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Statutory Residence Test

Monday, August 11th, 2014

The concept of residence in the United Kingdom is fundamental to the determination of UK tax liability for any individual. For over 200 years the term ‘residence’ has never been defined in our tax laws and the issue of interpretation in any situation has been dependent upon considering case law and HMRC practice. From 6 April 2013 a Statutory Residence Test (SRT) has been introduced into legislation.

The SRT provides, through a series of tests, a definitive process to determine the UK residence status of any individual. That status applies for income tax, capital gains tax and inheritance tax purposes.

Once that status has been established then other rules determine the extent of an individual’s liability to UK taxes. These other rules may include not just UK statute but also double tax treaties with other countries. These rules are not covered in this factsheet.

 

Counting days

The SRT relies heavily on the concept of counting ‘days of presence’ in the UK in the relevant tax year and so it is important to understand what this term means. The basic rule is a day of presence is one where the individual was in the country at midnight. There are two exceptions to this:

the individual only arrives as a passenger on that day and leaves the UK the next day and in between does not engage in activities that are to a substantial extent unrelated to their passage through the UK and

the individual would not be present in the UK at the end of the day but for exceptional circumstances beyond their control which prevent them from leaving and they would intend to leave as soon as those circumstances permit.

A further rule applies where an individual has been resident in the UK in at least one of the three previous tax years and has at least three ‘ties’ with the UK.  It will be then be necessary to add to the total of ‘midnight days’ the excess over 30 of any other days where the individual spent any time at all in the UK.

 

Three tests

The SRT is based on a series of three tests which must be considered in a particular order in every case. The tests are applied to the facts in the ‘relevant tax year’ i.e. the year for which residence status is being determined:

first consider the Automatic Overseas Test (AOT). If this test is satisfied the individual will be not resident in the UK in the relevant tax year and no further tests are required. If the AOT is not satisfied then move on to

the Automatic Residence Test (ART). If this test is satisfied the individual will be resident in the UK in the relevant tax year and no further tests are required. If the test is not satisfied move on to

the Sufficient Ties Test (STT). If this test is satisfied the individual will be resident in the UK and if it is not satisfied they will be not resident.

The detailed conditions relating to each test are discussed below. There are further tests which only apply if the individual has died in the year but these are not dealt with here.

 

The Automatic Overseas Test (AOT)

There are three possible tests in the AOT and if an individual satisfies any one of these they will be not resident in the UK in the relevant tax year. The conditions are that the individual:

was resident in the UK in one or more of the previous three tax years and they are present in the UK for fewer than 16 days in the relevant tax year

was not resident in the UK in all of the previous three tax years and they are present in the UK for fewer than 46 days in the relevant tax year

works full time abroad for at least a complete tax year and they are present in the UK for fewer than 91 days in the relevant tax year and no more than 30 days are spent working (currently defined as more than 3 hours) in the UK in the tax year.

The first two tests are simply based on a day count and ignore the existence of other factors such as other links with the UK like the availability of accommodation in the UK.

There are conditions for the third test which need to be considered by those planning to go abroad to work either as an employee or on a self-employed basis. Obviously the days of presence and the working days must be considered carefully. In addition it should be noted that:

full time work is defined as an average of 35 hours a week over the whole period of absence. Account can be taken of a range of factors such as holidays and sick leave to effectively improve the average

working days in the UK do not have to be the same as the days of presence so a day where there is UK work and the individual leaves the UK before the end of the day may well count as a working day

HMRC will expect evidence to be provided if it is claimed that the time limit for a working day has not been exceeded.

The way in which the subsequent tests are structured mean that it is really important that a working expatriate can pass the AOT and be treated as not resident otherwise they are likely to find a real problem under the later tests.

 

The Automatic Residence Test (ART)

If the AOT is not met then the individual must next consider the conditions of the ART. This test will be satisfied if any of the following apply to the individual for the relevant tax year:

they are present in the UK for 183 days or more in a tax year

they have a home in the UK and they are present in that home on at least 30 separate days in the relevant year. There must be a period of at least 91 consecutive days during which the home is available and at least 30 of those days must fall within the relevant tax year

they carry out full time work in the UK for a period of 365 days during which at least 75% of their time is spent in the UK.

The ‘home’ test may be of real significance because, if that test applies, the number of days in the UK is irrelevant. The legislation makes clear that a home can be a building or part of a building and can include a vessel or vehicle. It must have a degree of permanence or stability to count as a home but specific circumstances may have to be considered. If the individual also has a home abroad, the second test above will not apply if the person spends more than 30 days at the home abroad in the tax year.

 

The Sufficient Ties Test

If no conclusive answer to residence status has arisen under the first two tests, the individual must then look at how the STT applies to them for the relevant tax year. The test will be satisfied if the individual has sufficient UK ties for that year. This will depend on two basic conditions:

whether the individual was resident in the UK for any of the previous three tax years and

the number of days the individual spends in the UK in the relevant tax year.

The STT reflects the principle that the more time someone spends in the UK, the fewer connections they can have with the UK if they want to be not resident. It also incorporates the principle that residence status should adhere more to those who are already resident than to those who are not currently resident.

Under the STT an individual compares the number of days of presence in the UK against five connection factors. Individuals who know how many days they spend in the UK and how many relevant connection factors they have can then assess whether they are resident.

The five ties are summarily set out as:

a family tie – this will apply if either a spouse or minor child is resident in the UK in the relevant tax year

an accommodation tie – where there is accommodation which is available for at least 91 days in the tax year and is actually used at least once

a work tie – where there are at least 40 working days of three hours or more in the UK in the relevant tax year

a 90-day tie – more than 90 days were spent in the UK in either or both of the two immediately preceding UK tax years and

a country tie – more time is spent in the UK than in any other single country in the relevant tax year.

