Getting payroll right
Complying with payroll issues from salary to holiday entitlements, payslips to pensions is increasingly important for employers.
The National Minimum Wage and the National Living Wage
Since the establishment of the National Minimum Wage (NMW) in 1999, there have been constant changes to both rates and regulations, with perhaps the biggest being the introduction of the National Living Wage (NLW) in 2016.
The minimum wage is paid at an hourly rate, with payment bands depending on age, and special provisions applying to apprentices. The NLW is the minimum wage for those aged 25 and over, whilst the NMW applies to those above school leaving age and individuals aged under 25. For convenience, we refer to 'minimum wage' to cover both the NMW and the NLW.
Current minimum wage rates
Minimum wage rate Rate from 1.4.19
21-24 year-old rate £7.70
18-20 year-old rate £6.15
16-17 year-old rate £4.35
Apprentice rate £3.90
Failure to pay the minimum wage correctly can lead to penalties. A notice of underpayment will calculate the arrears of pay to be paid and the penalty set at 100% of the total underpayment, which can be doubled to 200%, unless the arrears are paid within 14 days. The maximum fine for non-payment is £20,000 per worker, and employers who fail to pay will be banned from being a company director for up to 15 years.
Payslips and holidays
Employees are legally entitled to receive a payslip showing their earnings before and after deductions. However, one in ten workers are not currently receiving a payslip. This makes it hard for them to calculate whether they are receiving the right level of pay, pension and holiday entitlement, and check Pay as You Earn (PAYE) deductions.
Around one in 20 workers receive no paid holiday entitlement, despite being legally entitled to at least 28 days' paid holiday a year. In addition, failure to offer staff workplace pensions under auto-enrolment rules can end in prosecution, with up to two years' imprisonment and unlimited fines possible.
Getting payroll right
Administering payroll and complying with the Real Time Information (RTI) regulations can be burdensome for businesses. The creation of customised payslips and the effective administration of PAYE, national insurance, Statutory Sick Pay and Statutory Maternity Pay is a time-consuming process. Many small and medium-sized enterprises (SMEs) may not have the resources or expertise to handle this themselves, but professional payroll services are available.
When is a car a pool car?
Rather than allocating specific cars to particular employees, some employers find it preferable to operate a carpool and have a number of cars available for use by employees when they need to undertake a business journey. From a tax perspective, provided that certain conditions are met, no benefit in kind tax charge will arise where an employee makes use of a pool car.
There are five conditions that must be met for a car to be treated as a pool car for tax purposes.
1. The car is made available to, and actually is used by, more than one employee.
2. In each case, it is made available by reason of the employee’s employment.
3. The car is not ordinarily used by one employee to the exclusion of the others.
4. In each case, any private use by the employee is merely incidental to the employee’s business use of the car.
5. The car is not normally kept overnight on or in the vicinity of any of the residential premises where any of the employees was residing (subject to an exception if kept overnight on premises occupied by the person making the cars available).
The tax exemption only applies if all five conditions are met.
When private use is ‘merely incidental’
To meet the definition of a pool car, the car should only be available for genuine business use. However, in deciding whether this test is met, private use is disregarded as long as that private use is ‘merely incidental’ to the employee’s business use of the car.
HMRC regard the test as being a qualitative rather than a quantitative test. It does not refer to the actual private mileage, rather the private element in the context of the journey as a whole. For example, if an employee is required to make a long business journey and takes the car home the previous evening in order to get an early start, the private use comprising the journey from work to home the previous evening would be regarded as ‘merely incidental’. The car is taken home to facilitate the business journey the following day.
Kept overnight at employee’s homes – the 60% test
For a car to meet the definition of a pool car, it must not normally be kept overnight at employees’ homes. In deciding whether this test is met, HMRC apply a rule of thumb – as long as the total number of nights on which a car is taken home by employees, for whatever reason, is less than 60% of the total number of nights in the period, HMRC accept that the condition is met.
When a benefit in kind tax charge arises
If the car does not meet the definition of a pool car and is made available for the employee’s private use, a tax charge will arise under the company car tax rules.
Private residence relief and the final period exemption
From a capital gains tax perspective, there are significant tax savings to be had if a property has been the owner’s only or main residence. The main gains are where the property has been the only or main residence throughout the whole period of ownership as private residence relief applies in full to shelter any gain arising on the disposal of the property from capital gains tax.
However, there are also advantages if a property enjoys only or main residence status for part of the ownership period; not only are any gains relating to that period sheltered from capital gains tax, but those covered by the final period exemption are also tax-free.
The final period exemption works to shelter any gain arising in the final period of ownership from capital gains tax if the property has at any time, however briefly, been the owner’s only or main residence. This can be particularly useful if the property is, say, lived in as a main home and then let out prior to being sold, or where a person has two or more residences.
Prior to 6 April 2020, the final period exemption applies generally to the last 18 months of ownership. Where the person making the disposal is a disabled person or a long-term resident in a care home, the final period exemption applies to the last 36 months of ownership.
From 6 April 2020, the final period exemption is reduced to nine months, although it will remain at 36 months for care home residents and disabled persons.
Where a property which has been occupied as a main residence at some point, it could be very advantageous to dispose of it prior to 6 April 2020 rather than after that date to benefit from the longer final period exemption.
Frankie has a cottage on the coast that he brought on 1 January 2010 for £200,000. He lived in it as his main residence for two years until 31 December 2011, when he purchased a city flat which has been his main residence since that date. He continues to use the cottage as a holiday home.
He plans to sell the cottage and expects to get £320,000.
Scenario 1 – sale on 31 March 2020
If Frankie sells the cottage on 31 March 2020, he will have owned the cottage for a total of 10 years and three months (123 months). Of that period, he lived in it for 24 months as his only or main residence. As the sale takes place prior to 6 April 2020, he will benefit from the final period exemption for the last 18 months.
The gain on sale is £120,000 (£320,000 - £200,000)
He qualifies for 42 months’ private residence relief, which is worth £40,976 (42/123 x £120,000).
The chargeable gain is therefore £79,024 (£120,000 - £40,976).
Scenario 2 – sale on 30 April 2020
If Frankie does not sell the property until 30 April 2020, he will only benefit from a nine-month final period exemption. If he sells on this date, he will have owned the property for 124 months. Assuming the sale price remains at £320,000 and the gain at £120,000, the gain which is sheltered by private residence relief is £31,935 (33/124 x £120,000), and the chargeable gain is increased to £88,065 (£120,000 - £31,935).
If planning to dispose of a property which has been an only or main residence for some but not all of the period of ownership, selling prior to 6 April 2020 will enable the owner to shelter the gain pertaining to the last 18 months of ownership.
Be aware of 60% tax rate risk on bonuses
In the lead up to Christmas and the end of the financial year for many businesses, some directors and employees may be fortunate enough to be thinking of a bonus. If this is the case, it might be worth reviewing things beforehand to see if there is a risk of suffering effective tax rates of up to 60%, and if so, whether this can be avoided.
The risk of paying a high effective tax rate on a bonus stems from the abatement of the personal tax allowance where the individual’s ‘adjusted net income’ is equal to, or above, £100,000 for a particular tax year. The personal tax allowance for 2019/20 is £12,500, but this will be reduced by £1 for every £2 the taxpayer’s income is over that limit. The personal allowance may be reduced to nil from this income limit. Broadly, ‘adjusted net income’ is total taxable income before any personal allowances, less certain tax reliefs (including trading losses, Gift Aid donations, and pension contributions).
As a consequence of the personal allowance abatement rules, a taxpayer with income between £100,000 and approximately £119,000 will suffer marginal tax rates of up to 60% as the personal allowance is withdrawn.
Graham is an employee of a company from which he draws a salary of £100,000 per annum He has no other sources of income. In December 2019 he will be paid a bonus of £7,000. He is entitled to a personal tax allowance of £12,500 in 2019/20, but he loses £3,500 of it (£1 for every £2 earned over £100,000 ((£107,000 – £100,000) /2)), leaving him with an allowance of £9,000. He will pay tax of £2,800 (£7,000 × 40%) on the bonus, plus an extra £1,400 due to lost allowances (£3,500 × 40%). His total tax attributable to the bonus is therefore £4,200. Graham will therefore pay tax on the bonus at an effective rate of 60% (£4,200/£7,000 x 100).
Hannah on the other hand, receives an annual salary of £125,000 from employment. She also has no other sources of income. Hannah is also expecting to receive a bonus of £7,000 in December 2019. She is entitled to a personal tax allowance of £12,500 in 2019-20, but she loses entitlement to all of it because her basic salary exceeds the point at which the allowance is fully withdrawn (£125,000). Receiving the bonus, therefore, results in no further adjustment to her personal allowance. She will simply pay tax of £2,800 (£7,000 × 40%) on the bonus, which means that her effective tax rate on that part of his income is only 40%.
So, what action can be taken to minimise exposure to these marginal rates?
