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Capital or income

Usually, when a company distributes its profits to its shareholders they are liable to income tax on the payments they receive. However, a special rule means that distributions made in the course of winding up a company are taxed as capital instead. This provides tax-saving opportunities.

 

Example. Owen and Jane are equal shareholders of Acom Ltd. Both are higher rate taxpayers. They decide to close the business and appoint a liquidator to wind up the company. All distributions of profit left in Acom from this point are capital meaning that Owen and Jane can deduct any unused part of their capital gains tax (CGT) annual exemption (£12,000 for 2019/20) and pay tax on the balance at a maximum of 20%. Assuming Acom has £98,000 to distribute in total, Owen and Jane would each be liable to CGT on £49,000. If their CGT exemptions are available in full they would each have to pay tax of up to £7,400 (£49,000 - £12,000) x 20%) but it would be less if they were entitled to entrepreneurs’ relief (ER).

By comparison, if Acom distributed its profits before starting the winding up process, Owen and Jane would each be liable to income tax of at least £15,925 (£49,000 x 32.5%). By comparison the CGT bill is less than half that, but there’s still room for further tax saving.

Winding up costs

Usually, the tax advantage of capital distributions is only available when you appoint a liquidator to wind up your company. The trouble is a liquidator’s fees can be high and, depending on the value of your company, might significantly eat into or even outweigh the tax saving achieved.

Rather than paying a liquidator to wind up your company you could do it yourself informally by notifying Companies House of your intention. However, CGT treatment will only apply if the amounts available to distribute are no more than £25,000 - any more than that and the whole of any distribution is taxed as income.

Reduce the distributable amount

If your company’s net value is more than £25,000 you’ll need to reduce it before you can use the informal winding up tax break. That will require you to make distributions from your company on which you’ll have to pay income tax. Despite this you can still save on tax and costs. You’ll need to crunch the numbers to see if it’s worthwhile.

Example. Shaun is a higher rate taxpayer and the only shareholder of Bcom Ltd. It has distributable reserves of £35,000. Shaun could formally liquidate Bcom so that what he receives, after paying the liquidator’s fees of, say, £3,000, is liable to CGT. This would leave him with £28,000 after tax. If instead he paid a dividend of £10,000 and then applied to Companies House to dissolve the company, he would net £29,150. Not a massive tax saving but Shaun also avoids the time and red tape that goes with a formal liquidation.

Reduce the value of your company to £25,000 by making distributions to shareholders and informally winding up the company. This will save the cost of a liquidator’s fees. Plus, each shareholder can use their annual capital gains tax exemption to reduce the amount on which they pay tax on their share of the final £25,000 distributed from the company.

HMRC has issued its last-minute advice for employers about submitting their final PAYE reports for 2019/20 and preparing for 2020/21.

End of year.

As usual, this time of year is a busy one for employers. There are several routine but important actions you need to take plus one or two new ones for 2020/21.

PAYE reports.

When you run your last payroll for 2019/20 you must use the final submission indicator in the full payment submission (FPS) to notify HMRC or it will assume there’s more to come and bombard you with reminders. If your software won’t accept the final report indicator on an FPS, submit an employer payment summary (EPS) with the indicator ticked instead. If you simply forgot to use the indicator, send an EPS with the indicator ticked to show that you didn’t pay anyone in the final pay period and use the final submission indicator. The deadline for your final FPS or EPS for 2019/20 is 19 April. If you find a mistake in your 2019/20 figures, there are different ways to correct it depending on the software you use.

Updating codes for 2020/21.

HMRC has just completed the issue of P9 notice of coding email and paper notifications of new tax codes which you must apply for your employees. The codes have been calculated using 2019/20 rates and thresholds because those for 2020/21 will not be definite until any changes announced in the Budget are made. If this is the case, you’ll receive a P6b notice with detail of the new codes which you should implement on the next payroll run.

Other changes.

Changes to the employment allowance mean that entitlement will not be automatically carried forward to 2020/21 and you must include a claim through your payroll software. Don’t forget to download and install the updated payroll app from your software provider or HMRC’s “Basic PAYE Tools”. Finally, check that your employees’ pay is at least equal to the new national minimum/living wage rates which apply from 6 April.