An individual who has been resident in the UK in any of the three preceding tax years must consider all five ties and they will be resident if any of the following apply:

 

Days in UK

Number of ties sufficient to establish residence

16 – 45

at least 4

46 – 90

at least 3

91 – 120

at least 2

121 – 182

at least 1

 

An individual who has not been resident in any of the three preceding years must consider all the ties apart from the country tie and they will be resident in any of the following situations:

 

Days in UK

Number of ties sufficient to establish residence

46 – 90

all 4

91 – 120

at least 3

121 – 182

at least 2

 

Special rules for international transport workers

The SRT rules are adapted where an individual is an ‘international transport worker’ This is defined as someone who:

holds an employment, the duties of which consist of duties to be performed on board a vehicle, aircraft or ship, while it is travelling or

carries on a trade, the activities of which consist of the provision of services on board a vehicle, aircraft or ship as it is travelling.

In either case substantially all the journeys must be across international boundaries. The individual has to be present on board the respective carrier as it makes international journeys in order to provide those services.

An individual who has some duties on purely domestic journeys will still be regarded as within the definition if the international duties are substantial (probably at least 80%).

Where an individual falls within this group the implications for the SRT are (broadly) that the individual:

cannot be non-UK resident on the grounds of working full time overseas

cannot be UK resident on the grounds of working full time in the UK and

in considering the work day tie for the STT an international transport worker is regarded as doing more than three hours work where any journey that day commences in the UK and fewer than three hours on any other day.

 

Split year rules

The basic rule will be that if an individual satisfies the conditions of the SRT to be treated as resident for a part of the UK tax year then they are resident for the whole of that year. Special rules will apply in certain circumstances to allow a year of arrival or departure to be split into resident and not resident parts as appropriate. We shall be pleased to discuss whether your plans or circumstances will be eligible for such treatment.

 

Anti-avoidance rules

The government wants to ensure that individuals are not able to exploit the rules to become not resident for a short period during which they receive certain types of income or make capital gains. Basically an individual with a history of at least four out of the previous seven years as a sole UK resident will need to maintain not resident status for at least five UK tax years otherwise certain income and all capital gains made in the period of absence will become taxable in the UK in the next year in which they are resident.

 

How we can help

A change of tax residence is always a major decision and detailed advice is necessary. Please bear in mind that whatever your UK residence status may have been in 2012/13, there is no automatic assumption that it will continue in future years. The facts will have to be separately considered each tax year and the changes in 2013/14 means that great care must be taken in that and subsequent years.

Please do contact us for any advice you may need.

Property Investment – Buy to Let

Wednesday, August 6th, 2014

In recent years, the stock market has had its ups and downs. Add to this the serious loss of public confidence in pension funds as a means of saving for the future and it is not surprising that investors have looked elsewhere.

The UK property market, whilst cyclical, has proved over the long-term to be a very successful investment. This has resulted in a massive expansion in the buy to let sector.

Buy to let involves investing in property with the expectation of capital growth with the rental income from tenants covering the mortgage costs and any outgoings.

However, the gross return from buy to let properties – ie the rent received less costs such as letting fees, maintenance, service charges and insurance – is no longer as attractive as it once was. Investors need to take a view on the likelihood of capital appreciation exceeding inflation.

 

Factors to consider

Do         – think of your investment as medium to long-term

              – research the local market

              – do your sums carefully

              – consider decorating to a high standard to attract tenants quickly.

Don’t     – purchase anything with serious maintenance problems

              – think that friends and relatives can look after the letting for you – you’re                                     probably better off with a full management service

              – cut corners with tenancy agreements and other legal documentation.

Which property?

Investing in a buy to let property is not the same as buying your own home. You may wish to get an agent to advise you of the local market for rented property. Is there a demand for say, two bedroom flats or four bedroom houses or properties close to schools or transport links? An agent will also be able to advise you of the standard of decoration and furnishings which are expected to get a quick let.

 

Agents

Letting property can be very time consuming and inconvenient. Tenants will expect a quick solution if the central heating breaks down over the bank holiday weekend! Also do you want to advertise the property yourself and show around prospective tenants? An agent will be able to deal with all of this for you.

 

Tenancy agreements

This important document will ensure that the legal position is clear.

 

Taxation

When buying to let, taxation aspects must be considered.

 

Tax on rental income

Income tax will be payable on the rents received after deducting allowable expenses. Allowable expenses include mortgage interest, repairs, agent’s letting fees and an allowance for furnishings.

 

Tax on sale

Capital gains tax (CGT) will be payable on the eventual sale of the property. The tax will be charged on the disposal proceeds less the original cost of the property, certain legal costs and any capital improvements made to the property. This gain may be further reduced by any annual exemption available and is then taxed at either 18% or 28% or a combination of the two rates. CGT is payable on 31 January after the end of the tax year in which the gain is made.

 

Student lettings

Buy to let may make sense if you have children at college or university. It is important that the arrangement is structured correctly. The student should purchase the property (with the parent acting as guarantor on the mortgage). There are several advantages to this arrangement.

Advantages

This is a cost effective way of providing your child with somewhere decent to live.

Rental income on letting spare rooms to other students should be sufficient to cover the mortgage repayments from a cash flow perspective.

As long as the property is the child’s only property it should be exempt from CGT on its eventual sale as it will be regarded as their main residence.

The amount of rental income chargeable to income tax is reduced by a deduction known as ‘rent a room relief’.  This is £4,250 each year. In this situation no expenses are tax deductible. Alternatively expenses can be deducted from income under normal letting rules where this is more beneficial.

 

Furnished holiday lettings

Furnished holiday letting (FHL) is another type of investment that could be considered. This form of letting is short holiday lets as opposed to letting for the residential market.

The favourable tax regime for furnished holiday letting accommodation has been significantly amended. Most importantly the regime has been extended to cover qualifying property located anywhere in the European Economic Area (EEA). This extension is effectively backdated and means that it may be possible to claim the benefits of FHL treatment of losses and capital gains in UK tax years within the normal four year time limit.

The conditions necessary to qualify for FHL treatment have been amended from 6 April 2012. From that date the property will have to be available for letting for at least 210 days in each tax year and must actually be let for 105 days.  Provided that there is a genuine intention to meet the actual letting requirement it will be possible to make an election to keep the property as qualifying for up to two years even though the condition may not be satisfied in those years. This will be particularly important to preserve the special CGT treatment of any gain as qualifying for the lower CGT rate of 10% where the conditions for Entrepreneurs’ Relief are satisfied.