Taxpayers with income slightly exceeding the £100,000 ceiling may avoid losing some or all of their personal allowance by taking steps to reduce ‘adjusted net income’ to below the abatement threshold. Options worth considering may include:
• Increasing pension contributions - for example, a taxpayer with income of £105,000 might consider making a pension contribution of £5,000. They will get 40% tax relief on the contribution, and the full personal allowance will be reinstated.
• Making donations to charity under the Gift Aid scheme. For the charity, the donation is assumed to be made net of basic rate tax, which the charity claims back from HMRC. For the taxpayer, their basic rate tax band is increased by the value of the gross donation, which in turn reduces the amount of income to be taxed at the higher rate.
• Consider transferring income-producing assets to a lower-earning spouse or partner.
As with all tax planning opportunities, the wider picture should be considered before taking any action. In particular, the benefits of any tax saving need to outweigh the cost and administrative inconvenience of the transaction.
Annual investment allowance or writing down allowance?
The way in which relief for capital expenditure is given depends on the way in which the accounts are prepared. For companies, and for sole traders and partnerships not eligible to use the cash basis, accounts must be prepared using the traditional accruals basis.
Under the accruals basis, a deduction is not permitted for capital expenditure when computing profits; instead relief is given in the form of capital allowances. By contrast, where accounts are prepared using the cash basis, capital expenditure can be deducted in computing profits unless the expenditure is of a type for which a deduction is expressly denied, as is the case for expenditure on land, buildings and cars.
AIA v WDA
There are two main types of capital allowance available for expenditure on plant and machinery – the annual investment allowance and writing down allowances. The annual investment allowance (AIA) gives an immediate deduction against profits, whereas the writing down allowance (WDA) provides a deduction over a number of years (the tax equivalent of depreciation).
Nature of the AIA
The annual investment allowance allows a business to deduct the full cost of an item when calculating taxable profits, as long as the available annual investment allowance is sufficient and the expenditure is qualifying expenditure.
It can be claimed on most items of plant and machinery, but is not available in respect of cars.
The AIA limit is set at £1 million from 1 January 2019 to 31 December 2020. It is due to revert to the normal level of £200,000 from 1 January 2021.
Where the accounting period falls wholly within the period from 1 January 2019 to 31 December 2020, the AIA limit is £1 million; where it spans either of these dates, transitional rules apply to determine the limit – check your limit for these periods with your accountant.
Nature of WDAs
Writing down allowances may be claimed where the AIA is not available, either because the limit has been used up or because the expenditure is of a type, such as that on cars, which does not qualify for the AIA. There are different rates of writing down allowance.
Items in the main rate pool attract a writing down allowance of 18%. The allowance is calculated on a reducing balance basis. Items are allocated to the main pool unless they are of a type that must be allocated to a single rate pool or they are in a single asset pool. Cars with CO2 emissions of more 130g/km or more, features integral to a building, long life assets or thermal insulation are allocated to the special rate pool, which has a lower rate of writing down allowance of 6%. Some assets, such as new cars with CO2 emissions of 50g/km or less qualify for 100% first year allowances.
AIA or WDA – which is better
Although the AIA provides immediate relief for expenditure, claiming the AIA will not always be the best option. If the trader is only planning to keep the asset for a short time, claiming the AIA now may trigger a large balancing charge on disposal – this may be something that the business wishes to avoid.
It may also be preferable to claim a writing down allowance where claiming the AIA would result in the personal allowance being wasted or create a loss.
There is no one size fits all – discuss the best option for your business with your accountant. Remember you can tailor the claim; it is not mandatory to claim the AIA on the full amount of the expenditure. However, the AIA can only be claimed in the period in which the expenditure is incurred. After that, any balance must be relieved by claiming WDAs.
Salary v dividend for 2019/20
A popular profits extraction strategy for personal and family companies is to extract a small salary, taking further profits as dividends. Where this strategy is pursued for 2019/20, what level should be the salary be set at to ensure the strategy remain tax efficient?
As well as being tax effective, taking a small salary is also advantageous in that it allows the individual to secure a qualifying year for State Pension and contributory benefits purposes.
Assuming the personal allowance has not been used elsewhere and is available to set against the salary, the optimal salary level for 2019/20 depends on whether the employment allowance is available and whether the employee is under the age of 21. The employment allowance is set at £3,000 for 2019/20 but is not available to companies where the sole employee is also a director (meaning that personal companies do not generally benefit).
In the absence of the employment allowance and where the individual is aged 21 or over, the optimal salary for 2019/20 is equal to the primary threshold, i.e. £8,632 a year (equivalent to £719 per month). At this level, no employee’s or employer’s National Insurance or tax is due. The salary is also deductible for corporation tax purposes. A bonus is that a salary at this level means that the year is a qualifying year for state pension and contributory benefits purposes – for zero contribution cost. Beyond this level, it is better to take dividends than pay a higher salary as the combined National Insurance hit (25.8%) is higher than the corporation tax deduction for salary payments.
Where the employment allowance is available, or the employee is under 21, it is tax-efficient to pay a higher salary equal to the personal allowance of £12,500. As long as the personal allowance is available, the salary will be tax free. It will also be free of employer’s National Insurance, either because the liability is offset by the employment allowance or, if the individual is under 21, because earnings are below the upper secondary threshold for under 21s (set at £50,000 for 2019/20). The salary paid in excess of the primary threshold (£3,868) will attract primary contributions of £464.16, but this is outweighed by the corporation tax saving on the additional salary of £734.92 – a net saving of £279.76. Once a salary equal to the personal allowance is reached, the benefit of the corporation tax deduction is lost as any further salary is taxable. It is tax efficient to extract further profits as dividends.
Dividends can only be paid if the company has sufficient retained profits available. Unlike salary payments, dividends are not tax-deductible and are paid out of profits on which corporation tax (at 19%) has already been paid.
However, dividends benefit from their own allowance – set at £2,000 for 2019/20 and payable to all individuals regardless of the rate at which they pay tax – and once the allowance has been used, dividends are taxed at lower rates than salary payments (7.5%, 32.5% and 38.1% rather than 20%, 40% and 45%).
Once the optimal salary has been paid, dividends should be paid to use up the dividend allowance. If further profits are to be extracted, there will be tax to pay, but the combined tax and National Insurance hit for dividends is less than for salary payments, making them the preferred option.
Can Airbnb lets qualify as furnished holiday lets?
Many Airbnb lets are used as holiday accommodation. From a tax perspective, furnished holiday lettings enjoy some tax advantages over other lets. So, is it possible for an Airbnb let to benefit from these advantages and what conditions must be met?
Qualifying conditions - Simply letting a property as furnished holiday accommodation is not in itself sufficient to qualify for the furnished holiday letting (FHL) treatment. As with other lets, Airbnb lets must meet the conditions set out in the legislation.
The first point to note is that the FHL treatment is only available to properties which are in the UK or the EEA and which are let furnished.
Occupancy conditions - There are three occupancy conditions which must be met for a property to be treated as FHL.
Condition 1 – the pattern of occupancy condition - The pattern of occupancy condition is met if the total of all lettings in the tax year exceeding 31 days is 155 days or less. The nature of holiday letting is multiple short lets rather than longer lets and this condition seeks to recognise this.
Condition 2 – the availability condition - To meet this condition the accommodation must be available for letting for at least 210 days in the tax year. Days where the owner stays in the property do not count as days when the property is available for letting.
Condition 3 – the letting condition - The letting condition is met if the property is let commercially as furnished accommodation to the public for at least 105 days in the tax year. Only commercial lets count towards this total – any days when the property is let to family or friends at a reduced rate or where they are allowed to use the property for free are ignored.
Longer term lets of more than 31 days are also ignored (unless a let which was supposed to be less than 31 days is extended due to unforeseen circumstances, such as a delayed flight or the holidaymaker becoming ill).
Averaging election - If a person has more than one property let as holiday accommodation (whether via Airbnb or similar or otherwise), an averaging election can be made where the letting condition of 105 days is not met. As long as the average let across all properties is at least 105 days in the tax year, the condition is treated as met. Thus, if a person has three holiday properties which were let commercially for periods of 31 days or less for at least 315 (3 x 105) days in the year, the average let would pass the test.
Period of grace election - A second election, a period of grace election, can be made if the landlord genuinely intended to meet the letting condition but was unable to do so, as long as the condition was met in the previous tax year. This will allow the property to continue to be treated as a FHL. If the condition is not met the following year, a second period of grace election can be made. However, if the condition is not met in the fourth year after two consecutive period of grace elections, the property will no longer qualify as a FHL.
Advantages - Qualifying as a FHL offers a number of advantages. It opens the door to various capital gains tax reliefs for traders, including entrepreneurs’ relief. The landlord is also eligible to claim plant and machinery capital allowances if the cash basis is not used. Profits also count as earnings for pension purposes.
Tax relief on business-related loans
Subject to certain conditions and restrictions, tax relief will generally be available for interest paid on loans to, or overdrafts of, a business in the form of a deductible expense. Different rules for loan interest relief apply to smaller businesses using HMRC’s cash basis for income tax purposes (see below).
