Powers

From the 1 April 2009 HMRC will be aligning its powers across all taxes and duties. In a nutshell they will be able to exercise the following powers:

. a power to inspect records required under the record-keeping legislation - this restricts the existing VAT and PAYE inspections to statutory records and introduces a new power of inspection for direct tax;

. a power to require supplementary information which is relevant to establishing the correct tax position;

. a power to require third parties to provide information which is relevant to establishing a taxpayer’s correct tax position;

. a power to visit business premises and to inspect records, assets and premises;

. removal of VAT and PAYE powers to undertake inspections at private homes without taxpayer consent;

. appeal rights against any penalty, and against information notices which have not been pre-authorised by an appeal tribunal;

. penalties for failure to allow an inspection and failing to comply with an information notice, including a tax-geared penalty which can be imposed by the new upper tier tribunals; and

. an updated criminal offence of destroying or concealing records requested under a notice authorised by a tribunal.

An additional power that has recently been granted to HMRC is the right to intercept phone calls - “bugging” powers! The Customs branch have always had this right, and it is now rolled out to investigations that involve all taxes. The powers were granted in the Serious Crimes Act 2007; the relevant implementation date was 15 February 2008.

Penalties

The Budget March 2008 included provisions that will enable the Revenue to introduce a single penalty regime across all the taxes, levies and duties they administer.

The changes are likely to commence for all incorrect return periods commencing on or after 1 April 2009, where the return is due to be filed on or after 1 April 2010.

New penalties for failure to notify the commencement of a new taxable activity are expected to have effect for those that arise on or after 1 April 2009.

The penalty will be determined by the amount of:

. the tax understated,
. the nature of the behaviour giving rise to the understatement, and
. the extent of disclosure by the taxpayer.

The use of suspended penalties will be extended.

There will be no penalty where a taxpayer makes a mistake, but there will be a penalty of up to:

. 30 per cent of the tax understated for failure to take reasonable care;
. 70 per cent of the tax understated for a deliberate understatement; and
. 100 per cent of the tax understated for a deliberate understatement with concealment.

The measure will provide for each penalty to be substantially reduced where the taxpayer makes a disclosure (takes active steps to put right the problem), more so if this is unprompted.

. For an unprompted disclosure of a failure to take reasonable care the penalty could be reduced to nil.
. Where a taxpayer discloses fully when prompted by a challenge from HMRC each penalty could be reduced by up to a half.

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For disposals after 5th April 2008 a flat rate of 18% comes into effect. Unfortunately this did mean a big tax increase for small business owners looking forward to selling their businesses, perhaps to fund their retirement, or maybe planning to invest in a different business.

Entrepreneur relief has been introduced to help resolve this problem. This taxes the first £1 million gain at 10%.

Relief is available on

• the disposal of the whole or part of a business
• the disposal of assets used for the purposes of a business at the time when the business ceases to be carried on
• disposals of shares or securities in a company

An individual may make claims for relief on more than one occasion, with a lifetime limit of £1million in gains qualifying for relief. The annual exemption which for 2008/09 is £9,600 will remain, however indexation relief and taper relief disappear from April 2008.

The business must be a trade, profession or vocation and the company must be a trading company or the holding company of a trading group. The individual must have been involved (ie been the owner or a partner) in the business for a year prior to disposal. For shares in companies, the individual must have been an officer or employee of the company and owned 5% of the company’s ordinary share capital with 5% of the voting rights. There is no need to have been a full time officer.

For a disposal of assets these must have been in use for the purposes of the business at cessation of trading, relief remains available providing the assets are disposed of within three years of the date of cessation.

Property investments

Commercial property qualified for taper relief and hence the 10% tax rate. It is important for landlords to realise that their investments will not be classed as a ‘business’ and they will not receive the new entrepreneur relief on the sale of the property. This is a disadvantage over the old taper relief rules.

Property used for ‘furnished holiday lettings’ will be treated as a business and will qualify for the 10% rate. Property used in a business, or let to the owners trading company and sold at the same time as the business, will qualify. All other property will be taxed at the ‘universal’ 18% rate.