One area of previous benefit which has now gone is that losses arising in an FHL business can no longer be set against other income of the taxpayer. This change applies for the 2011/12 tax year onwards. It also becomes necessary to segregate losses into UK losses and EEA losses. Each can only be offset against profits of the same or future years in each relevant sector.

FHL property has some advantages but it has other disadvantages which should also be considered.

Advantages

You will be able to take a holiday in your own property, or make it available some of the time to your family or friends. However, care would need to be taken to adjust the level of expenses claimed to reflect this private use.

Generally however the rules for allowable expenditure are more generous.

Disadvantages

Holiday letting will have higher agent’s fees, advertising costs, and maintenance fees (for example more regular cleaning).

Owning a holiday property may be more time consuming than you think and you may find yourself spending your precious holiday sorting out problems.

If you would like any further advice in this area please get in touch.

 

How we can help

Whilst some generalisations can be made about buy to let properties it is always necessary to tailor any advice to your personal situation. Any plan must take into account your circumstances and aspirations.

Whilst a successful buy to let cannot be guaranteed, professional advice can help to sort out some of the potential problems and structure the investment correctly.

We would be happy to discuss buy to let further with you. Please contact us for more detailed advice.

Research and Development

Monday, August 4th, 2014

Research and development (R&D) by UK companies is being actively encouraged by Government through a range of tax incentives.

The incentives are only available to companies and include:

  • increased deduction for R&D revenue spending and
  • a payable R&D tax credit for companies not in profit.

 

The relief

The R&D revenue relief increases the amount a company can obtain tax relief on to more than the normal 100% revenue deduction. This relief is 225% for expenditure incurred by a SME on or after 1 April 2012. Large companies are subject to a different regime not considered here.

Alternatively a SME may claim a payable R&D tax credit for an accounting period in which it has a surrenderable loss. For expenditure incurred on or after 1 April 2012 the amount of payable tax credit that a company is entitled to for an accounting period is 11% of the surrenderable loss for that period. For accounting periods ending on or after 1 April 2012 the R&D credit is no longer restricted to the PAYE/NIC liabilities of the company.

Example

The following is an example of the relief in operation.

Neuf Ltd is an SME and incurs qualifying R&D expenditure during the year to 31 March 2013 of £100,000.

Assuming Neuf Ltd is profitable it will be able to claim a deduction in respect of its R&D expenditure of £225,000. This will reduce its corporation tax liability by £45,000 (assuming a 20% rate), giving the company effective relief on the actual expenditure of 45%.

If, on the other hand, Neuf Ltd is making losses, the £225,000 attributable to the R&D expenditure can either be carried forward for relief against future trading profits or converted into a payable R&D tax credit. The rate of conversion is currently set at 11% so this would generate a payment to the company of £24,750 (£225,000 x 11%) which equates to 24.75% of the original expenditure.

 

Considerations

There are two main considerations to establish whether the reliefs for R&D are available. These are concerned with the activity and also the conditions relating to the expenditure incurred.

 

Is the activity qualifying R&D?

The first essential matter to determine is whether HMRC would accept that the particular activities constitute R&D.

Relief is available if a project seeks to achieve an advance in overall knowledge or capability in a field of science or technology through the resolution of scientific or technological uncertainty and not simply an advance in its own state of knowledge or capability.

Furthermore it must be related to your company’s trade either an existing one, or one that you intend to start up based on the results of the R&D.

HMRC guidance suggests when making the claim for relief that a company should answer the following questions, so they can see how your view of the definition applies to your project.

What is the scientific or technological advance?

What were the scientific or technological uncertainties involved in the project?

How and when were the uncertainties actually overcome?

Why was the knowledge being sought not readily deducible by a competent professional?

Please do get in touch if you would like advice on R&D so we can maximise the reliefs available.

 

Does the expenditure qualify?

The second consideration is to ensure the relevant tax conditions are met, the most important being:

  • the expenditure must be from a qualifying revenue category and not be capital expenditure
  • the spending must not be incurred in carrying out activities contracted to the company by another person (however a slightly different form of R&D tax credit may apply – you may still be able to claim, as a subcontractor, under the Large Company Scheme which is not considered further in this factsheet)
  • the expenditure must not have been met by another person (if the R&D project is funded in whole or part by ‘State Aid’ such as a government grant, none of the spending on that project can qualify for R&D tax credits).

The R&D does not have to be undertaken in the UK.

You must make a claim for R&D relief in your Company Tax Return.  The normal time limit for making a claim is two years after the end of the relevant Corporation Tax accounting period.

How we can help

If this is something that you would like to discuss in more detail, please contact us.

Taxation of the Family

Friday, August 1st, 2014

Individuals are subject to a system of independent taxation so husbands and wives are taxed separately. This can give rise to valuable tax planning opportunities. Furthermore, the tax position of any children is important.

Marriage breakdowns can also have a considerable impact for tax purposes.

We highlight below the main areas of importance where advance planning can help to minimise overall tax liabilities.

It is important that professional advice is sought on specific issues relevant to your personal circumstances.

 

Setting the scene

Married couples

Independent taxation means that husbands and wives are taxed separately on their income and capital gains. The effect is that both have their own allowances, savings and basic rate tax bands for income tax, annual exemption for capital gains tax purposes and are responsible for their own tax affairs. Since December 2005, the same tax treatment applies to same-sex couples who have entered into a civil partnership under the Civil Partnership Act.

Children

A child is an independent person for tax purposes and is therefore entitled to a personal allowance and the savings and basic rate tax band before being taxed at the higher rate. It may be possible to save tax by generating income or capital gains in the children’s hands.

Marriage breakdown

Separation and divorce can have significant tax implications. In particular, the following areas warrant careful consideration:

  • available tax allowances
  • transfers of assets between spouses.

 

Tax planning for married couples

Income tax allowances and tax bands

Everyone is entitled to a basic personal allowance. This allowance cannot however be transferred between spouses.

