Inheritance tax – making tax-free gifts
There are various exemptions, and potential exemptions, which make it possible to make gifts free of inheritance tax. Making tax-free gifts is a useful way to reduce the value of your estate – and ultimately the inheritance tax that may be payable on gifts.
What counts as a gift? - For inheritance tax purposes, a gift is anything that has value, for example, money, property or possessions. A gift may also arise if the value of your estate is reduced following a transfer, for example, if you sell your house to your children for less than it is worth; the discount element is regarded as a gift.
Gifts to spouses - Gifts to spouses and civil partners are free of inheritance tax.
Gifts out of income - The inheritance tax exemption for ‘normal expenditure out of income’ is very useful and can be used to make tax-free lifetime gifts. For the exemption to apply, the gift must meet three conditions:
An easy way to use this exemption, for example, would be to set up a standing order for a regular amount, say £X per month, to your children or grandchildren, or to meet the cost of school fees or similar.
Gifts made in this way are completely exempt – you do not need to survive seven years to keep the gifts tax-free.
Annual gifts exemption - There is an annual gifts exemption for inheritance tax which allows you to give away £3,000 of gifts in total IHT-free in each tax year. If the exemption is not used in full in one tax year, the unused amount can be carried forward to the following year, after which it is lost if it is not used.
Wedding gifts - Tax-free gifts can also be made, up to certain limits, on the occasion of a marriage or civil partnership. The tax-free limit for wedding gifts is £5,000 where the gift is to a child of yours, £2,500 where it is to a grandchild and £1,000 where the gift is to someone else.
Small gifts - It is also possible to give gifts of up to £250 per year IHT-free to as many people as you like, as long as the recipient has not benefited from another exemption.
Other tax-free gifts - Gifts to help another person with their living costs, such as an elderly relative or a child under the age of 18 can be made free of inheritance tax, as can certain gifts to charities and political parties, housing associations, gifts for national purpose and for the public benefit.
Potentially exempt transfers - You can also give as much as you like away IHT-free – as long you survive seven years. However, there are anti-avoidance rules where you have previously owned an asset or where you continue to retain the benefit of it after you have given it away (for example, if you give your house to your children and continue to live in it rent-free), and care must be taken not to fall foul of these.
If you survive less than three years after making the gift, IHT is payable in full at the usual 40% rate. However, if you survive more than three years but less than seven years from the date of the gift, taper relief reduces the amount of IHT payable. If you survive at least seven years from the date of the gits, it drops out of account and is IHT-free.
Inheritance Tax and potentially exempt transfers
It is possible to make gifts during your lifetime free of Inheritance Tax (IHT), as long as you live for more than seven years after making the gift. Most lifetime transfers are ‘potentially exempt transfers’ (PETs). They have the potential to be free of IHT as long as the donor survives seven years after making the gift. It is assumed at the time that the gift is made, that it will remain exempt; consequently, no IHT is payable at the time that the gift is made.
However, should the donor die within the seven-year period, the PET becomes a chargeable transfer at the date of the gift. This may mean some reworking if the donor has also made chargeable transfers after making the PET.
Example - Alfred gives each of his three daughters a cheque for £10,000. As a result of the gifts, the value of his estate is reduced by £30,000. The gifts are PETs at the time that they are made.
Donor dies within seven years - In the event that the donor dies within seven years of the date of the gift, the PET becomes a chargeable transfer at the time that the gift is made, and is taken into account working out the IHT, if any, due on the estate. The transfer forms part of the cumulative estate and must be cumulated with the death estate and any subsequent lifetime transfers. The death of the donor may trigger an IHT charge on the PET as it is also cumulated with previous transfers.
14-year window - Although the donor only needs to survive seven years for the PET to remain exempt, should he die within this period, it is also necessary to look at transfers in the seven years before the PET to see whether the failed PET was covered by the nil rate band at the time it was made. Hence, it may be necessary to consider a transfer window of up to seven years.
Taper relief - Taper relief reduces the amount of IHT payable on the gift – not the value of the gift. The amount of IHT payable depends on the period of time that has elapsed between the gift and the donor’s death.
Period between chargeable gift and donor’s death IHT payable
Up to 3 years 100%
More than 3 years and up to 4 years 80%
More than 4 years and up to 5 years 60%
More than 5 years and up to 6 years 40%
More than 6 years and up to 7 years 20%
Annual exemption - There is a £3,000 annual exemption for gifts.
Example - Julie gave £200,000 to her daughter Alice on 22 May 2012 on her 21st birthday and a further £200,000 to her son Henry on 3 February 2014 on his 21st birthday. Julie died on 16 April 2018, leaving her estate, valued at £500,000, to her husband Robert.
The transfer of value to her husband is an exempt transfer. However, as she died within seven years of making the gifts to her children, they become chargeable transfers.
The gift to Alice uses up the first £197,000 of her nil rate band of £325,000 (£200,000 gift less annual exemption of £3,000). The remainder of the nil rate band is available to set against the gift to her son (a chargeable transfer of £197,000 (£200,000 less annual exemption of £3,000)).
As only £128,000 of the chargeable transfer to her son is covered by the nil rate band, the remaining £69,000 is chargeable to inheritance tax. However, as the gift was made more than 4 years but less than 5 years before Julie’s death, taper relief applies. The IHT payable is therefore 60% (£69,000 @ 40%) = £16,560.
