Entrepreneurs’ Relief – Cutting through the continuing confusion

Judging by the number of calls I’m receiving on this issue, changes to entrepreneurs’ relief are continuing to cause much confusion, with many shareholders unsure as to whether their transaction still qualifies.

Before former Chancellor Philip Hammond moved the goal posts last year, the situation was quite straightforward. Most people with shares in a trading company could expect to pay capital gains tax at the much more palatable rate of 10% rather than 20% when they sold their shares.

To be eligible they simply had to show that their shares were in a company that traded (i.e. not in an investment business), they were an officer or employee of that company and they held at least 5% of the shares (giving them at least 5% of the voting rights), all for at least a  year before the sale.

But, in the  2018 Autumn Budget, a new “test” of what defines “personal company” was announced, with shareholders now needing to have the right to 5% or more of the dividends as well as to 5% or more of the proceeds if the company is wound up or, alternatively, to 5% of the proceeds if it is sold.  And all the qualifying tests must now be satisfied for two years, not one.

Some worried business owners are unsure whether their transaction qualifies for capital gains tax at all. Their concerns relate to the anti-Phoenix rules which affect people who wind up their company but then carry on the same or similar business either in another company or in some other form.   In such cases the proceeds of the winding up might be treated as income from dividends, not as a capital gain, so the business owner pays tax at up to 38.1%, the highest rate of income tax on dividends.

This scenario is most likely to apply where somebody has sold the trade from the company, or simply run the trade down, and is now winding up the company to get the proceeds out.  Because of the uncertainty introduced by the new rules, I am frequently asked to write reports on whether those rules will apply.

To guarantee receiving entrepreneurs’ relief, some people have started selling their company when it is no longer trading.  In response to this practice, HMRC has recently published its Spotlight 47 guidance (https://www.gov.uk/guidance/attempts-to-avoid-an-income-tax-charge-when-a-company-is-wound-up-spotlight-47), which suggests that some of these arrangements might be sufficiently artificial or contrived for HMRC to apply the wide ranging general anti-abuse rule (GAAR).

To be frank, my personal view is that HMRC is being ridiculous here.  While there may be some extreme cases that might be caught, I would not expect a sale of a money-box company that has ceased to trade to be caught by the anti-Phoenix rule, far less by the GAAR.  This is just scare-mongering and I do not consider it acceptable behaviour from a public authority!

This issue – and my thoughts on it – are covered in my recent article in Taxation magazine: https://www.taxation.co.uk/Articles/why-selling-a-company-is-not-tax-avoidance

Another common issue on which I’m increasingly being asked to advise relates to whether a company is a trading company.  Defining a company’s status can be a problem for businesses that have accumulated large amounts of cash which they haven’t distributed to shareholders, or where profits have been used to buy investment properties, as investment activities are not trading activities. I do not generally believe that large cash holdings should cause a problem, although I have had to argue the point with HMRC a couple of times (successfully, of course!)  And a large and active investment portfolio certainly could taint the status of the company so that it no longer qualifies as a trading company and its shareholders would not, therefore, be entitled to entrepreneurs’ relief.

If you are concerned about how the rule changes affect you, please get in touch.

We are experts in entrepreneurs’ relief and can guide you through the complexities.

Email pete.miller@themillerpartnership.com or call us on 0116 208 1020.

Changes to Entrepreneurs’ Relief: Do you still qualify?

Until recently, most people with shares in a trading company could be confident of qualifying for entrepreneurs’ relief when they came to sell those shares.

Their shareholder status meant that they would only have to pay capital gains tax at 10% instead of the higher rate of 20%.

And, qualifying for this tax relief was quite simple. To be eligible, all you had to do was satisfy each of the following conditions for at least a full year up to the date of selling your shares:

•          The company had to be a trading company, which, simply put, means it must be carrying on a trade, rather than operating as an investment business.

•          The shareholder had to be an officer or an employee of the company for the same period. Once again, this was usually straightforward and, indeed, in most of the cases I’ve looked at, the individuals concerned were directors of the company.

•          The family had to be the shareholder’s “personal company”, which broadly meant that the shareholder had to hold at least 5% of the shares of the company and those shares had to give that person at least 5% of the company’s voting power.

So far, so uncomplicated, until, completely out of the blue, the Chancellor moved the goalposts by announcing two major changes to entrepreneurs’ relief in his Autumn Budget speech.

With immediate effect of his announcement, the definition of a “personal company” became more onerous, with shareholders now also having to have the rights to 5% or more of the dividends and 5% or more of the proceeds if the company were wound up. 

What the Chancellor had effectively done was introduce a new test relating to the level of economic interest the individual has in the company.

As a direct result of these changes, some people instantly lost their right to entrepreneurs’ relief, in some cases because they held 5% or more of the shares and votes of the company but did not have rights to 5% or more of the dividends that would be paid.

And, as if this wasn’t bad enough, the Chancellor’s announcement appeared to deny entrepreneurs’ relief to shareholders with what are known as “alphabet shares.

