You have now completed your studies of the individual taxes covered in the
syllabus so we will turn our attention to how to use your knowledge. First we
consider how to answer questions about the impact of taxes on a given
Next, we look at the tax treatment of sources of finance and investment
products for individuals. We also compare the tax implications of businesses
raising equity and loan finance, and leasing an asset rather than buying it.
We then turn to tax planning, which is an integral part of any tax advice you
give. We have dealt with various tax planning aspects as they have arisen
earlier in this Text. In this chapter, we bring together topics by considering ten
specific scenarios in personal and business tax.
Finally, we consider the ethical rules which should be applied to every situation
that you are required to consider. Up to five marks on every paper will be given
for your comments on ethical matters. It is therefore important that you identify
ethical issues and comment as appropriate.
|B||THE IMPACT OF RELEVANT TAXES ON VARIOUS SITUATIONS AND COURSES OF ACTION, INCLUDING THE INTERACTION OF TAXES|
|1||Identify and advise on the taxes applicable to a given course of action and their impact.||3|
|2||Identify and understand that the alternative ways of achieving personal or business outcomes may lead to different tax consequences.||3|
|(a)||Calculate the receipts from a transaction, net of tax and compare the results of alternative scenarios and advise on the most tax efficient course of action.||3|
|3||Advise how taxation can affect the financial decisions made by businesses (corporate and unincorporated) and by individuals.|
|(a)||Understand and compare and contrast the tax treatment of the sources of finance and investment products available to individuals.||3|
|(b)||Understand and explain the tax implications of the effect of the raising of equity and loan finance.||3|
|(c)||Explain the tax differences between decisions to lease, use hire purchase or purchase outright.||3|
|(d)||Understand and explain the impact of taxation on the cash flows of a business.||3|
|4||Assess the tax advantages and disadvantages of alternative courses of action.||3|
|5||Understand the statutory obligations imposed in a given situation, including any time limits for action and advise on the implications of noncompliance.||3|
|C||MINIMISE AND/OR DEFER TAX LIABILITIES BY THE USE OF STANDARD TAX PLANNING MEASURES|
|1||Identify and advise on the types of investment and other expenditure that will result in a reduction in tax liabilities for an individual and/or a business.||3|
|2||Advise on legitimate tax planning measures, by which the tax liabilities arising from a particular situation or course of action can be mitigated.||3|
|3||Advise on the appropriateness of such investment, expenditure or measures given a particular taxpayer’s circumstances or stated objectives.||3|
|4||Advise on the mitigation of tax in the manner recommended by reference to numerical analysis and/or reasoned argument.||3|
|5||Be aware of the ethical and professional issues arising from the giving of tax planning advice.||3|
|6||Be aware of and give advice on current issues in taxation.||3|
|D||COMMUNICATE WITH CLIENTS, HM REVENUE AND CUSTOMS AND OTHER PROFESSIONALS IN AN APPROPRIATE MANNER|
|1||Communicate advice, recommendations and information in the required format:||3|
|For example the use of Reports, Letters, Memoranda and Meeting notes|
|2||Present written information, in language appropriate to the purpose of the communication and the intended recipient.||3|
|3||Communicate conclusions reached, together, where necessary with relevant supporting computations.||3|
|4||State and explain assumptions made or limitations in the analysis provided; together with any inadequacies in the information available and/or additional information required to provide a fuller analysis.||3|
|5||Identify and explain other, non-tax, factors that should be considered.||3|
A significant number of marks in the exam will be available for evaluation and advice. Before you start to write your answer, assess what is required. You may simply be asked to advise on the tax consequences of one course of action, or you may have to compare the tax consequences of two or more options. The options may be specified in the question, or you may be required to identify possible options. You may have to cover all taxes, or to restrict your answer to a single tax. Present your answer in the required format; if you are asked for notes do not write an essay and if you are asked to write a letter, do so.
There may be up to five marks awarded for your comments on ethical matters. You need to know the fundamental principles of the ACCA’s code of conduct, and when presented with a scenario you should quickly review these to make sure that they are not compromised. If there is a threat then consider how serious it is and how you should respond.
1 Impact of taxes
Questions on impact of taxes require you to use your technical knowledge of taxation in relation to particular scenarios. Avoid writing about technical areas in general terms as opposed to in relation to the question’s requirements.
1.1 Answering questions involving impact of taxes
In the P6 (UK) examination, most of the questions will require you to identify and advise on the taxes applicable to a given course of action and their impact. Here are some tips which will help you prepare for answering such exam questions.
1.1.1 Practise questions from past exams
Practise questions from past exams with the aim of adopting the style of the model answers. Questions 39 and 40 in the Questions Bank are examples of past exam questions which you should attempt when you have finished studying this chapter. BPP’s Practice and Revision Kit contains over 50 such questions and should be the core of your revision.
Avoid looking at the model answers whilst attempting questions – the biggest problem most students face is knowing how to approach answering questions. You do not want to be attempting this for the first time in the exam! Remember that you are not required to make all the points shown in the model answer, so don’t be discouraged if there are some that you miss when attempting a question. However, there will be a core of marks in each question which you should be aiming to obtain.
1.1.2 Address the requirement
Make sure you understand what you are required to do. In Section B questions, this means reading the requirement of the question. In Section A questions, you will usually need to look also at the more detailed instructions in one of the documents you are given (for example, an email or notes of a meeting) to find out exactly what is required. Look for key phrases in the question such as ‘I need the following ….’ or ‘Please prepare the following for me…’.
Apply your knowledge to the facts by reference to the requirement. Marks are awarded for satisfying the requirements and not for other information even if it is technically correct. Avoid writing about technical areas in general terms as opposed to in relation to the requirements of the question.
The requirements of each question are carefully worded in order to provide you with guidance as regards the style and content of your answers. You should note the command words (calculate, explain etc), any matters which are not to be covered, and the precise issues you have been asked to address.
You should also note any guidance given in the question or in any notes following the requirement regarding the approach you should take when answering the question. For example, you may be asked to provide explanations ‘briefly’ or, on the other hand, ‘in detail’. A brief explanation requires a succinct statement of the main points, a detailed explanation requires a wider consideration of the issues.
Pay attention to the number of marks available – this provides you with a clear indication of the amount of time you should spend on each question part. There is no point writing a page of explanation for a part which is allocated two or three marks.
Only provide explanations when you are asked to. For example, if you are asked to calculate, there is no need to explain what you are going to do before you do it; just get on with it.
1.1.3 Think before you start
Before you start writing, think about the issues and identify all of the points you intend to address and/or any strategy you intend to adopt to solve the problem set.
You should be methodical in your approach. Unless you are asked to consider only one or more specific taxes, you should get into the habit of running through all the taxes, even if to eliminate them from consideration. For P6 (UK), the taxes in the syllabus are:
|(a) Income tax||(e) Stamp taxes|
|(b) Capital gains tax||(f) Corporation tax|
|(c) Inheritance tax
(d) National insurance contributions
|(g) Value added tax|
If you are asked to compare the tax consequences of two or more options, you must consider the impact of each tax on each option in order to produce a complete picture.
1.1.4 Consider future consequences
Make sure that you consider the future consequences of your proposals, not just the immediate tax impact. In particular, remember that deferred gains crystallise on certain events; it may not be a good idea to claim gift relief if the donee will not be entitled to entrepreneurs’ relief to reduce the tax on a subsequent sale, and paying tax now at a lower rate is usually better than delaying paying tax at a higher rate. Sometimes it is better to make a gift of a business asset as part of a will where a CGT uplift will be given – BPR will extinguish any IHT charge.
1.1.5 Present your answer appropriately
Read the question carefully to ascertain the type of answer that may be required. You may have to prepare a formal report, letter or memorandum, or you may have to write notes for a colleague. In other cases you may just be required to prepare explanations or calculations.
Where the answer is formal, marks will be specifically awarded for the presentation of the material and the effectiveness with which the information is presented. There will be four such professional marks available in question one of the exam. You should get used to setting out the points in your answer in a logical order, giving full explanations and yet still being concise. You may find using headings will help you organise your answer. It is often better to present any calculations as an appendix, unless they are extremely short. Look back to the question; if you are asked to draw conclusions or make recommendations have you done so?
It is important to know who the report, letter etc is being prepared for. If you are writing to a client they are unlikely to understand technical terms, and certainly will not know, for example, what ‘early trade losses relief’ is. If, on the other hand, you are writing a memorandum to a partner you can assume a certain degree of familiarity with the underlying concepts.
1.1.6 Consider non-tax factors
Sometimes the information not given in the question is just as important as the information which is. You may have to make assumptions about what the taxpayer has done, or intends to do, or about his personal circumstances. If so, state them in your answer, so that if your assumptions are wrong the reader’s attention will be drawn to them. Otherwise the course of action that you are recommending may be totally unsuitable. You may be able to give some indication of how your answer would differ, but do not go wildly off on a tangent.
Remember also that tax should never be the only factor in a decision. For example, if you are advising someone to invest under the enterprise investment scheme to obtain a tax reducer and also to defer a gain, stop and think about the nature of the investment. Small unquoted companies often fail, and your client may prefer to pay the tax rather than lose his investment. There may be hints and clues in the question; a 74-year old is not likely to want to invest in a personal pension.
1.2 Alternative ways of achieving outcomes and different tax consequences
In the exam, you will often be asked to compare alternative ways of achieving personal or business outcomes and advise on the most tax efficient course of action.
For example, an individual may which to raise funds, to buy a house. Conversely, he may have funds which he can invest to generate an income or for capital growth. The tax treatment of the different sources of finance or investment products available (as detailed in this chapter), may affect the individual’s decision regarding which source or product to use.
2 Personal finance
2.1 Sources of finance for individuals
There are many sources of finance available for individuals, long or short term, secured or unsecured.
Investments can only be made if funds are available. The private investor will generally have his own funds to invest, accumulated from salary or from business profits, but he may even decide to borrow money in order to make an investment which is expected to be particularly profitable. And of course, many private individuals borrow money to invest in land and buildings, buying their homes with mortgage loans.
2.1.2 Sources of finance for private purposes
The following sources of finance are available to individuals for private purposes.
- Bank overdrafts
- Unsecured bank and building society loans
- Mortgage loans from banks and building societies, secured on the borrower’s home
- Credit cards
- Hire purchase facilities
- Credit facilities provided by retailers
If the individual wishes to buy or improve a house, a mortgage loan is likely to be the most suitable source of finance. The fact that it is secured reduces the risk to the lender, and therefore the interest charged. For other large purchases, hire purchase facilities or the credit facilities provided by retailers may be the most suitable: the cost may be reduced as an incentive to make the purchase concerned, and using a specific facility avoids tying up a large proportion of a more general facility such as an overdraft or a credit card. An alternative to such specific facilities is an unsecured bank or building society loan, which must be repaid by agreed instalments over a fixed period.
Small and varied purchases may be made using a credit card, although if credit is taken the interest rate is very high, to reflect the risk of non-payment accepted by the credit card company. A bank overdraft facility can be useful to allow the individual to cope with times when expenditure temporarily exceeds income, perhaps because of fluctuating business profits or because of occasional worthwhile new investment opportunities such as new share issues.
2.1.3 Mortgage products
A mortgage may be a repayment or interest only mortgage. Pensions or ISAs may be used to accumulate the capital required to repay an interest only mortgage.
Most people who buy a house need to borrow to finance the purchase. Mortgage loans are normally repayable not later than the end of a fixed term agreed at the start of the loan.
Key term A mortgage is a loan given on the security of a property. The purchaser pays a proportion of the purchase price of a property – a mortgage deposit – and the balance is lent by the mortgage lender.