If either you or your spouse were born before 6 April 1935, a married couple’s allowance is available. This is given to the husband, although it is possible, by election, to transfer it to the wife.

Joint ownership of assets

In general, married couples should try to arrange their ownership of income producing assets so as to ensure that personal allowances are fully utilised and any higher rate liabilities minimised.

Generally, when husband and wife jointly own assets, any income arising is assumed to be shared equally for tax purposes. This applies even where the asset is owned in unequal shares unless an election is made to split the income in proportion to the ownership of the asset.

Married couples are taxed on dividends from jointly owned shares in ‘close’ companies according to their actual ownership of the shares. Close companies are broadly those owned by the directors or five or fewer people. For example if a spouse is entitled to 95% of the income from jointly owned shares they will pay tax on 95% of the dividends from those shares. This measure is designed to close a perceived loophole in the rules and does not apply to income from any other jointly owned assets.

We can advise on the most appropriate strategy for jointly owned assets so that tax liabilities are minimised.

Capital gains tax (CGT)

Each spouse’s CGT liability is computed by reference to their own disposals of assets and each is entitled to their own annual exemption, for 2013/14 £10,900 per annum. Gains are treated as an individual’s top slice of income and charged at 18% or 28% or a combination of both rates.

Some limited tax savings may be made by ensuring that maximum advantage is taken of any available capital losses and annual exemptions.

This can often be achieved by transferring assets between spouses before sale – a course of action generally having no adverse CGT or inheritance tax (IHT) implications. Advance planning is vital, and the possible income tax effects of transferring assets should not be overlooked.

Further details of how CGT operates are outlined in the factsheet Capital Gains Tax.

Inheritance tax (IHT)

When a person dies IHT becomes due on their estate. Some lifetime gifts are treated as chargeable transfers but most are ignored providing the donor survives for seven years after the gift.

The rate of inheritance tax payable is 40% on death and 20% on lifetime chargeable transfers. The first £325,000 is not chargeable and this is known as the nil rate band.

Transfers of property between spouses are generally exempt from IHT. New rules have been introduced which allow any nil-rate band unused on the first death to be used when the surviving spouse dies. The transfer of the unused nil-rate band from a deceased spouse, irrelevant of the date of death, may be made to the estate of their surviving spouse who dies on or after 9 October 2007.

The amount of the nil-rate band available for transfer will be based on the proportion of the nil-rate band which was unused when the first spouse died.  Key documentary evidence will be required for a claim, so do get in touch to discuss the information needed.

A gift for family maintenance does not give rise to an IHT charge. This would include the transfer of property made on divorce under a court order, gifts for the education of children or maintenance of a dependent relative.

Gifts in consideration of marriage are exempt up to £5,000 if made by a parent with lower limits for other donors.

Small gifts to individuals not exceeding £250 in total per tax year per recipient are exempt. The exemption cannot be used to cover part of a larger gift.

Gifts which are made out of income which are typical and habitual and do not result in a fall in the standard of living of the donor are exempt. Payments under deed of covenant and the payment of annual premiums on life insurance policies would usually fall within this exemption.

 

Children

Use of allowances and lower rate tax bands

It may be possible for tax savings to be achieved by the transfer of income producing assets to a child so as to take advantage of the child’s personal allowance.

This cannot be done by the parent if the annual income arising is above £100. The income will still be taxed on the parent. However, transfers of income producing assets by others (eg grandparents) will be effective.

A parent can however allow a child to use any entitlement to the CGT annual exemption by using a ‘bare trust’.

Child Tax Credit

A Child Tax Credit (CTC) is available to some families. We have a separate factsheet which provides more detail about this area. To see whether you are entitled to claim go to HMRC website at www.hmrc.gov.uk

Junior Individual Savings Account (Junior ISA)

The government has introduced a new Junior ISA product which is available for UK resident children under the age of 18 who do not have a Child Trust Fund account. Junior ISAs are tax advantaged and have many features in common with existing ISAs. They are available as cash or stocks and share based products.

 

High Income Child Benefit Charge

A charge applies to a taxpayer who has adjusted net income over £50,000 in a tax year where either they or their partner are in receipt of Child Benefit for the year. Where both partners have adjusted net income in excess of £50,000 the charge will apply to the partner with the higher income.

The income tax charge will apply at a rate of 1% of the full Child Benefit award for each £100 of income between £50,000 and £60,000. The charge on taxpayers with income above £60,000 will be equal to the amount of Child Benefit paid.

Child Benefit claimants can elect not to receive Child Benefit if they or their partner do not wish to pay the charge.

This charge has effect from 7 January 2013 and for 2012/13 will apply to the Child Benefit paid from that date to the end of the tax year. The income taken into account will be the full income for 2012/13.

Example

The Child Benefit for two children amounts to £1,752.

The taxpayer’s adjusted net income is £54,000.

The income tax charge will be £700.80.

This is calculated as £17.52 for every £100 above £50,000.

For a taxpayer with adjusted net income of £60,000 or above the income tax charge will equal the Child Benefit.

For 2013/14 onwards the High Income Child Benefit Charge applies to the full year’s Child Benefit.

 

Marriage Breakdown

Maintenance payments

An important element in tax planning on marriage breakdown used to involve arrangements for the payment of maintenance. Generally no tax relief is due on maintenance payments.

Asset transfers

Marriage breakdown often involves the transfer of assets between husbands and wives. Unless the timing of any such transfers is carefully planned there can be adverse CGT consequences.

If an asset is transferred between a husband and wife who are living together, the asset is deemed to be transferred at a price that does not give rise to a gain or a loss. This treatment continues up to the end of the tax year in which the separation takes place.

CGT can therefore present a problem where transfers take place after the end of the tax year of separation but before divorce, although gifts holdover relief is usually available on transfers of qualifying assets under a Court Order.

IHT on the other hand will not cause a problem if transfers take place before the granting of a decree absolute on divorce. Transfers after this date may still not be a problem as often there is no gratuitous intent.

 

How we can help

Some general points can be made when planning for efficient taxation of the family.