Free fuel – is it worthwhile?
Where an employer meets the cost of fuel for private journeys in a company car, an additional benefit in kind charge arises in respect of the provision of the `free’ fuel (unless the employee makes good all the cost).
Working out the fuel benefit charge
The fuel benefit charge is found by multiplying the appropriate percentage (based on the level of the car’s CO2 emissions) used in working out the company car benefit charge, including the diesel supplement where appropriate, by the multiplier for the tax year in question.
For 2018/19, the multiplier is £23,400.
Tax cost of free fuel
For 2018/19, the appropriate percentage ranges from 13% for cars with CO2 emissions of 0 –50g/km to 37%. Consequently, the cash equivalent of the fuel benefit ranges from £3,042 (£23,400 @ 13%) to £8,658 (£23,400 @ 37%).
For a basic rate taxpayer, the tax cost of free fuel ranges from £608.40 (20% of £3,042) to £1,731.60 (20% of £8,658); for a higher rate taxpayer, the tax cost ranges from £1,216.80 (40% of £3,042) to £3,463.20 (40% of £8,658).
Is it worthwhile?
Free fuel is expensive. If it is paid in relation to a company car with a list price of less than £23,400, for 2018/19, more tax will be payable on the provision of `free’ fuel than on the provision of the car.
Whether the provision of fuel constitutes a perk will depend on how much private mileage the employee undertakes in the tax year, the cost of fuel, the appropriate percentage for the car and the rate at which the employee pays tax. In many cases, unless the appropriate percentage is low and private mileage is high, free fuel will not be much of a perk.
An employee has a company car with CO2 emissions of 145g/km. For 2018/19 the appropriate percentage is 30%. If fuel is provided for private motoring, the associated fuel benefit is £7,020, which if the employee is a higher rate taxpayer will cost him £2,808 in tax.
Assuming that petrol costs £127p per litre and the driver achieves 6 miles per litre, the driver would have to drive 13,266 private miles in the tax year to break even. This is the level at which the cost of fuel (13,266/6 x 127p) is the same as the tax on the fuel benefit.
If private mileage is less than 13,266 miles per year, it would be cheaper for the employee to give up free fuel and pay for the petrol himself. If the private mileage is higher, the free fuel will be a perk as the tax paid on the benefit will be less than the cost of the fuel.
It is advisable to do the sums to see if free fuel is actually worthwhile.
If a cash alternative is available, this may be preferable, particularly if private mileage is low. However, be aware that the alternative valuation rules may bite if a cash alternative if offered.
Claim a deduction for pre-trading expenses
As a general rule, a deduction is allowed for expenses that are incurred wholly and exclusively for the purpose of the trade. Thus, for the deduction to be available, the business must have started trading. However, most businesses will incur expenses in setting up the business. These may include rents and other premises costs, marketing and advertising costs, the purchase of office supplies and stationery, and such like. These costs will be incurred before the business starts to trade rather than when the business is trading; they are incurred to put the business in position to trade, rather than for the purposes of the trade.
Luckily, help is at hand and the tax legislation specifically allows relief for pre-trading expenses, as long as certain conditions are met. Relief is available for both income tax and corporation tax purposes, providing a deduction regardless of whether the trader operates as a sole trader or via a limited company.
The relief is available for:
Applying the ‘wholly and exclusively’ rule
The ‘wholly and exclusively’ rule applies equally to determine whether expenses which are incurred prior to the commencement of trade are deductible under the pre-trading expenses rule, as it does to determine the deductibility of expenses incurred while trading. Only those pre-trading expenses which are incurred wholly and exclusively for the purposes of the trade can be deducted under the pre-trading expenses rules.
How is relief given?
Relief is given by treating the qualifying expenses incurred in the seven years prior to the commencement of the trade as if they were incurred on the first day of trading. Consequently, they are deductible in computing the profits of the first accounting period.
The purchase of trading stock is not deductible as a pre-trading expense; it is deductible in computing profits once the trade as commenced.
Capital v revenue
Where the accruals basis is used, relief is only given for pre-trading expenses if they are revenue in nature, as is the case where the expenses are incurred once the trade as commenced. If the trader has opted to use the cash basis, capital expenses may also be deducted where these would be deductible under the cash basis rules.
Dave starts trading as sports therapist on 1 November 2018. He spends six months setting up the business, acquiring premises and preparing to trade. He incurs £2,000 on rent, and £800 on marketing the business. The expenses are treated as incurred on 1 November 2018 and are deducted in computing the profits of his first accounting period.
Are your workers employees?
Employee status continues to be in the spotlight. The Government are consulting on proposals to address non-compliance with the off-payroll working rules in the private sector. Earlier in the year they consulted on employment status, including the possibility of introducing a statutory employment status test.
It is important that the status of workers is correctly assessed as this will affect the tax and National Insurance that the worker pays, and consequently the state benefits to which they may be entitled, and also the extent to which they are able to benefit from employment rights. It will also determine whether the engager must operate PAYE and pay employer’s National Insurance contributions.
Current approach - While change is likely, under the current rules there is no single test that determines whether a worker is an employee or is self-employed. Rather it is a case of looking at the characteristics of the engagement and standing back and seeing whether the picture that emerges is one of employment or self-employment.