”Called “A shares”, “B shares”, and so on, alphabet shares are designed so that a different rate of dividend could be voted on for each class of share. 

But – under the new rule – even if two individuals between them held all the shares of a company, if they were alphabet shares, it is arguable that neither person had a right to any dividends until dividends were declared in respect of their class of share.  This meant that neither of the two shareholders would be entitled to 5% of the dividends!  My personal view was that this was not a problem, but the new test clearly made matters very uncertain.  Even HMRC were not sure of the correct analysis!

Fortunately, following pressure from various sources, the Government amended this rule to provide an alternative test of whether the shareholder would receive at least 5% of the proceeds if the shares were sold.  In most cases involving alphabet shares, this revised test should allow the shareholders to claim entrepreneurs’ relief, even if they are not entitled to 5% of dividends or the proceeds of a winding up.

The other change to entrepreneurs’ relief has extended the qualifying period from one year to two years, although this only comes into effect for disposals on or after 6 April 2019. 

So, if, for example, you hold qualifying shares which you acquired in November 2017, if you sell them between December 2018 and the end of March 2019 you will be eligible for entrepreneurs’ relief based on having held the shares for over a year.  But, if the sale is delayed until after 5 April, the new two-year qualifying period applies and you will need to defer your disposal until, say, December 2019.

If you are affected by these changes or would like more advice and information on entrepreneurs’ relief, please get in touch.

The Miller Partnership has wide experience and expertise in this area and can guide you through the complexities.

Autumn 2017 Budget: period drama or zombie apocalypse?

Thompson Reuters Practical Law asked leading tax practitioners for their views on the Autumn 2017 Budget.

Pete Miller’s contribution:

“There doesn’t seem to have been much action on the corporate tax side in this Budget, which given the massive changes over the last few years is something of a relief. If anything, the picture from a corporate perspective is of tinkering around the edges and fixing things, rather than making any major changes. For example, the complicated regime for hybrids brought in by Finance Act 2016 and the even more complex regime for restricting the interest deductions for companies, which only gained Royal Assent a week ago, are both being technically amended in order to make sure that they work properly. This is not a suggestion of incompetence on the part of the original drafters, but rather a reflection of the complexity both of the U.K.’s tax code and of the commercial world in which it operates, in that however hard all the stakeholders work, the fact is that complicated regimes like this will impact commercial transactions in a way that was not intended in some cases. It is, therefore, only common sense that those bits of the regimes that don’t work should be fixed as soon as possible.

Probably the most noticeable amendment was the removal of indexation allowance from companies. Indexation allowance was originally introduced at a time of relatively high inflation, to allow you to index link the price of assets between the date of purchase and the date of sale, so that capital gains tax or corporation tax on chargeable gains would, in effect, only tax the genuine increase in value of an asset, not simply the inflationary increase. The indexation allowance for individuals and others who do not pay corporation tax was repealed in 2008, from 31st March that year, so that, for all future gains, no indexation allowance could be given. It is interesting that in removing the indexation allowance from companies, they will still be able to claim the accumulated indexation up to 31 December 2017, but no further indexation will be given from 1 January 2018. This is in marked contrast to the treatment of individuals in 2008, where the immediate abolition of the relief effectively doubled or trebled the latent gains in certain cases!

The other point of particular interest is that, hidden away in the Red Book is a promise to consult on the regime for intangible fixed assets. The regime for companies owning intangible assets is that, in many cases, the cost of an asset can be amortised or impaired for tax purposes. There are also a series of reliefs and exemptions from taxation which largely mirror the rules applicable to tangible assets within the capital gains regime for companies. One of the areas that has been a problem for some years, however, is that some of the new reliefs from corporation tax on gains, such as the amended degrouping charge and the substantial shareholding exemption, are not mirrored in the intangible assets regime. This means that the reliefs, which were intended to apply across the board, only apply to companies with older trades, and not with new trading companies with substantial goodwill. We have made many representations to HMRC on this point, and we can only hope that the proposed consultation will address some of these concerns, albeit many years later than we would have hoped.”

Read the complete article here.

 

Newsletter May 2017

TAAR:   Why you should stop worrying about the new anti-phoenixing measures

When the details of the Finance Act 2016 were first published, new measures such as changes to the Targeted Anti Avoidance Rule (TAAR), were met with a fair degree of interest by company owners.

However, as the months have gone by and these changes have started to bed in, what was initially just a talking point has become a cause for concern for many of the businesses I talk to.

The TAAR was introduced by the Government to prevent what is known as “phoenixing” – the process whereby shareholders receive capital distributions on the winding up of company then go on to run a similar business in another form, such as carrying on the same business as a sole trader after winding up the company, or continuing the same trade through another company.

If you are caught by the TAAR then you could see your capital distributions being taxed as dividends at an income tax rate of up to 38.1 per cent – and not as capital gains tax which may attract entrepreneurs’ relief at the much more favourable rate of 10 per cent. The rules make quite a difference.

