Tax issues for unincorporated businesses Ros Martin CTA December - - PDF document
Tax issues for unincorporated businesses Ros Martin CTA December 2016 Autumn statement Nothing much to consider for self employed Reiteration of many previous announcements Some anti-avoidance provisions such as looking at FRS
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Ros Martin CTA December 2016
Nothing much to consider for self employed
Reiteration of many previous announcements
Some anti-avoidance provisions such as looking at FRS for VAT
No announcement on MTD
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What are the expected profits?
What is the other income of the proprietor?
Might there be losses?
Any need for limited liability?
Status issues?
Employees and incentives to be provided?
What is the long term aim?
Is pension planning relevant?
Taxed on all profit
NICs to be paid
VAT will be due once threshold exceeded
Investment only via loans
PAYE for employees
Providing incentives to employees may be difficult
No separation of risk
Losses can be utilised against other income
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As above
Except joint and several liability for debts
Losses are subject to more anti-avoidance provisions
Again as above
But the liability is limited
More restrictions on loss set off
And some cases where partners are taxed as employees
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Can be a limited partner
Or can have an LLP
Managing risk can be an important aspect of determining business structure
What does this protect you against?
Availability of losses in early years can be important too
But need to be aware of significant restrictions
And will see that HMRC are undertaking lots of work in this area
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LLPs holding property
Can be useful to non UK investors or tax exempt funds
UK tax liabilities are limited to basic rate band
And no CGT on disposal of property other than residential property
No tax on tax exempt bodies
No need to have central control and management
Can involve UK investors without anti-avoidance provisions applying
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LLPs can be useful vehicle to offer employees stake in business
Without wanting to trigger charge under ERS provisions
Can also get ER on share of underlying assets when sold
Can also save NICs
Need to be aware of anti-avoidance provisions
Losses allocated to partners in proportion to partnership share
Cannot get loss if not overall loss for partnership
Also true for profits
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HMRC have always argued that partners must put same allocation as partnership return
But recent tax case has contradicted this
Showed that can put a different figure as legislation is not at all clear
Restrictions on using losses sideways for partners
Limited partners Members of LLPs Non active members Film partnerships with guaranteed income
General rule is that losses are restricted to capital contributions less the losses already given
Different rules as to how this is calculated
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Amount contributed
Less any withdrawn capital
Less any amount which is not personally borne
Plus profits entitled to but not withdrawn
Amounts contributed
Less withdrawn capital
Less contributions not borne
Plus liability in winding up
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Sideways loss relief limited to amount could otherwise claim
Or £25,000 if lower
In early years of business
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Losses can be carried forward
Against profits of the same trade
But also set off against other income
Therefore open to abuse
Where can ‘pretend’ to trade in order to create losses
Two restrictions to prevent this
Cannot utilise losses sideways
But can still carry forward
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Must be trading on a commercial basis
With a view to realisation of trading profits
No specific time limit
Must have expectation even if it is quite a distant time away
Often depends if there is an alternative motive
Such as clearly a hobby
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Additional restriction for farming and market gardening
No sideways loss relief if loss in each of the previous five tax years
This is before capital allowances
Does not matter if claimed loss – it is just whether it has arisen or not
Where trade forms part of larger undertaking
If reasonable expectation of profit
If trade started within last five years
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Taxpayer was horse breeder who started trading as asparagus farmer
Knew that would be long lead in time
Claimed sideways loss relief but refused
FTT dismissed on basis single trade and as horse breeding not commercial no loss
UT found error in law as separate businesses
G was tax lawyer and wife was concert pianist
He set himself up as her promoter
HMRC argued no loss relief as not commercial
Definitely trading but probably did not have the correct infrastructure to be able to say was commercial venture
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Employee of bank with self-employed consultancy business
Claimed to offset losses but refused
Claimed costs had been incurred which showed was commercial
Felt that actually no loss as no evidence that these expenses had been incurred
So actually no need to think about commerciality
Car hire and forex business
Claimed losses
No real evidence that had done anything at all!
So no trade, let alone anything which was commercial
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Reminder of change which took effect from 6 April 2016
Extension of period over which can average so can now use 5 year averaging
Two year averaging remains too
Previously had to be less than 70% of profits to be able to average
With partial averaging if less than 75%
Full averaging now available if less than 75%
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Can claim if either of the following is less than 75% of
Average of profits for first four years Profits of the last tax year
£ 2012/13 50,000 2013/14 28,000 2014/15 26,000 2015/16 40,000 2016/17 96,000
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Evidence that HMRC are asking a lot more questions about allowability of expenditure
Often asking for detailed breakdown of expenses
Two tests
Revenue or capital Wholly and exclusively for the purposes of the trade
Gives basic test
Must incur expenditure ‘wholly and exclusively’ for the purposes of the trade
Lots of case law
But still areas of genuine uncertainty
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The test needs to be considered under three areas
The purpose must be identified and the sole purpose (if
expenses are to be allowed) must be for the trade
If there is duality of purpose, no deduction is allowed If there is more than one purpose, but the expenditure can
be apportioned, then such an apportionment can be made
Why is expenditure being incurred?