Employee v self-employed - An employee works under a contract of service whereas a self-employed person enters into a contract for service.
The following summarises some of the key indicators of employment and self-employment.
The employer is obliged to provide work and the worker is obliged to do it.
The worker must work regularly unless on leave.
The worker is required to work a minimum number of hours at set times.
The worker must do the job personally.
The worker is supervised and told what work to do.
The worker is entitled to paid holiday.
The worker is entitled to join the workplace pension scheme.
The worker receives employment-type benefits.
The worker is given the tools and equipment needed to do the job.
The employer deducts PAYE and NI contributions from the employee’s pay.
The worker is `part and parcel’ of the organisation.
The worker is included in company social events, such as the staff Christmas party.
The worker is in business on their own account.
The worker bears the financial risk.
The worker is generally paid a price for the job, regardless of how long it takes.
The worker does not have to do the work personally and can send a substitute.
The worker can decide when and how to do the job.
The worker does not get paid while on holiday.
The worker decides what jobs to take on.
The worker is responsible for correcting unsatisfactory work and bears the cost of this.
The worker provides the tools and equipment needed to do the job.
Marginal cases - It will often be clear cut as to whether a worker is employed or self-employed and the characteristics of the engagement will fall securely into one camp or the other. However, this will not always be the case; in marginal cases, the worker may exhibit characteristics of each. In such case, HMRC produce a ‘Check Employment Status Tool’ (CEST), which can be used to help reach a decision.
Cash basis for landlords – when does it apply?
The cash basis simply takes account of money in and money out – there is no need to worry about debtors and creditors and prepayments and accruals. Income is recognised when received and expenditure is recognised when paid. Since 6 April 2017, the cash basis has been the default basis for eligible landlords.
An eligible landlord is one in respect of whom none of the tests A to E below is met.
Test A is met if the business is carried on at any time in the tax year by:
• a company;
• a limited liability partnership;
• a corporate firm;
• the trustees of a trust; or
• the personal representatives of a person.
A partnership is treated as a ‘corporate firm’ (and thus not eligible for the cash basis) if a partner in the firm is not an individual.
Test B is met if the cash basis receipts for the year exceed £150,000.
The cash basis receipts are those that are taken into account in working out the profits of the property business on a cash basis.
Where individuals who are married or in a civil partnership and who live together own property jointly, for income tax purposes, the income is split equally between them. Where a landlord receives a share of income from a jointly owned property and that income is being treated as arising to the joint owners in equal shares (for example where the property is owned with a spouse or civil partner) and the other joint owner uses the accruals basis to calculate their profits, the landlord must also use the accruals basis to calculate his or her profits.
Consequently, if one party is not eligible for the cash basis, the cash basis is not available to the other party in respect of the property business receiving a share of the joint income.
Test D is met if a Business Premises Renovation Allowance is made in calculating the profits of the business property business and a balancing event in the year would give rise to a balancing adjustment. Where this is the case, profits must be computed using the accruals basis.
Test E is only relevant where none of A, B, C or D is met.
Test E is that the landlord has opted out of the cash basis by electing for the accruals basis to apply.
Cash basis by default
The cash basis for unincorporated landlords will apply if none of the Tests A to D above are met and the landlord has not made an election for the accruals basis (Test E) to apply.
Give away £3,000 IHT-free each year
There are various exemptions for inheritance tax purposes which enable a person to make tax-free gifts. One of the more useful is the annual exemption.
Nature of the exemption - The annual exemption is set at £3,000. The exemption allows an individual to make gifts of up to £3,000 each tax year without them being included in the transferor’s estates.
Gifts covered by the exemption do not count as potentially exempt transfers (PETs) – there is no requirement for the transferor to live a further seven years. Gifts covered by the annual exemption are exempt, even if the transferor dies the next day.
The annual exemption applies to:
• lifetime transfers by individuals
• the lifetime termination of an interest in possession in settled property
• transfers by close companies
Gifts totalling less than £3,000 - If an individual makes gifts in a year which do not exceed the amount of the annual exemption, the gift is tax-free. To the extent that the exemption has not been fully utilised, the excess can be carried forward – but only for one tax year.
Example - In 2017/18, Florence sold some shares and made a cash gift of £1,000 to each of her two granddaughters.
The gifts are covered in full by her annual exemption, using up £2,000 of the exemption. The balance of £1,000 is carried forward to 2018/19.
In 2018/19 Florence makes a further gift of £2,000 each to her granddaughters. Although the gifts total £4,000 in 2018/19, they are exempt in full, being covered by the annual exemption for 2018/19 of £3,000 and the unused exemption of £1,000 from 2017/18 which has been carried forward to 2018/19.
Gifts exceeding the annual exemption - If the value of the gifts in the tax year exceeds the available annual exemption (£3,000 plus any unused exemption brought forward from the previous tax year) and other exemptions are not available, the gifts are exempt up to the value of the available exemption. If the balance is a gift by an individual, it will be a PET; otherwise it may be an immediately chargeable lifetime transfer.
Example - Harry makes a gift from capital of £10,000 in 2018/19 to his son Paul. It is the only gift he makes in the tax year. In 2017/18 he used his annual exemption in full.
