Managing a rental business from home
A landlord will often manage their property rental business from home, and in doing so will incur additional household expenses, such as additional electricity and gas, additional cleaning costs, etc. As with other expenses, the landlord can claim a deduction for these when working out the profits of the rental business.
Most unincorporated landlords will now prepare accounts on the cash basis.
Wholly and exclusively incurred
The basic rule for an expense to be deductible in computing the profits of a rental business is that the expenses relate wholly and exclusively to that business. This applies equally to a deduction for household expenses – they can be claimed where they relate wholly and exclusively to the rental business.
Where the expenses are wholly and necessarily incurred, a deduction can simply be claimed for the actual expenses. In reality, this will take some working out as household bills will not be split between personal and business expenses. Any reasonable basis of apportionment can be used – such as floor area, number of rooms, hours spent etc. Records should be kept, together with the basis of calculation.
Where a landlord spends more than 25 hours a month managing the business from home, the simplified expenses system can be used to work out the deduction for the additional costs of working from home. The expenses depend on the number of hours worked in the home each month, and the deduction is a flat monthly amount, as shown in the table below.
Hours of business use per month Flat rate per month
25 to 50 hours £10
51 to 100 hours £18
101 hours or more £26
The hours are the total hours worked at the home by anyone in the property rental business.
Nadeem runs his property rental business from home. In 2018/19, he spends 60 hours a month working on the business in all months except August and December, in respect of which he spends 30 hours in each on those months working on the business.
For 2018/19 he is able to claim a deduction of £200 for expenses of running his business from home (10 months @ £18 plus 2 months @ £10).
The simplified expenses rule does not cover telephone and internet, which can be claimed in addition to the deduction for simplified expenses.
Timing dividends right could help save tax
Timing the date of a dividend payment from a company can determine the amount and the due date of the tax payable. This may be a useful strategy in a family-owned company.
The dividend allowance, which was originally introduced from 6 April 2016, was cut from £5,000 a year to £2,000 from 6 April 2018. Fortunately, the tax rates on dividend income, above the allowance, remain at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.
The amount of tax payable on dividend income is determined by the amount of overall income an individual receives during a tax year. This includes earnings, savings, dividend and non-dividend income. Dividend tax paid depends primarily on which tax band the first £2,000 falls in.
Accelerating payment - The timing of the dividend payment may have a marked impact on the directors’ and shareholders’ personal tax situation. A dividend is not paid until the shareholder receives the funds direct or the dividend amount is put unreservedly at his or her disposal, for example by a credit to a loan account on which the shareholder has the power to draw. If the personal tax allowance and basic rate band for a tax year have not been fully utilised towards the end of the tax year, payment of a dividend may mean that the unused portion can be mopped up.
Example - Graham is the sole director and shareholder of a limited company.
He is considering whether to pay a dividend before the end of the 2019/20 tax year. In that tax year he has other income of £25,000. He has retained profits in the company of £100,000.
For 2019/20 the personal tax allowance is £12,500 and the basic rate tax band is £37,500. The dividend allowance is £2,000.
If Graham pays a dividend of £27,000 before the end of the 2019/20 tax year, he will fully utilise his basic rate band, and will be liable to tax at 7.5% on the £25,000 of the dividend income (the first £2,000 of the dividend being covered by the dividend allowance).
Delaying payment - Where the shareholder already has income exceeding the basic rate band in one tax year, delaying the dividend until the start of the next tax year.
Example - Following on from the above example, say Graham has already paid himself a salary of £50,000 in the 2019/20 tax year, thus fully using up his basic rate band. If he pays the £27,000 dividend before the end of the tax year, he will pay tax on it of £8,125 (£27,000 - £2,000 allowance x 32.5%). This tax will be due for payment on 31 January 2021.
If he waits until the start of the next tax year (2020/21) to pay the dividend, and also receives a salary of £25,000 during that year, the tax due on the dividend will be £1,875 (£25,000 x 7.5%) – a potential saving of £6,250. Graham will also benefit from a delay in the due date for payment of the tax until 31 January 2022.
Fluctuating income - Dividend payments can often be timed to smooth a director/shareholder’s earnings year-on-year. Broadly, where profits fluctuate, a company could consider declaring and paying dividends equally each year, or by declaring a smaller dividend in the first year (when profits are higher) and treating the remainder of the payment as a shareholder loan. At the start of the next tax year, a further (smaller) dividend can be declared, which will repay the loan. Care must be taken with this type of arrangement, not least because the loan must be repaid within nine months of the company’s year-end to avoid a tax charge arising on the company.