For the purposes of the trade means ‘for the purposes
trade’
Facts must be ascertained
To disallow, must identify a non-trade purpose
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Not the nature of the expenditure which is important
Same type of expenditure can be allowable in one scenario but not in another
May be easy to see when extremes are involved, but can be very subtle
Cannot be allowable if there is a duality of purpose
Important to distinguish between a secondary purpose and an incidental benefit which is not a purpose in itself
So it is not the effect of the expenditure but the reason why it was incurred
Many cases which consider this point
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Subconscious purpose
Must not only consider conscious motives but also subconscious motives
Very difficult to prove or disprove subconscious motives
Will be subject to inference
Various cases where this has been looked at
Mallelieu v Drummond
Caillebotte v Quinn
Although ‘wholly and exclusively’ there is nothing precluding apportionment
If definite part can be shown to be trade and non-trade can allow trade part
Cannot apportion part for a subconscious private purpose
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Something HMRC are really looking at currently
Galvanised by various successes at FTT and beyond
For self employed individuals needs to be critically reviewing position to see if can claim
This case set the tone for many cases
Barrister who had chambers in Lincoln’s Inn
But lived in Whipsnade (where also did some work)
Claimed travelling between home and chambers
But this was rejected by Courts
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‘It is quite true that the Appellant carries on his profession at two places, but he travels between those two places not simply for the purposes of carrying on his profession, but also because his home, as the Commissioners have found, is at the Old Rectory,
his home and his chambers in 15, Old Square because he has to live somewhere, and because he wishes to go backwards and forwards between his chambers and his
substantial difference that he also carries on his profession and does a lot of work at a place which happens to be his home. His motive, his object and his purpose in travelling between these places, as it seems to me, are mixed.’
This allows travelling expenses to be claimed if home is base of operation
Jobbing builder who worked on many different sites
Proper office at home
Allowed all travelling expenses
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Self employed anaesthetist
Travelled from home (admin and management conducted here)
To hospitals where performed duties
Surgeon dictated terms of engagement
Two main hospitals where did work
Regular and predicable attendance
So not allowed travelling costs
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How often do you have to be visiting in order to be able to be regular?
Cases have not been marginal at this stage
But it is an issue which will have to be addressed at some point
Another area where we are seeing quite a lot of activity
General principle
Damages incurred as a result of normal trading activity are allowable
Penalties for infractions of law are not
Legal fees follow that
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The second test is to consider if expenditure is capital in nature
Very difficult question to answer
Does not include anything which is revenue
But again our view on this is largely governed by case law
Most famously, the Atherton v British Insulated and Helsby Cables Ltd
‘An advantage for the enduring benefit of the trade’
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Easiest way to consider some of the practical issues is to think about a common problem
Expenditure on refurbishment of property
Is it capital?
If it is capital, will capital allowances be due?
If not, then expenditure gets no initial relief
So very problematic for clients
There are basically two things which will make work done capital
Replacement of an entirety
Improvements
The first is relatively straightforward
The second is more problematic
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Again may be difficulties with repairs to newly acquired asset
Principles established in two familiar cases
Odeon Cinemas/Law Shipping
Key issues are
Could the asset have been used without the work being
done
Was the purchase price suppressed due to its condition
This is current issue
HMRC recently updated toolkit
Looking at whether enduring asset created
Previously focussed on purpose of website
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No statutory definition of trade
Need to rely on case law
Have come up with principle of ‘badges of trading’
Is still very relevant today
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Profit seeking motive
Number of transactions
Nature of the asset
Similar business interests
Modification to assets
The way the sale is carried out
Source of finance
Time between purchase and sale
Method of acquisition
Individual married to property developer and bought property
Renovated and then sold
Claimed venture had been a trade even though suggestion she had intended to occupy
HMRC argued that this was a capital gain
No intention to develop could be shown
Motivated by desire to deduct interest costs which would have meant no taxable profits
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Looking at contractual relationship between parties
If written contract then that is starting point
Autoclenz has changed the emphasis of contracts
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Number of factors to be considered
Not a tick list
Each has different relevant weight
Depending on circumstances
Very important
Some control in all relationships
But right of control is vital in determining employment
Falls into different categories
Where When How what
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Again, very important
Although not necessary considered so determinative
HMRC will want to make sure untrammelled
And substitute must be paid by worker or PSC
Cannot be employee if really can send substitute
Increasingly considered, particularly in IR35 case
Does this person feel like a person in business on their
Many different facets to this
Includes ability to benefit from sound financial management
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Employment law criteria
Commitment by one party to continue to provide work
And by other party to continue to be available for work
HMRC often not confident in arguing this point
Part of organisation
Employment type benefits
Training
Provision of equipment
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If HMRC want to argue that someone is an employee rather than partner, different argument applies
It is about showing NOT a partner
Rather than showing is an employee
Need to consider the basic principles of partnership law
Assume moving from self employed to employed
May be lucky and find HMRC will only change going forward
Rare these days to find that approach
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‘Status is an inaccuracy like any other and recovery action should be taken for all years where there has been a failure to operate PAYE and/or NICs’.