The first £3,000 of the gift is covered by the annual exemption. The remaining £7,000 is a PET.
Multiple gifts - Where a transferor makes multiple gifts in a tax year, the annual exemption is applied to the gifts in the order in which they are made.
Example - In May 2018, Barbara gives £2,000 to her daughter Julie; in October 2018, she gives £2,000 to her daughter Jane and in December 2018 she gives £2,000 to her son James.
In 2017/18, she fully utilised her annual exemption.
The gift to Julie is fully exempt, falling entirely within the annual exemption.
The first £1,000 of the gift to Jane is exempt, utilising the remaining £1,000 of the annual exemption. The remaining £1,000 is a PET. The gift to James is a PET.
Tip - Consider the timing of gifts and whether other exemptions, such as that for small gifts, may be available.
Tax code changes for 2018/19
Tax codes are the lynchpin of the PAYE system – unless the tax code is correct, the PAYE system will not deduct the right amount of tax from an employee’s pay.
The tax code determines how much pay an employee may receive before they pay any tax. The most straightforward scenario is that the person receives the personal allowance for that year. The code is then the personal allowance for the year with the last digit omitted and an `L’ suffix. So, for 2017/18, the personal allowance is £11,500 and the associated tax code is 1150L. This is also the emergency tax code.
Other codes - Employees’ situations vary and consequently different codes are needed to accommodate that. If an employee has more than one job, his or her allowances may be used up in job 1, leaving all the pay for job 2 to taxed. The 0T code – no allowances – accommodates this. A person may also have an 0T code if their personal allowance has been fully abated (at £123,000 for 2017/18 and £123,700 for 2018/19). An employee may have all his or her pay taxed at the basic rate, for which the relevant code is BR, or at the higher rate (code D0), or the additional rate (code D1). Code NT indicates that no tax is to be deducted.
Scottish taxpayers have an S prefix, indicating the Scottish rates of tax should be used.
Marriage allowance - Where one partner in a marriage or civil partnership is unable to use their personal allowance, they can transfer 10% of their personal allowance to their spouse or civil partner, as long as the recipient is not a higher or additional rate taxpayer. The person surrendering 10% of their allowance has a code with a `N’ suffix, whereas the recipient has an `M’ suffix’.
Adjustments - Tax underpayments or the tax due on benefits in kind may be collected through the PAYE system. The tax code is based on the net amount of the allowances less deductions. So, for example, if in 2017/18 a person had a personal allowance of £11,850 and a company car with a cash equivalent of £5,000, the net allowance due is £6,500 and the associated tax code would be 650L.
Where deductions exceed allowances, a person has a K prefix code – in this scenario, they do not have any free pay and are treated as if they have received additional taxable pay.
2018/19 updating - Tax codes need to be updated each year to reflect changes in allowances. The personal allowance is increased to £11,850. Where the employer does not receive a form P9(T) or an electronic notice of coding for an employee, the following changes should be made to update an employee’s tax code for the 2018/19 tax year:
Any week one or month one markings should not be carried forward.
Codes BR, SBR, D0, SD0, D1, SD1 and NT can be carried forward to 2018/19.
The emergency code for 2018/19 is 1185L.
If a new code has been notified on form P9(T) or electronically, that should be used instead.
The updated codes should be used from 6 April 2018 onwards.
Rent-a-room: New restrictions
Rent-a-room relief offers the opportunity to enjoy rental income of up to £7,500 tax-free from letting out a room in your own home. It does not matter whether you own or rent your home; what is important is that the let is of furnished accommodation in your own home.
How the relief works
The relief is automatic where the rental income is less than the threshold. If you are the only person receiving income from the let, the threshold is £7,500; where one or more other people receive income, the threshold is halved so each person can receive up to £3,750 tax-free (this is the case regardless of how many people receive income from the let).
Rental income more than the threshold
If the rental income exceeds the threshold, you can opt into the scheme and pay tax on the excess.
Not always the best option
Claiming rent-a-room relief will not always be the best option. For example, if rental income is more than the threshold, and expenses are also more than the threshold, computing rental profit in the normal way will give a lower taxable amount.
It will also be beneficial to opt out of rent-a-room if you make a loss, otherwise the benefit of the loss is lost and cannot be carried forward for offset against future rental profits.
Rent-a-room relief was introduced to boost the supply of low-cost residential accommodation. In light of concerns that it was providing an unintended benefit to those offering short-term lets through sites such as Airbnb, the relief is to be amended.
To ensure that the relief is used as originally intended, i.e. to encourage the availability of rooms for lodgers, a new shared occupancy test will apply from 6 April 2019.
Shared occupancy test
Under the shared occupancy test, the individual in receipt of the income (or a member of their household) must have a ‘shared occupancy’ for all or part of the period of the let. The draft legislation requires that the physical use of the accommodation by the tenant must overlap with the use of the residence as sleeping accommodation by the landlord or a member of his or her household. It should be noted that another tenant does not count as a member of the household for the purposes of satisfying the test.
The legislation does not, however, specify a minimum period of overlap – there is no requirement for the landlord to be present for the whole let and, indeed, under the legislation as drafted, a period of overlap of only one night would be sufficient to ensure this test is met.