Davies McLennon are Stockport Accountants

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R&D tax credits are a company tax relief for investment into research and development projects. The R&D credit goes up to 175% from April 2008 (prior to this the relief was 150%)

What does this mean? well simply if you spend £100,000 on qualifying R&D you get tax relief on £175,000.

For companies not making profits, it is possible to use the relief against the PAYE tax to create a cash refund.

What R&D activity qualifies for the incentive?

The definition of qualifying R&D activity is wide-ranging and sometimes challenging to apply in practice. HM Revenue & Customs (HMRC) and the Department of Trade and Industry (DTI) have issued guidelines to help companies identify their eligible activity.

The activity has to:

• constitute an advance in the field; and
• resolve scientific or technological uncertainty.

And it is worth noting the following points:

• A project does not have to result in a success to qualify for the incentive.
• SSAP13 disclosure is not an essential prerequisite for a claim.
• R&D is not just done in laboratories: for example,engineering can qualify, as can back-office software infrastructure projects or improvements to manufacturing processes.
• R&D activity need not be undertaken in the UK to qualify.

What R&D costs are eligible for the incentive?

There are four main categories:

• Staffing costs - salary, national insurance costs, pension contributions (and benefits in kind, for a limited period).
• Consumable and transformable materials - materials consumed/transformed in the R&D process, software used directly in the R&D and limited overhead payments for power, fuel and water.
• Externally provided workers - agency staff and workers provided by group employment companies.
• Payments to qualifying bodies/contributions to independent R&D efforts.

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Under the current system, small enterprises (and if you receive our newsletter, thats what yours is) get 50% of the cost of a new item of equipment or a commercial vehicle allowed against profit in the year it was purchased and then 25% of whats left in year 2 and so on.

A new system begins in April 2008, this gives 100% of the cost in year 1, subject to an annual limit of £50,000. (Note the 100% does not apply to cars, although 100% relief can be claimed on certain fuel efficient cars).

This is good news for small business owners.

Balances on capital allowances pools of up to £1,000 can be written off from 1 April 2008, more good news.

Industrial Buildings Allowances are claimed on buildings used for manufacturing. The current allowance of 4% on the qualifying cost of the buildingreduces to 3% in April 2008 then 2% in April 2009 1% in April 2010 and disappears completely from April 2011.

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All the professional bodies and the small business organisations (such as the FSB and the Professional Contractors Group) have been lobbying hard for the changes due to be introduced on the 6th April 2008 to be postponed, thankfully Alistair Darling has seen the light.

The proposed changes were unworkable.

What’s the fuss about? Well HM Revenue & Customs or perhaps more accurately the Government, feel that where husband and wife are in business together as partners or as shareholders in a limited company, they should not be ‘allowed’ to share the income from the business. The ‘proposal’ is that income needs to be allocated strictly in accordance with the amount of work done. So if the wife does 90% of the work, then 90% of the income should be allocated to her. This is something that is certain to be extremely bureaucratic and difficult to enforce - many of the professional bodies have called the proposals “ill thought out” and “unworkable”.

How do you determine the contribution made by each partner? Looking at time alone is surely not good enough. It is possible to contribute key ideas and strategy into a business with very little time, and tyet contribute greatly to success! Isn’t the whole idea of marriage that it is a complete partnership, each partner contributing to home or work as they decide between themselves. The Governments proposals are in fact a massive disincentive to getting married.

So further review and consultations are to take place, with some possible legislation in April 2009.

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Have you ever invested in a company which has failed?

Did you know, if the conditions set out below apply, it may be possible to set off a loss on the disposal of certain shares in unquoted, trading companies, against the earnings of the disposing shareholder.

In order to qualify:

• The shares disposed of must form part of the ordinary share capital of the company.
• The claimant (or spouse/civil partner) must have subscribed for the share.
• The company must be a qualifying trading company.
• The shares must not be listed on a recognised stock exchange - listing on the AIM market are not considered “quoted”.

Any loss relief computed will be limited to:

• A transaction made at arms length for full consideration.
• A distribution in the course of liquidation or winding up.
• A negligible value claim. (When shares have no value)

The relief can be claimed:

• For the tax year in which the loss occurred.
• Or, the preceding tax year.

