Practice Marketing August 2019 – General Articles
Four general articles:
HMRC produce a range of Toolkits for agents, which highlight errors commonly made in returns so that agents can take steps to avoid them. The business profits toolkit provides guidance on errors that are found in relation to business profits for small and medium-sized businesses. They are helpful to anyone computing taxable business profits.
Risk area 1 – Record keeping
Good record-keeping is essential for business profits to be calculated correctly. Poor records may result in sales or allowable expenditure being omitted from the accounts, with the result that the level of profit or loss is incorrect.
Risk area 2 – Business income
The profit or loss will only be correct if all income is included in the accounts. Unless the business is an unincorporated business that has opted to use the cash basis, business income should be included on an accruals basis, matching the income to the period in which it was earned.
Not all sources of business income will be immediately obvious – the income of the business may, for example, include scrap sales, contra sales or barter arrangements. Cash sales may also be overlooked.
Risk area 3 – Expenditure
To ensure that the profit is not overstated, all allowable expenditure should be taken into account. However, a deduction is only permitted for expenses which are wholly and exclusively incurred for the purposes of the business. Attention should also be paid to specific prohibitions, such as for business entertaining.
Purchases and expenses should be reviewed to ensure that they have been included.
Sole traders and partnerships comprising individuals can use simplified expenses rather than claiming actual expenses.
Risk area 4 – Stock and work in progress
Where the business is one that holds stock, care must be taken to include it at the correct value – this is the lower of cost and net realisable value. Errors will arise if stock is overlooked or valued incorrectly.
Work-in-progress can be a complex area and advice should be taken to ensure that the treatment is correct.
Risk area 5 – Miscellaneous items
Miscellaneous areas should also be considered. These may include a review of post-balance sheet events and consideration as to whether any adjustment to the accounts is required. Staff costs should also be reviewed and amounts unpaid nine months after the end of the period should be added back. As far as directors are concerned, consideration should be given to the date on which amounts are credited to the director’s loan account.
Partner note: HMRC’s Business Profits Toolkit – see www.gov.uk/government/publications/hmrc-business-profits-toolkit.
Inheritance tax and spouses and civil partners
Special rules apply for inheritance tax purposes to married couples and civil partners. To ensure valuable tax reliefs are not lost, it is beneficial to consider the combined position, rather than dealing with each individual separately. Married couples and civil partners benefit from exemptions that are not available to unmarried couples.
The main inheritance tax benefit of being married or in a civil partnership is the inter-spouse exemption. Transfers between married couples and civil partners are not subject to inheritance tax. This applies both to lifetime transfers and to those made on death.
The inter-spouse exemption makes it possible for the first spouse or civil partner to die to leave their entire estate to their partner without triggering an IHT liability, regardless of whether it exceeds the nil rate band.
Transferable nil rate band
The proportion of the nil rate band that is unused on the death of the first spouse or civil partner can be used by the surviving partner on his or her death. This makes tax planning easier and there is no panic about each spouse using their own nil rate band. If the entire estate is left to the spouse on the first death, on the death of the surviving spouse or civil partner, there will be two nil rate bands to play with.
If the first spouse or civil partner to die has used some of their nil rate band, for example, to leave part of their estate to their children, the surviving spouse or civil partner can utilise the remaining portion. It should be noticed it is the unused percentage that is transferred, rather than the absolute amount unused at the time of the first death – this provides an automatic uplift for increases in the nil rate band.
The nil rate band is currently £325,000.
Residence nil rate band
The residence nil rate band (RNRB) is an additional nil rate band which is available where a main residence is left to a direct descendant. It is set at £150,000 for 2019/20, and will increase to £175,000 for 2020/21. The RNRB is reduced by £1 for every £2 by which the value of the estate exceeds £2 million.
As with the nil rate band, the unused proportion of the RNRB can be transferred to the surviving spouse.
George and Maud have been married for over 50 years. Maud died in 2017 leaving £32,500 to each of her two children. The remainder of her estate, including her share of the family home, was left to her husband George.
George dies in July 2019. At the time of his death, his estate was worth £780,000 and included the family home, valued at £550,000, which was left equally to the couple’s children, Paul and Joanna.
At the time of her death Maud had used up £65,000 of her nil rate band. The nil rate band at the time of her death was £325,000. The transfer to George was covered by the inter-spouse exemption and was free from inheritance tax. Maud has used up £65,000 of her nil rate band (20%), leaving 80% unused. She has not used her RNRB band as she left her share of her main residence to George.
On George’s death, the executors can claim the unused portion of Maud’s nil rate band and RBRB. The nil rate bands available to George are as follows:
|Nil rate bands||£|
|George’s nil rate band||325,000|
|Unused portion of Maud’s nil rate band (80% of £325,000)||260,000|
|Unused proportion of Maud’s RNRB (100% of £150,000)||150,000|
As George’s estate on death is less than the available nil rate bands, no inheritance tax is payable.