In 2019, the Jones family let out their house for the Wimbledon fortnight and holiday in Tuscany for the entire period of the let. Their neighbours, the Smiths, let out three rooms for the Wimbledon fortnight, but remain at home for the first three days before joining the Jones’ in Tuscany. The Smiths meet the new shared occupancy test, but the Jones family do not.
Private lettings relief
Lettings relief potentially shelters some of the gain from capital gains tax on the disposal of a property which has been an only or main residence at some point during the period of ownership and which has also been let out.
Where a residence has been occupied as an only or main home, private residence relief exempts from capital gains tax not only the period for which the property was so occupied, but also the last 18 months of ownership. Where the property is let, to the extent that the letting falls outside the last 18 months of ownership, private residence relief is not available for that period. However, lettings relief may be.
Availability of lettings relief
Lettings relief is available where a gain arises on the disposal of a property which:
• at some time has been the individual’s only or main residence;
• during the period of ownership, all or part of the property has been let as residential accommodation; and
• a chargeable gain arises as a result of the letting.
Amount of the relief
The amount of the relief is the lowest of the following three amounts:
1. the amount of private residence relief;
2. £40,000; and
3. the amount of the chargeable gain arising as a result of the letting.
Rose buys a cottage on 1 January 2012 for £200,000 and lives in it as her only or main residence until 30 June 2015. She then moves in with her boyfriend and lets the cottage out. The cottage is sold for £350,000 on 30 June 2018.
The gain on the sale of the property is £150,000.
The property is owned for 6 years and 6 months (78 months).
She lived in it as her main residence for 3 years and 6 months (42 months).
Private residence relief is available for the period in which she occupied the property as her main residence and the final 18 months – a total of 60 months (42 months + 18 months).
The gain eligible for private residence relief is 60/78 x £150,000 = £115,385.
The gain attributable to the let period is the remainder of the gain, i.e. £34,615 (£150,000 - £115,385).
Lettings relief is the lower of:
1. £115,385 (gain eligible for private residence relief);
2. £40,000; and
3. £34,615 (gain attributable to the letting).
As a result of the lettings relief, the full gain is exempt from tax; £115,385 being sheltered by private residence relief and the remaining £34,615 being sheltered by lettings relief.
Living in a let property as a main residence for a period of time can be very beneficial. Not only does it shelter any gain for the period for which it was occupied as such, it also shelters the gain for the last 18 months and brings lettings relief to the table.
Subsistence expenses – using the benchmark scale rate
The option to pay employees flat rate subsistence expenses tax-free can be an attractive one; the employees are clear on what expenses will be paid, and the employer is saved the work involved in reimbursing the actual amounts incurred.
The rates - HMRC set benchmark scale rates which can be used to make subsistence payments to employees. The rates are as follows:
Minimum journey time Maximum amount of meal allowance
5 hours £5
10 hours £10
15 hours (and ongoing at 8pm) £25
For these purposes, a meal is taken to be the combination of food and drink. Where the £5 or £10 rate applies and the qualifying journey in respect of which it is paid lasts beyond 8pm, a supplementary rate of £10 can be paid tax-free to cover the additional expenses necessarily incurred by working late.
The rates are the maximum that can be paid tax-free; the employer can pay below these rates if they choose to do so. If a higher amount is paid without first agreeing that it is appropriate with HMRC, the excess over the above rates is liable to tax and National Insurance contributions. However, employers can negotiate a higher rate with HMRC where they can demonstrate that actual expenditure is more than the benchmark rates.
Conditions - The benchmark rates can only be used to make tax-free subsistence payments where the qualifying conditions are met. These are that:
• the travel is in the performance of the employee’s duties or to a temporary place of work on a journey that is not substantially ordinary commuting (i.e. the normal journey between home and work);
• the employee is absent from his normal workplace or home for a continuous period in excess of five hours or ten hours, as appropriate;
• the employee has incurred costs on a meal (food and drink) after starting the journey and retained evidence of their expenditure.
Checking - Under the rules as they currently apply, employers are required to have a checking procedure in place. The employer must be satisfied that the employee has in fact incurred expenditure of the type that are being reimbursed (e.g. by checking receipts or credit card statements) and had the employee not been reimbursed for that expenditure, it would be tax deductible.
The checking system which is appropriate will depend on the size and nature of the employer’s business. However, it should be sufficient to ensure that the expenditure relates to qualifying travel, it does not include any disallowable items (e.g. private expenditure) and it is not excessive.
However, the checking requirement will soon be history – legislation is to be introduced from 6 April 2019 to remove the requirement for employers to check evidence of amounts spent when making benchmark scale rate payments.
Tax deduction for employees - If the employer pays less than the benchmark rates, the employee is not allowed a deduction for the shortfall. However, if the employee’s actual expenditure is more than that reimbursed, the difference is deductible, as long as the usual conditions for deductibility are met.
Rewarding staff suggestions in a tax-free manner
Staff suggestion schemes reward employees where a suggestion saves money. The tax system allows suggestion scheme awards to be made tax-free. The tax exemption recognises two types of award:
Encouragement awards - An encouragement award is an award other than a financial benefit award for a suggestion with intrinsic merit or showing special effort.
Financial benefit awards - This is for a suggestion relating to an improvement in efficiency which the employer adopts & expects will result in financial benefits.