This relief provides a measure of compensation for shareholders who invested in companies, and have lost money when the company was subsequently sold or wound up.

Also bear in mind that losses of this type, set against other capital gains in the same year, will save capital gains tax at 18% after 5 April 2008. (If the proposed changes to CGT are carried through in the forthcoming Finance Bill.) If those same losses are set off against other income in 2008-2009, as suggested in this article, the tax savings at income tax rates could be 20% - 40%.

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• A loan itself is not remuneration for National Insurance purposes. Consequently no Class 1 contributions are due on the granting of a loan, or on the cash equivalent of a low interest or interest free loan.
• Class 1a contributions may become due if the loan is waived, written off, or if the employee/director does not pay interest on the loan at an amount equivalent to the “official rate”.
• An advance of pay is treated as a loan - any tax or National Insurance becomes deductible when the normal pay date arises.
• Loans provided to employees who are unable to work due to injury or accident will be subject to a National Insurance charge unless the loan is repayable whatever the outcome of the employee’s claim for damages.
• These rules apply to directors and other employees.

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We have noted below a number of tax issues that you may like to review prior to the end of the current tax year, 5 April 2008.

1. Capital Allowances. Clients may be advised to seek our advice before committing to any further capital expenditure before 5 April 2008. As from 6 April 2008 it is likely that new rules will apply to the way in which you are able to claim capital allowances for the purchase of certain qualifying assets. The Government has said it will introduce a new Annual Investment allowance. Essentially from the end of this tax year businesses will be able to write off 100% of their expenditure on plant and other equipment (excluding most cars) up to an annual limit of £50,000. This Annual Investment Allowance will apportioned in the first year if your year end is not 31 March. For instance if you spend £24,000 on a qualifying asset in April 2008 and your year end is June 2008; one-quarter of the £24,000, £6,000 will qualify for the 100% write down; any balance will be carried forward. This will only affect businesses whose accounting year end straddles 5 April 2008. Because of these changes businesses may be disadvantaged if they commit to capital expenditure before 6 April 2008. If you have plans to acquire assets you may be advised to check out the pros and cons of delaying the expenditure until after 5 April 2008.
2. Benefits in Kind. Don’t forget that if your employees reimburse you for the use of a company asset, or to cover other personal payments that have been made on their behalf, no benefit in kind will arise, and therefore no tax will be due. In most cases reducing taxable benefits in this way will also reduce the National Insurance Class 1A contributions for the business.
3. Corporation Tax Rates. If your taxable profits are likely to take you over the small companies rate, (currently your company can earn up to £300,000 at the small companies rate of 20%, unless you have associated companies which can reduce this entitlement), you could consider bringing forward expenditure to keep your profits under the threshold. The expenditure could be a business expense or capital expenditure.
4. Pension contributions. Tax relief on pension contributions made by the company is only available in the period in which the contributions are actually paid, so if it is planned to increase contributions in respect of the current year, these need to be paid out during the period.
5. Directors’ bonuses year to 31 March 2008.  Where it is planned to pay directors bonuses out of current profits it is necessary to hold a directors’ meeting confirming the decision to do so. This should then be minuted, even if the exact amount of the bonus is to be determined later. In this way the liability for the bonus is created in the current period, and it will be acceptable to provide for the bonus in the accounts. The bonus should then be finalised and paid out within 9 months of the year end to secure a corporation tax deduction for the payment.

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Employees and employers receive periodic updates to tax code numbers. This number is used by your employer/pension provider to calculate the amount of tax you are stopped on your salary and/or pension.

If your affairs are straight forward (and you are not able to claim certain age related allowances) you are entitled to earn the first £5,225 of your income in 2007-2008, tax free. If this were the case your code number would be 522L.

If your code number drops, to say 200L, you will pay more tax each pay period. If the tax code increases, you will pay less tax. (But see note on K codes below.)

We have listed below a number of generalised factors that may affect your code number. The list is not comprehensive so do contact us if you receive a code number adjustment that is difficult to understand.