The crux of the matter lies in whether or not you are trying to avoid paying income tax by phoenixing the company, which is something only you, or the clients you are advising, can decide.

Many people I have spoken with worry that the anti-phoenixing rules will catch them.  In many cases, the TAAR is not a problem; clients just need reassurance that they are 100 per cent commercial.  But there are cases where we need to look more closely at the rules and their application to the particular situation.

Crucially, businesses should note that the TAAR can only apply if you are liquidating and not selling your business.  We may be able to help you with opportunities to sell the company as a money-box, instead, so if this might be helpful, please call or email us at once.

Although the anti-phoenixing rules are still fairly new, The Miller Partnership has many years’ experience in advising on such motive-based tests in taxation law.  The chances are, the rules won’t apply to you, but if you think that they might, please talk to us. We can help.

Even in wholly commercial cases, HMRC might decide to enquire into the situation, because they think that the TAAR might apply.  Those cases will also need careful handling, to ensure that we are able to convince them of the commerciality of the winding up.  The evidence will be a major factor in HMRC’s decision, so call us if you are thinking of winding up your company, and we’ll help you make sure that you have all the proof you will need.

The changes to the transactions in securities rules mean that, apart from considering the TAAR, if you are planning to wind up or liquidate your business, you must get tax clearances from HMRC first. It’s vital you do so and I cannot stress this course of action strongly enough.

February 2017 Newsletter

Pete Miller of The Miller Partnership looks forward to another eventful 12 months for the business tax world

There is no doubt that 2016 was an eventful 12 months for the UK’s  corporate tax sector, with 2017 set to bring its own set of challenges for businesses and individual taxpayers.

In the year that brought us Brexit – not to mention new incumbents at Number 10 and Number 11 – we also witnessed the implementation of a number of far-reaching tax changes in the Finance Act 2016.

Although some of these rule changes could be accurately described as onerous, and in some instances a little too ‘one size fits all’, there have been some welcome developments.

One notable positive development for the tax sector – and, indeed, for common sense – has been HMRC’s s decision to roll back some of the worst excesses of the Finance Act 2015.

You may recall that HMRC made a number of amendments to Entrepreneurs’ relief in the 2015 Act, which, although intended to combat avoidance, were so poorly aimed that many commercial structures were unfairly affected.

Fortunately, tax professionals, myself included, sat down with HMRC to thrash out our concerns, resulting in amendments so that the rules were properly and accurately targeted – replacing the original blunderbuss approach with a sniper’s rifle – and also backdating the changes to the time when they were originally introduced.

This clearly demonstrates what can be achieved when the tax industry and HMRC come together in a spirt of co-operation and I’m proud to have played my part in achieving such a satisfactory outcome.

Looking forward to the year ahead, one  key change emerging from the Finance Act 2017 concerns the way in which ‘enablers’, such as tax advisers and accountants, are treated from a taxation perspective.  Until now tax avoidance penalties have only ever been targeted at tax-payers themselves – not the professionals who advise people on their tax affairs, so this is quite a significant step.  Once again, we are pleased to see that HMRC’s original and draconian proposals have been better targeted.  Under the new, revised proposals, enablers who assist their clients in gaining tax advantages that HMRC believes were never intended by Parliament, could be fined up to 100 per cent of their fees.  The new rules only apply to tax-saving arrangements that would be subject to the general anti-abuse rule. This is in contrast to HMRC’s original suggestion that these penalties might apply to tax advice on normal commercial transactions, such as the transactions in securities rules – an area in which we specialise.

In a related development, taxpayers will find it harder to avoid penalties if they have failed to take proper care when submitting their tax returns.  Until now businesses have only had to prove to HMRC that they sought general professional tax advice, but that is about to change.  Under the new rules business owners must be able to demonstrate that they took “appropriate” advice which is pertinent to their own business’s needs and circumstances.  So relying on generic advice, taken, for example from a scheme promoter, will no longer be adequate to prove that the taxpayer was not careless if the scheme fails and that they have therefore submitted an incorrect tax return.

Other measures which come into force courtesy of the Finance Act 2017 include the way business losses are treated for tax.  These welcome changes mean that companies will be able to use losses more flexibly, with carried forward losses being available to set against all future sources of income and also being available for group relief.   At the moment, carried forward losses can usually only be set against the same kind of income in future years and cannot be used for group relief.

Of course 2016 was not only a busy year for the UK tax sector – it was a memorable one for The Miller Partnership too.

It is now five and a half years since our tax consultancy was established in Leicester city centre, and in September we moved to more spacious premises in New Walk House, 108 New Walk; just a few hundred yards from our old office.

During 2016 I also had two technical tax books published – the Taxation of Partnerships published by CCH and Taxation of Company Reorganisations published by Bloomsbury – as well as continuing to lecture extensively on tax issues.

It was also gratifying to receive national recognition from the Chartered Institute of Taxation, (CIOT) the UK’s leading professional tax body.