Make sure the “final submission” indicator is used for your last payroll run for 2019/20 by 19 April, you claim the employment allowance for 2020/21 and your employees’ pay is at least equal to the new national minimum wage rates.

 

Over the last decade, the emergence of the sharing economy has meant that millions of people worldwide are now able to earn supplemental income from personal assets. Companies like Airbnb have expanded beyond short-term rentals; it is now possible to book local tours, classes, photoshoots, and other bespoke experiences. While this opens up a world of opportunities, any business should be structured properly to ensure tax efficiency.

Individual or company ownership?

If an individual is already earning via self-employment or PAYE, they may seek to incorporate a new business - particularly if they are in the higher-rate tax bracket - in order to take advantage of favourable corporation tax rates and tax-planning options. Although there are many more advantages to incorporation, there are some circumstances where an individual may prefer - or require - to retain ownership of a personal asset, rather than transferring ownership to a limited company.

Unless the individual has already built up funds in an existing company from a related venture, a newly-formed company will have limited capital, preventing it from purchasing the asset outright. The transfer can be achieved through crediting a director’s loan account to represent the amount due to the director. In the case of an existing company, if the director has borrowed money and has not yet repaid it, this can offset the balance owed. In either case, an individual must raise an invoice to their company listing all items; the sale price must be in keeping with the market value at the time of sale.

 

With a wide range of possibilities, careful consideration is crucial. This would be especially true for the transfer of specialised or classic/ antique equipment, where asset values may appreciate over time. If the asset was purchased many years ago and current market value has appreciated beyond the purchase price, the sale could give rise to a capital gains tax (CGT) liability for the individual. In this scenario, a director’s loan is unfavourable as the individual has incurred a tax bill but has received no financial compensation for the sale; a transfer of funds should be made, if possible.

Renting assets to the company

An entirely legal alternative would be for the individual to rent their personal asset to their limited company for business use. To ensure the arrangement is legitimate, the individual should draw up a formal lease agreement with the company, treating the agreement as if they were leasing to another party. The agreement should detail the monthly cost of the lease, due dates for payment(s), the term of the lease, any requirements relating to insurance, and arrangements in the event of a missed payment. The rental fee must be reasonable and in line with rental rates for similar assets locally.

The individual would then declare the lease/ rental income via a self-assessment tax return. While retaining the ability to use the asset for personal use may be required, if it is instead used solely for business purposes this can reduce one’s overall tax liability by allowing the individual taxpayer to deduct several expense types from their rental profits. This could include insurance, interest, repairs/maintenance and/or general administrative costs, amongst others.

You may rent many asset types to your limited company; office space, machinery, equipment, vehicles, computers, property, etc. Certain assets may require special treatment, so you should always consult with a professional to ensure your arrangements are legitimate.

 

Rollover relief is a relief available for capital gains made on business assets sold by traders such as sole traders or partnerships and includes those in furnished holiday letting businesses. This article focuses on unincorporated businesses, but the relief is also available to companies. The relief can also be used for sales by individuals if the business asset is being used in a company in which they have at least 5% of the voting shares. If an individual has more than one trade (e.g. if they have two sole trader businesses) they can rollover a gain on one trade to a purchase of an asset in their other trade.

What does rollover relief do?

Rollover relief, sometimes called ‘replacement of business assets’ relief, is a form of deferral for capital gains tax (CGT) purposes. Rather than a trader having to pay CGT on a gain on the sale of a business asset immediately, if the original asset is replaced with another business asset to be used in the trade, it is possible for the gain to be deferred until such time as that replacement asset is sold.

Unlike gift relief, rollover relief does not change the identity of the taxpayer of the gain, but it does change the timing of the payment, which moves from the date of the sale of the original asset to the date of the sale of the replacement asset. The replacement needs to be acquired within one year before and three years after the sale of the original asset, although with the approval from HMRC this window could be extended.

Why is it required?

When a business is trading, it will need to upgrade or replace assets occasionally. It is not convenient or conducive to efficient business practice for the trader to incur a CGT charge every time they sell and replace their business property.

Rollover relief allows the trader to put the CGT liability out of mind until they sell an asset that they are not immediately replacing.