1. Reduction for unpaid tax in earlier years. If you had underpaid tax in the tax year to 5 April 2006 by say £500 the Revenue will allow you, in certain circumstances, to pay the tax back in a following tax year. To facilitate this, the Revenue will deduct an amount from your tax code. For instance if you are a standard rate tax payer, currently 22%, your tax allowances would need to be reduced by £2,272 to effectively recover the £500 you owe. (For those of you who like to see the maths this is calculated by dividing £500 by 22 and multiplying the result by 100 = £2,272). On your notice of coding you would see a reduction in your code number from say 522L to 295L. (522-227).

2. Reduction for benefits provided by employer. If your employer provides you with a company car, or private medical insurance, or indeed any other form of benefit, without an adjustment to your tax code you would always owe the Revenue the tax on the benefit at the end of each tax year. So that this does not happen your code number will be reduced accordingly. The reduction works by deducting the value of the benefit from your code; thus a benefit of £500 will result in a reduction in your code number of £500, i.e. 50 points.

3. Reduction for higher rate tax payers. If your earnings are part subject to tax at 40%, and they include significant interest received or dividend income, you will owe the higher rate tax on your investment income at the end of the tax year. To counter this the estimated higher rate tax on your non-salaried/pensionable income will be recovered by reducing your tax code. As your interest and dividends received are taxed at the basic rate, only the marginal increase above the tax already deducted will be taken into account.

What happens if the reduction in your code number is more than your present code?

K Codes - If your tax free allowance of £5,225 is reduced by £2,272, as in example 1 above, you will still have a positive tax code of 295L. If however the deduction from your tax allowance is £10,000 you will have changed a positive tax free deduction of £5,225 into a negative position of -£4,775. This “negative deduction” is actually taxable income. Instead of receiving a tax free allowance of £5,225 you are being taxed on additional income of £4,775.

Your tax code could be changed from 522L to -477L. In their wisdom the Revenue have chosen to display -477L as K477. When you see a tax code prefixed by the letter “K” add on a zero and this is the equivalent income being added to your tax assessment for the year. The larger the K code, the more tax you will pay - although the revenue cannot take more than 50% of your salary in tax in this way!

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Most smaller companies pay corporation tax on their profits at the “Small companies rate” - presently 20%. However if profits exceed £300,000 the average rate of corporation tax payable gradually increases, until at profits of £1,500,000 and above all profits are taxable at the main rate of corporation tax, 30%.

Enterprising entrepreneurs might be tempted to make the most of the small companies rate, and transfer certain parts of their businesses to separate companies. If each separate company made profits of £300,000 or under, the possible tax saving could be significant - a reduction in tax payable from 30% of “grouped” profits, to 20%.

Not surprisingly the Revenue saw that strategy coming, hence the Associated Company rules.

Basically if two, on the face of it, separate companies are owned or controlled by persons who the tax man considers to be “Associated” then the amount of profits that each company can earn at the small companies rate (20%) is reduced pro rata. For example if two companies are judged to be associated in this way each company can earn up to £150,000 at the 20% rate. (£300,000 divided by the number of associated companies, in our example 2.)

It is easy to see that companies may be associated if they are both owned and controlled by the same person(s). Unfortunately the Revenue will also associate companies owned by the following groups as well.

1. Husband, wife, or civil partners, including separated but not divorced couples.

2. Parents, grandparents and more remote forebears.

3. Children or grandchildren or remoter issue.

4. Brothers or sisters, including half siblings but not step.

5. Business partners.

6. Certain trustees or personal representatives.

7. Certain beneficiaries of a settlement, or estate.

It is beyond the scope of this article to describe in detail the interesting possibilities that these associated groups can produce. For example spouses of business partners can be taken into account. To add to the mix the Revenue have also granted a concessionary treatment in the case of certain related persons, whose separate business interests have no “substantial commercial trading interdependence”.(This concession does not extend to husbands, wives and minor children.)

So beware. If a husband and wife each own totally independent businesses, they will be associated under these rules. Consequently each company can only earn up to £150,000 at the 20% corporation tax rate. Substitute any of the other 7 categories listed above and potentially large numbers of companies may be associated. If 6 companies are associated each can only earn up to £50,000 at the 20% rate.

If you are concerned that you may be caught by these rules, please call to discuss. This is a complex area of taxation, with its own unique “grey” areas.

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