In October the Institute presented me with the CIOT Award of Certificate of Merit for my contribution to education and conference lecturing.  It was a great honour – especially as this recognition came from my fellow tax professionals.

Nearer to home, The Miller Partnership is proud to play its part in Leicestershire’s thriving business community.

We continue to work closely with De Montfort University in offering mentoring to its business and finance students and graduates and in promoting the benefits of mentoring training to others.

Similarly we have forged a lasting relationship with our New Walk neighbours, Soft Touch Arts.

This award-winning local charity uses arts, media and music activities to engage with and change the lives of disadvantaged young people.

We have helped Soft Touch Arts to fund its ongoing mentoring programme as well as assisting financially by paying for table cloths and place mats at its pop-up café.  And we are linking together with the Leicester Comedy Festival to present Food, Glorious Food! At Soft Touch Arts, an evening of comedy and food, with amateur and professional comedians, a joke slam and a comedy quiz, and other excitements and surprises, all in aid of Soft Touch, on 21st February.

Although The Miller Partnership operates at a national as well as local level, it is great to be actively involved in the local business scene. We have a busy schedule planned for 2017 and look forward to taking a role in the Leicester Comedy Festival as one of its Platinum Business Partners.

 

Tax and The Great British Bake Off: What’s the connection?

Millions of us have been watching The Great British Bake Off over the last few weeks, alternately laughing and crying with the contestants as they bake fabulous show-stoppers or produce undercooked, soggy-bottomed disasters.  But this time there is also a sense of loss as the much-loved BAFTA-winning show moves from the BBC to Channel 4, leaving most of the original cast behind.

Such sad partings are actually very common in the commercial world: people who have gone into business together frequently reach a point where they want to move in different directions, and need to separate their interests.  It may be that the business’s owners no longer see eye to eye and have fallen out, or it could be that their opinions differ about what direction their business should take. Alternatively, it may simply be that some areas of the business are more exposed to risk than others, so a spilt will help to address these different risk profiles.

And that’s where tax comes in, because without expert help, a division of a business in this way can lead to unexpected tax bills for both the shareholders and the companies themselves.  We call these transactions “demergers”, although “division” is a better description.  Demerging a business might sound complicated and daunting, but with the right tax advice, breaking up can be as easy as pie.

More recently, demergers have been made more difficult with some hardening of attitudes within HM Revenue & Customs and also because of recent changes to stamp duty.  We have managed to develop mechanisms to ensure that these changes should not impact on commercial transactions, and we continue to engage with HMRC to try and reverse the worst effects of recent legislation.

The Miller Partnership has wide experience of dividing companies and groups into two or more parts, taking advantage of all the relevant tax reliefs and obtaining clearance in advance from HMRC.  We can use our expertise to carry out these demergers by any of the known mechanisms – distribution in specie, liquidation or reduction of capital – and we can advise you on which one best meets your commercial needs.

We are currently helping a large UK engineering group restructure ready for a major investment by a European multi-national group.  At the other end of the scale, we are working with a family-owned nursing home group to separate the valuable properties from the high-risk care business to protect its assets.  Another of our recent successes was in separating a multi-million pound property portfolio between its shareholder families, so that one family could focus on the rental side of the business and the other could move into property development.

In all cases, we design the demerger in the most tax-efficient way, we explain the transactions to HMRC so that they can formally approve the tax treatment before we start, and we work with the client’s lawyers and accountants to make sure the tax outcome is what our clients expect.  In every case, our timely intervention has allowed clients to fully exploit their businesses’ full potential.

Whether you are The Great British Bake Off or a family-owned business, please contact The Miller Partnership by phone or by email for more information. We can help you break up your business painlessly and effectively; in fact with our help it should be a piece of cake!

Direct Line: 0116 208 1020

Mobile: 07802 197269

Email: pete.miller@themillerpartnership.com

August 2016 Newsletter

The Finance Act 2016: What does it mean for your business?

Brexit and the introduction of complex new rules courtesy of the Finance Act 2016 have given UK businesses much to contend with in recent weeks.

Fortunately, Brexit’s tax implications can be “parked” for a few months as Teresa May has made it clear that she has no plans to invoke Article 50 until early next year. The PM’s decision means that there are unlikely to be any immediate changes, tax wise, for British businesses as a direct consequence of us leaving the European Union.

This is just as well given that UK companies must first of all get to grips with hard hitting new anti-avoidance measures contained in the Finance Bill as well as a raft of other changes, such as the revision of rules pertaining to Patent Box.

Transactions in Securities – be afraid!

As highlighted in our recent newsflash, anti-avoidance rules in force from  April 1 2016 mean that the proceeds of a liquidation might be charged to income tax at up to 38.1%, instead of to capital gains tax at only 10%.

Given this situation, we strongly recommend that all insolvency practitioners ask HMRC for a clearance before distributing any of the assets of a company in liquidation.

To learn more about how TIS might affect you, please click here.

Targeted Anti Avoidance Rule – be very afraid!