The family business potentially offers considerable scope for structuring tax-efficient payments to family members using a mixture of both salary and dividends. A pre-dividend review may be particularly beneficial towards the end of the company’s year-end.
Closing - when a member’s voluntary liquidation is beneficial
Although it is possible to strike off a company and for distributions made prior to dissolution to be treated as capital rather than as a dividend, this is not an option where the amount of the distributions exceeds £25,000.
Where the taxpayer’s personal circumstances are such that it is beneficial for the remaining funds to be taxed as capital (and liable to capital gains tax), rather than as a dividend, a member’s voluntary liquidation (MVL) can be an attractive option, as depending upon the level of funds to be extracted the costs of the liquidation may be more than covered by the tax savings that can be achieved.
What is an MVL?
An MVL is a process that allows the shareholders to put the company into liquidation. This route is only an option if the company is solvent (i.e. its assets are greater than its liabilities). The directors must sign a declaration of solvency confirming that the company is able to pay its debts in full within the next 12 months and 75% of the members must agree to place the company into liquidation. The shareholders must pass a special resolution to wind up the company. They will also need to pass an ordinary resolution to appoint liquidators. The liquidator must be a licenced insolvency practitioner.
What are the tax implications?
Under an MVL the capital extracted from the company is treated as a capital distribution and is liable to capital gains tax, rather than being taxed as a dividend. Where entrepreneurs’ relief is in point, the rate of tax will only be 10%, assuming enough of the entrepreneurs’ relief lifetime limit remains available. If significant funds are available for distribution, this can generate considerable tax savings.
Edward and Oliver are directors of a company in which they both own 50% of the shares and 50% of the voting rights. Each is entitled to 50% of the profits available for distribution and 50% of the assets on a winding up.
They wish to wind the company up, but as they have cash and assets of £10 million to distribute, they opt for an MVL, to allow them to take advantage of the capital gains tax treatment. Both are additional rate taxpayers, and both meet the qualifying conditions for entrepreneurs’ relief.
Edward and Oliver each receive £5 million on the winding up of the company. They both have the full amount of the entrepreneurs’ relief lifetime limit (£10 million) unused, and it is assumed for simplicity that the annual exempt amount has been used elsewhere. The gain is therefore taxed at 10% and each will pay tax of £500,000 on their distribution of £5 million.
Had they not opted for an MVL and the extracted funds taxed as a dividend, they would have each paid £1,905,000 in tax on the £5 million distribution (£5m @ 38.1%).
Anti-avoidance provisions apply which are designed to target ‘moneyboxing’ (where the company retains more funds than it needs in order to extract them as capital when the company is liquidated) and ‘pheonixism’ (where the company is liquidated, the value extracted as capital and a new company is set up to carry on what is essentially the same business). Liquidation distributions which are caught by the rules are treated as income rather than capital.
Tax-free childcare update
HMRC have recently run a campaign to remind people that they could be missing out on up to £2,000 per child, per year, towards the cost of childcare.
Working parents and guardians may be eligible to receive government top-ups of £2 for every £8 that they pay into a tax-free childcare account, up to a maximum of £2,000 per child (or £4,000 for disabled children), although there is an overall maximum limit of £10,000.
The scheme is open to all working parents across the UK with children under 12, or under 17 if disabled.
Under the scheme, the parent/guardian opens an online account via the government’s Childcare Choices website and decides how much to pay in and how often. The flexible nature of the accounts mean that accountholders can pay in more in some months, and less at other times, depending on how much they have spare to invest. The account holder’s circumstances are re-confirmed online every three months. Money can be withdrawn at any time but the government contribution will be lost.
Again, the flexible nature of tax-free childcare allows anyone to pay into the account, including grandparents, other family members or employers.
To qualify for the government contribution, account holders will usually have to be in work, expecting to earn at least the National Minimum Wage (NMW) or National Living Wage (NLW) for 16 hours a week on average, over the next 3 months. This currently equates to at least £1,707.68, which is equivalent to the NLW for people over 25.