One of the main qualifying conditions for the deduction is that the interest must be paid wholly and exclusively for the purposes of the business and at a reasonable rate of interest. Tax relief is only available on interest payments - the repayment of the capital element of a loan is never tax-deductible.
Where only part of a loan satisfies the conditions for interest relief, only a proportion of the interest will be eligible, for example, interest payable in respect of, say, a car used partly for business and partly for private purposes will be apportioned accordingly. Note, however, that tax relief is not available for an employee using a privately-owned car for the purposes of his or her employment, although tax-free business mileage payments may usually be claimed.
A deduction cannot be claimed for notional interest that might have been obtained if money had been invested rather than spent on (for example) repairs.
In addition, a deduction will not be allowed if a loan effectively funds a business owner’s overdrawn current/capital account.
Anti-avoidance rules exist to prevent tax relief on loan interest paid where the sole or main benefit to the payer from the transaction is to obtain a tax advantage.
In addition to loan interest relief, the incidental costs of obtaining loan finance, such as fees, commissions, advertising and printing, will also be deductible in most cases. The deduction for incidental costs is given at the same time as any other deduction in computing profits for income tax purposes.
From 2013/14 onwards, eligible unincorporated small businesses may choose to use the cash basis when calculating taxable income, and all unincorporated businesses have the option to use certain flat-rate expenses when calculating taxable income.
The general rule for businesses that have chosen to use the cash basis is that no deduction is allowed for the interest paid on a loan. This is however, subject to a specific exception. Where the deduction for loan interest would be disallowed under this general rule or because (and only because) it is not an expense wholly and exclusively for the trade, a deduction is allowed of up to £500.
This £500 limit does not apply to payments of interest on purchases, provided the purchase itself is an allowable expense, as this is not cash borrowing. However, if the item purchased is used for both business and non-business purposes, only the proportion of interest related to the business usage is allowable.
If a deduction is also claimed for the incidental costs of obtaining finance, the maximum deduction for both these expenses together is £500.
If a business has interest and finance costs of less than £500 then the split between business costs and any personal interest charges does not have to be calculated.
Businesses should review annual business interest costs - if it is anticipated that these costs will be more than £500, it may be more appropriate for the business to opt out of the cash basis and obtain tax relief for all the business-related financing costs.
Party time for small companies
Although there is no specific allowance for a Christmas party, or any other employer-provided social function, HMRC do allow limited tax relief against the cost of holding an ‘annual event’ for employees, providing certain conditions are met.
Broadly, the cost of staff events is tax deductible for the business. Specifically, the legislation includes a let-out clause, which means that entertaining staff is not treated for tax in the same way as customer entertaining. The expenses will be shown separately in the business accounts – usually as ‘staff welfare’ costs or similar.
There is no monetary limit on the amount that an employer can spend on an annual function. If a staff party costs more than £150 per head (see below regarding this threshold), the cost will still be an allowable deduction, but the employees will have a liability to pay tax and National Insurance Contributions (NICs) arising on the benefit-in-kind.
The employer may agree to settle any tax charge arising on behalf of the employees. This may be done using a HMRC PAYE Settlement Agreement (PSA), which means that the benefits do not need to be taxed under PAYE, or included on the employees’ forms P11D. The employer’s tax liability under the PSA must be paid to HMRC by 19 October following the end of the tax year to which the payment relates.
The full cost of staff parties and/or events will be disallowed for tax if it is found that the entertainment of staff is in fact incidental to that of entertaining customers.
VAT-registered businesses can claim back input VAT on the costs, but this may be restricted where this includes entertaining customers.
The employee’s position - A staff event will qualify as a tax-free benefit if the following conditions are satisfied:
• the total cost must not exceed £150 per head, per year
• the event must be primarily for entertaining staff
• the event must be open to employees generally, or to those at a particular location, if the employer has numerous branches or departments
The ‘cost per head’ of an event is the total cost (including VAT) of providing:
a) the event, and
b) any transport or accommodation incidentally provided for persons attending (whether or not they are the employer's employees),
divided by the number of those persons.
Provided the £150 limit is not exceeded, any number of parties or events may be held during the tax year, for example, there could be three parties held at various times, each costing £50 per head.
The £150 is a limit, not an allowance - if the limit is exceeded by just £1, the whole amount must be reported to HMRC.
The £150 exemption is mirrored for Class 1 NIC purposes, (so that if the limit is not exceeded, no liability arises for the employees), but Class 1B NICs at the current rate of 13.8%, will be payable by the employer on benefits-in-kind which are subject to a PSA.
If there are two parties, for example, where the combined cost of each exceeds £150, the £150 limit is offset against the most expensive one, leaving the other one as a fully taxable benefit.
Example - Generous Ltd pays for a Christmas party for its employees, which costs £150 per head and a further social event in the same tax year costing £45 per head. The Christmas party will be covered by the exemption, but employees will be taxed on subsequent social event costs as a benefit-in-kind.
Directors’ loans – Beware of ‘bed and breakfasting’
It can make sense financially for directors of personal and family companies to borrow money from the company rather than from a commercial lender. Depending on when in the financial year the loan is taken out, it is possible to borrow up to £10,000 for up to 21 months without any tax consequences. However, if the loan remains outstanding beyond a certain point, tax charges will apply.
Company tax charge - In the event that a loan made to a director of a close company in an accounting period remains outstanding on the date when the corporation tax for that period is due, the company must pay a tax charge (‘section 455 tax’) on the outstanding value of the loan. The trigger date for the charge is the corporation tax due date of nine months and one day after the end of the accounting period. The amount of section 455 tax is 32.5% of loan remaining outstanding on the trigger date.
Traps to avoid - In days of old, it was relatively simple to prevent a section 455 charge from applying by clearing the loan balance just before the trigger date and, if the director still needed the loan, re-borrowing the funds shortly after the trigger date (bed and breakfasting). However, anti-avoidance provisions mean that as a strategy this is no longer effective.
Trap 1 – The 30-day rule - The 30-day rule comes into play where, within a period of 30 days of making a repayment of £5,000 or more, the director re-borrows money from the company. The rule effectively renders the repayment in-effective up to the level of the funds that are re-borrowed. Section 455 tax is charged on the lower of the amount repaid and the funds borrowed within a 30-day window.
Example - John is a director of his personal company J Ltd. The company prepares accounts to 31 January each year. In May 2018, John borrowed £8,000 from the company. On 28 October 2019, he repays the loan with money lent to him by his wife. On 7 November 2019, he re-borrows £7,000 from the company to enable him to pay his wife back. He does not make any further borrowings in November 2019.
Corporation tax for the year to 31 January 2019 is due on 1 November 2019. Although the director’s loan is not outstanding on that date, the 30-day rule bites and only £1,000 of the repayment made on 28 October 2019 is effective -- £7,000 of the £8,000 paid back is re-borrowed within 30 days. Consequently, the section 455 charge applies to £7,000 – the lower of the repayment and the funds borrowed within 30-days of the repayment – and the company must pay section 455 tax of £2,275 (32.5% of £7,000).
Avoiding the trap - The 30-day rule can be avoided if the company pays the director a dividend, bonus or any other payment that’s taxable and this is used to repay part or all of a loan. In this situation, it’s OK to take another loan from the company within 30 days without the anti-avoidance rule being triggered. Keeping repayments and re-borrowings below £5,000 will also prevent the 30-day rule from biting.
Trap 2 – Intentions and arrangements rule - The ‘intention and arrangements’ rule applies where the balance of the loan outstanding immediately before the repayment is at least £15,000, and at the time a loan repayment is made there are arrangements, or an intention, to subsequently borrow £5,000.
This rule applies even where the new borrowing is outside 30 days. The rule bites if the repayment is made with the intention of redrawing at least £5,000 of the payment, irrespective of when this is done. Again, the rule does not apply to funds extracted by way of a dividend or bonus as these are within the charge to income tax.
Plan repayments carefully - Where looking to repay loans to prevent a section 455 charge from arising, these should be planned carefully to avoid falling foul of the traps.
Gift cards and the trivial benefits exemption
The trivial benefits exemption allows employers to ignore benefits in kind that cost £50 or less for tax purposes, as long as the conditions of the exemption are met. Where the exemption applies the benefit does not need to be reported to HMRC.
Staying within the scope of the exemption is perhaps easier said than done.
To qualify, the benefit must not be provided as a reward for services. This means, for example, giving an employee a bunch of flowers as a thank you for staying late to meet a deadline will not fall within the scope of the exemption, even if the flowers cost the employer £50 or less.
Further, the exemption only applies to benefits in kind – cash or vouchers which are exchangeable for cash do not qualify. The exemption is also lost if provision is made via a salary sacrifice scheme.
Unless the employee is a director of a close company, there is no limit on the number of tax-free trivial benefits that can be provided in a tax year; close company directors are subject to an annual cap of £300.