The borrower gives the lender legal rights over the property for the duration of the loan. While the loan is outstanding the property is the lender’s security that the loan will be repaid. If the borrower does not keep up repayments on the loan – defaults – the lender has the right to take possession of the property, sell it, recover the amount of the loan (assuming the sale price is higher than the loan) and pay the balance to the borrower. If the loan is repaid according to the terms of the mortgage, the legal rights of the lender over the property cease at the end of the term.
During the term of the mortgage the borrower must pay interest. The interest rate charged by a lender may be variable (variable rate mortgage). Some variable rates of interest are limited to a specified maximum but may rise or fall subject to that maximum. These are ‘capped’ mortgages. Fixed rate mortgages are available at a rate of interest which is fixed for a specific period of time.
There are two methods of repaying the capital: during the term or at the end of it. It is possible to combine the two types of mortgage. For example, a borrower might borrow £70,000 on a repayment basis and £30,000 on an interest only basis.
With a repayment mortgage each time interest is paid to a lender, part of the capital is repaid at the same time. Payments are often of a fixed regular amount. However, flexible mortgages may allow underpayments (ie less than the regular monthly amount), overpayments or payment holidays. There may also be additional borrowing facilities.
With an interest only mortgage the entire capital sum is repaid on the last day of the mortgage. Most lenders will want the borrower to take some action over the term of the mortgage to accumulate sufficient money to repay the loan, for example by investing in a pension or individual savings account.
2.1.4 Tax treatment of borrowings
Tax relief is only available for interest paid in limited circumstances.
Apart from business borrowings or in connection with a property letting business, where the interest paid is a deduction from profits, interest relief is only available if the interest is charged on a qualifying loan such as for loans to invest in close companies or partnerships. This precludes relief for interest on overdrafts or credit card borrowings.
Note that interest relief is not available on a loan to buy shares in a close company if EIS relief is claimed for the investment.
Unless tax relief is available for interest, it may be advisable to repay loans if surplus funds are available. In evaluating the situation, however, as well as comparing the interest charge on the borrowing with the income generated by the surplus funds you need to take into account any capital return which may be generated if the surplus funds are invested.
2.2 Investment products for individuals
There is a very wide range of investment products available to individuals, ranging from an almost risk free bank deposit to a high risk investment in shares in a small unquoted trading company under the seed enterprise investment scheme.
It may be preferable to invest for capital growth, rather than income, since capital gains are taxed at 28% for an individual who is a higher or additional rate taxpayer compared with the higher and additional rates of income tax of 40% and 45% (or 32.5% and 37.5% for dividends).
2.2.2 Deposit based investments
Most deposit based investments are fairly low risk investments in which an investor receives a low rate of interest in return for depositing his capital with the institution.
Some of the products available and their tax treatment are:
|Provider||Type of account||Tax treatment|
|Banks and building societies||Instant access accounts, notice accounts, fixed term deposits, money market accounts||Interest taxable as savings income. Normally paid net of 20% tax, except on money market deposits over £50,000 or if investor certifies that he is a non-taxpayer.|
|Banks and building societies,
National Savings and
|Cash ISAs||Tax free|
|National Savings and Investments (NS&I)||Direct Saver accounts, Investment accounts||Interest taxable as savings income. Paid gross.|
|National Savings and Investments (NS&I)||Savings certificate, fixed interest or index linked||Tax free|
2.2.3 Fixed interest securities
A fixed interest security pays a fixed rate of interest and has a known maturity value so long as it is held until its redemption date.
Key term A fixed interest security is a loan to a government, a local authority, a company, or a building society. The security pays a fixed rate of interest and has a known maturity value so long as the stock is held until its redemption date.
Government securities and corporate bonds are negotiable and can therefore be traded in the market.
The securities available and their tax treatment are:
|Investment||Income tax||Capital gains tax|
Local authority bonds
|Interest is taxed as savings income. Paid gross. Accrued income scheme applies.||Exempt gains, losses not allowable|
|Company loan stock which
is qualifying corporate bond
|Interest is taxed as savings income. Paid net of 20% tax unless loan stock is listed on a recognised stock exchange, when paid gross. Accrued income scheme applies.||Exempt gains, losses not allowable|
|Company loan stock which
is not a qualifying corporate bond
|Interest is taxed as savings income. Paid net of 20% tax unless loan stock is listed on a recognised stock exchange, when paid gross. Accrued income scheme applies.||Taxable gains, losses allowable|
2.2.4 Individual savings accounts (ISAs)
Individual savings accounts (ISAs) provide a tax-free wrapper for investments in cash, and stocks and shares.
Key term ISAs are tax efficient savings accounts. There are two types of ISA.
- Cash ISA (which only has a cash component).
- Stocks and shares ISA (which only has a stocks and shares component, although uninvested cash may be held in a stocks and shares of ISA if the provider allows this).
The investor must be resident in the UK in the year the investment is made. The investor must normally be 18 years or over. However, a cash ISA can be held by individuals aged 16 or 17.
The annual subscription limit for ISAs is £15,240 for 2015/16. This can be invested in cash, stocks and shares, or any combination of the two.
Where the holder of one or more ISAs dies, their spouse/civil partner is entitled to an additional ISA allowance equal to the value of the ISAs held by the deceased person at their death.
Investments within ISAs are exempt from both income tax and capital gains tax.
Exam focus From 1 December 2015, a new help-to-buy ISA is to be introduced for first-time home buyers. The helppoint to-buy ISA is not examinable in P6(UK).
Equities are high risk investments as neither the income nor the capital is secure.
When an investor buys a share in Marks and Spencer plc that is exactly what he has done; he has bought a share in the ownership of the company.
Dividends are received with a non-refundable tax credit of 10%. The gross amount of dividends received are subject to income tax as described earlier in this Text.
A capital gain arising on shares, calculated using the matching rules, is subject to CGT. Losses are allowable losses.
Equities are high risk investments as neither the income nor the capital is secure. Equities in companies listed on a recognised stock exchange are generally less risky than those in unlisted companies. 2.2.6 The enterprise investment scheme (EIS)
The enterprise investment scheme (EIS) is a scheme designed to promote enterprise and investment by helping high-risk, unlisted trading companies raise finance by the issue of ordinary shares to individual investors who are unconnected with that company.
Individuals who subscribe for EIS shares are entitled to income tax relief. This has already been discussed earlier in this Text, but as a summary the rules are that individuals can claim a tax reducer of the lower of 30% of the amount subscribed for qualifying investments (maximum qualifying investment is £1,000,000 and the individual’s tax liability for the year after deducting VCT relief).
The investor may claim to have all or part of the shares treated as issued in the previous tax year. This is subject to the total actual and deemed investment not exceeding the limit for the previous year.
The relief may be withdrawn if certain events, such as the sale of the shares, occur within three years.
Where EIS income tax relief is available there are also capital gains tax reliefs:
- Where EIS shares are disposed of after the three year period any gain is exempt from CGT. If the shares are disposed of within three years any gain is computed in the normal way.
- If EIS shares are disposed of at a loss at any time, the loss is allowable but the acquisition cost of the shares is reduced by the amount of EIS relief attributable to the shares. The loss is eligible for share loss relief against general income (see earlier in this Text).
EIS deferral relief may be available to defer chargeable gains if an individual invests in EIS shares in the period commencing one year before and ending three years after the disposal of the asset (see earlier in this Text). Note that this relief is not conditional on income tax relief being available.
2.2.7 Seed enterprise investment scheme (SEIS) )
The seed enterprise investment scheme (SEIS) is similar to the EIS scheme but rewards investment in small, start up unquoted trading companies with a greater tax reducer.
Individuals can also invest in SEIS shares and obtain income tax relief and capital gains tax reliefs as detailed earlier in this Text.
The qualifying companies are smaller, start up companies and the greater tax reducer of 50% (available on up to £100,000 of investment) reflects the greater risk of investing in these companies. In the exam, you may advise investing in an EIS or SEIS company: remember to point out the risks as well as the tax reliefs.
SEIS reinvestment relief can exempt 50% of a gain matched with an investment under SEIS made in the same tax year.
2.2.8 Venture capital trusts (VCTs)
Venture capital trusts (VCTs) are listed companies which invest in unquoted trading companies, so enabling investors to spread their risk over a number of higher-risk, unquoted companies whilst obtaining income tax and capital gains tax reliefs.
Venture capital trusts (VCTs) are listed companies which invest in unquoted trading companies and meet certain conditions. The VCT scheme differs from EIS in that the individual investor may spread his risk over a number of higher-risk, unquoted companies.
An individual investing in a VCT obtains the following tax benefits on a maximum qualifying investment of £200,000:
- A tax reduction of 30% of the amount invested. There is a withdrawal of relief if the shares are disposed of within five years or if the VCT ceases to qualify.
- Dividends received are tax-free income.
- Capital gains on the sale of shares in the VCT are exempt from CGT (and losses are not allowable).
In addition, capital gains which the VCT itself makes on its investments are not chargeable gains, and so are not subject to corporation tax.
Note that there is no minimum holding period requirement for the benefits of tax-free dividends and CGT exemption.
3 Business finance
3.1 Sources of finance for business
Businesses may require short or long term finance to start up, carry on or expand.
Businesses need funds in order to start up and expand, and their requirements are often far beyond the means of the entrepreneurs concerned. Outside capital may be sought from banks, from other lenders or from new shareholders or partners.
The following sources of finance are available for businesses.
- The entrepreneur’s own capital
- Bank overdrafts
- Bank loans (which may be short term, medium term or long term)
- Loans secured by mortgages of land
- Leasing and hire purchase arrangements
- Sale and leaseback arrangements
- Loans from private individuals
- Capital invested by partners
- Share issues (for incorporated businesses)
- Loan stock issues (for incorporated businesses)
- Venture capital institutions
The tax treatments of equity and loan finance differ, as do the tax implications of leasing equipment compared with buying it outright.
3.2 The tax implications of equity finance and of loan finance
A business may obtain finance through loans and obtain tax relief for interest paid. A company can raise finance by issuing shares to shareholders.
3.2.1 Loan finance
You saw earlier in this Text that if a company is a party to a loan relationship for the purposes of its trade, any debits are deductible in computing its trading profits. If, however a loan relationship is not one for the purposes of a trade any debits or credits are pooled. A net credit on the pool is chargeable as interest income. A net deficit may be relieved in the various ways described earlier in this Text.
It is not only the interest costs of borrowing that are allowable or taxable. The capital costs are treated similarly. Thus if a company issues a loan at a discount and repays it eventually at par, the capital cost is allowed.
A sole trader or partnership will not obtain a deduction in respect of capital repayments of loan finance. A trading deduction will only be available in respect of interest incurred wholly and exclusively for trade purposes.
3.2.2 Equity finance
Companies can raise finance by issuing shares to shareholders. Capital can be raised in this way for trading and non-trading purposes. Companies can distribute profits to shareholders in a variety of ways, of which the payment of dividends is the most common. The cost of making distributions to shareholders is not allowable in computing taxable profits.
The main types of share are:
|Type of share||Features|
|Ordinary shares||The sh
|areholder is entitled:
To a share of profit distributed as a dividend
|(b)||To the right to vote on matters affecting the company|
|(c)||In the event of a winding up, to a share of assets, but note that shareholders do not take precedence over the creditors|
|Preference shares||(a)||These shareholders are placed ahead of the ordinary shareholders for dividend payments and in the event of a liquidation|
|(b)||The dividend is usually a guaranteed amount but if the distribution to the ordinary shareholders is higher, the preference shareholders do not receive the increase|
|Convertible preference shares||The dividend paid on these is usually less than the non-convertible preference share but there is the option to convert to ordinary shares in the future at preset dates and at pre-set prices|
Legal and professional expenses relating to capital or non-trading items are disallowable. This includes fees incurred, for example, in issuing share capital. However, a deduction is allowed to companies under the loan relationship rules for the incidental costs of obtaining medium or long term business loans and for issuing loan stock.