Any plan must take into account specific circumstances and it is important that any proposed course of action gives consideration to all areas of tax that may be affected by the proposals.

Tax savings can only be achieved if an appropriate course of action is planned in advance. It is therefore vital that professional advice is sought at an early stage. We would welcome the chance to tailor a plan to your own personal circumstances so please do contact us.

Seed Enterprise Investment Scheme

Wednesday, July 30th, 2014

The Enterprise Investment Scheme (EIS) has been in place for a number of years and provides tax relief for individuals prepared to invest in new and growing companies. Investors can obtain generous income tax and capital gains tax (CGT) breaks for their investment and companies can use the relief to attract additional investment to develop their business. A junior version of EIS known as Seed Enterprise Investment Scheme (SEIS) has been introduced from 6 April 2012 and is expected to be available for five years.

Key features

The key features of the new relief can be summarised as follows:

  • a qualifying investor will be able to invest up to £100,000 into qualifying companies in a tax year
  • they will receive income tax relief of up to 50% of the sum invested
  • unused relief in one tax year can be carried back to the preceding tax year if there is unused relief available for that year
  • the maximum amount that a company can attract in investment qualifying for SEIS is £150,000 in total
  • the company must not have net assets of more than £200,000 before any SEIS investment
  • an individual who makes a capital gain on another asset and uses the amount of the gain in making a SEIS investment will not pay tax on that gain in 2012/13 and 50% of the liability for 2013/14 subject to certain conditions
  • there is a huge amount of anti-avoidance legislation to prevent exploitation for tax avoidance purposes.

 

Who can invest?

The official term is a ‘qualifying investor’. The primary requirement is that the investor or someone who is associated with them must not be an employee of the company in which the investment is being made. They can however be a director. They must also ensure that they do not have (directly or indirectly) a substantial interest in the company. This is defined by reference to holding more than 30% of any of the following (in either the company itself or a 51% subsidiary of the company):

  • ordinary shares
  • issued shares
  • voting rights
  • assets in a winding up.

 

Which shares qualify?

The shares must be ordinary shares which have been subscribed for wholly in cash and are fully paid up. They must be held for a three year period from the date of issue. The company must have issued the shares for the purpose of raising money to fund a qualifying business activity which either involves the carrying on (or preparations to carry on) a new trade. Using the funds to meet the costs of research and development intended to create or benefit a new qualifying trade will also be acceptable. The money must be spent within three years of the date of issue of the shares. The anti-avoidance requirement is that there must be no pre-arranged exit for the investor involving the purchase of the shares, or the disposal of assets.

 

Which companies qualify?

The rules are intended to benefit new companies. The basic requirements are that the company must be unquoted. The trade must be a ‘new’ qualifying trade. This is one not carried out by either the company or any other person for longer than two years at the date the shares are issued. The company must exist wholly for the purpose of carrying out one or more qualifying trades throughout the three year period from the date of issue of the shares. If the company goes into receivership or administration or is wound up during this period, this will not prevent the relief being given provided there was a commercial justification for the action.

The other main conditions relating to the company can be summarised as follows:

  • the company must have a permanent establishment in the UK
    • the company must be effectively solvent at the date of issue of the shares
    • the company may have a qualifying subsidiary
    • the company must not be a member of a partnership
    • immediately before the investment, the gross assets of the company plus the value of any related entity (one that holds more than 25% of the capital or voting power in the issuing company) must not exceed £200,000
    • there are less than 25 full-time employee equivalents in the company and any related entity
    • the company must not have had EIS or Venture Capital Trust (VCT) investment before the SEIS shares are issued
    • the company can seek EIS or VCT investment after it has received SEIS investment but must show that it has spent at least 75% of the money received under SEIS, and
    • the total amount of investment made under SEIS in the company must not exceed an aggregate of £150,000.

 

Which trades qualify?

The primary requirement is that the company must carry on a genuine new trading venture. There may be a problem if the same activities had been carried on as part of another trade. Basically any trading activity will qualify unless it is an excluded activity within the definitions used for EIS. This means that activities such as property development, retail distribution, hotels, nursing homes and farming will not qualify. The trade must be carried out on a commercial basis.

 

How is relief obtained?

The relief is given as a reduction against the total tax liability for the year but cannot turn a tax liability into a tax repayment. In that situation the individual would be able to carry back the unused relief to the preceding tax year for use if there was any tax unrelieved for that year. HMRC have indicated that no carryback to 2011/12 will be allowed for shares issued in 2012/13, as 2012/13 is the first tax year of the scheme.

Examples

Samantha invests £60,000 under SEIS in 2012/13. Potentially her tax relief is 50% of her investment which is therefore worth £30,000. As her tax liability for the year is £45,000, the maximum relief is available to reduce her tax liability to £15,000.

Richard is also planning to invest £60,000 under SEIS but not until 2013/14. His forecast tax liability for 2013/14 is only £20,000 so the claim to relief under SEIS will be limited to £20,000 for that tax year. However, Richard can in addition make a claim to carry back the unused relief of £10,000 (£30,000 less £20,000 relieved in 2013/14) to the preceding tax year 2012/13.

The relief must be claimed and requires a certificate from the company issuing the shares. This is a critical point in relation to the validity of any claim as the relief can only be claimed when the company has spent at least 70% of the money raised by the share issue on qualifying business activities.

 

Can the relief be withdrawn?

The short answer is ‘yes’ if certain events happen within three years of the date on which the shares are issued. The most obvious event is the disposal of the shares in that period. There are complex rules that will cause the relief to be withdrawn if the investor receives ‘value’ from the company during this period.

 

What about the CGT position?

Where shares are sold more than three years after the date on which they are issued then any resulting gain is free of CGT. Shares sold within three years would be chargeable but may qualify for the 10% rate of CGT under Entrepreneurs’ Relief if the various conditions are met.

Where a disposal is exempt for gains purposes, this would normally mean that a loss would not be allowable for CGT purposes, but an allowable loss is available under the scheme. Where SEIS income tax relief has been obtained and is not withdrawn then the capital loss is reduced so that tax relief is not duplicated.