The problem with gift cards
HMRC have recently drawn attention to a potential problem that may arise where an employer uses a gift card to provide an employee with trivial benefits. It is easy to see how an employer who tops up a gift card several times a year would be confident that the trivial benefits exemption applies, provided that each top up is less than £50 and the other conditions are met.
However, rather than considering each top-up in isolation, HMRC’s approach is to treat the gift card as a single benefit and look at the total amount put on the gift card in the tax year – if this is more than £50, their view is that the trivial benefits exemption does not apply.
An employer is keen to make use of the trivial benefits exemption to provide employees with tax free benefits. The employer provides each employee with a gift card at the start of the tax year with a balance of £30. The employer then tops up the gift card by £30 each month. The gift card can only be used for purchases; it is not exchangeable for cash.
As each top up is less than £30, the employer thinks that the trivial benefits exemption is in point and does not report the benefit to HMRC.
However, from HMRC’s perspective, the employer has provided employees with a benefit that cost £360 for the tax year – as this is more than £50 the trivial benefits exemption does not apply.
Employers should avoid topping up gift cards – this trap can be avoided by providing employees with a separate gift card each month. Changing the nature of the gift card each time further supports the view that each benefit stands alone.
Avoid tax traps on setting up
Successful entrepreneurs often move from one business project to another.
If you are about to start up a new business having closed down an old one, be careful not to fall into the phoenix trap.
This is when one company is liquidated, so the cash accumulated in the company is distributed to the shareholders and subject to capital gains tax. Then the same owner starts a new business running a very similar trade, only to close that after a few years and phoenix again.
The targeted anti-avoidance rule (TAAR) can ruin this strategy as the accumulated cash distributed on liquidation is taxed as income rather than as a gain.
The TAAR applies when the person who receives the distribution starts up a similar trade or activity (not necessarily in a company) within two years of the liquidation. It must also be reasonable to assume that the main purpose, or one of the main purposes, behind winding up the company was to reduce the owner's income tax liability.
HMRC can argue that the TAAR may also apply when the original company is sold rather than liquidated by the owners.
There will be a range of circumstances between selling the company with no intention to work in the area again and disposing of the assets and trade of the company then selling the cash-rich shell to a third party to liquidate. In the latter case HMRC may invoke the general anti-abuse rule (GAAR) to counter the perceived tax avoidance.
If you are planning to sell your company and start another, please talk to us first so that we can steer you out of the phoenix trap.
Zero charge for zero emission cars
From 6 April 2020, the way in which carbon dioxide emissions for cars are measured is changing – moving from the New European Driving Cycle (NEDC) (used for cars registered prior to 6 April 2020) to the Worldwide Light Testing Procedure (WLTP) for cars registered on or after 6 April 2020.
For an introductory period, the appropriate percentages for cars registered on or after 6 April 2020 are reduced – being two percentage points lower than cars with the same CO2 emissions registered prior to 6 April 2020 for 2020/21 and one percentage point lower for 2021/22. From 2022/23 the appropriate percentages are aligned regardless of which method is used to determine the emissions.
Zero emission cars
As part of the transition, the appropriate percentage for zero emission cars is reduced to 0% for 2020/21 and to 1% for 2021/22. This applies regardless of when the car was registered.
The charge was originally set at 2% for 2020/21 and 2021/22, and will revert to this level from 2022/23.
Electric company car drivers were already set to enjoy a tax reduction. The appropriate percentage for 2019/20 is 16% and was due to fall to 2% from 6 April 2020. However, the further reduction to 0% means that those who have opted for an electric company car can enjoy the benefit tax-free in 2020/21. Their employers will also be relieved of the associated Class 1A National Insurance charge.
Kim has an electric company car throughout 2019/20, 2020/21 and 2021/22. The car has a list price of £32,000. Kim is a higher rate taxpayer.
In 2019/20, Kim is taxed on 16% of the list price – a taxable benefit of £5,120. As a higher rate taxpayer, the tax hit is £2,048 (40% of £5,120). Her employer must also pay Class 1 National Insurance of 13.8% on the taxable amount (£706.56).
In 2020/21, the appropriate percentage is 0% so there is no tax or Class 1A National Insurance to pay. This is a significant reduction compared to 2019/20.
In 2021/22, the charge is 1% of the list price, equal to £320, on which the tax is £128 (assuming a 40% tax rate) and the Class 1A National Insurance is £44.16.
From 2021/22 the charge is 2% of the list price – equal to £640.
Not quite zero emissions
It is also possible to enjoy a company car tax-free in 2020/21 if it is registered on or after 6 April 2020, has emissions of between 1 and 50g/km (measured under the WLTP) and an electric range of at least 130 miles.
The benefits of choosing electric cars from a tax perspective, as well as from an environmental one, are significant.
Make use of the CGT inter-spouse exemption
There are a number of tax concessions available to married couples and civil partners which recognise that their financial affairs may be interlinked. One of these concessions relates the transfer of assets between spouse and civil partner for capital gains tax purposes. The disposal is deemed to take place at a value which gives rise to neither a gain nor a loss. This means that the spouse or civil partner making the disposal does not end up with a capital gains tax bill; the spouse or civil partner acquiring the asset simply takes over his or her partner’s base cost. This rule can be very useful from a tax planning perspective as the following case studies show.
Case study 1
Jane and John have been married for a number of years. Jane has built up a portfolio of shares, which she wishes to now sell so that the couple can take a mid-life gap year. The sale of the shares will realise a gain of £30,000. Jane is a higher rate taxpayer and John is a basic rate taxpayer. Neither has used their 2019/20 annual exemption and the intention is to sell the shares before the end of the 2019/20 tax year.
The annual exemption for 2019/20 is set at £12,000.
If Jane simply goes ahead and sells the shares, she will realise a chargeable gain of £18,000 after deducting the annual exempt amount. As a higher rate taxpayer, the gain will be taxed at 20%, giving rise to a capital gains tax bill of £3,600.
However, if Jane and John make use of the inter-spouse exemption to transfer shares which would otherwise give rise of a gain of £18,000 to John, the position is very different. Jane is left with a gain of £12,000 which is covered by her annual exempt amount, leaving nothing in charge. John, however, is left with a chargeable gain of £6,000 (£18,000 - £6,000) after deducting his annual exempt amount. As the gain falls within his basic rate band, it is taxed at 10%, resulting is a capital gains tax liability of £600.
By making use of the inter-spouse exemption, the couple’s combined capital gains tax bill is reduced by £3,000.
Case study 2
Karamo owns an investment property jointly with his civil partner Robert. The property is let and the couple receive rental income of £20,000 a year. Karamo is a higher rate taxpayer, whereas Robert is in the process of setting up a photography business and earning around £14,000 a year.
Each civil partner is deemed to have received rental income of £10,000 a year. Karamo pays tax of £4,000 (£10,000 @ 40%) on his share, while Robert pays tax of £2,000 (£10,000 @ 20%) on his share. The total tax paid on the rental income is therefore £6,000.
By making use of the inter-spouse exemption, Karamo transfers his share of the property to Robert. As a result, Robert receives all the rental income, which is now all taxed at 20%, reducing the tax bill to £4,000, saving the couple £2,000 a year.
Where entrepreneurs' relief falls short
When you sell your business you can expect to pay capital gains tax on any gains you make.
Currently CGT is payable at 10% (if within your basic rate band for income tax) or 20% on such gains. But the 10% rate can also apply to gains of up to £10m if entrepreneurs' relief (ER) applies.
To qualify for ER the business must have been trading for at least two years before the sale date. A business is trading when most or all of its activities relate to a trade rather than to investments.
The focus for ER is on the effort put in to produce the trading or investment income, rather than the proportion of turnover which is generated by the investments compared to the trade.
For example, a cash-rich company may receive much of its income from passive investments but the directors spend all of their time try-ing to drum up new sales leads. As long as the majority of the activities of the company (expenses and time spent) relate to the trade, the company will be considered to be trading even if most of the income arises from the passive investments.
By contrast, a company which owns a let property that the directors spend some time managing will not be considered to be a trading company unless there is some other activity within the company which can be classified as a trade. Letting a property is only regarded as a trade if there are considerable activities around receiving and catering for those who pay the rent.
Furnished holiday accommodation let on a commercial basis is regarded as a trade, as is a bed and breakfast business or a hotel. However letting an industrial unit is not generally treated as a trading activity.
If you are thinking of selling your business, ask us to check whether ER will apply before you agree the terms of the sale.
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Special tax rules apply to scholarships, which include exhibitions, bursaries or other similar education endowments.
Provided certain conditions are met, there will be no tax or reporting implications where an employer funds a ‘fortuitous’ scholarship for an employee’s family member. Broadly, this means that there must be no direct connection between the employee working for the employer and their family member getting the scholarship.