3.2.3 Legal and professional expenses
Interest income received from a company on loan stock etc is taxable income for the recipient (and will have suffered 20% tax at source if paid on unlisted loan stock).
Dividend income received from a shareholding in a company is taxable on an individual investor only to the extent he is a higher or additional rate tax payer. The tax credit on dividend income can never be repaid to non-taxpayers but the tax suffered on interest income is repayable.
UK dividend income is not taxable in the hands of a company shareholder, for the purposes of the P6(UK) examination.
No gain or loss can arise to the original creditor when he disposes of his debt. A purchaser of a debt may have a chargeable gain and (unless he is connected with the original creditor) an allowable loss.
A debt on a security can give rise to a gain or loss to the original creditor.
3.3 The lease or buy decision
A business may lease or buy assets. Short term leasing costs may be deductible expenses. Longer term costs may attract capital allowances in a similar way to buying an asset outright.
If assets are leased and the term of the lease is less than 5 years, then the lease payments are in general deductible in computing taxable profits. If they are bought on hire purchase or leased under a long term lease, then the cash price of the assets may qualify for capital allowances and the finance charges are deductible in computing taxable profits, making the tax effects very similar to those of taking out a loan and then buying the asset.
If assets are bought outright then capital allowances may be available on the purchase cost. These will be given on a reducing balance basis each year. The ultimate lease or buy decision is likely to depend on the availability of funds and whether leasing the asset allows the company to keep funds free to finance other activities.
4 Tax planning
It would be impossible to write a definitive section on tax planning and mitigation, as no two scenarios are ever the same. This section covers nine scenarios, highlighting the points which need to be considered, both tax and non-tax. You may well think of other situations where taxpayers may seek advice.
4.2 Employment and self-employment
As a general rule, self-employment leads to lower overall tax and NIC burdens than employment.
A taxpayer who has a choice between being employed and being self-employed, on similar gross incomes, should consider the following points.
- An employee must pay income tax and NICs as salary is received, under the PAYE system and on a current year basis. A self-employed person pays income tax and NICs which are at least partly payable after all of the profits concerned have been earned. There is thus a cash flow advantage in self-employment.
- An employee is likely to suffer significantly higher NICs in total than a self employed person, although the employee’s entitlement to state benefits will also be higher.
- An employee may receive benefits as well as salary. Taxable values of benefits may be less than their actual value to the employee and benefits do not attract employee NICs. Most benefits attract employer’s Class 1A NIC.
- The rules on the deductibility of expenses are much stricter for employees (incurred wholly, exclusively and necessarily in the performance of duties) than for the self-employed (normally incurred wholly and exclusively for the purposes of the trade).
4.3 Remuneration packages
If someone is to be an employee, the tax effects of the remuneration package should be taken into account.
4.3.1 Income tax planning for employment situations
An employee will usually be rewarded largely by salary, but several other elements can be included in a remuneration package. Some of them bring tax benefits to the employee only, and some will also benefit the employer.
Bonuses are treated like salary, except that if a bonus is accrued in the employer’s accounts but is paid more than nine months after the end of the period of account, its deductibility for tax purposes will be delayed.
The general position for benefits is that they are subject to income tax and employer Class 1A NICs. The cost of providing benefits is generally deductible in computing trading profit for the employer (but if a car with carbon dioxide emissions over 130 g/km is provided, the employer’s capital allowances (or deductions for lease payments) are reduced). However, there are a large number of tax and NI free benefits and there is a great deal of planning that can be done to ensure a tax and NIC efficient benefits package for directors and employees. The optimum is to ensure that the company receives a tax deduction for the expenditure while creating tax and NI free remuneration for employees.
Employee A receives a salary of £32,500.
Employee B receives a salary of £27,500, the use of a new digital camera which cost £800 on 6 April 2015 and the use of a car purchased by the employer on 6 April 2015 which has a list price of £15,000 and has CO2 emissions of 100g/km, so the taxable percentage is 15%. No fuel is supplied.
Employee B is also in an occupational pension scheme to which he contributes 5% of his gross salary (excluding benefits) and his employer company contributes 10% of his gross salary (excluding benefits).
Show the tax and the NIC effects of the two remuneration packages on both the employees and their employers. Use 2015/16 tax rates and allowances and assume that the employer prepares accounts to 31 March each year and that the employer will only claim writing down allowances for capital allowance purposes. A and B both have no other income. Ignore the Employment Allowance for secondary NICs.
A’s income tax and NIC computations are as follows.
|Less personal allowance||(10,600)|
|£(32,500 8,060) 12%||£2,933|
|B’s income tax and NIC computations are as follows.|
|Use of digital camera £800 20%||160|
|Car £15,000 15%||2,250|
|Less pension contribution £27,500 5%||(1,375)|
|Less personal allowance||(10,600)|
A’s employer must pay NICs of (£32,500 – £8,112) 13.8% = £3,366, and can deduct £(32,500 + 3,366) = £35,866 in computing trading profits.
|£(27,500 8,060) 12%
B’s employer must pay NICs as follows.
|Class 1 NICs|
|£(27,500 – 8,112) 13.8%||2,676|
|Class 1A NICs|
|£(2,250 + 160) 13.8%||333|
|B’s employer will have the following deductions in computing profits.|
|Pension contribution £27,500 10%||2,750|
|Car £15,000 18%||2,700|
|Digital camera £800 18%||144|
4.3.2 NIC planning for employment situations
NIC is payable on ‘earnings’ which is defined as ‘any remuneration or profit derived from employment’. Remuneration packages structured to include the following items which are not ‘earnings’ would reduce the NIC burden.
- Dividends – director/shareholders could take remuneration in the form of dividends. Dividend waivers and adjustments to bonuses would probably be required. There are CT implications as salary and NIC costs are allowable business expenses whereas dividends are not.
Dividends are an efficient way of avoiding NIC. However dividend income is not earnings for pension purposes. There is also a cash flow impact since PAYE does not apply to dividends.
- Rents – a director owning a property used by a company could be paid rent instead of remuneration. However, this will impact entrepreneurs’ relief for associated disposals (if available) on the subsequent sale of the property. The rental expense is a deductible business expense for the company but the income is not earnings for pension contribution purposes for the individual.
4.4 The choice of a business medium
An individual can choose between trading as a sole trader or trading through a company. That choice, and if a company is chosen, the choice between dividends and remuneration, can significantly affect the overall tax and NIC burden. Cashflow is also an important consideration.
4.4.1 General considerations
When starting in business the first decision must be whether to trade as a company (with the individual as a director taxable on earnings) or as an unincorporated business, either as a sole trader or a partnership. Certain professions may not be practised through a limited company (although unlimited companies and limited liability partnerships may be allowed).
The attraction of incorporation lies in the fact that a sole trader or a partner is liable for business debts to the full extent of his personal assets. A limited company’s shareholder’s liability is limited to the amount, if any, unpaid on his shares. However, limited liability is often reduced by the demands of bankers or landlords for personal guarantees from company directors. In addition, compliance with the statutory obligations (eg annual returns, audits etc) that apply to a company can be costly.
A company often finds raising finance easier than an unincorporated business. This is partly because of the misguided view that a company has greater reliability and permanence. A company can obtain equity finance through venture capital institutions and can borrow by giving a floating charge over its assets as security whereas a sole trader or partnership cannot do this.
A business may be seen as more reputable or creditworthy if conducted through the medium of a company. Companies, however, have to comply with disclosure requirements and this may be unattractive to proprietors who wish to keep information from employees, potential competitors etc. This could be avoided by using an unlimited company but in that case any advantage of limited status is lost. The disclosure requirements could be reduced by filing abbreviated accounts.
4.4.2 The effect of marginal tax rates and national insurance
A trader’s profits whether retained or withdrawn are taxed at a marginal rate of 40% on taxable income between £31,785 and £100,000, at a marginal rate of 60% between £100,000 and £121,200 (due to the withdrawal of the personal allowance), at a marginal rate of 40% between £121,200 and £150,000 and at a marginal rate of 45% on taxable income above £150,000. In addition Class 2 and Class 4 National Insurance contributions are payable.
A controlling director/shareholder can decide whether profits are to be paid out as remuneration or dividends, or retained in the company. The Employment Allowance of up to £2,000 per tax year reduces the secondary Class 1 NICs payable by the company.
If profits are retained, the consequent growth in asset values will increase the potential capital gain when shares are sold. Where remuneration is paid the total national insurance liability is greater than for the proprietor of an unincorporated business.
Where a spouse is employed his or her salary must be justifiable as ‘wholly and exclusively for the purposes of the trade’; HMRC may seek to disallow excessive salary cost. On the other hand, a spouse as active partner can take any share in profits, provided that he or she is personally active in the business and there is evidence of a bona fide partnership. Thus the spouse’s personal allowance, basic rate and higher rate bands can be used.
In choosing a business medium, we should also remember that a sole trader will be denied the enhanced state benefits that are available to an employee who pays Class 1 national insurance contributions.
Alan is starting a new business and expects to make annual profits of £36,500 before tax and national insurance.
Consider the fiscal effects of his choosing to trade as a sole trader or, alternatively, through a company, paying him a salary of £22,500 and then the largest possible dividend not giving rise to a loss of capital. Assume that accounting profits equal taxable trade profits. Use 2015/16 tax rates.
As a sole trader
Less personal allowance (10,600)
Taxable income 25,900
Tax thereon at 20% 5,180
National Insurance Classes 2 (52 £2.80) and 4 (£(36,500 – 8,060) 9%) 2,705
Net income £(36,500 7,885) 28,615
Through a company
Less: salary (22,500) employer’s NI (22,500 – 8,112) × 13.8% 1,986
Less: Employment Allowance (below maximum £2,000) (1,986) (0)
Taxable profits 14,000
Less: corporation tax 20% £14,000 (2,800) Net profits 11,200
A dividend of £11,200 can be paid without loss of capital.
Dividends £11,200 100/90
Net income 22,500 34,944
Less personal allowance )
|Less tax suffered £12,444 10%||(1,244)|
|Income tax payable||2,380|
Taxable income 12,444 24,344
|Less: income tax||2,380|
|employee’s NIC £ (22,500 – 8,060) 12%||1,733|
Trading through a company would give annual net income of £(29,587 28,615) = £972 more than trading as a sole trader.
Let’s say we have a business earning profits of £18,060.
Compare the retained profit for the business owner if he operates the business as a sole trader with a year ended 31 March 2016 to that of a company with the same year end but paying out £8,060 as a salary (no Class 1 NIC but preserving the business owner’s state benefits) and the remaining post-tax profits as a dividend.
|Trading profits of £18,060 in 2015/16|
|Year ended 31 March 2016|
|£(18,060 – 10,600) = £7,460||£|
|£(18,060 – 8,060) 9%||900|
|Total Income Tax and NIC||2,538|
|£(18,060 – 2,538)||£15,522|
|Year ended 31 March 2016|
|Taxable total profits = £(18,060 – 8,060)||10,000|
|£10,000 20% before distribution||(2,000)|
|Maximum distribution is||8,000|
Salary covered by PA
|Remaining £(8,889 – 2,540) = £6,349 taxable income.|
|Less tax credit||(635)|
|Class 1 NIC||Nil|
|Net income £(8,060 + 8,000)||£16,060|
Gross dividend income = £8,889, of which £(10,600 – 8,060) = £2,540 covered by PA,
As a sole-tradership the business would typically pay £2,538 in the 2015/16 tax year as income tax and National Insurance contributions. The same business operating as a limited company for the same year would have a tax bill of £2,000.