Example

Murat invests £25,000 in SEIS in 2012/13 for which he will receive £12,500 relief against his income tax liability of £35,000. If 4 years later the company is unsuccessful and is liquidated with no value returned to the shareholders then his allowable capital loss will be £12,500 being the amount invested of £25,000 less the income tax relief obtained of £12,500.

Clearly investors will hope that they are not in a capital loss position but where this does happen, the allowable loss qualifies for relief against either gains or income. The facility to use a capital loss against income is only available in certain specified circumstances which include a capital loss on SEIS. It can be used in the year of the loss and/or the preceding year to relieve net income and can therefore potentially save tax at the individual’s highest rate of tax.

 

A bonus exemption

There is also an additional exemption for 2012/13 only where assets are disposed of at a gain in that year and funds equal to the amount of the gain are invested in SEIS shares. Where only part of the gain is invested in such shares then only that part is exempt. The maximum gain to be relieved is capped at £100,000. Further, this relief will only be allowed where the investment also qualifies for income tax relief and a claim is made. If for any reason the SEIS relief is withdrawn on the shares then the 2012/13 gain will be reinstated.

Example

Isaac sells quoted shares in 2012/13 for £200,000 making a gain of £80,000. He invests £60,000 of the proceeds in new shares which qualify under SEIS. He will be able to claim a reduction of £60,000 in the chargeable gain on the shares.

A further bonus exemption

The availability of reinvestment relief has been extended to gains made in 2013/14. Reinvestment relief is available at 50% of the matched gain where the proceeds are invested in SEIS shares in either 2013/14 or 2014/15.

Example

Isaac sells some more quoted shares in 2013/14 for £200,000 making a gain of £80,000. He invests £80,000 of the proceeds in new shares which qualify under SEIS. He will be able to claim a reduction of £40,000 (being 50% of the amount invested in SEIS) in the chargeable gain on the shares.

Comparison to EIS

The introduction of SEIS from April 2012 supplements the current long established EIS scheme. Some aspects of both schemes are similar but there are also key differences. These are not considered in detail here but for example, consider the position of the individual investor. Improvements to the EIS scheme mean that those investing in qualifying companies under that scheme be able to put up to £1 million into EIS companies, for which they will receive income tax relief at up to 30%. From a tax relief perspective on investments up to £100,000, the SEIS is more favourable but it clearly cannot be used for larger investments.

 

How we can help

SEIS is a welcome addition to the existing EIS and related Venture Capital Trust investment schemes particularly as it may be an alternative way of attracting funds at a time when it is still difficult to obtain finance from traditional sources such as banks. Great care will be required to ensure that all opportunities to use it are obtained for investor and qualifying company alike. Please do contact us if this is an area of interest.

Patent Box

Monday, July 28th, 2014

The Patent Box provides a reduced rate of corporation tax for companies exploiting patented inventions or certain other innovations protected by particular intellectual property (IP) rights.

How it works

The reduced rate applies to a proportion of the profits derived from the licensing or sale of the patent rights or from the sale of the patented invention or products which incorporate the patented invention. Profits derived from routine manufacturing, development or exploitation of brands and marketing intangible assets are excluded.

The reduced rate of tax is given by providing an additional deduction in the corporation tax computation.

To minimise administrative costs, Patent Box profits for many claims can be calculated using a formulaic approach which is intended to identify, in most circumstances, a reasonable figure for profit derived from the patent.  Companies can opt to identify the profit through a more detailed calculation (not considered in this factsheet).

The election allows a deduction to be made in calculating the profits of the trade period.  The amount of the deduction is:

RP   x      (MR – IPR)
                    MR

where:

  • RP is the relevant IP profits of the trade of the company,
  • MR is the main rate of corporation tax, and
  • IPR is the special IP rate of corporation tax (10%).

 

HMRC Example

If a company has trade corporation tax profits of £1,000, which qualify in full for the Patent Box when the main rate of tax is 22%, then instead of arriving at a tax charge of £100 by multiplying £1,000 by 10%, the calculation proceeds as follows:

Profits of Company’s trade chargeable to CT        £1,000

Patent Box Deduction 1,000 x (22-10)/22            545

Profit Chargeable to corporation tax                     455

Tax Payable £455 x 22%                                       £100

This approach is used, rather than directly charging the relevant profits at 10%, to avoid complications if the company claims losses or other reliefs and to simplify the way the Patent Box will be administered on corporation tax returns.

The formula is the same for companies charged at the main rate of corporation tax and for companies charged at the small profits rate, or at the main rate with marginal relief.  This means that in some cases Patent Box profits may be charged at a little below 10%.

 

Phasing in of the regime

The regime applies to accounting periods commencing on or after 1 April 2013 and is to be phased in over the following four financial years.

The phasing in is achieved by applying the appropriate percentage to the relevant IP profits of the company for each accounting period as follows:

 

2013        60%

2014        70%

2015        80%

2016        90%

 

Conditions

The company must be a qualifying company and own or hold a license for a UK or European patent. There are two main conditions:

  • the company must have undertaken qualifying development by making a significant contribution to the creation or development of the item protected by the patent or a product incorporating this item; and
  • if the company holds a license in patent rights, the license must give it exclusivity for those rights.  This must extend at least country-wide.

There are a number of detailed conditions and qualifying criteria within the scheme. We will be happy to discuss this matter in more detail.

 

How we can help

 

Please contact us if you would like more information on the Patent Box regime.

Personal Tax – When is Income Tax and Capital Gains tax Payable

Friday, July 25th, 2014

Under the self assessment regime an individual is responsible for ensuring that their tax liability is calculated and any tax owing is paid on time.

 

Payment of tax

The UK income tax system requires the payer of key sources of income to deduct tax at source which removes the need for many tax payers to submit a tax return or make additional payments. This applies in particular to employment and savings income. However this is not possible for the self employed or if someone with a significant amount of investment income is a higher rate taxpayer. As a result we have a payment regime in which the payments will usually be made in instalments.

The instalments consist of two payments on account of equal amounts:

  • the first on 31 January during the tax year and
  • the second on 31 July following.