A scholarship is 'fortuitous' if all the following apply:
• the person with the scholarship is in full-time education
• the scholarship would still have gone to that person even if their family member did not work for the employer
• the scholarship is run from a trust fund or under a scheme
• 25% or fewer of the payments made by the fund or scheme are for employment-linked scholarships
If the scholarship does not qualify for exemption, the employer must report it to HMRC on form P11D and pay Class 1A NICs on the cost of providing it.
Unfortunately, in a family company, directors’ children are unable to take advantage of this provision because the tax legislation deems there to be a benefit in kind. However, in some circumstances a remoter relative (for example a grandparent) could establish such a scheme provided that the student was validly employed and their parents are not involved with the company.
Sandwich courses - An employee in full-time employment may leave that employment for a period to attend an educational establishment but continue to receive payments from their employer, for example where the employee is on a ‘sandwich’ course. Such payments will be treated as exempt from income tax, provided the following conditions are satisfied:
1. The employer must require the employee to be enrolled at the educational establishment for at least one academic year and to attend the course for at least 20 weeks in that academic year. If the course is longer, the employee must attend for at least 20 weeks on average, in an academic year over the period of the course.
2. The establishment must be a recognised university, technical college or ‘similar educational establishment’, open to the public and offering more than one course of practical or academic instruction.
3. The payments must not exceed a specified maximum figure for the academic year. This figure must include lodging, subsistence and travel allowances but does not include any tuition fees payable to the establishment by the employee. Note that:
(a) the exemption can apply to payments of earnings payable to the student for periods spent studying at the educational establishment
(b) it cannot, however, cover payments made for any periods spent working for the employer, whether during vacations or otherwise
(c) the current maximum figure is £15,480 per academic year
(d) in principle, the limit is all or nothing: if it is breached then the whole amount is taxable. However, if an increased payment is made during the academic year then this does not invalidate earlier payments made within the agreed limit
Qualifying payments will also be exempt for Class 1 National Insurance Contributions purposes.
Director’s salary or bonus?
Given current tax rates, paying a dividend rather than a salary will often be a more cost-effective way of withdrawing profits from a company. Tax is currently payable on any dividend income received over the £2,000 annual dividend allowance at the following rates:
• 7.5% on dividend income within the basic rate band (up to £37,500 in 2019-20)
• 32.5% on dividend income within the higher rate band (£37,501 to £150,000 in 2019-20)
• 38.1% on dividend income within the additional rate band (over £150,000 in 2019-20)
However, if the company is loss-making and has no retained profits, it will not be possible to declare a dividend, and an alternative will need to be considered. This often involves an increased salary or a one-off bonus payment.
From a tax perspective, the position will be the same whether a salary or bonus is paid. Both types of payment attract income tax at the recipient’s relevant rate of tax (20%, 40% or 45% as appropriate).
However, from a National Insurance Contributions (NICs) perspective, the position, and any potential cost savings, will depend on whether or not the payment is made to a director.
Directors have an annual earnings period for NIC purposes. Broadly, this means that NICs payable will be the same regardless of whether the payment is made in regular instalments or as a single lump sum bonus. In addition, since there is no upper limit of employer (secondary) NICs, the company’s position will be the same regardless of whether the payment is made by way of a salary or a bonus.
Where a bonus or salary payment is to be made to another family member who is not a director, the earnings period rules mean that it may be possible to save employees’ NICs by paying a one-off bonus rather than a regular salary.
Example - Henry is the sole director of a company and an equal 50% shareholder with his wife Susan. In 2019/20 they each receive a salary of £720 per month.
In the year ended 31 March 2020, the company makes profits of £24,000 (after paying the salaries). The profits are to be shared equally between Henry and Susan. They want to know whether it will be more cost effective to extract the profits as an additional salary – each receiving an additional £1,000 per month for the next twelve months - or as a one-off bonus payment with each receiving £12,000.
The income tax position will be the same regardless of which method is used.
As Henry is a director, his NIC position will be the same regardless of which route is taken as he has an annual earnings period for NIC purposes.
Susan is not a director, so the normal earnings period for NIC in a month will be the interval in which her existing salary is paid.
Assuming NIC rates and thresholds remain the same in 2020/21, if Susan receives an additional salary of £1,000 a month, she will pay Class 1 NIC of £120 (£1,000 x 12%) a month on that additional salary. Her annual NIC bill on the additional salary of £12,000 will be £1,440.
However, if she receives a lump sum bonus of £12,000 in one month (in addition to her normal monthly salary of £720), she will pay NIC on the bonus of £585 ((£3,450 x 12%) + (£8,550 x 2%)).
Paying a bonus instead of a salary reduces Susan’s NIC bill by £855.
Finally, it is important to note that in determining an effective company profit extraction strategy, tax should never be the only consideration. Any profit extraction strategy should be consistent with the wider goals and aims of the company.
Grounds and gardens for SDLT
Stamp duty land tax (SDLT) on residential property also applies to land that form the garden or grounds of the property. To ensure that the right rate of SDLT is applied, it is therefore important to ascertain whether any land purchased with a property constitutes its garden or grounds. The rules here are not the same as those applying for capital gains tax private residence relief.
HMRC have recently updated their guidance in this area.
Status of the building - The first step in determining whether land is residential land is to determine the status of the associated building. If the building is a residential property for SDLT purposes, all land forming part of the ‘garden or grounds’ is residential property. Consequently, if at the time of purchase the property is not capable of being used as a dwelling, or is in the process of being constructed or adapted for residential use, the building is not residential property for SDLT purposes and any associated land is also not residential property.
Status of the land - Land that constitutes the ‘garden or grounds’ of a building which counts as residential property for SDLT purposes will also be residential property, and therefore subject to SDLT residential property rates, even if it is sold separately from the building.
The key date is the date of the transaction. However, past use of the land is taken into account by HMRC is order to establish the relationship between the land and the building. Future or planned future use is not relevant, although where use changes over time, the status of the land may also change.
No single factor - In deciding whether land counts as ‘garden or grounds’ a range of factors will come into play – there is no single determining factor. However, not all factors will carry equal weight. It is necessary to consider how the land is used.
Questions to ask include:
• Is there evidence that the land has been actively and substantially exploited on a commercial basis?
• If the activity could be for leisure or commercial purposes, such as beekeeping or equestrian use, is there evidence of commercial use?
• Has a lease been granted to a third party for exclusive use of the land? This would suggest that the land is unlikely to be 'garden or grounds'.
• Is the land of a type which would be expected to be ‘garden or grounds’ unless commercial use is established, such as land used as a paddock or orchard?
• Is the land agricultural land which is sitting fallow? Such land is unlikely to be regarded as ‘garden or grounds’.
Outbuildings - The nature and layout of any outbuildings can be significant in determining whether land is ‘garden or grounds’. The presence of domestic outbuildings, areas laid out for hobbies, small orchards or stables and paddocks suitable for leisure use would indicate that the land is ‘garden or grounds’. However, the presence of commercial farming, commercial woodland, commercial equestrian use or other commercial use would suggest the contrary.
Size and proximity to dwelling - Physical proximity to the dwelling makes it more likely that the land is ‘garden or grounds’. However, land separated from the building may also fall into this category.
The size of the land in relation to the size of the building will also be relevant – a small cottage is unlikely to have a garden and grounds of many acres but a stately home may do.
The overall picture - In deciding the character of the land for SDLT purposes, it is necessary to look at the overall picture that emerges at the transaction date.
Electricity for electric cars – a tax-free benefit
The Government is keen to encourage drivers to make environmentally friendly choices when it comes to choosing a car. As far as the company car tax market is concerned, tax policy is used to drive behaviour, rewarding drivers choosing lower emission cars with a lower tax charge, while penalising those whose choices are less green.
The use of the tax system to nudge drivers towards embracing electric cars also applies in relation to the taxation of ‘fuel’. As a result, tax-free benefits on are offer to those drivers who choose to ‘go electric’.
Company car drivers
Electricity is not a ‘fuel’ for the purposes of the fuel benefit charge. This means that where an employee has an electric company car, the employer can meet the cost of all the electricity used in the car, including that for private journeys, without triggering a fuel benefit charge. This can offer significant savings when compared with the tax bill that would arise if the employer pays for the private fuel for a petrol or diesel car. However, it should be noted that a fuel charge may apply in relation to hybrid models.
Maisy has an electric company car with a list price of £20,000. Her employer meets the cost of all electricity used in the car, including that for private motoring. As electricity is not a fuel for these purposes, there is no fuel benefit charge, and Maisy is enabled to enjoy her private motoring tax-free.
By way of comparison, the taxable benefit that would arise if the employer meets the cost of private motoring in a petrol or diesel company car with an appropriate percentage of 22% would be £5,302 (£24,100 @ 22%) for 2019/20. The associated tax bill would be £1,060.40 for a basic rate taxpayer and £2,120.80 for a higher rate taxpayer.
However, the rules do not mean that an employee loses out if they have an electric company car and initially meets the cost of electricity for business journeys and reclaim it from their employer. There is now an advisory fuel rate for electricity which allows employers to reimburse employees meeting the cost of electricity for business journeys at a rate of 4p per mile without triggering a tax bill. However, amounts in excess of 4p per mile will be chargeable.