Where an individual is not working, they may still be eligible for tax-free childcare if their partner is working, and they receive Incapacity Benefit, Severe Disablement Allowance, Carer’s Allowance or Employment and Support Allowance. It is also possible to apply where the claimant is starting or re-starting work within the next 31 days.
Self-employed people who do not expect to make enough profit in the next three months can use an average of how much they expect to make over the current tax year. Additionally, the earnings limit does not apply to self-employed individuals who started their business less than twelve months ago.
Where the individual, or their partner, has an ‘adjusted net income’ over £100,000 in the current tax year they will not be eligible for tax-free childcare.
Broadly, ‘adjusted net income’ is total taxable income before any personal allowances and minus certain payments, such as those made under Gift Aid. It is also worth noting that the £100,000 limit includes any expected bonuses.
It is not possible to receive tax-free childcare at the same time as claiming Working Tax Credit , Child Tax Credit , Universal Credit (UC) or childcare vouchers. Which scheme the individual is better off with depends on their situation. The Childcare Choices website includes a childcare calculator for parents to compare all the government’s childcare schemes on offer and check which works best for their families, including the 30-hour free childcare offer, tax-free childcare or universal credit.
Tax-free childcare effectively replaces HMRC’s employer-supported childcare scheme. However, parents who joined an employer-childcare voucher scheme before 4 October 2018 have the option of remaining in that scheme for as long as the employer offers it, or for as long as they stay with the employer. The employer-provided voucher scheme closed to new entrants from 4 October 2018.
Where an individual decides to switch from childcare vouchers or directly contracted childcare, they must tell their employer within 90 days of applying for tax-free childcare.
Finally, with regards to UC, HMRC recommend that the claimant waits until a decision on a tax-free childcare application is received before cancelling a UC claim.
Anyone who pays for childcare would be wise to check their eligibility for tax-free childcare as they could be missing out on considerable financial support.
Payroll – how to deal with new starters
From a payroll perspective, there are various tasks that an employer has to perform when they take on a new starter.
For 2019/20 an employer needs to operate PAYE where the employee earns more than £118 per week (the lower earnings limit for National Insurance purposes). However, if any employees earn more than £118 per week, the employer must comply with RTI and report all payments to employees to HMRC (even those below £118 per week).
Work out what tax code to use - The tax code is fundamental to the operation of PAYE and it is important that the correct tax code is used. To ensure that a new employee is taxed correctly, the employer will need to know the correct tax code to use.
If the employee has a P45 and left their last job in the current tax year, the employer can simply use the code shown on the P45. If the employee left their last job in the 2018/19 tax year, the code on the P45 can be updated by adding 65 to codes ending in L, 59 for codes ending in N and 71 for codes ending in M.
If the employee does not have a P45, the employer will need to ask the employee to complete a new starter checklist.
New starter checklist - The new starter checklist enables the employer to gather information on the new employee. Even if the employee has a P45, it is still useful for the new starter to complete the checklist as it contains information which cannot be gleaned from the P45 (such as the type of loan where the new starter has a student loan which has not been repaid).
As far as establishing which tax code to use, the employee will need to select one of three statements:
• A: ‘This is my first job since 6 April and I have not been receiving taxable Jobseeker’s Allowance, Employment and Support Allowance, taxable Incapacity Benefit, State or Occupational Pension’.
• B: ‘This is now my only job but since 6 April I have has another job or received taxable Jobseeker’s Allowance, Employment and Support Allowance or taxable Incapacity Benefit. I do not receive a State or Occupational Pension.
• C: ‘As well as my new job, I have another job or receive a State or Occupational Pension’.
The following table indicates what code should be used for 2019/20 depending on what statement the employee has ticked.
Statement ticked Tax code to use
A 1250L on a cumulative basis
B 1250L on a Week 1/Month 1 basis
Does the employee have a student loan? - The employer will also need to establish whether the employee is making student loan repayments. If the employee has a P45 and is making loan repayments, the student loan box will be ticked. However, the P45 will not provide details of the type of loan. Student loan information can be provided on the new starter checklist, enabling the employer to ascertain whether the employee has a student loan, and if so what type, and also whether the employee has a post-graduate loan.
Tell HMRC about the new employee - The employer will need to add the new employee to the payroll and also tell HMRC that the employee is now working for the employer. This is done by including the new starter details on the Full Payment Submission (FPS) the first time that the employee is paid.