4.4.3 Benefits and expenses
The restrictions on deducting expenses against earnings may make self-employment rather more attractive than employment as a company director. Although the same expense deduction rules apply to a company and a sole trader, the company’s deductible business expenses may give rise to taxable benefits as earnings for directors.
On the other hand, the provision of fringe benefits can be an advantage of incorporation. Tax exempt benefits can be used to maximise directors’ net spendable income, although care is required because not all benefits are tax-efficient.
4.4.4 Opening years
Companies have no equivalent of the opening year rules that apply for income tax purposes. For a sole trader or partnership, profits earned when basis periods overlap are taxed twice. Relief is available for such overlap profits but that may not take place for many years, by which time inflation may have reduced the value of the relief for overlap profits.
If a partnership is envisaged it may be worthwhile to commence trading with the prospective partner as a salaried employee for a year or so, thereby obtaining tax relief twice on his salary during the overlap period.
Losses in the first four years of an unincorporated business can be used to obtain tax repayments (using early trade losses relief). In these and later years a loss relief claim against general income permits relief for trading losses against other income (and capital gains) of either or both of two tax years.
With corporation tax, although there is considerable flexibility for the company itself, a company’s losses are not available to reduce shareholders’ taxable income.
4.4.6 Capital gains tax
One difference between companies and individuals is that companies do not benefit from an exempt amount of the first £11,100 of total gains (for 2015/16).
Chargeable gains of an individual are charged to capital gains tax at 10%, 18% or 28%. In contrast, companies’ gains are charged at 20%.
The principal disadvantage of incorporation is the double charge to tax which arises when a company sells a chargeable asset. Firstly, the company may pay corporation tax on the chargeable gain. Secondly, the shareholders may be taxed when they attempt to realise those proceeds, either in the form of dividends or, when the shares are sold, incurring a further charge on capital gains.
If there are no tax advantages in the company owning an asset, the asset should be held outside the company, perhaps being leased to the company. The lessor may receive rent without restricting IHT business asset relief. However, rent received will restrict entrepreneurs’ relief for CGT.
4.4.7 Tax cash flows
A sole trader/partner is assessable to income tax and NICs on a current year basis but will use a prior year basis to calculate two payments on account due on 31 January in and 31 July directly following the tax year. The balance of tax is due on 31 January following the tax year. Thus tax on profits earned in the year to 30 April 2015 (assessable 2015/16) will not be payable in full until 31 January 2017 and will be used to calculate payments on account due 31 January 2017 and 31 July 2017. Where profits are rising this lag gives a considerable benefit. A sole trader’s/partner’s drawings do not of themselves attract or accelerate a tax charge.
A company usually pays corporation tax nine months after the end of its accounts period. Large companies are required to make quarterly payments on account based on the current year’s estimated liability. As an employer it will have to account for PAYE and NICs 14 days after the end of each tax month in which the pay date falls.
Generally therefore a business held by a company will pay tax earlier than a business held by a sole trader or partnership.
4.4.8 What if things go wrong?
Sound tax planning should always take account of possible changes in circumstances. A successful business may fail or a struggling concern may eventually become profitable.
Running down an unincorporated business does not normally give rise to serious problems. The proprietor may be able to cover any balancing charges with loss relief.
Taking a business out of a company (disincorporation), or winding up a corporate trade altogether is more complex and involves both tax and legal issues. Consider the following:
- No subsequent relief is available for a company’s unused losses once the trade ceases
- Liquidation costs may be considerable
- A double charge on capital gains may arise, although certain small companies may be able to take advantage of relief if they disincorporate (see earlier in this Text).
4.4.9 Personal service companies (PSCs)
The ‘IR 35 provisions’ (see earlier in this Text) are anti-avoidance rules which attack the provision of personal services by personal service companies (PSCs). If an individual would have been an employee if he had been working directly for a client, he will generally be subject to tax and NIC on income from the PSC as if he was in fact an employee of the client.
4.5 The incorporation of a business
The incorporation of a business should be carefully planned, taking account of consequent tax liabilities. There are both advantages and disadvantages to incorporating a business. A disposal of shares can also have several tax consequences.
4.5.1 Advantages of incorporating a business
- Retained profits subject only to corporation tax not income tax or NIC.
- Easier to dispose of shares in a company than interest in a business – thus advantage for raising equity and selling to outside investors.
- Pension provision can be made by employer (the company) for employees (eg directors) with no national insurance liability.
- Benefits for employees can be more tax efficient.
- Loan finance easier to arrange as lender can take out charge on company assets.
- Limited liability for shareholders if the company is a limited company.
- A company arguably has a more respectable image than a sole trader or partnership.
- Incorporation is a means of converting the value of a business into shares which could eventually become listed on a recognised stock exchange. This provides for succession of ownership and can make the original proprietors very wealthy.
4.5.2 Disadvantages of incorporating a business
- Potential double capital gains charge on assets (see above).
- Trading losses restricted to set-off against corporate profits.
- No carry back of trading losses in opening years (ie no early trade losses relief equivalent).
- Partner’s share of profit not openly challenged by HMRC provided the recipient is a genuine partner. Conversely excessive remuneration to employee/director can be challenged.
- NIC for employer company and employee will generally exceed the contributions required of a selfemployed person.
- Tax payment dates for tax for a company and its employees (CT, PAYE and NIC) are generally well in advance of those for self-employed.
- Assets used in a business but held outside the business entity can qualify for 50% BPR for IHT. In the case of a partnership the owner merely has to be a partner but in the case of a company using an asset the owner must be a controlling shareholder.
- There may be statutory requirements of audit, keeping books, filing accounts etc.
- Disclosure requirements of published accounts may give information to employees/ competitors that business owners would not have willingly disclosed.
4.5.3 Income tax
When an unincorporated trade is transferred to a company the trade is treated as discontinued for tax purposes and the cessation rules apply. Careful consideration of the level of profit, available overlap profits and date of transfer is required to avoid large taxable profits in one year and to utilise the personal allowance and basic rate tax band as effectively as possible.
For example, if a trader with a 31 December year end incorporates his business on 31 March 2016, the year of cessation will be 2015/16. If he makes profits of £3,000 per month, he will be taxed on profits in 2015/16 between 1 January 2015 to 31 March 2016 (15 months) which will be £45,000 (less any overlap relief). If, however, he delayed incorporation until 30 April 2016, the year of cessation will be 2016/17. He will be taxed on profits of £12,000 in 2016/17 (again less any overlap relief) and on 12 months of profit in 2015/16 (£36,000). This may be more advantageous if he does not have other income to use up his personal allowance and/or his basic rate band in 2016/17.
On the transfer of a trade to a company a balancing charge will usually arise as plant and machinery are treated as being sold at market value. However, where the company is controlled by the transferor, the two are connected and an election may be made so as not to treat the transfer as a permanent discontinuance for capital allowances purposes. Plant is then transferred at its tax written down value.
Unrelieved trading losses cannot be carried forward to a company as such, but may be set against any income derived from the company by way of dividends, remuneration and so on, provided the business is exchanged for shares and those shares are still held at the time the loss is set off. Terminal loss relief may also be available for the loss of the last twelve months of trading.
4.5.4 Capital gains tax
When the transfer takes place the chargeable assets are deemed to be disposed of to the company at their open market values. Capital gains tax liabilities are likely to arise, particularly on land and buildings and on goodwill.
If the whole business (or the whole business other than cash) is transferred to the company as a going concern in exchange for shares in the company, any chargeable gains are automatically rolled over through incorporation relief, reducing the base cost of the shares on a subsequent disposal. If the shares are held until death the tax liability may never arise as no capital gains tax arises on death.
Individuals who incorporate a business can elect that incorporation relief should not apply. This election must usually be made within two years of 31 January following the end of the tax year in which the business was incorporated. Making the election could be advantageous if the gains are quite small and entrepreneurs’ relief would apply. However, entrepreneurs’ relief will not apply on the disposal of goodwill to a close company of which the individual(s) are participators.
It may not be desirable for all the assets comprised in the business to be transferred to the company. As an alternative, an individual can use gift relief to transfer chargeable business assets to a company and defer any gains by deducting them from the base costs of the assets for the company.
4.5.5 Value added tax 6/14
The transfer of assets will not be treated as a supply for VAT purposes (a transfer of a going concern (TOGC)) if all of the following conditions are satisfied.
- The assets are to be used by the company in the same kind of business (whether or not as part of an existing business) as that carried on by the transferor, the business being transferred as a going concern
- If only part of the business is transferred, that part is capable of separate operation
- If the transferor is a taxable person, the company is a taxable person when the transfer takes place or immediately becomes one as a result of the transfer
- There must be no significant break in the normal trading pattern before or immediately after the transfer
- In the case of land and buildings, the company makes an election to tax if the transferor has done so (f) In the case of ‘new’ buildings the company makes an election to tax.
Note. For the last two points if the election to tax is not made by the company the supply of land or buildings is standard rated. All the other business assets can be transferred outside the scope of VAT under the TOGC rules.
An application may be made for the company to take over the existing VAT registration number. In this case the company will take over all the debts and liabilities of the business but it will be able to claim VAT impairment loss relief in respect of supplies made before the transfer.
If the above conditions cannot be satisfied VAT will be charged on the transfer, but this will only represent a cash flow problem in most cases.
HMRC should be notified of the incorporation within 30 days.
4.5.6 Stamp duty land tax
The transfer of land will be subject to Stamp Duty Land Tax as a transfer at market value. The use of the gift relief route should be considered so that land can be retained outside the company.
4.6 Disincorporation of a company
If disincorporation relief applies, there will be no corporation tax charge on the transfer of land and buildings and goodwill by a company to its shareholders. Other reliefs may apply to transfers of inventory and plant and machinery. A tax charge may arise for the shareholders on the distribution of assets, either income tax or capital gains tax.
Disincorporation is the process of a business changing its legal form from a limited company to one run by a self employed individual or partnership. It is achieved by the transfer of the business as a going concern, with its assets and liabilities, from the company to one or all of the shareholders. The business is then continued by them in their capacity as a sole trader or a partnership.
A key reason for wanting to disincorporate may be to avoid the additional administrative and regulatory requirements of being a limited company. This includes sending a corporation tax return to HMRC. The directors and shareholders of the company may also need to complete individual tax returns. Operating as a company is also likely to entail operating PAYE, which would not otherwise be necessary if the business has no other employees.
Some individuals find it difficult to understand the notion of the company as a legal entity separate from the shareholders/directors, and consequently fail to keep personal cash separate from the business: this may result in errors or underpayment in their tax returns. In these circumstances, it may be better for the business to be carried on in an unincorporated form.
On the other hand, where a business is operated properly through a limited company, the company’s finances are kept separate from the personal finances of the shareholders/directors who are not directly liable for company’s debts. The loss of limited liability for the business as a result of disincorporation must be balanced against the simpler administration required for an unincorporated business.
4.6.2 Tax implications for company on disincorporation
- Land and buildings – disposal by company on transfer to shareholders. If disincorporation relief applies, deemed to be transferred at the lower of market value and allowable acquisition cost so that no gain arises for the company. Acquired by shareholders at the deemed disposal value.
- Goodwill – disposal by company on transfer to shareholders. If disincorporation relief applies, deemed to be transferred at the lower of its market value and its tax written down value so that no profit arises for the company. Acquired by shareholders at the deemed disposal value.
- Inventory – disposal by company on transfer to shareholders. If the company and the shareholders are connected persons and an election is made, the transfer is made at the greater of the original cost of the stock and the transfer price (see Chapter 6 Section 2.12.2).
- Plant and machinery – disposal by company on transfer to shareholders. Balancing adjustments can be avoided if the company and the shareholders are connected persons and an election is made for assets to be transferred at tax written down value (see Chapter 7 Section 9).