Employees using their own cars
Currently, there is no separate rate for electric cars under the approved mileage payments scheme. This means that the usual rates apply where an employee uses his or her own electric car for business. Consequently, the employer can pay up to 45p per mile for the first 10,000 business miles in the year and 25p per mile for subsequent business miles tax-free. If the employer pays less than this, the employee can claim a deduction for the shortfall. Payments in excess of the approved amounts are taxable.
Employees with their own electric cars can also enjoy the benefit of tax-free electricity for private motoring – but only if they charge their car using a charging point provided by their employer at or near their place of work. The exemption also applies to cars in which the employee is a passenger, so would apply, for example, if an employee’s spouse drove the employee to work, charging their car when dropping the employee off or picking the employee up.
Self-employed – How to calculate your payments on account
The deadline for filing the self-assessment tax return for 2018/19 is 31 January 2020. This is also the date by which any outstanding tax for 2018/19 must be paid and, where payments need to be made on account, the date by which the first payment on account of the 2019/20 liability must be made.
What is a payment on account? - As the name suggest, a payment on account is an advance payment towards a taxpayer’s tax and Class 4 National Insurance bill. Where payments on account are due, the tax is payable in two instalments on 1 January in the tax year and on 31 July after the tax year rather than in full in a single instalment of 31 January after the tax year.
As the payments on account are based on the previous year’s liability, it is not an exact science – there may be more tax to pay or the taxpayer may have paid too much. Any balancing payment must be made by 31 January after the end of the tax year. If the taxpayer has paid too much, the excess will normally be set against the next year’s payments on account or refunded if none are due.
When must payments on account be made? - Payments on account must be made where tax and Class 4 National Insurance for the previous tax year was £1,000 or more, unless at least 80% of the tax owed has been deducted at source, for example under PAYE.
Payments on account are not required when tax and Class 4 National Insurance bill for the previous year was less than £1,000.
Calculating the payments on account - Each payment on account is 50% of the previous year’s tax and Class 4 National Insurance liability.
Class 2 National Insurance contributions are not taken into account in calculating the payments on account and must be paid in full by 31 January after the end of the tax year.
Example - Richard is a sole trader. In 2018/19 his profits from self-employment were £30,000. He has no other income.
His income tax liability for 2018/19 is £3,630 (20% (£30,000 - £11,850)) and his Class 4 National Insurance liability is £1,941.84 (9% (£30,000 - £8,424).
His combined tax and Class 4 National Insurance liability is thus £5771.84.
As this is more than £1,000, he must make payments on account of the 2019/20 tax year of £2,785.92 on 1 January 2020 and 31 July 2020. Each payment is 50% of the previous year’s liability of £5771.84. If the liability for 2019/20 is more than £5,771.84, the balance must be paid by 31 January 2021, together with the Class 2 National Insurance for 2019/20.
Beware fluctuating years - Where the tax and Class 4 liability is under £1,000 one year but not the next, the payments can fluctuate widely – this may hit the taxpayer hard.
Example - Tim has a tax and Class 4 National Insurance liability of £900 in 2017/18. As a result, he is not required to make payments on account for 2018/19. However, 2018/19 is a good year and his tax and National Insurance liability is £4,000. As payments on account were not made, the amount is due in full by 31 January 2020. Also, because it is more than £1,000, he must make payments on account for 2019/20.
As a result, he has to pay £6,000 on 31 January 2019 – the full liability for 2018/19 (£4,000) and the first payment on account of £2,000 (50% of £4,000) for 2019/20. The second payment on account for 2019/20 of £2,000 is due by 31 July 2020.
Reduce payments on account - If the taxpayer knows that income in the current year will be less than the previous year, they can ask HMRC to reduce the payments on account. However, interest is charged on the shortfall if the payments are reduced below the level they should be.
Can my company buy me a new bicycle?
The government introduced ‘cycle to work’ back in 1999. Broadly, this is an annual tax exemption that allows a business to loan bicycles and cycle safety equipment to employees as a tax-free benefit. This tax break has had a positive impact on workplace health and employee motivation and has encouraged new groups of people to take up physical activity. But can it work for small companies?
The ‘cycle-to-work’ tax breaks apply equally to directors of one-person limited companies as they do to regular employees of large businesses. This means that the company (the employer) can buy a bike and bike safety equipment and loan it to the director (the employee) for qualifying business journeys. There is no requirement for a formal agreement to be drawn up and no need for prior approval by HMRC.
The company can purchase the bike directly and reclaim VAT, where relevant, on the purchase price. For corporation tax purposes, a deduction may be claimed on the full cost of the bike using the capital allowances annual investment allowance (AIA).
The company can also provide any safety equipment for the cyclist i.e. helmets, high visibility jackets, cycle clips, and so on, and these will be treated as revenue expenditure, eligible for corporation tax relief.
There are a couple of conditions to be met in order to qualify for the deductions:
• ownership of the bike is not transferred to the employee during the loan period – so the bike remains owned by the company; and
• the equipment is used mainly for qualifying journeys. Broadly this means at least 50% business use - i.e. for journeys made between home and the workplace, or part of those journeys (for example, to the station), travel to clients or for journeys between one workplace and another.
Note that travel to work can include a permanent workplace, so the definition of what qualifies as a work journey for providing tax-free bicycles is wider than the normal travel rules.
For the director/employee, there will be no taxable benefit-in-kind arising from the use of the bike and there doesn’t need to be a reduction in salary to offset the cost of the bike. Therefore, the director’s salary summary will remain unaffected.
The director potentially saves on income tax, because the bike is being funded with gross fee income and not personal income. This could save between 20% - 25%, in comparison with the bike being purchased personally, depending on the director’s earnings.
If the bike is transferred into the director’s personal ownership at a future date a taxable benefit charge will arise based on the market value of the bike at that date. This contrasts slightly with the normal rule that specifies that a taxable benefit charge arises in the value of the bike at the time it was first provided to the employee. Where the bike is transferred, the company will pay corporation tax on the market price, but the director will have potentially gained significant tax relief on the bike’s purchase.
Note that the company owns the bike, the cost of any repairs will remain a cost to the company.
Mileage allowances - Along similar lines to claiming mileage for using a private motor vehicle for business journeys, it is also possible to claim mileage for bikes owned personally and used for journeys to and from a temporary workplace. HMRC allow cyclists to claim 20p per mile for business journeys.
On average, a person who cycles an additional five miles to work and back each week will burn up around 4,500 extra calories and reduce their carbon footprint by around 45kg CO2. With such positive health benefits to be gained, coupled with the current generous tax breaks on offer, swapping car journeys for pedal-power should be well worth considering.
Mileage allowance payments – what is NIC-free?
Employees frequently use their cars for work and may be paid a mileage allowance by their employer for doing so. Employers are generally familiar with the rates that can be paid tax-free; however, it is easy to assume (wrongly as it happens) that the same rules apply for National Insurance purposes. While it is true that mileage allowances can be paid NIC-free up to certain limits, there are differences in the rules.
Recap – The tax rules
Under the approved mileage allowance scheme, as long as employers do not pay a mileage allowance for business travel that is more than the ‘approved amount’, the allowance can be paid tax-free and does not need to be reported to HMRC. The approved amount is simply the number of business miles in the tax year multiplied by the relevant approved mileage rate. The rate for cars and vans is 45p per mile for the first 10,000 reimbursed business miles in the tax year and 25p per mile for any subsequent business miles.
If the amount paid exceeds the approved amount, the excess is taxable and must be reported on the employee’s P11D. By contrast, if the allowances paid by the employer are less than the approved amount, the employee can claim tax relief for the shortfall.
Unlike PAYE, NIC does not work on a cumulative basis – in determining the NIC liability for a particular earnings period, only the earnings for that period are taken into account. As a result of the non-cumulative nature of NICs, when looking at mileage payments, only those paid in the particular earnings period are relevant – it is not necessary to look at the position for the whole year. A consequence of this is that the 45p per mile rate for cars and vans applies for NIC purposes to all reimbursed business miles in the tax year, not just the first 10,000.
The terminology for National Insurance purposes is different too – rather than the ‘approved amount’ the relevant amount is the ‘qualifying amount’ (QA). As long as the mileage payments paid in the earnings period are not more than the qualifying amount, they are NIC-free.
The qualifying amount is found by the formula M x R where M is the number of business miles for which payment is being made and R is rate applicable to the vehicle at time that the payments were made. The rates are as follows:
• 45p per mile for cars and vans
• 24p per mile for motorcycles
If the mileage payments in the period (referred to as ‘relevant motoring expenditure’ (RME)) exceeds the qualifying amount, the excess is earnings for NIC purposes (but not for PAYE). Consequently, this excess is included in gross pay for NIC purposes but not for PAYE purposes – any excess over the approved amount for tax purposes is reported on the P11D.