VAT refunds for DIY builders
If you build your own house or convert an existing property into a home, you may be eligible to apply for a VAT refund on building materials and services. You do not need to be VAT registered to claim a refund.
Refunds can be claimed in respect of building materials that are incorporated into the building and which cannot be removed without tools or without damaging the building. Refunds are available for materials used to build both new homes and for certain conversions.
A new home will qualify if it is separate and self-contained and you build it for you and your family to live in. The property must not be used for business purposes, although you are permitted to use one room as a home office.
Conversions will qualify if the property was previously used for non-residential purposes and is converted for residential use. Conversions of residential building will only qualify if they have not been lived in for at least 10 years.
Where you use a builder, the builder’s services will normally be zero-rated where they work on a new home. However, you can claim a refund for VAT charged by a builder working on a conversion.
What does not qualify?
Refunds are not available in respect of:
• materials or services on which no VAT is payable because they are zero-rated or exempt;
• professional fees, such as architects’ fees or surveyors’ fees;
• costs of hiring machinery or equipment;
• building materials which are not permanently attached to or part of the building;
• fitted furniture, some gas and electrical appliances, carpets and garden ornaments.
A refund is also denied if the building is not capable of being sold separately, for example, as a result of planning restrictions.
How to claim
The claim is made on form 431NB where it relates to a new build and on form 431 where it relates to a conversion. The forms are available on the Gov.uk website. The claim must be made within three months of the date on which the building work was completed.
You must include all the relevant supporting documentation with your claim, such as valid VAT invoices to support the amount claimed. The refund will normally be issued within 30 days of making the claim.
Partner note: www.gov.uk/vat-building-new-home/eligibility.
Fuel and mileage payments for company car drivers
The car benefit tax charge does not cover fuel provided for a company vehicle. Where the company pays for all fuel, the fuel benefit will be charged, which is based on the cash equivalent of the benefit each tax year (£24,100 for 2019/20 multiplied by a percentage depending on the car’s CO2 emissions).
If the company pays for all fuel, but the employee reimburses the company for private use, as long as the amount paid back is equal to, or more than, the amount for personal fuel in the same tax year, the employer will not have to pay anything to HMRC or report on such transactions.
Where the employer does not directly meet the cost of fuel used for business in a company car, but pays the employee a business mileage allowance, no fuel benefit charge will arise if the mileage allowance does no more than meet the cost of fuel used for business travel. If the mileage allowance is excessive, but it’s only paid for genuine business travel, the ‘profit element’ will be chargeable to tax in the normal way. However, a car fuel benefit charge will arise where, for instance, the payments to the employee cover travel between home and work.
An employee using their own car for work can claim a mileage allowance from their employer, which is designed to cover the costs of fuel and wear and tear for business trips. The mileage allowance will be tax-free if it does not exceed HMRC’s Approved Mileage Allowance Payment rates.
The AMAP scheme does not apply for company cars. However, employees can still claim fuel expenses for all business mileage where they pay for the fuel. The rates are lower than the AMAP rates and are updated quarterly.
HMRC’s guidance on fuel-only mileage rates for company cars confirms that employers are not obliged to use advisory fuel rates. Where an employer wishes to use them, they only apply where the employer:
• reimburses employees for business travel in their company cars; or
• requires employees to repay the cost of fuel used for private travel in those company cars.
If the employer pays more than the relevant advisory fuels rates and the payments are not an actual reimbursement, the excess is taxed and subject to employees’ and employers’ National Insurance Contributions.
Advisory fuel rates do not apply to electric cars, so any mileage payments should be based on actual costs incurred.
Where an individual is provided with workplace facilities for charging a battery of a vehicle used by them (including as a passenger), no taxable benefit arises for costs relating to the provision of electricity at those facilities if the following conditions are met:
• the charging facilities must be provided at or near an employee’s workplace
• charging must be available to either all the employer’s employees generally, or all the employer’s employees generally at the employee’s workplace
• charging facilities must be for a battery of a vehicle in which the employee is either the driver or a passenger.
The benefit will remain taxable if it’s offered in conjunction with an optional remuneration arrangement.
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Travel expenses and the 24-month rule
As a general rule, employees are denied a tax deduction for the cost of travel between home and work. Likewise, subject to a few limited exceptions, if the employer meets the cost of home to work travel, the employee is taxed on it.