Conditions - The tax exemption applies where an employer establishes a scheme for the making of suggestions which is open on the same terms to employees of the employer generally or to a particular description of them, eg. all employees at a site or department.
The following conditions must also be met:
• the suggestion relates to activities carried on by the employer,
• the suggestion is made by an employee who could not reasonably be expected to make it in the course of the duties of employment; and
• it is not made at a meeting which is held for the purpose of proposing suggestions.
Tax-free limit for encouragement awards - are capped at £25.
Tax-free limit for financial benefit awards - depends on the savings & number of awards.
The starting point is the suggestion maximum which is the financial benefit share or, if less, £5,000.
The financial benefit share is the greater of:
• 50% of the financial benefit that could reasonably be expected to result from the adoption of the benefit for the first year after its adoption; and
• 10% of the financial benefit that could be expected to result from its adoption in the first five years.
If no award has been made for the suggestion before, the tax-free limit is the suggestion maximum where one award is made or the appropriate proportion of the suggestion maximum if two awards are made on the same occasion to different people (for example 25% if an award is made at the same time to four people).
If further awards are made for the same suggestion, the tax-free limit is the remainder of the suggestion maximum if one such further award is made, or an appropriate proportion of the remainder of the suggestion maximum if two or more further awards are made.
Example - Two employees suggest replacing disposable cups with reusable cups. The suggestion will save £8,000 in year 1, and £10,000 pa thereafter. The financial benefit share is the greater of:
• £4,000 (50% of £8,000); and
• £4,800 (10% of £48,000 (savings in years 1 to 5 being £8,000 and 4 x £10,000))
As this is less than £5,000, the suggestion maximum is £4,800.
The maximum tax-free award that can be made to each employee is £2,400 (50% of £4,800).
Savings income – how is it taxed?
The taxation of savings income can be complicated as there are various allowances and rates that come into play. However, most people are able to enjoy savings income tax-free. For these purposes, savings income means interest on savings – separate rules apply to the taxation of dividends.
The first allowance which may be available to shelter savings income from tax is your personal allowance. If your personal allowance has not been fully used up elsewhere, for example against your wages or salary or against pension or rental income, any unused balance can be set against your savings income.
The personal allowance is set at £11,850 for 2018/19. However, it is reduced by £1 for every £2 by which income exceeds £100,000. Consequently, those with income in excess £123,700 for 2018/19 do not receive a personal allowance.
Starting rate for savings income
Those whose non-savings income is low may be able to enjoy the 0% starting rate on savings income. The availability of the starting rate for savings depends on the amount of non-savings income that you have in excess of your personal allowance.
For 2018/19, the savings starting rate band is £5,000. If non-savings income in excess of the personal allowance is more than £5,000, the savings starting rate of 0% is not available.
If non-savings income above the personal allowance is less than £5,000, the savings starting rate band of £5,000 is reduced by the amount of the non-savings income is excess of the personal allowance. Savings income falling within the remainder of the band is taxed at the zero rate.
Peter has a pension of £13,000 a year and receives interest on his savings of £2,500 a year.
For 2018/19, his personal allowance is £11,850. His pension exceeds his personal allowance by £1,150 (£13,000 - £11,850).
The savings starting rate band is reduced by the non-savings income in excess of the personal allowance. The savings starting rate band is therefore £3,850 (£5,000 - £1,150).
As Peter’s saving income is less than £3,850, it all benefits from the 0% savings starting rate.
Personal savings allowance
In additional to the personal allowance, basic rate and higher rate taxpayers receive a personal savings allowance. The amount of the allowance depends on the income tax band in which the taxpayer falls. The allowance is set at £1,000 for basic rate taxpayers and £500 for higher rate taxpayers. Additional rate taxpayers do not receive the savings allowance.
Savings income sheltered by the personal savings allowance is tax-free.
Up to £17,850 of savings income tax-free
If your only income is savings income, it is possible to receive up to £17,850 of savings income tax-free in 2018/19. This is made up of the personal allowance of £11,850, the starting rate (0%) band of £5,000 and the personal savings allowance of £1,000.
How to choose your main residence to maximise relief
Private residence relief (also known as main residence relief) takes the gain arising on the disposal of a person’s main or only residence out of the charge to capital gains tax. This relief means that in the majority of cases, any gain arising when a person sells their home is tax-free.
However, as with any relief, there are conditions. Relief is available for a property that is, or has been at some point, the individual’s only or main home. Where the property meets this criteria throughout the period of ownership (and assuming it has not been used partially for business), the whole gain arising on the disposal of the residence is tax-free. Where the property has not been the main residence throughout, the gain is apportioned. However, as long as it has been the home at some point, the gain relating to the last 18 months of ownership is exempt. If the property has been let at any time, letting relief may further reduce the chargeable gain.
More than one home
For the purposes of the relief a person can only have one main residence at any one time. Where a person has more than one residence, they can choose which one is the main one – this can be useful in mitigating future tax bills.
A property can only be a main residence if it is in fact a residence. Broadly, this is a property which someone occupies as their home. A property which is let, such as a buy to let property, does not count as it is not occupied by the taxpayer as his or her home. However, a city flat in which a taxpayer spends the week, and a family home elsewhere would both count as residences, as would a property in this country in which a person spends the summer and a property abroad in which they spend their winter.