Michelle uses her car for work. She is paid monthly. In one particular month she drives 750 business miles. Her employer pays a mileage allowance of 50p per mile.
The mileage payments made to Michelle in the month are therefore £375 (750 miles @ 50p per mile) and the qualifying amount is £337.50 (750 miles @ 45p per mile). As the payments (RME) exceed the qualifying amount (QA), the excess of £37.50 (£375 - £337.50) is treated as earnings and included in gross pay for NIC purposes.
Help employees beat the post-Christmas bulge
Promoting employee health and wellbeing is increasingly seen as a vital part of a successful business. According to government figures, in 2016/17, 1.3 million workers suffered from work-related ill-health, which equated to 25.7 million working days lost. This has been estimated to cost £522 per employee, and up to £32 billion per year for UK business. There are several areas where employers can use tax breaks and exemptions to help promote health and fitness at work.
Sporting facilities - Larger organisations are often able to offer gym or leisure facilities for staff in the workplace (or at a location convenient to work) run either by the organisation directly, or by a third-party provider. The facilities can be offered to employees to access for free or on a paid-for basis.
In-house gym facilities may be provided tax and NIC free if the following conditions are satisfied:
• the facilities must be available for use by all employees, but not to the general public;
• they must be used mainly by employees, former employees or members of employees’ families and households (employees of any companies grouped together with to provide the facilities also count);
• the facilities must not be located in a private home, holiday or other overnight accommodation (including any associated sporting facilities); and
• they must not involve use of a mechanically propelled vehicle (including road vehicles, boats and aircraft).
Where an employer is unable to provide in-house gym facilities, it may be possible to negotiate favourable membership rates with a local gym or leisure centre. Whilst this may lead to a tax liability for employees, the preferential rate can often be up to 20% - 30% cheaper than the normal price, so this is still an attractive offer for employees. Depending on how the cost of the gym membership is funded, the fees will either be taxed as earnings or as a taxable benefit-in-kind. So, for example, if an employer gives the employee additional salary to pay for their gym membership, the money is taxed as earnings through PAYE. If the employer pays the gym membership direct, a taxable benefit-in-kind arises on the employee and should be reported to HMRC on form P11D
Tax-breaks to promote good health - It’s a well-established fact that a healthier workforce is a more productive workforce. The government recognises these benefits too and has introduced several tax breaks to promote good health.
A tax and NIC-free exemption allows employers to fund one health-screening assessment and/or one medical check-up per year per employee. Subject to an annual cap of £500 per employee, employer expenditure on medical treatments recommended by employer-arranged occupational health services may be exempt for tax and employee NICs. ‘Medical treatment’ means all procedures for diagnosing or treating any physical or mental illness, infirmity or defect. Broadly, in order for the exemption to apply, the employee must have either:
• been assessed by a health care professional as unfit for work (or will be unfit for work) because of injury or ill health for at least 28 consecutive days;
• been absent from work because of injury or ill health for at least 28 consecutive days.
Employer-funded eye, eyesight test, and ‘special corrective appliances’ (i.e. glasses or contact lenses) may also be exempt for tax and NICs, providing certain conditions are satisfied.
Fitness and health issues inevitably become more popular following several weeks of seasonal festivities and the dreaded over-indulgences. Anything an employer can do to help employees beat the post-Christmas bulge is likely to be most welcome.
Should an LLP partner be treated as a salaried partner?
As a general rule, the individual partners in a partnership are treated as self-employed for tax purposes. Consequently, they pay tax under the self-assessment system and pay Class 2 and Class 4 National Insurance contributions on their profits.
However, in a limited liability partnership (LLP), some of the partners are more like employees in nature than partners in a traditional partnership. In recognition of this, legislation was introduced to treat such partners as employees rather than as self-employed partners, with the upshot that they are taxed on their partnership earnings (‘salary’) under PAYE rather than under self-assessment, and they pay Class 1 National Insurance rather than Classes 2 A and 4.
The salaried partner treatment only applies if all of the following three conditions are met.
Condition A is met if the partner receives a reward that is more like a salary than a share of business profits.
An amount falls within this condition if:
• it is fixed;
• it is variable but without reference to the overall amount of the profits of the LLP; or
• it is not, in practice, affected by the overall profits and losses of the LLP
However, it should be noted that payments made on account of a profit share are not treated as disguised salary and the payments are contingent on future profits being made.
Condition B is met if the mutual rights and duties of the members of the LLP and the rights and duties of the LLP and its members do not give the individual significant influence over the affairs of the LLP. This condition seeks to identify partners who do not have significant influence – in a traditional partnership, the partners are in business together and have an influence on how business is done and the decisions made. A partner who is more like an employee will lack that degree of influence.
A partner will, however, be regarded as having significant influence if they are involved in the day-to-day management. Partners acting in a senior management role who may leave the day-to-day running to others but who can exert significant influence over the strategic decision of the business will also be regarded as having significant control.
Condition C is met if the individual’s capital contribution is less than 25% of the disguised salary which it is reasonable to expect will be received by the partner in return for the services that they perform for the LLP. New partners are allowed two months in which to contribute the capital.
Where all of the above conditions are met by a partner of an LLP, the partner must be treated like an employee for tax and National Insurance purposes. Payments treated as salary are taxed under PAYE and the employee must pay Class 1 National Insurance contributions. The LLP must also pay secondary Class 1 National Insurance.
Dual purpose expenditure – can landlords claim a deduction?
Landlords are able to claim tax relief for expenses that are incurred wholly and exclusively for the purposes of the property rental business. However, some expenses have both a private and a business element. Where this is the case, is any relief available?
Business element separately identifiable
If it is possible to separate the business and the private expenditure, a deduction can be claimed for the business element. This may be the case, for example, in relation to a car which is used for both private journeys and for the purposes of the property rental business, to visit tenants or to check on the properties. Likewise, a landlord may use his or her mobile phone for private calls and also for business calls. From the call log, it will be possible to identify the business calls and to apportion the bill between business and private calls.
Business element cannot be separately identified
If the expenditure is dual purpose in nature and it is not possible to identify the business element, no deduction is allowed. The expenditure does not meet the ‘wholly and exclusively’ test, and as such is not deductible in computing the profits of the property rental business. An example of expenditure that may fall into this category is clothing, even if only worn for working in the property rental business. The clothing fails the wholly and exclusively test as it also provides the landlord with warmth and decency (a private purpose). However, it should be noted that a deduction is allowed for clothing that bears a conspicuous advert for the business, such as a sweatshirt featuring the name of the property rental business and the logo.
Dave is a landlord and has a number of properties that he rents out to students. He uses the same car for the purposes of the property rental business as for private journeys.
Dave undertakes the decorating and much of the maintenance on the properties himself. He has purchased overalls specifically for this purpose, which he wears only when undertaking work on the let properties. In the tax year, he spends £80 on overalls.
In the tax year in question, Dave drove 6,800 miles of which 4,200 were for the purposes of his property rental business.
A deduction is allowed for the business mileage. Dave uses the simplified mileage system, claiming a deduction of £1,890 (4,200 miles @ 45p per mile).
However, although he only wears the overalls when working on his let properties, the private benefit cannot be distinguished from the business use. Consequently, the ‘wholly and exclusively’ test is not met, and the £80 which Dave spent on overalls cannot be deducted in computing the taxable profit for his property rental business.
IT consultant held contract for services
HMRC’s application of the IR35 rules remains ambiguous after an IT contractor successfully appealed to the First Tier Tribunal (FTT) against a tax charge arising under the intermediaries' legislation.
In RALC Consulting Ltd v HMRC  TC 07474, the FTT allowed an appeal against HMRC's determination that IR35 applied because the ‘hypothetical contract’ between various parties making up the service provider chain lacked the requisite mutuality of obligation.
In this case, RALC Consulting Ltd (RALC) (the appellant), was the personal service company (PSC) of IT consultant Richard Alcock, who was the company’s sole director and shareholder.
During the tax years in question, RALC Consulting Ltd contracted with Mr Alcock’s former employer Accenture UK Ltd (Accenture) and with the Department for Work and Pensions (DWP), a client whose projects Mr Alcock had previously worked on, to provide Mr Alcock’s services working on a large IT project.
The contractual arrangements entered into by the appellant with Accenture and DWP were four-party chains, namely Mr Alcock, RALC, an agency, and the end clients. HMRC contended that as Mr Alcock had carried on working for his previous employer an ‘expectation of continued work existed’. The FTT, however, did not agree with HMRC’s submission that the long history of Mr Alcock’s previous engagement and operation of the contract in practice led to an expectation that Mr Alcock would be provided with work every day during the course of an assignment, such that it amounted to a legal obligation.
The FTT looked not only at the terms of the contract, but also at their application in practice and concluded that it was not satisfied on balance that sufficient ‘mutuality of obligations’ existed between Mr Alcock and the end clients in the hypothetical contracts to establish an employment relationship. Since there was no minimum obligation to provide work and no ability to charge for just making himself available, the FTT found that the key elements of mutuality, in the work, or wage bargain sense, were missing, and therefore Mr Alcock could not be considered an employee.