If TIS wasn’t scary enough, the Finance Act 2016 has also brought us TAAR, the Targeted Anti Avoidance Rule.

TAAR has been introduced by the Government to stop ‘phoenixing’ – the practice where shareholders receive capital distributions on the winding up a company, then run a similar business in some other form. Examples of this would include starting to carry on the same business after winding up your previous one or if you continued to trade through another company.

To learn more about TAAR and its implications, please click here.

Stamp duty – just when you thought it was safe…

And, in another move that many people haven’t spotted yet, a new rule came into being on June 29 2016 which makes stamp duty chargeable in many situations where you put a holding company on top of an existing company in a share exchange transaction.

For reasons explained here, this is another rule we’d like HMRC to rethink as it has the potential of catching unintended targets and imposing a double tax charge. To learn more, please click here.

Patent Box – the opposite of simplification!

If the changes already highlighted weren’t confusing enough, then let’s turn to the innovator’s tax relief, Patent Box, which has just become a whole lot more complicated.

Originally Introduced in April 2013, Patent Box was lauded as a welcome boost to UK technology and innovation – effectively offering Britain’s entrepreneurs a 10 per cent cut in corporation tax on the income they received from their patents. However, for a number of reasons, calculating the relief has become much less straightforward as our more in-depth article explains:  For more information please click here.

Entrepreneurs’ relief – What a relief!

Although many of the changes implemented by the Finance Act 2016 are indeed onerous and, in our view, are in some instances too broad brush, we’re relieved to report that it’s not all bad news.

We are delighted to be able to tell you that some of the worst excesses of last year’s Finance Act have been rolled back.  You will recall from last year’s newsletters that HMRC made a number of changes to Entrepreneurs’ relief in the Finance Act 2015, which, although intended to combat avoidance, were so poorly targeted that many commercial structures were affected.

Thanks to the tax community and HMRC coming together to thrash out these concerns, revisions have since been made which not only remove the changes but backdate them to the time when they were originally introduced. For further information on what this timely intervention means for Entrepreneurs’ Relief, please click here.

Changes resulting from the Finance Act 2016 are a lot to take in but don’t struggle with their complexities on your own.

We have the in-depth knowledge, expertise  and experience e to help you make more  sense of the new rules, so if you have any concerns at all, please contact  Pete Miller on 0116 208 1020

Finance Act 2016: The Devil is in the Detail

The Finance Act 2016 has resulted in a whole raft of taxation changes for British businesses and their professional advisors.

Pete Miller, tax expert with The Miller Partnership, looks at the wider implications of the Act’s new anti-avoidance measures and explains what the new legislation might mean for your business.

He also takes a more in-depth look at how the new tax rules will affect stamp duty, Patent Box and Entrepreneurs’ Relief.

Changes to Transactions in Securities:

HMRC has extended the reach of the transactions in securities rules to counter what it regards as an income tax advantage when you take money out of a company in such a way that you pay capital gains tax at 10% or 20%, instead of income tax on dividends, at up to 38.1%.

This change to TIS – and what it means for insolvency practitioners as well as businesses – was highlighted in our recent newsflash.

From April 6 2016, TIS rules potentially apply if you liquidate a company – which you might do if you have sold the business and don’t need the company any more.  If these rules do apply to you, it means HMRC can charge income tax as if on a dividend, instead of on capital gains tax.

HMRC keeps telling us that it does not intend to use these rules in a ‘normal’ liquidation, whatever that is.  But we cannot rely on these statements, so we strongly recommend that you ask HMRC for a clearance before your company is liquidated. If you are an adviser, it may well be that your professional indemnity insurers would expect you to apply for these clearances as a matter of course.

Tax law says that HMRC must answer these clearance applications within 30 days and we are very experienced at preparing them, so please give us a call.

Of course, this change means that HMRC is going to have to cope with tens of thousands more new applications. This bureaucratic headache for our already over-stretched Revenue is among the concerns the professional tax community shares in respect of changes implemented by the Finance Act 2016.

TAAR

The Government’s new Targeted Anti Avoidance Rule (TAAR) is designed to prevent ‘phoenixing’ – the practice where shareholders receive capital distributions on the winding up a company, then run a similar business in some other form. Examples of this would include starting to carry on the same business after winding up your previous one or if you continued to trade through another company.

If you are caught by TAAR, then you may well find that your capital distributions are taxed as dividends at a tax rate of up to 38.1 per cent, rather than as capital gains which may attract entrepreneurs’ relief at much more palatable 10 per cent.

The crux of the new rule is whether you are trying to avoid income tax by phoenixing the business, which only you or your clients can decide.

Crucially, there is no clearance for these new rules, so under self-assessment you and your clients will have to decide whether the new rules apply. This carries the threat of having to pay extra tax and penalties if you get it wrong.

While this is new legislation, we have many years’ experience dealing with these motive-based tests in the tax legislation, so if you’re worried, please call!