Choosing the main residence
A person can elect which of their residences is their main residence by writing to HMRC. The deadline is two years from the date on which the combination of residence changes. In a simple case where a person acquires a second home, this will be two years from the date on which the second home was acquired.
If no election is made, the home which is the main home is a question of fact – and will be the home that the person spends most of their time, where their family is based etc.
Where a person has more than one residence it is beneficial for each of them to be the main residence at some point. At the very least, this will shelter the gain relating to the period of occupation as a main residence and the last 18 months. Where a property has been let, making it the main residence for a period also opens up the opportunity of letting relief to further reduce the gain. The period as a main residence can be after the period of letting.
Flipping the main residence can be very beneficial – however, the property must be occupied as a residence. The election can only be made on paper and all owners must sign.
Use of home as office
Use of home as office is a catch-all phrase to describe the costs that a self-employed businessperson has in running at least part of their business operations from home. It need not be an office as people may use a spare bedroom to hold stock for assembly and postage, or similar.
Many will have used the figures that HMRC has long published for employees’ ’homeworking expenses’ - initially £2 a week, then £3 a week, changing to £4 a week from 2012/13.
From 2013/14 onwards HMRC has adopted the following rates:
Hours of business use per month 25-50 flat rate per month £10
Hours of business use per month 51-100 flat rate per month £18
Hours of business use per month 101+ flat rate per month £26
So in HMRC’s eyes, I am entitled to a deduction of £120 a year for the use of home office space (or similar), but basically only so long as I spend at least 25 hours a month working from home. Working more than 25 hours a week - broadly full time - from home gets me the princely sum of £312 per year.
Working from home may be cheap, but it’s not that cheap.
The following guidance assumes that the claimant is not using the cash basis of assessment for tax purposes, as the rules work differently.
'Wholly and exclusively’ - Business expenses are allowed if incurred 'wholly and exclusively for the purposes of the trade'. This is a cardinal rule; however, there is a further point:
'Where an expense is incurred for more than one purpose, this section does not prohibit a deduction for any identifiable part or identifiable proportion of the expense which is incurred wholly and exclusively for the purposes of the trade’ (ITTOIA 2005, s 34).
Applying these principles, I do not have to use a room in my house exclusively for my self-employment, just so long as when I am using it for business purposes, that is all it is being used for.
The costs you are allowed to claim - It is worth bearing in mind that HMRC does have guidance on how to make a more comprehensive claim for using one’s home in the business, in its Business Income manual however you may find it strange that almost all of the examples result in a claim of around £200 a year or less!
HMRC’s guidance nevertheless includes the following potentially allowable costs:
If you incur appreciable costs on the above then just £120 a year as a standard use of home deduction, or even £312 a year, is likely to make you feel more than a little aggrieved.
Tax-free Christmas parties
Although the tax legislation contains an exemption to prevent employees from suffering a benefit-in-kind tax charge on the staff Christmas party, the exemption is limited in scope and application. It is unwise to assume that there will be no tax to pay – without proper planning, an unwanted tax charge may accompany the post-party hangover.
The exemption applies to an annual party or similar function which is provided to the employer’s employees generally, or to those at a particular location. Where only one annual party or similar function is provided in the tax year, no income tax liability arises as long as the cost per head figure does not exceed £150. Where more than one such function is provided in the tax year, the exemption applies if the cost per head of the exempt party or parties does not exceed £150 in aggregate.
Trap 1 – annual functions only
The first trap is that the exemption applies only to annual functions – i.e. functions that are held each year. The staff Christmas party or annual summer barbecue may qualify, but a one-off event, such as a party to celebrate the company’s 10-year anniversary, will not.
Where the function is not an annual function, a benefit in kind charge may arise. However, if the cost is less than £50 per employee, it may fall within the trivial benefits exemption.
Trap 2 – all employee condition
The exemption only applies if the party is open to all employees, or to those at a particular location. So, for example, if the company has sites in Birmingham and Manchester, an annual Christmas party for the Manchester-based employees would be permitted under the terms of the exemption, a party to which only directors and senior managers were invited would not.
Trap 3 – exemption capped at £150 per head
The exemption is limited to £150 per head. There are several points to note as regards to this condition.
The first is that the cap is applied per head, not per employee. The cost per head figure is found by dividing the total cost of providing the function by the number or people attending the function – employees and guests. The total cost of the function includes not only the expenses of providing the function itself, but also the cost of any transport and accommodation which may also be provided. The cost is inclusive of VAT – even if this is subsequently reclaimed.
So, if the total cost of a function is £5,440 and it is attended by 38 employees and 30 guests at a total of 68 people - the cost per head figure is £80 per head (£5,440 ÷ 68).
The second point to note is that the exemption is not a tax-free allowance – if the cost per head figure is more than £150, the whole amount is taxed, not just the excess over £150. Where, say, the cost per head is £175 and an employee brings a guest, the amount of the benefit on which the employee is taxed is £350 (employee plus their guest).
Where there is more than one qualifying function, the exemption can be used to best effect. If an employee attends three functions with cost per head figures of £80, £60 and £65, best use may be to use the exemption for the functions costing £80 and £65 per head. The remaining £5 is lost as it cannot be set against the cost of the £60 per head function.