establish the facts for all in date years during which there is a potential failure
consider whether in respect of each year HMRC has a strong case
concede any or all years where HMRC has a weak position and document the reason(s) for the decision which has been taken.
The decision whether or not to settle a case and for what years must be made on the basis of an honest and realistic assessment of the strength of the case for each
believe that for the year in question there is at least a 60% chance of success at the First-tier Tribunal.
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Tax can be collected from employer using Regulation 80 determination
But have to consider if Regulation 72F might apply
Then if Regulation 72 might apply
Both of these cannot apply once Reg 80 issued
Can subsequently consider Reg 81 issues
Often called ‘Demibourne’ principle
This addresses situation where individual paid tax as self employed
But where HMRC then wants to collect from employer
Demibourne confirmed that HMRC do not have to do
But HMRC decided to bring in Reg 72F as appreciated inequity
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Direction issued which relieves employer of PAYE liability
Must meet specific conditions
HMRC do have discretion as to whether apply
Relevant payments made on which
the employer has deducted or
HMRC are satisfied tax paid on this
Trigger event has occurred
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Four possible triggers the employer has been issued with a notice of
determination which includes tax on the relevant payment;
the employee's self-assessment return has been
received and includes an adjustment for a PAYE credit in relation to the relevant payments;
the employee's amended self-assessment return, or an
claim), has been received and includes an adjustment for a PAYE credit in relation to the relevant payments;
HMRC have received a letter of offer to agree an
amount in settlement of the employer’s liability to pay an amount of tax, including tax on the relevant payment in question.
HMRC indicated that where condition for direction apply will always issue
Unless evidence of collusion
No right of appeal by employer
But failure to issue should be challenged
Employee can appeal against it
NB Employer still remains liable to penalties on liability if HMRC want to levy
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Transfers liability from employer to employee
Must meet condition A or condition B
HMRC satisfied that employer
took reasonable care to comply with PAYE regulations Failure to deduction was error in good faith
Only applicable in status cases in rare cases
Only if status was truly marginal
Employees can appeal against determination
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The employee or director received payments knowing that the employer had wilfully failed to deduct the correct amount of PAYE from their earnings and
The prospects of recovery from the employee or director are reasonably good
Tend to be in cases where directors have defaulted
So again rare to apply in status cases as rare to find employee that involved
Where Reg 80 issued to employer
But not paid within 3 days
Again must show employee received payment knowing employer wilfully failed to deduct
Similar to Condition B
Again rare in status situations
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Falls within the general provisions outlined above
The employer will always have to bear their own NI liability
No wider ability to reclaim NI over tax
Class 1 employers NIC
Marginal Class 4 benefit for self employed
But this may not continue
Likely to be the employment law impact which is more important
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Change of accounting date provisions are complicated This derives from pre 50% tax rate Trying to move income into earlier year by lengthening
accounting period
Cannot have period of more than 18 months Unless split into two Accountant did not deal with this correctly so change
did not work
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Individuals were members of LLP
Disagreed with the profit allocation so put different figures on return
HMRC said could not be done
But FTT found that legislation is not entirely clear
So could not see why this was wrong
Has significant impact
HMRC issued notice of enquiry showing tax return to 6 April 2009 being looked at
Once closure notice issued, taxpayer argued no valid enquiry as no such year
HMRC argued that was clear what was intended
But FTT felt that this was not an acceptable mistake!
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Change of policy by HMRC
When incorporating a business which has been conducted through corporate partnership
Cannot claim s162 relief if using same company
Need to be careful