What qualifies?

Not all assets qualify for rollover relief. The detail is in the legislation, but the most common qualifying assets are land and buildings, aircraft, goodwill, and fixed plant and machinery.

If the trader were a farmer, for instance, they could claim rollover relief on a new milking parlour but not on a new combine harvester, which would be movable machinery. More unusual qualifying assets include space stations, satellites, and hovercrafts!

The replacement asset does not need to be the same type of asset as the original asset, so a building could be replaced with an aircraft and still be eligible.

Entrepreneurs relief

It may not be in the trader’s best interests to roll over the gain.

For example, if the current gain would be eligible for entrepreneurs’ relief, but any future gain would not be, it may be better to pay the gain at the time of the sale of the original asset.

Rollover relief requires a claim, so does not happen automatically. The claim must be made within four years of the end of the tax year in which either the gain arises on the original asset, or the replacement asset is purchased, whichever is later. Provisional claims are available to defer the gain even if the new assets have not yet been purchased at the time the CGT would be normally due.

 

In the current tax year, for the first time, the cost to the UK government of state pensions is set to surpass £100 billion, according to the Office for Budget Responsibility. This figure does not take into account other benefits state pensioners can claim, and is set to rise each year.

 

There will come a point where the state pension scheme is unsustainable, as some countries across the world have already found.

The rising cost of UK pensions is caused partly by improved healthcare, which helps us all to live longer. The government has tried to redress it to some extent by increasing the age state pensions can be claimed, but this has not dropped the annual figure, which is now 14% of GDP.

Voluntary pensions

In the UK, the employer must have a pension scheme in place, but it does not have to be used. Employees can opt not to contribute to the scheme, and if that is the case the employer does not have to contribute either.

Self-employed workers also have the choice whether to contribute to a pension or not.

The need for a pension other than from the state

Most people have ideas about how they would like to live when they retire, but very few think about how they will finance the lifestyle they desire until it is too late. For those that wait until their forties to start thinking about a pension, the contributions needed to give them a reasonable pension can be too high.

For people in their twenties, retirement seems a very long way off, but that is the best time to get something in place. A delay of just ten years in starting a scheme can make a big difference to the pension pot when they reach retirement. This is because for those ten years all their contributions will be making money and will continue to do so for the length the scheme has to run.

Of course, there are some jobs that have pensions attached, such as the armed forces and many roles within large organisations. Unless someone is lucky enough to have a pension included, they really need to think about saving for their future now.

A tax-efficient way of saving

Pensions are the most tax-efficient way of saving as tax relief is given on the contributions. This relief is given at the highest rate of tax being due as long as the contributions are not more than the annual salary or do not exceed the annual allowance, which is currently £40,000.

All other forms of savings or investments are taxed for most people, and for those that do not have any other income, they can claim their returns on investments tax-free. A pension goes one step further and basically amounts to a contribution from the government towards your retirement pot.

Prepare for the worst?

The government needs to do whatever it can to reduce the burden of state pensions and whether someone is employed or a business owner, they can’t rely on the government to provide for their old age. Our current trajectory makes it likely the government will go the way of other countries, and state pensions will be stopped.

 

If a business provides a canteen for staff, VAT is due on what the business actually charges for the meals, etc. If a business charges the market rate, VAT would be due in the normal way.

 

However, if a business provides subsidised or free meals to staff, VAT is still only due on the actual monies received. This means that no VAT is due on catering supplied free to staff and is only due on what the staff actually pay for a subsidised meal. Even if catering is provided free to staff, any associated input tax is fully recoverable (assuming the employer is not partially exempt) as a legitimate business expense.

 

Employee contributions

 

Where employees pay for meals and so on under a salary sacrifice arrangement, following the judgment of the CJEU in Astra Zeneca (Case C-40/09), employers must account for VAT on the value of the supplies unless they are zero-rated. Subject to the normal rules, the employer can continue to recover the input VAT incurred on related purchases.

However, in RW Goodfellow and M] Goodfellow (MAN/85/0020), the tribunal held that deductions made from an emp1oyee’s wages to take account of catering and accommodation paid in accordance with the Wages Order in force for the industry could not be regarded as monetary consideration and no VAT was due.