The Tribunal was satisfied that Mr Alcock had substantial control over his contracts and control over how he performed his services. The FTT also accepted that Mr Alcock’s engagements permitted him to provide a substitute but the end clients had the right to refuse to authorise any substitute proposed if they were deemed unsuitable. Therefore, while it was a genuine right of substitution, it was a fettered right subject to the approval of his clients.
The FTT concluded that the intermediaries legislation did not apply as the hypothetical contracts with the end clients indicated ‘contract for services’, meaning Mr Alcock would have been self-employed. HMRC’s determinations, decisions and notices were cancelled. The appellant was not liable to pay income tax and NICs assessed by HMRC. The appeal was allowed in full.
The outcome of the decision in this case rested largely on the FTT’s interpretation of mutuality of obligation. HMRC’s interpretation that where one party agrees to work for the other in return for payment satisfies mutuality of obligation between the two parties, was dismissed by the Tribunal. The appellant’s circumstances were such that they were not caught by the IR35 legislation, and in turn, this outcome now throws further uncertainty into the IR35 framework.
HMRC have recently updated their online Check Employment Status for Tax (CEST) tool. Whilst the tool does have flaws, it is generally held that if CEST gives the required answer then it can be relied upon, at least until circumstances change or it is challenged by HMRC. But if CEST does not give the required answer then an employment contract review is recommended.
Partner note: ITEPA 2003, Pt 2, Ch 8; RALC Consulting Ltd  TC 07474 (http://financeandtax.decisions.tribunals.gov.uk/judgmentfiles/j11432/TC07474.pdf); Check employment status for tax (CEST) tool: https://www.gov.uk/guidance/check-employment-status-for-tax
Buying a property to let – the importance of keeping records
For tax purposes, good record keeping is essential. Without complete and accurate records, it will not be possible to provide correct details of taxable income or to benefit from allowable deductions. Aside from the risk of paying more tax than is necessary, landlords who fail to take their record keeping obligations seriously may also find that they are on the receiving end of a penalty from HMRC.
Recording expenses - A deduction is available for expenses that are incurred wholly and exclusively for the purposes of the rental business. A deduction is available for qualifying revenue expenses regardless of whether the accounts are prepared on the cash basis or under the traditional accruals basis.
Revenue expenses are varied and are those expenses incurred in the day to day running of the property rental business. They include:
• office expenses • phone calls • cost of advertising for tenants • fees paid to a managing agent • cleaning costs • insurance • general maintenance and repairs
A record should be kept of all revenue expenses, supported by invoices, receipts and suchlike.
The treatment of capital expenditure depends on whether the cash or the accruals basis is used. For most smaller landlords, the cash basis is now the default basis.
Under the cash basis, capital expenditure can be deducted unless the disallowance is specifically prohibited (as in the case in relation to cars and land and property). Under the accruals basis, a deduction is not given for capital expenditure, although in limited cases capital allowances may be available. Capital expenditure would include improvements to the property and new furniture or equipment which does not replace old items.
Records should identify whether expenditure is capital or revenue and also whether it relates to private expenditure so that it can be excluded.
Records should also be kept of replacement domestic items and the nature of those items. A deduction is available on a like-for-like basis.
Start date - Although the property rental business does not start until the property is first let, records should start as soon as expenditure is incurred in preparation for the letting.
As well as allowing relief for expenses incurred while the property is let, relief is also available for expenses which are related to the property rental business and which are incurred in the seven years prior to the start of the business. Relief is given on the same basis as for expenses incurred after the start of the property rental business; expenses can be deducted as long as they are incurred wholly and exclusively for the purposes of the property rental business. Capital expenditure is treated in accordance with rules applying to the chosen basis of accounts preparation.
Relief is available under the pre-trading rules, as long as:
• the expenditure is incurred within a period of seven years before the date on which the rental business started
• the expenditure is not otherwise allowable as a deduction for tax purposes
• the expenditure would have been allowed as a deduction has it been incurred after the rental business had started
Relief is given by treating the expenses as if they were incurred on the first day of the property rental business.
Expenses incurred in getting a property ready to let can be significant. It is important that accurate records are kept of all expenditure incurred wholly and exclusively for the purposes of the let from the outset so that valuable deductions are not overlooked.
Correcting an overpayment of wages
Recording directors’ expenses correctly
It is only permissible for a company to deduct expenditure in computing its taxable profits if incurred wholly and exclusively for the purposes of the trade. Since a company is a separate legal entity that stands apart from its directors and shareholders, it will not incur personal expenses. However, many companies, particularly 'close' companies (broadly a company under the control of 5 or fewer participants) pay for personal expenses of the directors. It is important to note that where payments, either made to or incurred on behalf of a director, do not form part of their remuneration package, these amounts may not be an allowable company expense. In such circumstances it may be appropriate for these items to be set against the director's loan account. Establishing whether a payment forms part of a director's remuneration package can be complex and good record keeping is essential to back up such claims.
Accounting disclosure requirements for directors’ remuneration include sums paid by way of expense allowance and estimated money value of other benefits received other than in cash. The money value is not the same as the taxable amount, although this is often used in practice. This means the onus is on the director to justify why amounts not disclosed in accounts should be accepted as part of the remuneration package rather than debited to his or her loan account.
Where the expenditure forms part of the remuneration package it will be an allowable expense of the company and the appropriate employment taxes (PAYE income tax and NICs) should be paid, where relevant. Where the expenditure does not form part of the remuneration package the relevant amount should normally be debited to the director's loan account.
Cash transactions between the company and a director may have tax consequences. Broadly, at the end of an accounting period, if the director owes the company money, a tax charge may arise. Subject to certain conditions, a charge may arise where a director’s loan account is overdrawn at the end of the accounting period and remains overdrawn nine months and one day after the end of that accounting period. The tax charge (known as the ‘s 455 charge’) is the liability of the company and is calculated as 32.5% of the amount of the loan. The tax charge can potentially be avoided if the loan is cleared by the corporation tax due date of nine months and one day after the end of the accounting period.
Good record keeping of all cash and non-cash transactions between a company and its directors is essential. Poorly kept records can mean that information provided is not accurate, which in turn may result in non-business expenditure incurred by the directors being incorrectly recorded or misposted in the business records and claimed in error as an allowable expense. Conversely, justifiable business expenditure incurred by the directors may not be claimed or claimed inaccurately. Consequently, directors' loan account balances may be incorrect resulting in the company being liable for a s 455 charge if the loan account is overdrawn, or corporation tax relief not being claimed on allowable expenses by the company at the appropriate time.
A review of particular accounts headings may identify directors' personal expenditure that has not yet been allocated appropriately. Transactions should normally be recorded as they occur and a detailed transaction history maintained, so that it is possible to identify the director's loan account balance on any given date.
Properties not let at a commercial rent
There may be a number of reasons why a property is occupied rent-free or let out at rent that is less than the commercial rate. This may often occur where the property is occupied by a family member in order to provide that person with a cheap home. For example, a parent may purchase a house in the town where their student son attends university and let it to the student, and maybe even his housemates, at a low rent to help them out. While the parents’ motives are doubtless philanthropic, their generosity may cost them dearly when it comes to obtaining relief for the associated expenses.
Wholly and exclusively rule
Expenses can only be deducted in computing taxable rental profits if they are incurred wholly and exclusively for the purposes of the property rental business. Unfortunately, HMRC take the view that unless the property is let at full market rent and the lease imposes normal conditions, it is unlikely that the expenses are incurred wholly and exclusively for business purposes. So, where the property is occupied rent-free, there is no tax-relief for expenses.
If the property is let at a rent that is below the market rent, a deduction is permitted, but this is capped at the level of the rent received from the let. This means that where a property is let at below market rent, it is not possible for a rental loss to arise, or for expenses in excess of the rent to be offset against the rent received from other properties in the same property rental business.
Periods between lets
Where there are brief periods where the property is occupied rent-free or let out cheaply, it may be possible to obtain full relief for expenses. For example, if the landlord is actively seeking a tenant and a relative house sits while it is empty, relief will not be restricted as long as the property remains genuinely available for letting. In their guidance HMRC state, that ‘ordinary house sitting by a relative for, say, a month in a period of three years or more will not normally lead to loss of relief’. However, if a relative takes a month’s holiday in a country cottage, relief for expenses incurred in that period will be lost.
Commercial and uncommercial lets
Where a property is let commercially some of the time and uncommercially at other times, expenses should be apportioned on a just and reasonable basis between the commercial and non-commercial lets. Any excess of expenses over rents in the period when commercially let can be deducted in the computing the profit for the rental business as a whole. However, an excess of expenses over rent when the property is let uncommercially are not eligible for relief.
Timing must also be considered – expenses relating to uncommercial lets cannot be deducted simply because they are incurred when the property is let commercially.