- Losses – any unused losses will not be transferable to the unincorporated business and will therefore be lost.
4.6.3 Tax implications for shareholders on disincorporation
- Distribution – generally, distributions of assets to the shareholders are treated as income and taxed like a dividend (see Chapter 23 Section 1.8.2) However, if the shareholder is a basic rate taxpayer, the tax credit relating to the dividend will cover the income tax liability.
- Capital receipt – if assets are distributed to the shareholders as part of a liquidation, this will be as a part disposal of shares in the hands of the shareholder (see Chapter 23 Section 1.8.1). A similar situation arises in relation to certain distributions made in anticipation of an application to strike off a company (see Chapter 23 Section 1.8.2). Any chargeable gain may be covered by the annual exempt amount. Entrepreneurs’ relief may be applicable.
4.7 Tax efficient profit extraction
There are several methods by which profit can be extracted from a company.
4.7.1 Methods of extracting profits
When trading activities are carried on through a limited company, careful thought needs to be given to the level and method of extraction of the profits generated. This decision should take into account both the needs of the individual shareholders and directors as well as the needs of the company itself. For instance, the company may need to retain a certain level of profit in order to reduce its bank overdraft or fund an expansion project.
The table below compares the various methods of extracting profits in outline. They are looked at in more detail below.
|Method of extraction||Company||Individual|
Tax free benefits
Deductible/Class 1 NICs
Deductible/Class 1A NICs
Taxable/Class 1 NICs
|Dividends||Not deductible||No tax for basic rate taxpayer
Higher rate tax at 32.5% or additional rate at 37.5%, reduced by 10% tax credit
|Loan interest||Deductible on accruals basis as interest on a loan relationship||Taxable as savings income|
|Rental income||Deductible||Taxable non-savings income|
|Pension contributions to registered pension schemes||
4.7.2 Dividends or remuneration
Director/shareholders may wish to consider either extracting profits as dividend or remuneration. Payments of dividends or remuneration will reduce a company’s retained profits which means a reduction in net asset value and hence the value of the shares, ultimately reducing any chargeable gain on the disposal of those shares. However, the immediate tax cost of paying dividends or remuneration must be weighed against this advantage.
Remuneration and the cost of benefits will be allowed as deductions in computing the company’s total profits. The decision whether or not to make such payments could affect the rate of corporation tax by reducing the level of profits. However, the national insurance cost must also be borne in mind. A combination of dividends and remuneration may give the best result.
A Ltd is wholly owned by Alex who is also the sole director. There are no other employees. A Ltd makes a profit before remuneration of £40,000 in the year to 31 March 2016.
Consider the director’s disposable income available by paying out the profit entirely as salary (of £37,890, allowing for employer’s national insurance contributions of £2,110 after taking account of the Employment Allowance) or by paying it out as a mixture of salary (at £8,060, so that no national insurance contributions are payable but preserving Alex’s entitlement to state benefits) and the remaining profits as a dividend.
|Salary and dividend|
|(a)||The company’s tax position|
|employer’s national insurance||(2,110)|
Corporation tax at 20% £0 £6,388
|(b)||The director’s tax position|
|Less personal allowance||(10,600)|
|Salary and dividends|
|Dividends ( 100/90)||28,391|
|Less personal allowance||(8,060)||(2,540)|
|Less tax credit on dividend (restricted)||(2,585)|
Cash dividend (31,940 – 6,388) £25,552
|Less employee’s national insurance|
|£(37,890 – 8,060) 12%||(3,580)|
|Less tax payable||(5,458)|
The overall saving through paying a dividend is £(33,612 28,852) = £4,760.
4.7.3 Dividend payments
If dividends are paid, timing can be important. The tax year in which a dividend is paid affects the due date for any additional tax, and if a shareholder’s other income fluctuates it may determine whether or not there is any additional tax to pay. Higher rate taxpayers must pay tax at 32.5% on dividend income and additional rate taxpayers tax at 37.5%, subject to a 10% tax credit.
Dividends carry a 10% tax credit and are taxed only at 10% in the hands of basic rate taxpayers which means that dividends are attractive to such individuals. However, the 10% tax credit is not repayable to non-taxpayers.
The payment of dividends does allow flexibility, ie family members need not work for a company in order to receive a dividend. However, this must be weighted against the fact that the company must generate sufficient profit to pay a dividend. Furthermore, HMRC may seek to invoke anti-avoidance legislation if dividends are paid to non-working family members if those who do work for the company do not draw a commercial salary. Most banks and building societies will recognise regular dividends from an owner managed company as income for mortgage or other loan purposes. This takes away a potential drawback of extraction of funds in the form of investment income.
Dividends are not subject to NICs. They do not give rise to an entitlement to pay pension contributions whereas remuneration and benefits do. They are not an allowable trading expense for the company.
An alternative to both dividends and remuneration is to retain profits in a company and then liquidate it. The company itself may have capital gains on the sale of its assets, and the shareholders will have capital gains on the liquidation, which will be treated as a disposal of their shares for the amounts paid to them. The CGT charges on the shareholders may be mitigated by spreading the capital distributions over two tax years, so as to use both years’ annual exempt amounts. Entrepreneurs’ relief may be available, in which case the rate of CGT will be 10%.
This route may be worth considering when a company is set up to undertake a single project which will be completed within a few years.
A director/shareholder may choose to lend money to the company and extract profits as interest income in return.
Interest income is taxed on the director/shareholder as savings income but it is not subject to NIC. It does not count as relevant earnings for pension purposes.
From the company’s point of view, tax relief for the interest will be available under the loan relationship rules (ie either as a trading expense or as a deficit on a non-trading loan relationship).
4.7.6 Loans by close companies
Although loans by close companies to participators are not treated as distributions, on making such a loan the company suffers a tax charge: a payment equal to the amount of the loan 25% is made to HMRC. This tax charge cannot be recovered until the loan is repaid or written off.
4.7.7 Rental income
On incorporation the owner(s) may decide to retain business premises outside the company and charge rent for its use. The advantages of this method of profit extraction are that the company will obtain a trading income deduction for rent charged up to a commercial rate. Also, no NIC is payable.
The disadvantage is that income from a property business does not qualify as relevant income for pension purposes. The payment of rental income will also restrict entrepreneurs’ relief on a subsequent disposal of the premises.
For many small companies, the directors’ own homes are often used for company business. It is possible to claim a deduction in the company for reasonable rent paid by the company. Care should be taken so as not to deny principal private residence relief on a proportion of the home. To do this, it must be shown that the room(s) are not used exclusively for company business, ie the occasional guest stays in the ‘study’.
4.7.8 Pension provision
It is becoming increasingly important to save for one’s own retirement. Fortunately, it is also something the government recognises as important and, as a result, pension provision has become the most efficient way of extracting funds from a family company.
Employers are required to make pension contributions for their employees under automatic enrolment and may set up an occupational pension plan for their employees. Employees may contribute to the occupational pension plan and all individuals may contribute to a personal pension plan. Employers may also contribute to an employee’s personal pension plan.
The tax breaks for registered pension schemes are listed below.
- No taxable benefit for employer contributions
- No NIC is due on employer contributions
- The individual receives tax relief on his contributions
- The employer obtains tax relief for normal contributions actually paid during its accounting period.
- Pension fund grows tax free (tax credits on dividends not repayable)
- Tax free lump sum available up to 25% of the fund
4.8 Tax efficient exit routes
|Capital gains and inheritance tax planning are important when disposing of a family business.|
Advice on tax efficient exit routes is probably the biggest area that a professional adviser is asked to deal with in tax planning for an owner managed business. This section will explore the key tax implications of passing on and selling the family business or company and suggest useful planning tips to help structure the business in the most efficient manner from the outset.
4.8.2 Capital gains tax planning
Regardless as to whether the business or company is to be sold or passed down to the next generation, a capital gain is likely to arise. It is therefore essential to maximise the reliefs available. Entrepreneurs’ relief may be particularly valuable especially since the lifetime limit for gains is £10 million.
4.8.3 Inheritance tax planning
IHT is only a consideration where the family business or company is to be passed on to the next generation. An outright sale of the business to a third party does not constitute a transfer of value for IHT.
When a taxpayer wants to pass on his family business a major question exists as to whether to gift the assets now or wait until death.
If the assets are given during lifetime there may never be an IHT liability, either because the PET does not become chargeable or because the gift is covered by BPR provided the transferee still owns it (or other relevant business property) at the time of the transferor’s death.
A lifetime gift will be subject to CGT at some point, either on transfer or on sale of the assets by the transferee assuming a gift relief claim is made.
However, a transfer of assets on death receives a free uplift in the CGT base cost to current market value and any business property is passed on with the benefit of 100% BPR.
There are strong arguments in favour of the approach to hold business property until death but other points are worthy of serious consideration:
- If a business is hit by recession the gain itself may be fairly low in any case.
- The gain may be deferred through EIS reinvestment relief.
- BPR at 100% may not be around forever.
- Free CGT uplift on business assets may be abolished in the future on the basis that such assets should either be taxed under capital gains tax or under inheritance tax.
Some other tax pitfalls exist which can be avoided provided they are identified and acted upon. The main areas as to consider include:
- Holding assets, such as business premises, outside the company or partnership restricts BPR to a rate of only 50%. This reduces to nil if the shares or partnership interest are disposed of before the business premises.
- Where a lifetime gift is made it is important that the property remains ‘business property’ for the next seven years and that the transferee retains ownership of it (or owns alternative business property) to prevent a charge to IHT on a sudden death.
- Beware of buy and sell arrangements included in the Articles of Association or partnership or shareholder agreements as BPR may be denied.
- It will be important to ensure that a gift does not fall foul of the ‘reservation of benefit’ rules.
4.8.4 Repurchases of own shares
It may be advantageous for individuals to sell shares back to the issuing company as a repurchase of own shares (see earlier in this Text). This will be treated as a capital gain (if the conditions are satisfied) or, if not, as a distribution. If distribution treatment is preferable it may be necessary to alter the proposal to ensure the conditions are not satisfied.
4.9 Planning for corporate growth
At each stage of a ‘company’s life’ from its beginning, through growth and future expansion overseas, tax planning strategies should be adopted.
Exam focus This section looks at a company as it begins trading, acquires additional business, and eventually expands point abroad. It looks at the commercial decisions taken by the company and its shareholders at the different stages in the company’s development, and summarises the tax implications of those decisions. It focuses, in particular, on those elements of corporation tax that are likely to be examined.
4.9.1 New company
Companies often start small. One or two individuals will set up a company using their own funds (or borrowed funds) to do so. Some shareholders may be active in running the company on a daily basis whilst others will be passive investors looking for a return on their investment.
Points to consider:
- Is the company a close company?
If so, are any benefits provided to participators (treated as dividends) or loans made to participators (trigger a charge at 25% on the company)?
- Can the shareholders receive tax relief for their investment?
If the company is a close company interest paid on a loan to invest in the company is deductible from total income.
EIS income tax relief may be available to small investors.
- Level of tax paid on company profits
Salaries paid to employees reduce total profits, dividends paid to shareholders do not.
- Losses made can be relieved by carry back up to 12 months (if there are any profits to carry back against) or carry forward against future trading profits.
- Don’t forget to consider registration for VAT.
4.9.2 Expansion in UK
A company can grow bigger by increasing its own activities or purchasing the activities of another business and either assuming those activities within itself or setting up a subsidiary company.
Points to consider:
- Single company (no related 51% group companies) or group of companies. Number of related
51% group companies affects CT payment dates (see (c) below)
- If a group is formed: group relief for losses; asset transfers and tax planning regarding asset groups in respect of capital gains and losses; VAT group registration
- As taxable total profits grow, may need to consider payment of CT and VAT in instalments (large company)
- When a company acquires the trade of another company, capital losses remain within the vendor company. Trading losses will also remain with the vendor company unless the two companies are under common ownership.