 

Businesses should be careful to distinguish between a contract of employment, such as in the above tribunal case where no VAT was due, and any agreement between employer and employee whereby a deduction from salary or wage is specifically related to a supply of catering, in which case VAT is due.

 

Where deductions are made other than under a contract of employment, the value of the supply is the amount deducted. HMRC argues that deductions made from an emp1oyee’s wages to take account of catering and accommodation amount to monetary consideration, and that the amount of the deduction was, therefore, liable to VAT.

 

Vending machines

 

In other commercial situations, employers may provide free or subsidised meals or catering in another form, such as drinks or food from a vending machine.

If a business installs vending machines for its employees to use free of charge and it gives them tokens to operate the machine or it is operated Without tokens or coins, no VAT is due on the supplies from the machine. If a business gives its employees money, or they have to pay for tokens to operate the machines, the supplies are standard rated, and the business must account for VAT on them.

 

Restaurants and hotels

 

If the proprietor of a restaurant, café or other catering establishment supply themselves or their family with meals, this is not regarded as catering and they need not account for VAT on those meals.

 

However, they must account for tax on the full cost to the business of any standard rated items (e.g. ice cream, sweets and chocolates, crisps, soft or alcoholic drinks) that they take out of their business stock for their own or their family’s use.

 

If an employer provides staff with free meals or accommodation in the establishment (e.g. a night manager) no VAT is due.

 

If a business provides its staff with meals or accommodation it only has to account for VAT on the amount paid, so if they are supplied free no VAT is due. Any input tax incurred in providing free or subsidised meals can be recovered as a legitimate business expense.

 

A business generally comprises various assets, one of which is often goodwill. However, a new business will not normally have goodwill; the goodwill of a business is broadly the advantage of the reputation and connection with customers that the business possesses. A new business will not usually have a ‘name’ or reputation as such. Goodwill is not necessarily reflected in the accounts of a business, even if goodwill exists. The business may have built up its goodwill from scratch over time. HM Revenue and Customs (HMRC) confirms: ‘The fact that goodwill may not be reflected in the balance sheet of a business does not mean that it does not exist’. However, in some cases HMRC may contend that there is little or no goodwill in the business.

 

For example, if the goodwill is attributable to the personal skills of the proprietor (e.g. a chef or mobile hairdresser), HMRC’s view is that such ‘personal’ goodwill is not transferable on a sale of the business. Thus if a business with personal goodwill is sold to a company upon incorporation of the business (with the proceeds being left outstanding as a loan owed to the proprietor, which is repaid by the company as funds allow), there is a danger that the value of the goodwill transferred will be lower than anticipated because of the personal goodwill element, which HMRC considers cannot be transferred to the company.

 

There may be circumstances where HMRC argues there is no goodwill in the business whatsoever. This might happen if an asset such as land or buildings generates one or more income streams; HMRC could contend that the income streams do not represent goodwill. For example, in The Leeds Cricket Company Football Sr Athletic Company Limited v Revenue and Customs [2019] UKFTT 559 (TC), the appellant (‘the company’) contracted with Yorkshire County Cricket Club for the sale and purchase of freehold property at Headingley cricket stadium. Prior to the sale, the company carried on a cricket business comprising hospitality (i.e. finding clients and organising/attending meetings), advertising (i.e. selling advertising packages for boards at the ground), and catering (i.e. 19 full-time staff were employed to provide meals and refreshments to stadium visitors on cricket days).

 

The issue was whether the sale involved: (a) a disposal of a business with attached goodwill; or (b) only a disposal of land with attached income streams. The First-tier Tribunal found that distinguishing between certain goodwill types (i.e. inherent (or ‘site’) goodwill and adherent (or ‘free’) goodwill) was an ‘artificial exercise’. The tribunal concluded that the cricket business (with attached goodwill) was transferred together with the property. The transfer was not merely a transfer of land with attached income streams. The appellant’s appeal was allowed.

For a helpful summary of points to consider when seeking to establish whether goodwill exists, see Balloon Promotions and Others v Wilson (Inspector of Taxes) and another [2006] SpC 524, at paras 159-169. Even if goodwill contains a personal (non-transferable) element, there may also be elements of non-personal goodwill.