One of the main exceptions to this rule is where an employee attends a ‘temporary workplace’. This is a workplace that the employee goes to in order to perform a task of limited duration or one that he attends for a temporary purposes, even if the attendance is on a regular basis.
Example 1 - Polly is based in the Milton Keynes office. She is seconded to the Bedford office for 12 months to cover an employee’s maternity leave. At the end of the secondment, she will return to the Bedford office.
The Bedford office is a temporary workplace.
Consequently, Polly is allowed a deduction for travel from her home to the Bedford office.
Example 2 - James is a health and safety officer. He is based in the Liverpool head office. Each week he visits factories in Manchester and Bury to carry out safety checks. The factories are temporary workplaces as each visit is self-contained.
Consequently, James is allowed a deduction for travel expenses incurred in visiting the factories, even if he travels there from home.
24-month rule - A workplace does not count as a temporary workplace if the employee attends it in a period of continuous work which lasts, or is expected to last more than 24 months. A ‘period of continuous work’ is one where the duties are performed at the location in question to a ‘significant extent’. HMRC regard duties being performed to a 'significant extent' at a particular location if an employee spends 40% or more of their working time there.
The upshot of this rule is that where the employee has spent, or is likely to spend, 40% of their working time at the location in question over a period of more than 24 months, that location will be a permanent location rather than a temporary location. Consequently, home to work travel is ‘ordinary commuting’ (travel between home and a permanent workplace), which is not deductible.
It is important to appreciate that both parts of the test must be met for the workplace to be a permanent workplace – more than 40% of time spent there and over a period of more than 24 months.
Example 3 - George is employed full-time at a care home in Southampton, a role which he has held for four years. He is sent to full-timework at a new care home in Bournemouth for three years, after which time he will return to the Southampton care home.
Although the move to the Bournemouth posting is not permanent, the posting lasts more than 24 months and, as such, the Bournemouth home does not qualify as a temporary workplace.
Consequently, George is not allowed a deduction for the cost of travelling from home to the Bournemouth care home.
Change of circumstances - Circumstances can and do change. If at the outset a posting is expected to last 24 months, the workplace will be treated as a temporary workplace. If later the posting is extended so that it will last more than 24 months, the workplace ceases to be a temporary workplace from the date that it becomes apparent the posting will exceed 24 months.
Fixed term appointments rule - An employee undertaking a fixed-term appointment is not entitled to relief for home to work travel, even where it lasts less than 24 months, if the employee attends the workplace for all, or almost all of the period which they are likely to hold the appointment.
Example - Imogen takes on a 12-month contract at an office in Marlow. Although the appointment is less than 24 months, the Marlow office is not a temporary workplace as Imogen works there for duration of the contract.
Tax exemption - If the employer pays or reimburses travel expenses which would be deductible if met by the employee, the payment or reimbursement is exempt from tax.
Inheritance tax and spouses and civil partners
Special rules apply for inheritance tax purposes to married couples and civil partners. To ensure valuable tax reliefs are not lost, it is beneficial to consider the combined position, rather than dealing with each individual separately. Married couples and civil partners benefit from exemptions that are not available to unmarried couples.
Inter-spouse exemption - The main inheritance tax benefit of being married or in a civil partnership is the inter-spouse exemption. Transfers between married couples and civil partners are not subject to inheritance tax. This applies both to lifetime transfers and to those made on death.
The inter-spouse exemption makes it possible for the first spouse or civil partner to die to leave their entire estate to their partner without triggering an IHT liability.
Transferable nil rate bandThe proportion of the nil rate band that is unused on the death of the first spouse or civil partner can be used by the surviving partner on his or her death. This makes tax planning easier and there is no panic about each spouse using their own nil rate band. If the entire estate is left to the spouse on the first death, on the death of the surviving spouse or civil partner, there will be two nil rate bands to play with.
If the first spouse or civil partner to die has used some of their nil rate band, for example, to leave part of their estate to their children, the surviving spouse or civil partner can utilise the remaining portion. It should be noticed it is the unused percentage that is transferred, rather than the absolute amount unused at the time of the first death – this provides an automatic uplift for increases in the nil rate band. The nil rate band is currently £325,000.
Residence nil rate band - The residence nil rate band (RNRB) is an additional nil rate band which is available where a main residence is left to a direct descendant. It is set at £150,000 for 2019/20, and will increase to £175,000 for 2020/21. The RNRB is reduced by £1 for every £2 by which the value of the estate exceeds £2 million.
