their year-on-year contributions for tax years prior to 2009-10.
The rules will apply to employer contributions as well as to employee contributions, and will also rule out salary sacrifice arrangements as a means of avoiding a tax charge.
Thus the scope for planning will be limited to those who had income below £150,000 for 2008/09 (and 2007/08 for 2009/10 contributions) but who anticipate having income above that level for 2009/10 and/or 2010/11. Use of techniques such as incorporation, income splitting or investing for growth can still be useful to such people as planning devices.
9. Tax-efficient employment benefits-in-kind
“The brain is a wonderful organ; it starts working the moment you get up in the morning and does not stop until you get into the office.”
Robert Frost
The advent of additional tax liabilities for those with six figure incomes, and of higher rates of national insurance for employers and employees will no doubt concentrate minds on ways of deriving tax-free income from employment, such as the following:
· Childcare vouchers. Provided the benefit is made available to all employees, vouchers to a value up to £55 per week can be provided to pay for (non-family provided) childcare for employees. This benefit is free of tax and national insurance, and thus provides a significant saving for employer and employee if it is given on a salary sacrifice basis. Care is required in respect of the impact of vouchers on tax credit claims and their continued availability during maternity leave.
· Mobile phones. These can be provided free of tax and national insurance to selected employees, although it may be advisable to cap the level of bills that the employer will meet!
· Medical check-ups. These can again be provided tax and national insurance-free to selected employees.
· The cycle to work scheme allows the tax-free provision of cycles and cycle safety equipment by employers to employees – the facility must be made available to all employees. In theory the bicycle must be mainly for home to work use, but given that employers are not required to monitor the use of bicycles it is difficult to see how this can be enforced in practice.
· The alternative to the above approach is for the employee to provide his or her own bicycle, for which they can be paid a tax and NI-free mileage rate of 20p per mile for business mileage, on a similar basis to the fixed profit car scheme rates of 40p and 25p per mile.
· Before leaving the subject of bicycles, employers can also provide tax-free cyclists’ breakfasts to employees who cycle to work. We have thus far waited in vain for the introduction of joggers’ breakfasts and walkers’ breakfasts!
· Pension contributions by employers are in general a tax-free benefit for employees, although the above regime for those with income in excess of £150,000 must now be taken into account in this respect, as well as the annual pensions allowance (currently £245,000).
· Outplacement counselling provided to help employees to adjust to cessation of employment or to find a new job is a tax-free benefit. It is important to note that this can be provided on retirement as well as on redundancy etc.
· Loans of up to £5,000 can be made tax and NI free to employees. This is a de minimis relief, so if the loan exceeds £5,000 the whole loan is subject to an income tax (and employers’ NI) charge, currently based on 4.75% per year of the amount lent. Care also needs to be taken about making loans to shareholders, as these can give rise to a different tax charge under the corporation tax regime.
10. Enhanced capital allowances
“We assume that everything's becoming more efficient, and in an immediate sense that's true; our lives are better in many ways. But that improvement has been gained through a massively inefficient use of natural resources.”
Paul Hawken
There are significant tax incentives for investment in energy-saving plant and machinery and in environmentally beneficial plant and machinery. These incentives take the form of a 100% first year capital allowance, unlimited in value and in addition to the £50,000 annual investment allowance.
The relief is only available to limited companies (another potential tax incentive for incorporation), and is a fairly highly specified relief, in the sense that it is given on the basis of particular criteria. The mechanisms for this are two official on-line lists of eligible product criteria:
The Energy Technology Product List (www.eca.gov.uk)
The Water Technology Product List (www.eca-water.gov.uk)
The major categories of product on these lists are as follows:
Energy Technology Product List
Boilers
Combined heat and power
Lighting
Motors and drives
Pipe-work insulation
Refrigeration
Air to water heat pumps for space heating
Radiant and warm air heaters
Compressed air equipment
Solar thermal systems
Automatic monitoring and targeting equipment
Air-to-air energy recovery equipment
Compact heat exchangers and heating
Ventilation and air conditioning zone controls
Uninterruptible power supplies
Water Technology Product List
Water meters
Flow controllers
Leakage detection equipment
Low flush toilets
Efficient taps
Rainwater harvesting equipment
Membrane filtration systems for wastewater treatment
Cleaning in place equipment
Efficient showers
Efficient washing machines
Small-scale slurry and sludge dewatering equipment
Vehicle wash waste reclaim units
Efficient industrial cleaning equipment
Waste management for mechanical seals
It is vital, given the specific nature of the reliefs, that detailed specifications are given to architects and contractors when designing and specifying new buildings, or renovating existing ones.
It is also now possible for loss-making companies to surrender enhanced capital allowances for a 19% cash tax credit in order to improve cash flow. The maximum tax credit receivable is the greater of:
£250,000;
and
the company’s PAYE and NI liability for the relevant accounting period.
11. Research and development expenditure
"Research is what I'm doing when I don't know what I'm doing."
Werner von Braun
"If we knew what it was we were doing, it would not be called research, would it ?"
Albert Einstein
R & D is defined as the extension of knowledge in the fields of science and technology, with a view to the resolution of scientific or technological uncertainty.
There are separate regimes for small and medium-sized enterprises and for large companies. Like ECA’s, R & D tax reliefs are available only to limited companies.
I will concentrate here on the SME regime. In order to be eligible R & D expenditure, costs must meet the above criteria and also the following:
· The company incurring the expenditure must own the intellectual property to which that expenditure relates.
· The expenditure must not be subsidised (e.g. by way of R & D grant).
· The expenditure must be revenue expenditure.
· The company must not be acting as a subcontractor.
· The expenditure must be on staffing or external workers, software, consumable items or sub-contracted R & D.
Examples of cases I have successfully dealt with include:
On-line real-time gaming platforms
Improved movie camera design
Customisable e-commerce software
Bespoke Second Life application for a musician
among many others.
There are 3 types of relief available:
1. Enhancement of pre-trading expenditure to 175% of actual, and treatment as a trading loss.
2. Enhancement of trading expenditure to 175% of actual, allowable against trading profits.
3. Surrender of 175% of actual expenditure for a 14% cash tax credit (effective rate of credit 24.5%). The tax credit cannot exceed the company’s PAYE & national insurance liability for the accounting period of the claim.
12. Enterprise Management Incentive Schemes
An EMIS is a tax-efficient share option scheme for key directors or employees, and is intended to tie them into the business and give them a stake in its success.
A director or employee who owns more than 30% of the company shares is ineligible to benefit from an EMIS.
The problem with ordinary share option schemes is that an income tax charge arises at the point that the option is exercised, even though that may well not be a point at which the employee receives any cash for the shares. The advantage of an EMIS is that this tax charge is deferred until the employee sells the shares, at which point he or she will pay 18% capital gains tax (or 10% if a 5%+ shareholder) instead of 40% income tax.
It is possible to set performance targets for the exercise of options, which must be capable of exercise within 10 years of grant. It is normal to provide for unexercised options to lapse if the employee leaves employment, and to provide that the employee must sell the shares if he or she leaves post-exercise.
Summary
There is still ample scope for tax mitigation to significantly reduce your tax bills and increase your disposable income. How much longer that will remain the case is open to question, but it is best to take advantage while you still can.