Specialist advice should be sought, if appropriate.

 

ER conditions

While the conditions for capital gains tax (CGT) entrepreneurs’ relief (ER) were made tougher in April 2019, there was also good news for shareholders of companies who raise more capital by issuing more shares. Prior to the new rules the issue of new shares could result in an existing shareholder losing their entitlement to ER.

Example. Acom Ltd, a family company, has ten shareholders who own between 5% and 15% of the company’s shares. John owns 5% and has proportionate voting rights on company matters. Acom needs more working capital and intends to offer new shares to existing shareholders. John can’t afford to buy new shares. But if he doesn’t his stake in Acom will be diluted to less than 5% and he’ll lose his right to ER.

Individuals whose shareholding is diluted on or after 6 April 2019 to below the 5% qualifying threshold as a result of a new share issue can make an election to preserve their right to ER, but only for the period up to the date on which the new shares were issued. ER doesn’t apply to capital gains made after that date unless the individual acquires more shares so they again meet the 5% condition. If you make the election you might trigger a CGT bill.

Deemed sale

One of the terms of the election is that the shareholder is treated for CGT purposes as if they sold their shares. The amount they are deemed to receive for them is a proportion of the value of the whole company. For example, if Acom was worth £1 million, the value of John’s 5% stake would be £50,000. If the cost of John’s shares was, say, £5,000, he is deemed to have made a capital gain of £45,000 but because ER applies he’ll only pay tax at 10% of the gain after deducting any exemptions or reliefs he’s entitled to.

Timing

The time limit for making an election is twelve months from the 31 January that follows the tax year in which the new shares were issued. So if the shares were issued on 1 May 2019 the election must be made by 31 January 2022. Once the election has been made it is irrevocable.

Avoiding the CGT bill

Paying CGT, even at the ER rate of 10%, might not seem like an especially great deal as it means you’ll have to find the cash to pay the tax despite not actually having sold anything. However, a different election can be made to defer the gain from being taxed until you actually sell or transfer your shares. The time limit for this election is four years from the end of the tax year in which the new shares were issued, e.g. for shares issued in 2019/20 you have until 5 April 2024.

Under rules which took effect on 6 April 2019 you will lose ER if your shareholding falls to less than 5% of the company’s total share issue because of a new share issue. The good news is that by making two elections you can preserve your entitlement to ER and defer the tax bill that results until you sell your shares.

 

There are circumstances where using the cash basis of accounting can reduce your profits and create a permanent tax saving. These include where calculating your profits using the normal basis of accounting means:

 • you’re liable to the high income child benefit charge (HICBC)

 • some of your income falls into a higher tax bracket; or

 • your taxable income exceeds £100,000.

Example

 

John is self-employed. His accounts (prepared on the normal accruals basis) for the year ended 31 March 2019 show a profit of £61,000.

 

If the cash basis of accounting were used his profit would be £52,000. John’s spouse receives child benefit for two children for 2018/19 of £1,789.

 

Because his profit for that year is greater than £50,000 John is liable to the HICBC. The maximum charge would apply because his income exceeded £60,000, i.e. the charge would be £1,789. However, using the cash basis of accounting would reduce John’s profits and therefore the HICBC to £358 saving him £1,431.

 

You can apply in writing or by using HMRC’S online service to reduce the amounts of income tax payable on account of your self-assessment tax liability.

If applying in writing, send details of:

 • how much you want to reduce the payments to; and

 • the reason why you think your tax liability will be less than the existing payments on account. For example, the income on which you pay tax through self-assessment, say dividends, is lower than for the previous year or you’re entitled to more tax deductions say, for additional pension contributions.

You should address your application to the HMRC office shown on your most recent tax statement of account.

Alternatively, you can complete an application online, print and send it to HMRC. To start your application, go to:

https://public-online.hmrc.gov.uk/lc/content/xfaforms/profiles/forms.html?contentRoot=repository:///Applications/SA_iForms/1.0/SA303&template=SA303.xdp

 

To use the online service, sign in to your HMRC account, choose the self-assessment service and on the following screen click “Claim to reduce payments on account” (which is usually near the bottom of the page). Follow the on-screen instructions from there.