The unused proportion of the RNRB can be transferred to the surviving spouse.
Example - George and Maud have been married for over 50 years. Maud died in 2017 leaving £32,500 to each of her two children. The remainder of her estate, including her share of the family home, was left to her husband George.
George dies in July 2019. His estate was worth £780,000 and included the family home, valued at £550,000, which was left equally to the couple’s children, Paul and Joanna.
At the time of her death Maud had used up £65,000 of her nil rate band. The nil rate band at the time of her death was £325,000. The transfer to George was covered by the inter-spouse exemption and was free from inheritance tax. Maud has used up £65,000 of her nil rate band (20%), leaving 80% unused. She has not used her RNRB band as she left her share of her main residence to George.
On George’s death, the executors can claim the unused portion of Maud’s nil rate band and RBRB. The nil rate bands available to George are as follows:
Nil rate bands £
George’s nil rate band 325,000
George’s RNRB 150,000
Unused portion of Maud’s nil rate band (80% of £325,000) 260,000
Unused proportion of Maud’s RNRB (100% of £150,000) 150,000
As George’s estate on death is less than the available nil rate bands, no inheritance tax is payable.
Check your tax calculation
Each year HMRC undertake a PAYE reconciliation for employed individuals who are not required to submit a tax return to check that the correct amount of tax has been paid. Where it has not, HMRC will send out either a P800 tax calculation or a PA302 simple assessment.
P800 tax calculation
A P800 tax calculation may be issued if an employee has paid too much tax, or if they have paid too little and the tax underpayment can be collected automatically through an adjustment to their PAYE tax code. There are various reasons why a person who pays tax under PAYE may have paid the wrong amount of tax. This may be because:
• they finished one job and started a new one and were paid for both jobs in the same tax month;
• they started receiving a pension at work; or
• they received Employment and Support Allowance or Jobseeker’s Allowance (which are taxable).
P800 calculations for 2018/19 are being sent out by HMRC from June to November 2019.
If the P800 shows that tax has been overpaid, it will say whether a refund can be claimed online. If so, this can be done through the personal tax account. Where a claim is made online, the money should be sent to the claimant’s bank account within 5 working days. In the event a claim is not made within 45 days of the date on the P800, HMRC will send out a cheque. If an online claim is not possible, HMRC will also send out a cheque.
PA302 simple assessment
Instead of a P800 tax calculation, an individual may instead receive a PA302 simple assessment. This is effectively a bill for tax that has been underpaid. HMRC may issue a simple assessment if:
• the tax that is owed cannot be taken automatically from the individual’s income;
• the individual owes HMRC tax of more than £3,000; or
• they have to pay tax on the State Pension.
A simple assessment bill can be paid online.
Check your calculation
If you receive a tax calculation or simple assessment from HMRC, do not simply assume that it is correct – HMRC can and do make mistakes. It is prudent to check that their figures are correct. When checking the calculation, check HMRC’s figures against your records, such as your P60, your bank statements and letters from the DWP. Check that employment income and any pension income is correct, and that relief has been given for expenses and allowances. HMRC have produced a tax checker tool (available on the Gov.uk website at www.gov.uk/check-income-tax) which can be used to check the amount of tax that should have been paid.
If you think that your tax calculation is incorrect, you will need to contact HMRC. This can be done by phone by calling 0800 200 3300. If you do not agree with your simple assessment, you have 60 days to query this with HMRC by phone or in writing. The simple assessment letter explains how to do this.
Avoiding common errors when computing business profits
HMRC produce a range of Toolkits for agents, which highlight errors commonly made in returns so that agents can take steps to avoid them. The business profits toolkit provides guidance on errors that are found in relation to business profits for small and medium-sized businesses. They are helpful to anyone computing taxable business profits.
Risk area 1 – Record keeping
Good record-keeping is essential for business profits to be calculated correctly. Poor records may result in sales or allowable expenditure being omitted from the accounts, with the result that the level of profit or loss is incorrect.
Risk area 2 – Business income
The profit or loss will only be correct if all income is included in the accounts. Unless the business is an unincorporated business that has opted to use the cash basis, business income should be included on an accruals basis, matching the income to the period in which it was earned.