These are set by reference to the previous year’s net income tax liability (and Class 4 NIC if any).

A final payment (or repayment) is due on 31 January following the tax year.

In calculating the level of instalments any tax attributable to capital gains is ignored. All capital gains tax is paid as part of the final payment due on 31 January following the end of the tax year.

A statement of account similar to a credit card statement is sent to the taxpayer periodically which summarises the payments required and the payments made.

Example

Sally’s income tax liability for 2011/12 (after tax deducted at source) is £8,000. Her liability for the following year is £10,500. Payments for 2012/13 will be:

                                                                                                      £

31.1.2013 –    First instalment (50% of                                       4,000

                      2011/12 liability)

31.7.2013 –    Second instalment                                                4,000

                      (50% of 2011/12 liability)

31.1.2014 –    Final payment (2012/13                                       2,500

                      liability less sums already paid)                      _____________

                                                                                                £10,500

                                                                                              ______________

 

There will also be a payment on 31 January 2014 of £5,250, the first instalment of the 2013/14 tax year (50% of the 2012/13 liability).

Late payment penalties and interest

Using the late payment penalties HMRC may charge the following penalties if tax is paid late:

  • A 5% penalty if the tax due on the 31 January 2014 is not paid within 30 days (the ‘penalty date’ is the day following)
  • A further 5% penalty if the tax due on 31 January 2014 is not paid within 5 months after the penalty date
  • Additionally, there will be a third 5% penalty if the tax due on 31 January 2014 is not paid within 11 months after the penalty date.

These penalties are additional to the interest that is charged on all outstanding amounts, including unpaid penalties, until payment is received.

Nil payments on account

In certain circumstances the two payments on account will be set at nil. This applies if either:

  • income tax (and NIC) liability for the preceding year – net of tax deducted at source and tax credit on dividends – is less than £1,000 in total or
  • more than 80% of the income tax (and NIC) liability for the preceding year was met by deduction of tax at source and from tax credits on dividends.

Claim to reduce payments on account

If it is anticipated that the current year’s tax liability will be lower than the previous year’s, a claim can be made to reduce the payments on account.

 

How we can help

We can prepare your tax return on your behalf and advise on the appropriate payments on account to make.

We can advise you whether a claim to reduce payments on account should be made and to what amount. Please do contact us for help.

 

Travel and Subsistence for Directors and Employees

Wednesday, July 23rd, 2014

Travelling and subsistence expenditure incurred by or on behalf of employees gives rise to many problems.

We highlight below the main areas to consider in deciding whether tax relief is available on travel and subsistence.

 

Employees with a Permanent Workplace

Many employees have a place of work which they regularly attend and make occasional trips out of the normal workplace to a temporary workplace. Often an employee will travel directly from home to a temporary workplace and vice versa.

An employee can claim full tax relief on business journeys made.

A business journey is one which either involves travel:

  • from one place of work to another or
  • from home to a temporary workplace or
  • to home from a temporary workplace.

Journeys between an employee’s home and a place of work which he or she regularly attends are not business journeys. These journeys are ‘ordinary commuting’ and the costs of these have to be borne by the employee. The term ‘permanent workplace’ is defined as a place which the employee ‘regularly’ attends. It is used in order to fix one end of the journey for ordinary commuting. Home is the normal other end of the journey for ordinary commuting.

Example 1

An employee usually commutes by car between home in York and a normal place of work in Leeds. This is a daily round trip of 48 miles.

On a particular day, the employee instead drives from home in York to a temporary place of work in Nottingham. A round trip of 174 miles.

The cost here is the cost of the travel undertaken (174 miles). A deduction would be available for that amount.

Example 2

An employee who normally drives 40 miles in a northerly direction to work is required to make a 100 mile round trip south to a client’s premises. His employer reimburses him for the cost of the 100 miles trip.

A deduction would be available for that amount.

Subsistence payments

Subsistence includes accommodation and food and drink costs whilst an employee is away from the permanent workplace. Subsistence expenditure is specifically treated as a product of business travel and is therefore treated as part of the cost of that travel.

Anti-avoidance

Some travel between a temporary workplace and home may not qualify for relief if the trip made is ‘substantially similar’ to the trip made to or from the permanent workplace.

‘Substantially similar’ is interpreted by HMRC as a trip using the same roads or the same train or bus for most of the journey.

Temporary postings

Where an employee is sent away from his permanent workplace for many months, the new workplace will still be regarded as a temporary workplace if the posting is either:

  • expected to be for less than 24 months, or
  • if it is expected to be for more than 24 months, the employee is expected to spend less than 40% of his working time at the new workplace.

The employee must still retain his permanent workplace.

Example 3

Edward works in New Brighton. His employer sends him to Wrexham for 1.5 days a week for 28 months.

Edward will be entitled to relief. Any posting over 24 months will still qualify provided that the 40% rule is not breached.

 

Site-based Employees

Some employees do not have a normal place of work but work at a succession of places for several days, weeks or months. Examples of site-based employees include construction workers, safety inspectors, computer consultants and relief workers.

A site-based employee’s travel and subsistence can be reimbursed tax free if the period spent at the site is expected to be, and actually is, less than two years.

There are anti-avoidance provisions to ensure that the employment is genuinely site-based if relief is to be given. For example, temporary appointments may be excluded from relief where duties are performed at that workplace for all or almost all of that period of employment. This is aimed particularly at preventing manipulation of the 24 month limit through recurring temporary appointments.

 

Other Employees with no Permanent Workplace

Travelling appointments

For some employees, travelling is an integral part of their job. For example, a travelling salesman who does not have a base at which he works, or where he is regularly required to report. Travelling and subsistence expenses incurred by such an employee are deductible.

Home based employees

Some employees work at home occasionally, or even regularly. This does not necessarily mean that their home can be regarded as a place of work. There must be an objective requirement for the work to be performed at home rather than elsewhere.

This may mean that another place becomes the permanent workplace for example, an office where the employee ‘regularly reports’. Therefore any commuting cost between home and the office would not be an allowable expense. But trips between home and temporary workplaces will be allowed.