Changes to stamp duty

Another new rule came into force on June 29 2016 which makes stamp duty chargeable in many situations where you put a holding company on top of an existing company in a share exchange transaction.

However these regulations relating to stamp duty should only be applicable in certain circumstances.

If the new holding company issues shares of the same class and in the same proportions, as it usually will, there should not be a stamp duty charge.

This is because the new rule is intended only to impose a charge where a takeover is intended and stamp duty is otherwise avoided.

But the way the new rule is worded means that it also catches a number of normal commercial transactions, such as certain demergers and sales where stamp duty is payable in the normal way. These are clearly not the intended targets.  As a result, there is now a real possibility of double taxation in completely inoffensive transactions.

We have suggested to HMRC that this new rule needs revisiting, so that it targets only the intended transactions and does not impose a double tax charge.  Unfortunately, any changes must wait until Parliament returns from its summer recess in September.

If you are relying on this relief, however, please ring or email to see if we can help.

Patent Box

Another tax regime which has been somewhat revised by Finance Act 2016 is Patent Box, the initiative aimed at rewarding and encouraging innovation among UK businesses.

First introduced in April 2013, Patent Box effectively offers Britain’s entrepreneurs a 10 per cent cut in corporation tax on the income they received from their patents. However, for a number of reasons, calculating the relief has become much less straightforward.

Some of the changes to Patent Box have been implemented because of objections from other EU member States (actually, just Germany) and also stem from the international anti-avoidance initiative, the Base Erosion and Profit Shifting (BEPS) project.

Hypothetically businesses paying £100,000 of corporation tax, can, through Patent Box, make savings of around £50,000.

However, as part of the Finance Act 2016, the rules have now been modified to incorporate new ‘nexus’  calculations which link research and development spend directly to patents.

Under the old regime, it was irrelevant who undertook the original research resulting in the patents. But, in order to satisfy the revised rules, Patent Box claimants must now prove that they did the work themselves or paid for it to be done by somebody else.

Patent Box relief under the new regime will often need separate calculations of the profits made by each individual patent or product, which will hugely increase the complexity of the calculations.

These tough new regulations have caused UK entrepreneurial companies to re-evaluate their corporate structures – and I’m sure that all the red tape will have put off some smaller businesses from pursuing Patent Box.

It’s not been made any simpler by the 71 amendments to the draft legislation that were passed by Parliament in June!  So we are all still trying to make sense of the detail of the new regime.

In the meantime, businesses who lodged their patent application before  July  1 2016, or who already hold a patent, have two years (until June  30 2018) to opt into the old, much less complex, regime, so it is worth making the most of Patent Box’s potential tax benefits.

If you or your clients are exploiting patents that they own or license, call us to see if they can claim the patent box relief.

Entrepreneurs’ relief

Although many of the changes implemented by the Finance Act 2016 are indeed onerous, it is not all bad news.

Thanks to the collaborative approach taken by the tax community and HMRC – and following lengthy negotiations – some of the worst excesses of last year’s Finance Act have now been rolled back.

Last year HMRC made a number of changes to Entrepreneurs’ relief in the Finance Act 2015, which, although intended to combat avoidance, were so poorly targeted that many commercial structures were affected.

Under those changes made in the Finance Act 2015, entrepreneurs’ relief was not available for a sale of a business by a sole trader or a partnership to a company owned by a relative.

Thankfully this has now been amended, so that you can sell your business to a relative through a company and still claim entrepreneurs’ relief.

Additionally entrepreneurs’ relief was not available where the trade was carried on as a joint venture or a corporate partnership.

This has since been amended so that the shareholders of the parent or partner company can now claim relief, as long as their interest in the underlying trade is at least 5%.

And, under last year’s rules, the relief for associated disposals was often not available when shares or partnership interests were sold to family members – a particular problem within the farming community.  This aspect too has been revised to prevent an inadvertent barrier to family successions.

All of the changes relating to this relief have been backdated to the dates that the original changes were effective.  This is an excellent example of HMRC and the tax profession working together to understand each other’s positions and coming up with workable solutions to these problems.  It’s a pity that the initial changes were not drawn up in this way, which would have saved a lot of time and trouble on all sides, but all’s well that ends well.

Having been closely involved with the new amendments, we are extremely well placed to help you with your entrepreneurs’ relief questions.

For more information and advice on the Finance Act 2016 and how it affects you, please contact Pete Miller on 0116 208 1020

Tax evasion or tax avoidance: Did Prime Minister David Cameron conduct his taxation affairs improperly and just how much past tax should Google have paid in the UK?

The recent media furore resulting from the revelations in the leaked Panama Papers has again thrown up the big question of what constitutes tax evasion and, indeed, tax avoidance.

Firstly, it’s vital to make the proper distinction between evasion and avoidance: If you are hiding untaxed profits in an offshore account, deliberately concealing your profits from the tax authorities, then that constitutes tax evasion, which is a criminal act for which the perpetrators can be prosecuted. Avoidance is perfectly legal, regardless of what people think about it ethically.