Partner note: IHTA 1984, ss. 8A, 18.
Closing a business – when a member’s voluntary liquidation is beneficial
Although it is possible to strike off a company and for distributions made prior to dissolution to be treated as capital rather than as a dividend, this is not an option where the amount of the distributions exceeds £25,000.
Where the taxpayer’s personal circumstances are such that it is beneficial for the remaining funds to be taxed as capital (and liable to capital gains tax), rather than as a dividend, a member’s voluntary liquidation (MVL) can be an attractive option, as depending upon the level of funds to be extracted the costs of the liquidation may be more than covered by the tax savings that can be achieved.
What is an MVL?
An MVL is a process that allows the shareholders to put the company into liquidation. This route is only an option if the company is solvent (i.e. its assets are greater than its liabilities). The directors must sign a declaration of solvency confirming that the company is able to pay its debts in full within the next 12 months and 75% of the members must agree to place the company into liquidation. The shareholders must pass a special resolution to wind up the company. They will also need to pass an ordinary resolution to appoint liquidators. The liquidator must be a licenced insolvency practitioner.
What are the tax implications?
Under an MVL the capital extracted from the company is treated as a capital distribution and is liable to capital gains tax, rather than being taxed as a dividend. Where entrepreneurs’ relief is in point, the rate of tax will only be 10%, assuming enough of the entrepreneurs’ relief lifetime limit remains available. If significant funds are available for distribution, this can generate considerable tax savings.
Edward and Oliver are directors of a company in which they both own 50% of the shares and 50% of the voting rights. Each is entitled to 50% of the profits available for distribution and 50% of the assets on a winding up.
They wish to wind the company up, but as they have cash and assets of £10 million to distribute, they opt for an MVL, to allow them to take advantage of the capital gains tax treatment. Both are additional rate taxpayers, and both meet the qualifying conditions for entrepreneurs’ relief.
Edward and Oliver each receive £5 million on the winding up of the company. They both have the full amount of the entrepreneurs’ relief lifetime limit (£10 million) unused, and it is assumed for simplicity that the annual exempt amount has been used elsewhere. The gain is therefore taxed at 10% and each will pay tax of £500,000 on their distribution of £5 million.
Had they not opted for an MVL and the extracted funds taxed as a dividend, they would have each paid £1,905,000 in tax on the £5 million distribution (£5m @ 38.1%).
Anti-avoidance provisions apply which are designed to target ‘moneyboxing’ (where the company retains more funds than it needs in order to extract them as capital when the company is liquidated) and ‘pheonixism’ (where the company is liquidated, the value extracted as capital and a new company is set up to carry on what is essentially the same business). Liquidation distributions which are caught by the rules are treated as income rather than capital.
Partner note: Insolvency Act 1986, Pt. IV, Ch. III.
Using a SIPP to save for retirement
A SIPP is a self-invested personal pension which is set up by an insurance company or specialist SIPP provider. It is attractive to those who wish to manage their own investments. Contribution to a SIPP may be made by both the individual and, where appropriate, by the individual’s employer.
The range of potential investment is greater for a SIPP than for a personal pension or group personal pension scheme.
The SIPP can invest in a wide range of assets, including:
A SIPP can also borrow money to purchase investments. For example, a SIPP could take out a mortgage to fund the purchase a commercial property, which could be rented out. The rental income would be paid into the SIPP and this could be used to pay the mortgage and other costs associated with the property.
Tax-relieved contributions can be made to the SIPP up to the normal limits set by the annual allowance. This is set at £40,000 for 2019/20. The annual allowance is reduced by £1 for every £2 which adjusted net income exceeds £150,000 where threshold income exceeds £110,000, until the minimum level of £10,000 is reached. Anyone with adjusted net income of £210,000 and above and threshold income of at least £110,000 will only receive the minimum annual allowance of £10,000. Where the annual allowance is unused, it can be carried forward for three years. Any contributions made by the employer also count towards the annual allowance.
SIPPs operate on a relief at source basis, meaning that the individual makes contributions from net pay. The SIPP provider claims back basic rate relief, with any higher or additional rate relief being claimed through the self-assessment return.
Drawing a pension
A SIPP is a money purchase scheme and the value of benefits available to provide a pension depend on contributions that have been made to the scheme, investment growth (or reduction) and charges.
It is possible to draw retirement benefits at age 55. A tax-free lump sum can be taken to the value of 25% of the accumulated funds. Withdrawals in excess of this are taxed at the individual’s marginal rate of tax.
To prevent recycling contributions, where pension benefits have been flexibly accessed a reduced money purchase annual allowance, set at £4,000 for 2019/20, applies.
Partner note: www.pensionsadvisoryservice.org.uk