Tip - Remember to consider the impact of guests – in the above example, if the £65 function was for employees only but the £60 function was for employees and guests, it would be better to use the exemption for the £80 and £60 functions, leaving the £65 function in charge. If the £60 function was left in charge, the cash equivalent of the benefit would be £120 for the employee and guest – which is more than £65.
Any tax liability could potentially be met by the employer via inclusion in a PAYE Settlement Agreement.
Class 2 NICs – happy to pay?
Subject to certain conditions and limits, self-employed earners over the age of 16 and below state retirement age are currently entitled to pay both Class 2 and Class 4 National Insurance contributions (NICs) unless specifically excepted by provisions contained in the Social Security Contributions and Benefits Act 1992.
Class 4 contributions are calculated with reference to an individual’s income from self-employment, but Class 2 contributions are simply charged at a flat weekly rate - £2.95 per week in 2018/19 – where the individual’s self-employed income exceeds the ‘small profits threshold’ (SPT) for the year in question. For 2018/19 the SPT is £6,205, so anyone with profits above that limit should be entitled to pay the weekly Class 2 contribution.
It might be worth noting that for these purposes, ‘profits’ has the same meaning as given for Class 4 NICs, which broadly, means the charge is based on “all profits […] immediately derived from the carrying on or exercise of one or more trades, professions or vocations […] chargeable to income tax […] for the year of assessment and [which] are not profits of a trade, profession or vocation carried on wholly outside the UK”.
HMRC are responsible for administering Class 2 NICs, and liability to the charge is reported through self-assessment. This means that they can be paid together with income tax and Class 4 NICs in one go on the 31 January following the end of the relevant tax year.
Those that report profits below the SPT are not liable for Class 2 NICs, although they can usually pay voluntarily to protect their entitlement to contributory benefits.
So, what are the benefits of paying Class 2 contributions? In broad terms, they are the entry fee allowing the self-employed to enter the UK’s contributory benefits system. Payment will generally give the payer access to the following benefits, if and when the need arises:
Payment does not however, count towards contribution-based jobseeker’s allowance.
Future reform? - Government proposals to abolish Class 2 NICs and reform the system for paying Class 4 NICs were due to take effect from April 2019. The proposals were designed to simplify the tax system for the self-employed and offer them more equal access to contributory benefits. However, the Treasury subsequently announced that it will not be proceeding as planned with the abolition of Class 2 NICs - a move which is estimated will save some £360m for each of the three years to 2021 based on the original impact assessment.
There is, however, a good deal of speculation that NIC rates increases are likely in the near future, which are bound to affect employees and the self-employed alike.
As the current system stands, Class 4 NICs do not count towards any state benefits, but Class 2 contributions provide a cheap route for self-employed people to safeguard entitlement to a future state retirement pension and certain other state benefits. It may be possible to pay for gaps in a National Insurance record from the past 6 years. It’s therefore a good time to check that NIC payments are up-to-date and to take action where appropriate.
Mileage allowances – what is tax-free
Employees are often required to undertake business journeys by car, be it their own car or a company car, and may receive mileage allowance payments from their employer. Up to certain limits, mileage payments can be made tax-free. The amount that can be paid tax-free depends on whether the car is the employee’s own car or a company car.
Employee’s own car
Where an employee uses his or her own car for work, under the approved mileage allowance payments (AMAP) scheme, payments can be made tax-free up to the approved amount. The rates for cars (and vans) are set at 45p per mile for the first 10,000 business miles in the tax year and 25p per mile for any subsequent business miles. A rate of 24p per mile applies to motorcycles and a rate of 20p per mile applies to bicycles.
Jack frequently uses his car for work and in the 2017/18 tax year he undertakes 13,420 business miles.
Under the AMAP scheme, the approved amount is £5,355 ((10,000 miles @ 45p per mile) + (3,420 miles @ 25p per mile)).
Amounts up to the approved amount can be paid tax-free and do not need to be reported to HMRC.
Where the mileage allowance paid is more than the approved amount, the excess over the approved amount is taxable and must be reported to HMRC on form P11D in section E.
The facts are as in example 1 above. Jack is paid a mileage allowance by his employer of 50p per mile.
The amount paid of £6,710 (13,420 miles @ 50p per mile) is more than the approved amount of £5,355, therefore the excess over the approved amount (£1,355) is taxable and must be reported on Jack’s P11D (unless his employer has opted to payroll the benefit).
Where the mileage allowance paid is less than the approved amount, the employee can claim tax relief for the shortfall, either in his or her tax return or on form P87.
For NIC, the 45p per mile rate is used for all business miles in the tax year, not just the first 10,000 miles.
Beware salary sacrifice
The value of tax exemption is lost if the mileage payments are made under a salary sacrifice or other optional remuneration arrangement, and instead the employee is taxed on the amount of salary foregone where this is higher.
Where an employee has a company car, the AMAP scheme does not apply. However, mileage payments can still be made tax-free, but at the lower advisory fuel rates. These are updated quarterly and the rate which can be paid tax-free depends on the engine size of the car and fuel type. The rates are available on the Gov.uk website at www.gov.uk/government/publications/advisory-fuel-rate.
As with the AMAP rates, where the amount paid is in excess of the advisory rate, the excess is taxable.