4.9.3 Expansion overseas
As a company grows it may consider expanding overseas.
The tax implications of the overseas business depend on the legal structure used. From a tax point of view, there are two distinct ways of establishing the business:
- It could be owned by the UK company. Under this option, it would be an overseas PE of a UK resident company
- The UK company could incorporate a new subsidiary in the overseas country to acquire the business. Under this option, it would be an overseas subsidiary of a UK resident company.
Points to consider:
- Overseas permanent establishment (PE)
- PE is not a separate legal entity but is an extension of the company that owns it. The profits or losses of the PE belong directly to the company.
Provided the PE is controlled from the UK, any trading loss made could be offset by the UK company (or group) against its income and gains of that year, reducing the company’s UK corporation tax liability. Once the PE is profitable, the company owning the PE will be subject to overseas corporation tax on the PE profits, because it is trading within the boundaries of the overseas country from a PE.
The profits will also be subject to UK corporation tax because a UK resident company is subject to tax on its worldwide income and gains. However the UK corporation tax liability, in respect of the PE profits, will be relieved by double tax relief.
A UK company may make an election to exempt the profits and losses of all its overseas PEs from UK corporation tax. The election means that the profits of a PE are only taxed overseas, but the election will disallow loss relief or overseas PEs against UK profits. Once made, the election must apply to all of the UK company’s PEs and is irrevocable, so it is important to consider whether PEs in the future are likely to make a loss.
Double tax relief should also be taken into account when deciding whether to make the election. If the operation of DTR means that there is little or no UK corporation tax payable on overseas profits, it may be better not to make the election, and keep loss relief available in future accounting periods.
- Overseas subsidiary
- subsidiary is a separate legal entity. A company incorporated in an overseas country will be resident in that country for tax purposes, provided it is not managed and controlled from the UK. Its profits or losses will then be subject to the tax regime of the overseas country.
Any trading loss of the year would be carried forward and deducted from the company’s future trading profits arising out of the same trade.
Once the company is profitable, it will be subject to tax in the overseas country. Any dividends paid to the UK parent company will normally be exempt from corporation tax.
- It is usually suggested that a PE should be used where an overseas enterprise is expected to make initial losses. This strategy enables the losses to be offset against any other profits of the company (as long as the exemption election is not made). The PE can be incorporated once it is profitable. However, the particular facts of the situation must be considered carefully.
4.10 Group tax minimisation strategies
There are several tax planning opportunities available to groups of companies.
4.10.1 Tax planning for groups
There are many tax planning opportunities for groups of companies. The following points should be considered, in addition to the points made earlier in this Text.
- Minority interests should be restricted so as to ensure that the holding company has a 75% effective interest in every company. This will enable losses to be group relieved to whichever company can make the best use of them.
- The group can be regarded as one unit for the purposes of rollover relief on the replacement of business assets.
- VAT will arise on intra-group trading unless a VAT group is formed. It may be best to concentrate all exempt supplies in one or two companies which can be left outside the VAT group, and zero rated supplies in one or two other companies which can also be left outside the VAT group (or can form their own separate VAT group) and can make monthly repayment claims.
- Capital losses cannot be group relieved. However, an election can be made to transfer gains and losses between group members. There are restrictions on the use of pre-entry losses.
4.11 Divisionalised v group company structure
Careful consideration needs to be given as to whether a group structure or a divisionalised company would be better.
4.11.1 General principles
In certain circumstances a business can be operated through a group company structure or through a single divisionalised company.
The setting up of a trading group has a number of implications, namely:
- It is easier to give status to a key employee by appointing him director of a subsidiary company.
- Group relief of losses is available.
- Assets may be transferred between the group without giving rise to a charge to tax. (d) Group wide rollover relief may be claimed.
There are a number of disadvantages to a group structure that must be considered, particularly where the parent company or subsidiaries are to be sold.
Where the parent company is sold then the group would either:
- Sell the group and then buy back the required subsidiaries
- Reconstruct the group which would need tax clearances and cause delays, or (c) Sell assets
Where a subsidiary is sold this could give rise to a capital gain although the relief for substantial shareholdings may be available.
The advantages of divisionalised company structure are:
- Automatic set-off losses in respect of the various divisions
- Automatic set-off of capital gains and losses (c) Administration is simplified
On the other hand, the disadvantages include:
- Lack of incentive for divisional directors
- Difficulty in giving equity interest in a venture (but may consider profit-related bonuses) (c) It may be difficult to find a prospective purchaser for the whole company
In common with most professional organisations, the ACCA require members and students to observe the highest professional standards in all aspects of their work. This section discusses how these standards can be maintained, with particular reference to giving tax planning advice. The requirements apply equally to members and students, and in this section the term ‘members’ should be taken to include students.
In addition to the ACCA’s own requirements, there are many instances where members are required to comply with statutory and regulatory requirements. If a member is in doubt as to the course of action he should take, he should approach the ACCA for guidance. Failure to observe the ACCA’s standards may result in disciplinary action.
The ACCA publish a Code of Ethics and Conduct covering the standards and ethical requirements which they expect. It details the fundamental principles and sets out a framework for applying those principles. Members must apply this framework to particular situations to identify instances where compliance with the ethical standards may be compromised so that safeguards may be put in place to avoid threats, or to reduce them to below the minimum level that can be regarded as acceptable. The ACCA, jointly with certain other professional bodies, also publishes more specific guidance for members working in tax called Professional Conduct in Relation to Taxation.
Normally a member’s responsibility will be to a client, or to an employer, but there may be instances where a member may need to act in the public interest.
5.2 The fundamental principles 9/15
The fundamental principles of ethics should underlie all of a member’s professional behaviour.
The fundamental principles are:
- Integrity: Requires all members to be straightforward and honest in professional and business relationships.
A member should not be associated with information if he believes that the information contains a materially false or misleading statement, statements or information furnished recklessly, or omits or obscures information required to be included where such omission or obscurity would be misleading.
- Objectivity: Imposes an obligation on members not to compromise their professional or business judgement because of bias, conflict of interest or the undue influence of others.
Relationships that bias or unduly influence the professional judgement of the member should be avoided.
- Professional competence and due care: Requires members to: 00
- Maintain professional knowledge and skill at the level required to ensure that clients or employers receive competent professional service based on current developments in practice, legislation and techniques; and
- Act diligently in accordance with applicable technical and professional standards when providing professional services.
Any limitations relating to the service being provided must be made clear to clients and other users to ensure that misinterpretation of facts or opinions does not take place.
- Confidentiality: Imposes an obligation on members to refrain from:
- Disclosing outside the firm confidential information acquired as a result of professional and business relationships without proper and specific authority or unless there is a legal or professional right or duty to disclose; and
- Using confidential information acquired as a result of professional and business relationships to their personal advantage or the advantage of third parties
A member should consider the need to maintain confidentiality of information within the firm. A member should also maintain confidentiality of information disclosed by a prospective client or employer.
The need to maintain confidentiality continues even after the end of relationships between a member and a client or employer. When a member changes employment or acquires a new client, the member is entitled to use prior experience, but not confidential information obtained from the previous relationship.
- Professional behaviour. Imposes an obligation on a member to comply with relevant laws and regulations and avoid any action that may bring discredit to the profession.
This includes actions which a reasonable and informed third party, having knowledge of all relevant information, would conclude negatively affects the good reputation of the profession.
Members should be honest and truthful and should not:
- Make exaggerated claims for the services they are able to offer, the qualifications they possess, or experience they have gained
- Make disparaging references or unsubstantiated comparisons to the work of others
5.3 The conceptual framework
A member may find himself in a situation where there is a specific threat to compliance with the fundamental principles. There are many possible scenarios, and rather than trying to specify how each situation should be dealt with, the ACCA provide a conceptual framework that requires members to identify, evaluate and address such threats. Unless an identified threat is clearly insignificant, members should apply safeguards to eliminate the threat or reduce it to an acceptable level so that compliance with the fundamental principles is not compromised.
The member is obliged to evaluate any threat as soon as he knows, or should be expected to know, of its existence. Both qualitative and quantitative factors should be taken into account.
Most threats to compliance with the fundamental principles fall into the following categories:
- Self-interest threat, which may occur as a result of the financial or other interests of a member or of an immediate or close family member
- Self-review threat, which may occur when a previous judgment needs to be re-evaluated by the member responsible for that judgement
- Advocacy threat, which may occur when a member promotes a position or opinion to the point that subsequent objectivity may be compromised
- Familiarity threats, which may occur when, because of a close relationship, a member becomes too sympathetic to the interests of others
- Intimidation threats, which may occur when a member may be deterred from acting objectively by threats, actual or perceived
5.3.3 Safeguards to offset the threats
If a member cannot implement appropriate safeguards, he should decline or discontinue the specific professional service involved, or where necessary resign from the client.
Safeguards that may eliminate or reduce threats to an acceptable level fall into two broad categories:
- Safeguards created by the profession, legislation or regulation, such as education and training, continuing professional development, professional or regulatory monitoring and disciplinary procedures
- Safeguards in the work environment, such as effective, well publicised complaints systems operated by the employing organisation
The nature of the safeguards to be applied will vary depending on the circumstances. In exercising professional judgement, a member should consider what a reasonable and informed third party, having knowledge of all relevant information, including the significance of the threat and the safeguards applied, would conclude to be unacceptable.
5.4 Ethical conflict resolution
There may be instances where a particular situation leads to a conflict in the application of the fundamental principles.
When initiating either a formal or informal conflict resolution process, a member should consider five factors:
- Relevant facts
- Ethical issues
- Fundamental principles related to the matter
- Established internal procedures
- Alternative courses of action
Having considered these issues, the appropriate course of action can be determined which resolves the conflict with all or some of the five fundamental principles. If the matter remains unresolved, the member should consult with other appropriate persons within the firm for help in obtaining resolution.
Where a matter involves a conflict with, or within, an organisation, a member should also consider consulting with those charged with governance of the organisation.
It is advisable for the member to document the issue and details of any discussions held or decisions taken, concerning that issue.
If a significant conflict cannot be resolved, a member may wish to obtain professional advice from the ACCA or legal advisors, to obtain guidance on ethical and legal issues without breaching confidentiality.
If, after exhausting all relevant possibilities, the ethical conflict remains unresolved, a member should, where possible, refuse to remain associated with the matter creating the conflict.
The member may determine that, in the circumstances, it is appropriate to withdraw from the engagement team or specific assignment, or to resign altogether from the engagement or the firm.
5.5 Disclosure of information
5.5.1 When to disclose
A member may disclose confidential information if:
- Disclosure is permitted by law and is authorised by the client or the employer
- Disclosure is required by law, such as under anti-money laundering legislation
- There is a professional duty or right to disclose, when not prohibited by law, such as under a quality review
5.5.2 Factors to consider regarding disclosure
In deciding whether to disclose confidential information, members should consider:
- Whether the interests of all parties, including third parties, could be harmed if the client or employer consents to the disclosure of information
- Whether all the relevant information is known and substantiated, to the extent it is practicable to do so. When the situation involves unsubstantiated facts, incomplete information or unsubstantiated conclusions, professional judgement should be used in determining the type of disclosure to be made, if any
- The type of communication that is expected and to whom it is addressed; in particular, members should be satisfied that the parties to whom the communication is addressed are appropriate recipients
5.6 Conflicts of interest 6/13
A conflict of interest is a commonly met threat to compliance with the fundamental principles.
5.6.1 The threat of a conflict of interest
A member should take reasonable steps to identify circumstances that could pose a conflict of interest. These may give rise to threats to compliance with the fundamental principles.