Not all sources of business income will be immediately obvious – the income of the business may, for example, include scrap sales, contra sales or barter arrangements. Cash sales may also be overlooked.
Risk area 3 – Expenditure
To ensure that the profit is not overstated, all allowable expenditure should be taken into account. However, a deduction is only permitted for expenses which are wholly and exclusively incurred for the purposes of the business. Attention should also be paid to specific prohibitions, such as for business entertaining.
Purchases and expenses should be reviewed to ensure that they have been included.
Sole traders and partnerships comprising individuals can use simplified expenses rather than claiming actual expenses.
Risk area 4 – Stock and work in progress
Where the business is one that holds stock, care must be taken to include it at the correct value – this is the lower of cost and net realisable value. Errors will arise if stock is overlooked or valued incorrectly.
Work-in-progress can be a complex area and advice should be taken to ensure that the treatment is correct.
Risk area 5 – Miscellaneous items
Miscellaneous areas should also be considered. These may include a review of post-balance sheet events and consideration as to whether any adjustment to the accounts is required. Staff costs should also be reviewed and amounts unpaid nine months after the end of the period should be added back. As far as directors are concerned, consideration should be given to the date on which amounts are credited to the director’s loan account.
Tax credits – do I have to tell HMRC if my circumstances change?
Tax credits are benefit payments that are paid to people in work who are on a low income or have children. There are two tax credits – working tax credit (for those working but on a low income) and child tax credit (for those on low income, regardless of whether they are working or not, with children). Existing tax credit claimants need to renew them each year.
New claimants must claim Universal Credit rather than Working or Child Tax Credits; eventually, existing tax credit claimants will be moved over to Universal Credit.
Tax credits can go up or down as a result of changes in family or work circumstances.
A tax credit claimant must report any of the following changes in circumstance to HMRC.
1. Living circumstances change, for example if a partner moves out, or you start to live with a new partner, you get married or form a civil partnership, or you separate permanently, or you divorce.
2. Your partner or child dies.
3. A child leaves home or is taken into care.
4. A child is taken into custody.
5. A child over the age of 16 leaves approved education or training or a careers service.
6. Childcare costs go down by more than £10 per week, or you start receiving help with childcare costs.
7. If you are in a couple, your combined working hours fall to below 30 hours per week.
8. Working hours fall below the minimum needed for working tax credit, which depend on circumstances.
It is necessary to make a new claim if a relationship ends or you start a new relationship, or if your partner dies.
You must also tell HMRC if any of the following occur.
1. You go abroad for eight weeks or more.
2. You leave the UK permanently or lose your right to reside in the UK.
3. You reduce your working hours to less than 16 hours per week while claiming childcare costs.
4. You have been on strike for more than 10 consecutive days.
Changes in income, benefits and working hours
If tax credits are overpaid, the overpayment will need to be returned to HMRC. To avoid building up an overpayment which will have to be paid back, HMRC should be notified if any of the following occur.
1. A change in income (if increases or decreases by £2,500 HMRC should be notified immediately so that tax credit payments can be adjusted)
2. Combined working hours for a couple who have children are increased to 30 hours a week or more.
3. You have a baby or take on responsibility for another child.
4. You start or stop claiming benefits or your benefits change.
5. You start or stop getting a disability payment.
6. Your child is certified blind (or is no longer blind).
7. You start paying for registered or approved childcare.
8. You stop getting help with childcare.
The above changes must be reported to HMRC within one month of the date on which they occur.
Changes can be notified online at www.gov.uk/changes-affect-tax-credits.
Director’s loan accounts – avoiding the risks
HMRC produce a series of toolkits which set out common errors that they find in returns. The hope is that by being familiar with the mistakes that are routinely made, steps can be taken to avoid them. Although the toolkits are aimed primarily at agents, they are useful for anyone who has to complete a tax return. The director’s loan accounts toolkit highlights the key areas of risk in relation to directors’ loan accounts. The latest version of the toolkit was published in May 2019 and should be used for personal tax returns for 2018/19 and for company returns, for the financial year 2018.
Expenses are only deductible in computing taxable profits to the extent that they are incurred wholly and exclusively for the purposes of the trade. A company is a separate legal entity to the directors and shareholders. However, many close companies meet director’s personal expenses. Where these are not part of the director’s remuneration package, the company cannot deduct the cost when computing its taxable profits. Instead, they should be charged to the director’s loan account. The director’s loan account toolkit focuses on expenses that do not form part of the director’s remuneration package.