Banking secrecy is not a crime, despite what the media might be suggesting.  Just because people choose to keep their money in offshore accounts does not mean they are doing anything unlawful or dodgy – in respect of their tax liability or anything else for that matter.

For the moment all we have is information about people using Panama for their banking affairs, not that they are avoiding or evading tax.

It is also inaccurate and wrong to suggest that David Cameron’s £200,000 gift from his mother is tax avoidance.  The Prime Minister has not broken any taxation rules by accepting the money, as there is no tax on gifts of cash, regardless of what certain newspapers have suggested, clearly in total ignorance of the capital gains tax laws.  And under the UK’s inheritance tax laws, tax-free gifts are permitted if the donor survives for seven years after making the gift.  Parliament says that this should be the case, so it is hardly tax avoidance to take advantage of those rules.

Despite the hard-hitting front page editorials following the Panama fall-out, every newspaper’s financial pages tell readers to make the most of the seven-year gift rules as part of sensible inheritance tax planning.

Perhaps the editorials should concentrate on the need for informed specialist tax planning to enable people to make some sense of an over-complicated tax system, rather than berating people who have done nothing wrong?

The media’s ill-informed take on the Panama situation, and indeed commentators’ reactions to the corporate taxation positions of major international businesses such as Google, have come as no huge surprise to me.

As a business tax adviser I have often found that journalists and politicians have a poor grasp of the way tax works.

When  Google  recently announced it was settling its past tax liability of £130 million, some raged that this sum was nowhere near enough, while  others tried to ‘guestimate’ the internet giant’s  UK taxable profits over the period.  This is a pointless exercise, as my understanding is that the settlement was a technical issue relating to employee shares and options, so it had nothing to do with Google’s international structure.

The issue with the international group structure, which is not in dispute for previous years, hinges on whether or not it forms a ‘permanent establishment’, the concept which determines what  proportion of company profits, if any, should be chargeable  to tax in other countries.  Under this rule, aspects such as sales and marketing through agents may be tax-exempt in certain circumstances.

Specifically, a dependent agent, i.e. one employed, in this case, by Google, does not create a taxable presence in the UK if those agents are only able to negotiate sales but are not allowed to conclude the contracts.

Google has always argued that its contracts are concluded in Ireland, which is where the taxable profits arise, however much of the negotiating is done in the UK by its agents.

While it has been suggested that Google’s contracts are actually concluded in the UK, we must assume that HMRC is satisfied that this is not the case.

Some people find this offensive, but, to use a football analogy, nobody suggests that a player is cheating by getting as close to being offside as he can, without actually being offside.

Let’s not forget that for every Google investing in the UK but able to take advantage of the permanent establishment rules, there are UK corporations investing into other countries and doing the same – paying UK corporation tax rates at 20%, rather than at those countries’ higher rates.

So, as far as we are aware, Google is complying absolutely with its UK tax obligations. Anyone who thinks that it should be paying more tax should remember that the same argument could be levied at the many UK multinationals investing outwards into other countries with higher corporation tax rates.

We should also bear in mind that Google has 2,300 employees in Britain earning on average £160,000 a year and all paying tax under the PAYE system.   With income tax rates of up to 45% and National Insurance contributions (employer’s and employees’) up to another 25%, Google is paying a substantial amount of tax in respect of those people.  So it’s not as though the company is not making a fairly major contribution to the UK economy.

As Google consumes services in this country, it also pays VAT at 20%.  VAT, National Insurance contributions and income tax are by far the three largest components of the UK’s tax take, so, while corporation tax is not insubstantial, it only makes up around 7 per cent of the total.

And despite comments to the contrary, companies are not morally obliged to pay tax. They are simply under a legal obligation to pay the tax levied under the law of each state in which they operate.

As Google and others have pointed out, if the rules on permanent establishments are not fit for purpose it is up to national governments, not the companies doing business here, to change them.

Both professionally and on a personal level I have had substantial input in feeding back to HMRC the tax sector’s reaction to recent anti-avoidance provisions.

As a member of the CIOT, and of the ICAEW Tax Faculty, and as an independent corporate tax consultant, I have asked HMRC to consider whether such measures are practical to operate, whether they will have the required impact and whether they are in fact fair.

In last year’s Budget,  for example, the Chancellor made  several changes  to entrepreneurs’ relief ‘to counter avoidance’  but  his  revised rules went  far beyond  their intended  targets and prevented  business owners  from passing businesses on to their families.  I was very involved in discussions with HMRC about this apparent attack on family businesses and it was gratifying to see that, thanks to our hard work, the rules were subsequently changed to hit only the intended targets.

All of this proves that we are more likely to have a coherent and sensible tax system if we put aside the hysteria about so-called avoidance – which often isn’t – and engage professionally with HMRC to get our tax legislation right.