A conflict may arise between the firm and the client or between two conflicting clients being managed by the same firm. For example, where a firm acts for both a husband and wife in a divorce settlement or acts for a company and for its directors in their personal capacity.
Evaluation of threats includes consideration as to whether the member has any business interests or relationships with the client or a third party that could give rise to threats. Safeguards should be considered and applied as necessary.
Depending upon the circumstances giving rise to the conflict, safeguards should ordinarily include the member in public practice:
- Notifying the client of the firm’s business interest or activities that may represent a conflict of interest
- Notifying all known relevant parties that the member is acting for two or more parties in respect of a matter where their respective interests are in conflict
- Notifying the client that the member does not act exclusively for any one client in the provision of proposed services (for example, in a particular market sector or with respect to a specific service)
In each case the member should obtain the consent of the relevant parties to act.
Where a member has requested consent from a client to act for another party (which may or may not be an existing client) and that consent has been refused, then he must not continue to act for one of the parties in the matter giving rise to the conflict of interest.
The following additional safeguards should also be considered:
- The use of separate engagement teams
- Procedures to prevent access to information (eg strict physical separation of such teams, confidential and secure data filing)
- Clear guidelines for members of the engagement team on issues of security and confidentiality (d) The use of confidentiality agreements signed by employees and partners of the firm
(e) Regular review of the application of safeguards by a senior individual not involved with relevant client engagements
Where a conflict of interest poses a threat to one or more of the fundamental principles that cannot be eliminated or reduced to an acceptable level through the application of safeguards, the member should conclude that it is not appropriate to accept a specific engagement or that resignation from one or more conflicting engagements is required.
You have acted for Robenick Ltd for several years, and also for the three director shareholders, Rob, Ben and Nick. During 2015 Rob has a disagreement with Ben and Nick over the direction of the company. What should you do?
When you commenced acting for both the company and Rob, Ben and Nick you should have advised each that you were acting for the others, and asked their permission to act. Providing there were no areas where the interests of the clients conflicted, there is no reason why you should not have acted for all the clients, although it may be advisable to have ensured that, for example, a different tax manager was responsible for each client.
However, now that there has been a disagreement between Rob and the other clients the situation has changed and there is a conflict of interest. It is most likely that it would be inappropriate to continue to act for all the clients, and you will need to cease to act, either for Rob, or for Ben, Nick and the company.
5.7 Prospective clients 6/13, 12/13, 6/15
Members invited to act as tax advisers by clients must contact the existing tax advisers to ascertain if there are any matters they should be aware of when deciding whether to accept the appointment.
Before accepting a new client, members should consider whether acceptance of the client or the particular engagement would create any threats to compliance with the fundamental principles.
Potential threats to integrity or professional behaviour may be created from, for example, questionable issues associated with the client, or a threat to professional competence and due care may be created if the engagement team does not possess the necessary skills to carry out the engagement. Where it is not possible to implement safeguards to reduce the threats to an acceptable level, members should decline to enter into the relationship.
There are also client identification procedures to be followed (see later in this chapter).
5.7.2 Changes in professional appointment
Members who are asked to replace another accountant should ascertain whether there are any professional or other reasons for not accepting the engagement. This may require direct communication with the existing accountant to establish the facts and circumstances behind the proposed change so that members can decide whether it is appropriate to accept the engagement.
Communication with the existing accountant is not just a matter of professional courtesy. Its main purpose is to enable members to ensure that there has been no action by the client which would on ethical grounds, preclude members from accepting the appointment and that, after considering all the facts, the client is someone for whom members would wish to act. Thus, members must always communicate with the existing accountant on being asked to accept appointment for any recurring work.
The existing accountant is bound by confidentiality. This means the extent to which a client’s affairs may be discussed with a prospective accountant will depend on the nature of the engagement and on whether the client’s permission has been obtained. If the client refuses permission, the existing accountant should inform the prospective accountant, who should then inform the client that he is unable to accept the appointment.
If the existing accountant fails to communicate with the prospective accountant despite the client’s permission, the prospective accountant will need to make other enquiries to ensure there are no reasons not to accept the appointment. This could be through communications with third parties, such as banks.
Where the member is the existing accountant then, subject to obtaining the client’s permission, he should disclose all information requested without delay.
You have acted for Alexander but have discovered a serious tax irregularity which Alexander has refused to correct and you have advised Alexander that you can no longer act for him. You receive a letter from another ACCA member advising you that he has been asked to act for Alexander. Alexander has forbidden you to divulge any information about him. What should you do?
You should advise the new accountant that Alexander has not given you permission to divulge any information. The new accountant should then refuse to act for Alexander.
5.7.4 Acting as agent or principal
Where you are performing tax compliance work eg preparing and submitting tax returns, you will be acting as agent to the client. This means that the client remains responsible for all of the information provided in the return.
When you are providing tax planning advice, however, you will be acting as ‘principal’ which means that you are fully responsible for the advice you give.
5.7.5 Tax planning concerns
At the very least, anything you recommend must be legal. You should understand the basic distinction between tax avoidance (tax mitigation through legal means) and tax evasion (illegal, such as fraud). Apart from the specific rules regarding disclosure of avoidance schemes (see below), you must understand that the taxpayer has the responsibility of preparing a tax return that is complete and correct (see above), and this will include an accurate disclosure of the facts.
That is not to say that you may not suggest a course of action where HMRC might disagree with your conclusion as to the tax consequences. You need to explain to the client that full details must be given to enable HMRC to consider the matter, and you should warn him that any negotiations with HMRC will take time and incur expense.
Make sure that you know the time limits for any claims that need to be made. If you miss the limit, the relief will be denied. Late returns incur penalties, and late payment of tax leads to an interest charge.
5.8 Tax irregularities 6/12, 12/12, 6/14, 12/14
If a member discovers that a client has misled him in order to obtain a tax advantage, the member has to consider his position in relation to both the client and the tax authorities.
5.8.1 Discovery of errors
A member may discover that a client has committed a taxation offence. Tax legislation prescribes monetary penalties for a number of offences. There is also the possibility of criminal proceedings being brought against the client.
The evasion or attempted evasion of tax may be the subject of criminal charges under both tax law and money laundering legislation. This applies not only to direct taxes such as income tax or corporation tax, but also to indirect taxes such as VAT. The member has the following responsibilities:
- If the information obtained concerns computations or returns that the member is currently preparing, the member must ensure that the information is accurately reflected therein. If the client fails to provide any information requested by the member, or objects to way in which the member has presented the information, the member needs to consider whether he can continue to act for that client.
- If the information obtained concerns computations or returns that the member has already prepared and submitted to HMRC, the member cannot allow HMRC to continue to rely on them. He should advise his client to make full disclosure to HMRC, or to authorise him to do so, without delay. If the client refuses, then the member can no longer act for the client. The client should be advised of this, and also that the member must inform HMRC that they have ceased to act for the client. If the documents submitted to HMRC contain any accountant’s report, the member must also advise HMRC that the report should no longer be relied on. The member should not, however, advise HMRC in what way the accounts are defective unless the client has consented to such disclosure.
- If the information relates to a new client and concerns computations or returns that have been prepared by the client or a third party and submitted to HMRC, the member should advise the client to make full and prompt disclosure. If the error affects the current computations or returns then the member must inform the client that an appropriate adjustment must be made in the current accounts, and if the client refuses the member should consider whether he should act for that client. Indeed, even if the error does not affect current returns and computations the member should consider whether he should act for the client if the client refuses to disclose the error to
Whether or not the member feels able to act for a client, he is still under a professional duty to ensure that the client understands the seriousness of offences against HMRC. He should also warn the client that notification that he is no longer acting for a client may alert HMRC, and urge the desirability of making a full disclosure, subject to any legal advice obtained. Any accounts, returns, computations or reports submitted on behalf of taxpayers are deemed to be submitted by the taxpayer and/or with their consent unless they prove otherwise.
This emphasises the need for members to ensure that clients have approved computations and returns, and signified their approval by signing them. There should always be a letter of engagement in place setting out the precise responsibilities of both the member and the client.
You are preparing the tax return for Sonia and amongst her papers you find a bank statement for a new account which was opened with the transfer of a significant amount from her own account. Sonia says that this new account belongs to her young son, and that the interest should not be put on her tax return. What should you do?
First, you should explain that income from funds provided by a parent are taxed as the parent’s income, unless the income is less that £100, so that the interest must be shown. If Sonia still refuses to enter the interest on her return you should advise her that you can no longer act for her, and you must also advise HMRC that you no longer act. You are not obliged to disclose the reason to HMRC.
At this stage you have a suspicion that a tax offence may be committed, and you should discuss this with your firm’s money laundering officer.
5.8.3 HMRC powers
HMRC have certain statutory powers to compel disclosure in particular instances. Where information is sought under such powers, members must check that the statutory power being invoked actually covers the information sought and, if in any doubt, should take legal advice.
In some cases HMRC will ask for information to be provided voluntarily, rather than resorting to the use of their statutory powers. In this case the member must consider carefully whether it is in the client’s interest to make voluntary disclosure, rather than await a statutory demand, and again may wish to take legal advice.
5.8.4 Errors by HMRC in the taxpayers’ favour
Problems may arise if HMRC erroneously makes an excessive repayment of tax to taxpayers, even though they have received full disclosure of the facts.
If the repayment is made directly to the client, the member should urge them to refund the excess sum to HMRC as soon as possible. Failure to correct the error may be a civil and/or criminal offence by the client. If the client refuses the member must consider whether he should continue to act for the client. If he ceases to act, he must notify HMRC that he no longer acts for the client, but is under no duty to give HMRC any further details, although it may be necessary to consider whether a report should be made under the money laundering rules.
If the repayment is made to the member on the client’s behalf, the member must notify the tax authorities. Failure to do so could involve both the member and client in a civil and/or criminal offence.
It should be noted that if HMRC make the repayment because they have adopted a different treatment of a transaction to that taken by the member and client, this is not an excessive repayment, it merely arises from a different interpretation of the legislation. This is subject to the proviso that full details of the transaction has been returned, so that HMRC have reached their decision on an informed basis.
|Tax evasion may include keeping a repayment of tax to which the client is not entitled. This point was tested in December 2012 Question 1 Flame plc group in relation to a group member, Bon Ltd. The examiner commented that ‘Most candidates recognised this situation and were able to list the actions that the firm needed to take and the matters that needed to be drawn to the attention of Bon Ltd.’|
Exam focus point
5.9 Money laundering
Money laundering is the process by which criminals attempt to conceal the true origin and ownership of the proceeds of their criminal activity, often with the unwitting assistance of professionals such as accountants and lawyers.
Members are bound by legislation to implement preventative measures and to report suspicions to the appropriate authority. Failure to follow these legislative requirements will often be a criminal offence, leading to a fine and/or imprisonment. The legal position and its application to any given set of facts may not be straightforward and members are advised to take legal advice whenever they are uncertain as to their conduct.
Members should have appropriate procedures to ensure that client identification procedures are carried out correctly and that knowledge and suspicions of money laundering are reported to the firm’s money laundering officer.
5.9.1 Client identification procedures
Where a new client is taken on a member should verify his identity by reliable and independent means. This could comprise the following:
- Where the client is an individual: by obtaining independent evidence, such as a passport, driving licence, HMRC document such as a notice of coding, and proof of address;
- Where the client is a company: by obtaining proof of incorporation; by establishing the primary business address; by identifying the members and directors of the company; and by establishing the identities of those persons instructing the member on behalf of the company and verifying that those persons are authorised to do so.
If satisfactory evidence cannot be obtained, no work should be undertaken.
Members should retain all client identification records for at least five years after the end of the client relationship, together with records of all work carried out for the client.