1. Review of the accounts - any personal expenditure incurred by the director and paid for by the company must be allocated correctly, i.e. an allowable expense where it forms part of the director’s remuneration package and charged to the director’s loan account. Account headings should be reviewed to identify director’s personal expenditure which has not been treated correctly.
2. Loans to participators – under the close company rules, tax (section 455 tax) is charged at 32.5% on loans to directors who are also shareholders where the loan remains outstanding nine months and one day after the end of the accounting period. Review overdrawn loan accounts to check whether the company is liable to pay section 455 tax.
3. Review of expenses and benefits – where a director is provided with anything other than pay, it may need to be reported to HMRC as a benefit in kind on form P11D. Review expenses and benefits for taxable items that may have been missed. It should be noted that if the director’s loan account balance exceeds £10,000 at any point in the tax year, a benefit in kind charge will arise on the loan unless the director pays interest at a rate that is at least equal to the official rate (2.5% since 6 April 2017).
4. Self-assessment – check whether the director needs to send a self-assessment return. The directors’ loan accounts toolkit states that “Company directors do not need to send a tax return unless that have other taxable income that needs to be reported, or if HMRC has sent a notice to file a return”.
5. Record keeping – good keeping is essential. Poor records may mean expenditure is missed or allocated incorrectly.
The toolkit features as useful checklist which can be completed to make sure that nothing is overlooked. The checklist contains a helpful link to HMRC guidance.
Calculating the Class 4 NIC liability
The self-employed pay two classes of National Insurance contributions – Class 2 and Class 4.
Class 2 contributions are weekly flat rate contributions which provide the mechanism by which the self-employed build up their entitlement to the state pension and certain contributory benefits. By contrast, Class 4 contributions are based on profits from the self-employment and operate more like a tax in that they do not confer any benefit or pension entitlement.
Nature of Class 4 contributions - Class 4 National Insurance contributions are payable by self-employed earners aged 16 or over and below state pension age. The liability is triggered once profits from the self-employment reach the lower profits limit, set at £8,632 for 2019/20. This is aligned with the primary and secondary thresholds for Class 1 National Insurance purposes.
Class 4 contributions are payable at the main rate on profits between the lower profits limit and the upper profits limit and at the additional rate on profits in excess of the upper profits limit. For 2019/20, the upper profits limit is set at £50,000, aligning with both the upper earnings limit for Class 1 National Insurance purposes and the rate at which higher rate tax becomes payable.
The main Class 4 rate is set at 9% for 2019/20 and the additional Class 4 rate is set at 2%.
Example 1 - John is self-employed as a personal trainer. In 2019/20 his profits from self-employment are £7,250.
As his profits are below the lower profits limit, he does not need to pay any Class 4 National Insurance contributions for 2019/20.
However, as his profits exceed the small profits limit of £6,365 for Class 2 National Insurance purposes, he must pay weekly Class 2 contributions of £3 per week.
Example 2 - Jane is self-employed as an interior designer. In 2019/20 her profits from self-employment are £32,000.
She must pay Class 4 National Insurance contributions on her profits to the extent that they exceed the lower profits limit for 2019/20 of £8,632.
Her Class 4 National Insurance liability is as follows:
9% (£32,000 - £8,632) = £2,103.12
Jane must also pay Class 2 contributions of £3 per week.
Example 3 - Jackie is a self-employed accountant. For 2019/20 her profits from self-employment are £77,000. She must pay Class 4 National Insurance contributions on her profits to the extent that they exceed the lower profits limit for 2019/20 of £8,632.
Her Class 4 National Insurance liability is as follows:
(9% (£50,000 - £8,632)) + (2% (£77,000 - £50,000)) = £4,263.12
Jackie must also pay Class 2 contributions of £3 per week.
Paying the Class 4 National Insurance liability - Class 4 National Insurance contributions are payable with tax under the self-assessment system. The liability must be paid by 31 January after the end of the tax year to which it relates – so Class 4 National Insurance contributions for 2019/20 must be paid by 31 January 2021.
Unlike Class 2 contributions, Class 4 contributions are taken into account in computing payments on account. Payments on account must be made where the previous year’s tax and Class 4 National Insurance liability was £1,000 or more unless at least 80% of the tax due for that year was collected at source.