If there is no permanent workplace then the employee is treated as a site-based employee. Thus all costs would be allowed including the occasional trip to the employer’s office.

The home may still be treated as a workplace under the objective test above. If so, trips between home and any other workplace in respect of the same employment will be allowable.

 

How We Can Help

Full tax relief can be given for travel and subsistence costs but there are borderline situations.

We can help you to decide whether an employee can be paid expense payments which are covered by tax relief and do not result in a taxable benefit.

Please note that if you do make payments for which tax relief is not available, there may be PAYE compliance problems if the payments are made free of tax.

Please contact us if you require advice whether payments can be made to employees tax free.

Valuing Your Business

Monday, July 21st, 2014

There are many reasons why you may need to calculate the value of your business. Here we consider the range of methods available as well as some of the factors to consider during the process.

It is important to remember throughout that valuing a business is something of an art, albeit an art backed by science!

Why value your business?

One of the most common reasons for valuing a business is for sale purposes. Initially a valuation may be performed simply for information purposes, perhaps when planning an exit route from the business. When the time for sale arrives, owners need a starting point for negotiations with a prospective buyer and a valuation will be needed.

Valuations are also commonly required for specific share valuation reasons. For example, share valuations for tax purposes may be required:

  • on gifts or sales of shares
  • on the death of a shareholder
  • on events in respect of trusts which give rise to a tax charge
  • for capital gains tax purposes
  • when certain transactions in companies take place, for example, purchase of own shares by the company.

Share valuations may also be required:

  • under provisions in a company’s Articles of Association
  • under shareholders’ or other agreements
  • in disputes between shareholders
  • for financial settlements in divorce
  • in insolvency and/or bankruptcy matters.

When a business needs to raise equity capital a valuation will help establish a price for a new share issue.

Valuing a business can also help motivate staff. Regular valuations provide measurement criteria for management in order to help them evaluate how the business is performing. This may also extend to share valuations for entry into an employee share option scheme for example, again used to motivate and incentivise staff.

 

Valuation methods

While there is a ready made market and market price for the owners of listed public limited company shares, those needing a valuation for a private company need to be more creative.

Various valuation methods have developed over the years. These can be used as a starting point and basis for negotiation when it comes to selling a business.

Earnings multiples

Earnings multiples are commonly used to value businesses with an established, profitable history.

Often, a price earnings ratio (P/E ratio) is used, which represents the value of a business divided by its profits after tax. To obtain a valuation, this ratio is then multiplied by current profits. Here the calculation of the profit figure itself does depend on circumstances and will be adjusted for relevant factors.

A difficulty with this method for private companies is in establishing an appropriate P/E ratio to use – these vary widely. P/E ratios for quoted companies can be found in the financial press and one for a business in the same sector can be used as a general starting point. However, this needs to be discounted heavily as shares in quoted companies are much easier to buy and sell, making them more attractive to investors.

As a rule of thumb, typically the P/E ratio of a small unquoted company is 50% lower than a comparable quoted company. Generally, small unquoted businesses are valued at somewhere between five and ten times their annual post tax profit. Of course, particular market conditions can affect this, with boom industries seeing their P/E ratios increase.

A similar method uses EBITDA (earnings before interest, tax, depreciation and amortisation), a term which essentially defines the cash profits of a business. Again an appropriate multiple is applied.

Discounted cashflow

Generally appropriate for cash-generating, mature, stable businesses and those with good long-term prospects, this more technical method depends heavily on the assumptions made about long-term business conditions.

Essentially, the valuation is based on a cash flow forecast for a number of years forward plus a residual business value. The current value is then calculated using a discount rate, so that the value of the business can be established in today’s terms.

Entry cost

This method of valuation reflects the costs involved in setting up a business from scratch. Here the costs of purchasing assets, recruiting and training staff, developing products, building up a customer base, etc are the starting point for the valuation. A prospective buyer may look to reduce this for any cost savings they believe they could make.

Asset based

This type of valuation method is most suited to businesses with a significant amount of tangible assets, for example, a stable, asset rich property or manufacturing business. The method does not however take account of future earnings and is based on the sum of assets less liabilities. The starting point for the valuation is the assets per the accounts, which will then be adjusted to reflect current market rates.

Industry rules of thumb

Where buying and selling a business is common, certain industry-wide rules of thumb may develop. For example, the number of outlets for an estate agency business or recurring fees for an accountancy practice.

What else should be considered during the valuation process?

There are a number of other factors to be considered during the valuation process. These may help to greatly enhance, or unfortunately reduce, the value of a business depending upon their significance.

Growth potential

Good growth potential is a key attribute of a valuable business and as such this is very attractive to potential buyers. Market conditions and how a business is adapting to these are important – buyers will see their initial investment realised more quickly in a growing business.

External factors

External factors such as the state of the economy in general, as well as the particular market in which the business operates can affect valuations. Of course, the number of potential, interested buyers is also an influencing factor. Conversely, external factors such as a forced sale, perhaps due to ill health or death may mean that a quick sale is needed and as such lower offers may have to be considered.

Intangible assets

Business valuations may need to consider the effect of intangible assets as they can be a significant factor. These in many cases will not appear on a balance sheet but are nevertheless fundamental to the value of the business.

Consider the strength of a brand or goodwill that may have developed, a licence held, the key people involved or the strength of customer relationships for example, and how these affect the value of the company.

Circumstances

The circumstances surrounding the valuation are important factors and may affect the choice of valuation method to use. For example, a business being wound up will be valued on a break up basis. Here value must be expressed in terms of what the sum of realisable assets is, less liabilities. However, an on-going business (a ‘going concern’) has a range of valuation methods available.

 

How we can help

With any of the valuation methods discussed above, it is important to remember that valuing a business is not a precise science. In the end, any price established by the methods described above will be a matter for negotiation and more than one of the methods above will be used in the process. Ultimately, when the time for sale comes, a business is worth what someone is prepared to pay for it at that point in time.

We would be pleased to discuss how we can help value your business as well as help you develop an exit strategy to maximise the value of your business.