5.9.2 Suspicions of money laundering
During the course of the engagement, members should regularly review the client’s actions to satisfy themselves that they are consistent with the client’s usual activities. Anything which appears to be out of the ordinary should be closely examined and a written record made of the member’s conclusions. If members’ suspicions are aroused, a money laundering report should be made.
Suspicion is more than mere speculation, but which falls short of proof based on firm evidence. What is suspicious in relation to one client may not be suspicious in relation to another client. Therefore, the key to recognising a suspicious transaction or situation is for members to have a full understanding of the client and his activities.
Transactions which appear to have no apparent economic or visible lawful purpose should be looked at carefully to establish their purpose and any findings recorded in writing. If no purpose for the transaction can be established, this may be a ground for suspicion.
Where members know or suspect that funds are directly or indirectly the proceeds of crime, they should report their suspicions promptly to the National Crime Agency. Where tax evasion is involved members will also need to examine their responsibilities to the tax authorities.
Where the work done by members for their clients is covered by legal professional privilege, members are not required to report their suspicions. Whether or not legal professional privilege applies to members and in what circumstances will depend on local law and members are strongly advised to seek legal advice as and when the issue arises.
5.9.3 Tipping off
Members should not ‘tip off’ a client that a report has been made. This may cause a member difficulties if a client refuses to disclose tax irregularities to HMRC as ceasing to act for the client might tip off the client that a report has been made. Any attempts to persuade a client not to proceed with an intended crime will not constitute tipping off.
Members faced with money laundering issues may call upon the Advisory Services Section of the ACCA for confidential advice.
5.10 Disclosure of tax avoidance schemes
There are disclosure requirements for promoters of direct tax avoidance schemes. Businesses may be required to disclose use of VAT avoidance schemes.
5.10.1 Direct tax avoidance schemes
Promoters of tax avoidance schemes have disclosure obligations. There is also an obligation on taxpayers to disclose details of schemes in certain cases.
Notification is required from a promoter of arrangements or proposed arrangements, the main benefit of which is to enable any person to obtain an advantage in relation to tax. A ‘promoter’ is defined as a person who, in the course of a trade, profession or business involving the provision of tax services to other persons, is to any extent responsible for the design of the arrangements, or who makes a proposal available for implementation by other persons.
The information to be given by a promoter must be provided within a prescribed period of five days after being made available. The information to be provided and the manner in which it is to be provided is set out in the regulations.
A taxpayer is required to provide details of arrangements where the arrangements have been purchased from an offshore promoter, and that promoter has made no disclosure. Disclosure must also be made by large businesses which have entered into arrangements not involving a promoter.
HMRC may allocate a reference number to arrangements notified under the disclosure rules. Promoters are required to notify clients of that reference number so that they can enter that number on their tax return.
Any person that fails to comply with any of the disclosure provisions is liable to a penalty not exceeding £5,000. If the failure continues after that penalty has been imposed, that person is liable to a further penalty or penalties not exceeding £600 for each day on which the failure continues.
A tax advantage is defined as relief or increased relief from tax, repayment or increased repayment of tax, avoidance or reduction of a charge to a tax. It also includes the deferral of any payment of tax or advancement of any repayment of tax or the avoidance of any obligation to deduct or account for tax. Hallmarks are laid down by regulations specifying types of notifiable schemes.
The taxes covered by these provisions are IT, NIC, CGT, CT, IHT, and stamp taxes.
5.10.2 VAT avoidance schemes
Businesses using VAT avoidance schemes must disclose their use. Certain VAT avoidance schemes (‘notifiable’ schemes) are put on a statutory register.
Businesses with an annual turnover of £600,000 or more that use designated schemes must inform HMRC. A designated scheme is one which has been designated by the Treasury.
Businesses with an annual turnover of £10 million or more must also inform HMRC if they use notifiable schemes, that are not designated schemes, for the purpose of securing a tax advantage.
Detailed regulations deal with the notification procedure to be used.
The penalty for failure to notify HMRC of the use of a designated scheme is 15% of the VAT saving as a result of the use of the scheme. The penalty for using other arrangements is £5,000.
5.11 General anti-abuse rule (GAAR)
There is a general anti-abuse rule to enable HMRC to counteract tax advantages gained from abusive tax arrangements.
The GAAR provides additional means for HMRC to ‘counteract’ tax advantages arising from abusive ‘tax arrangements’.
5.11.2 Tax arrangements
Tax arrangements are arrangements with a main purpose of obtaining a tax advantage.
Arrangements are abusive if they cannot be regarded as a reasonable course of action, for example, where they lead to unintended results involving one or more contrived or abnormal steps and exploit any shortcomings in the tax provisions.
Examples of abusive arrangements include those that result in:
- Significantly less income, profits or gains
- Significantly greater deductions or losses, or
- A claim for the repayment or crediting of tax (including foreign tax) that has not been, and is unlikely to be, paid
5.11.3 Tax advantage
A ‘tax advantage’ includes:
- Relief or increased relief from tax
- Repayment or increased repayment of tax (c) Avoidance or reduction of a charge to tax
- Avoidance of a possible assessment to tax
- Deferral of a payment of tax or advancement of a repayment of tax
- Avoidance of an obligation to deduct or account for tax
5.11.4 Counteracting tax advantages
HMRC may counteract tax advantages arising by, for example, increasing the taxpayer’s tax liability.
HMRC must follow certain procedural requirements and, if it makes any adjustments, these must be on a ‘just and reasonable’ basis.
|||Questions on impact of taxes require you to use your technical knowledge of taxation in relation to particular scenarios. Avoid writing about technical areas in general terms as opposed to in relation to the question’s requirements.|
|||There are many sources of finance available for individuals, long or short term, secured or unsecured.|
|||A mortgage may be a repayment or interest only mortgage. Pensions or ISAs may be used to accumulate the capital required to repay an interest only mortgage.|
|||Most deposit based investments are fairly low risk investments in which an investor receives a low rate of interest in return for depositing his capital with the institution.|
|||A fixed interest security pays a fixed rate of interest and has a known maturity value so long as it is held until its redemption date.|
|||Individual savings accounts (ISAs) provide a tax-free wrapper for investments in cash, and stocks and shares.|
|||Equities are high risk investments as neither the income nor the capital is secure.|
|||The enterprise investment scheme (EIS) is a scheme designed to promote enterprise and investment by helping high-risk, unlisted trading companies raise finance by the issue of ordinary shares to individual investors who are unconnected with that company.|
|||The seed enterprise investment scheme (SEIS) is similar to the EIS scheme but rewards investment in small, start up unquoted trading companies, with a greater tax reducer.|
|||Venture capital trusts (VCTs) are listed companies which invest in unquoted trading companies, so enabling investors to spread their risk over a number of higher-risk, unquoted companies whilst obtaining income tax and capital gains tax reliefs.|
|||Businesses may require short or long term finance to start up, carry on or expand.|
|||A business may obtain finance through loans and may be able to obtain tax relief for interest paid. A company can raise finance by issuing shares to shareholders.|
|||A business may lease or buy assets. Short term leasing costs may be deductible expenses. Longer term costs may attract capital allowances in a similar way to buying an asset outright.|
|||As a general rule, self-employment leads to lower overall tax and NIC burdens than employment.|
|||If someone is to be an employee, the tax effects of the remuneration package should be taken into account.|
|||An individual can choose between trading as a sole trader or trading through a company. That choice, and if a company is chosen, the choice between dividends and remuneration, can significantly affect the overall tax and NIC burden. Cash flow is also an important consideration.|
|||The incorporation of a business should be carefully planned, taking account of consequent tax liabilities. There are both advantages and disadvantages to incorporating a business. A disposal of shares can also have several tax consequences.|
|||If disincorporation relief applies, there will be no corporation tax charge on the transfer of land and buildings and goodwill by a company to its shareholders. Other reliefs may apply to transfers of inventory and plant and machinery. A tax charge may arise for the shareholders on the distribution of assets, either income tax or capital gains tax.|
|||There are several methods by which profit can be extracted from a company.|
|||Capital gains and inheritance tax planning are important when disposing of a family business.|
|||At each stage of a ‘company’s life’ from its beginning, through growth and future expansion overseas, tax planning strategies should be adopted.|
|||There are several tax planning opportunities available to groups of companies.|
|||Careful consideration needs to be given as to whether a group structure or a divisionalised company would be better.|
|||The fundamental principles of ethics should underlie all of a member’s professional behaviour.|
|||A conflict of interest is a commonly met threat to compliance with the fundamental principles.|
|||If a member discovers that a client has misled him in order to obtain a tax advantage, the member has to consider his position in relation to both the client and the tax authorities.|
|||There are disclosure requirements for promoters of direct tax avoidance schemes. Businesses may be required to disclose use of VAT avoidance schemes.|
|||There is a general anti-abuse rule to enable HMRC to counteract tax advantages gained from abusive tax arrangements.|
- What are the main sources of finance for private purposes?
- What are the two main methods of repaying the capital of a mortgage?
- How are the returns on NS&I savings certificates taxed?
- What additional ISA allowance is available to a surviving spouse/civil partner?
- What are the features of a preference share?
- What are the main NIC differences between the tax positions of employees and the self employed?
- What is a major attraction of incorporation?
- Why might a newly commencing trader employ a prospective partner at first, before forming a partnership?
- What is the major disadvantage for an individual shareholder of an incorporated business where losses are anticipated?
- List the methods by which profit may be extracted from a company.
- What are the advantages of a divisionalised company structure?
- Can an ACCA member act for both parties in a marriage/civil partnership?
- What should you do if you suspect that a client may have taken a bribe from a customer?
- What is the maximum initial penalty for failure to notify a tax avoidance scheme relating to income tax?
- When may HMRC use the general anti-abuse rule?
Answers to quick quiz
- (a) Bank overdrafts
- Unsecured bank and building society loans
- Mortgage loans
- Credit cards and credit facilities provided by retailers (e) Hire purchase facilities
- Capital of a mortgage may be paid back during the term or at the end of the term.
- Returns on NS&I savings certificates are tax free.
- An additional allowance equal to the value of ISAs which were held by the deceased spouse/civil partner at the date of their death.
- Preference shares:
- Ahead of ordinary shares for dividends/liquidation
- Guaranteed dividend amount (but no increase if surplus)
- Employees suffer Class 1 NIC. Their employers suffer Class 1 and Class 1A NIC too.
The self employed pay Class 2 and Class 4 NIC. The rates of NIC due under these classes are smaller than Class 1 and Class 1A NIC.
- The attraction of incorporation is limited liability. A sole trader or partner is liable for business debts to the full extent of his personal wealth. A limited company’s shareholder is liable to the amount, if any, unpaid on his shares.
- Commencing trade with a prospective partner as a salaried employee for a year or two obtains tax relief twice on his salary during any overlap period.
- A company’s losses are not available to reduce shareholders’ taxable incomes (unlike losses of an unincorporated business which can reduce the sole trade/partners incomes).
- (a) Remuneration (b) Dividends
- Loan interest
- Rental income
- Pension contributions
- (a) Automatic set off of trading losses in respect of various divisions
- Automatic set off of capital gains and losses
- Administration is simplified
- It depends on whether there are any relationships between the two that could give rise to a conflict of interest. For example, they may be business partners, or one may employ the other. Even so, it may be sufficient to ensure that each is aware that you act for both, provided you keep the position under review. In other cases the conflict of interest might be such that you should not; for example if there has been a breakdown in their relationship.
- This is likely to be a criminal offence and you should report your suspicions to the firm’s money laundering officer.
- The general anti-abuse rule may be used by HMRC where a taxpayer has used abusive tax arrangements to obtain a tax advantage.
Question 40 has been analysed to show you how to approach paper P6 exams.