Revised changes to Entrepreneurs’ Relief are welcome while Budget’s latest anti-avoidance measures remain questionable

One of the most welcome business taxation measures in the March 2016 Budget is without doubt the Chancellor’s revised changes to Entrepreneurs’ Relief

As you will recall, corporate tax experts were concerned by the original ER changes in last year’s Budget which, although designed to ‘prevent avoidance’, also adversely impacted upon business owners’ exit strategies when selling to family members.

The 2015 changes went far beyond their intended targets and were widely seen as an attack on owners’ rights to pass on their trades to their families.

I was part of the team, representing both the Chartered Institute of Taxation (CIOT) and the Institute of Chartered Accountants in England and Wales (ICAEW), that met to discuss the new rules with HMRC.

Happily, HMRC listened to our concerns and has, in this Budget, amended the new rules to hit only the intended targets. Additionally, the revised rules will be backdated to the time when they were first introduced.

This development is a victory for collaborative working and shows what can be achieved when tax advisers and their counterparts at HMRC come together to discuss difficult business taxation issues. Tax practitioners put in a lot of hard work to present their case, effectively working voluntarily, but the outcome was well worth the effort.

Another positive step for small business owners is the extension of Entrepreneurs’ Relief to external investors – i.e. non-employees of unlisted companies – as long as the investors subscribe for new shares and hold them for at least three years.  Making the use of company losses more flexible – probably as from 2017 – and cutting both corporation tax (from 2017) and business rates are also among the welcome measures for small businesses.

A reduction in Capital Gains Tax to 20 per cent is good news for everyone, although unfortunately it will not apply to residential property as the Government wants to encourage investment in trading companies. These CGT cuts may not have the desired effect though, as I’m sure people would rather invest in bricks and mortar if they can, than in unlisted companies which are far riskier.

Less happily, the Budget contains an increase in the tax charge on loans to shareholders and a raft of new anti-avoidance measures which will introduce instability and make life more confusing for the average business owner.  They will also result in greater complexity and higher compliance costs for everyone.

Whether HMRC will be able to bring in an additional £12bn through George Osborne’s anti-avoidance plan remains to be seen.  His estimates are usually way out and any extra tax collected is often relatively low so the merit of these latest measures is questionable.

Entrepreneurial businesses advised to apply for Patent Box before rule changes introduced

Entrepreneurial UK businesses who want to make the most of the Government’s Patent Box tax savings initiative should consider applying now before stringent new rules take effect this summer.

By joining the scheme before the end of June, they could avoid onerous red tape and still enjoy the benefit of paying less tax on the money earned from their patents.

As you will be aware, Patent Box, which was introduced in April 2013 to encourage UK technology innovation and entrepreneurship, effectively offers a 10 per cent reduction in corporation tax on income received from patents.

Hypothetically, this means that businesses paying £100,000 of corporation tax, could, through Patent Box, save themselves as much as £50,000.

The scheme has, however, recently been reassessed making the rules much tighter, so new entrants wanting to benefit from the existing regime need to apply before June 30 2016.

Under the current regime, it does not matter who carried out the original research leading to the patent.  From July 2016, however, new Patent Box claimants will need to prove that they did the research themselves, or paid for it to be done by someone else.

And claims will become more complicated to make, as companies will have to track their Patent Box profits on a patent-by-patent or product-by-product basis. Some historic R&D projects may also be subject to this bureaucratic new requirement.

Larger companies with a complex corporate structure and whose R&D is undertaken by more than one of their businesses, will also find it harder to satisfy the terms of the modified scheme.   Under the new arrangement the advantages of Patent Box will be lessened because of something called the R&D fraction.

If, for instance, a  British company subcontracts  some of its R&D work to  another  business within its group, the  R&D fraction will be reduced whether or not  the company undertaking the R&D is based  in the UK or overseas. On the other hand if a UK company subcontracts its R&D to a third party outside its organisation, the R&D fraction will not be cut.

These stringent changes are causing larger British companies to re-evaluate their corporate structure in order to fulfil the terms of the revised scheme and to ensure they continue to gain from it, tax-wise.

Smaller businesses will, I fear, find it too much of a challenge to meet the scheme’s onerous new administrative requirements and could well be put off the Patent Box despite its obvious benefits.

However there is still time to take advantage of the potential tax savings offered in the existing scheme so it is well worth seeking professional corporate tax advice.

Dividend tax changes represent genuine tax rise for hard-working small businesses

When the Chancellor announced changes to how dividends are taxed in his Summer Budget, it was suggested there would be no tax increase, except for people receiving dividends of more than £140,000 a year.

This reassurance always seemed unlikely however, and HMRC’s recent explanation as to how the new tax system would work proves our point.

In fact the new regime represents a genuine tax rise for many people. The Conservative Party’s first solo Budget in many years delivers a kick in the teeth for entrepreneurial small businesses and is not an incentive for them to work harder and strengthen the UK economy

Under the current system, if you pay yourself a salary from your company of less than £10,600, the current personal allowance, and take the rest of your income in dividends, you will not pay any Income Tax on salary or dividends until your total pay exceeds £42,385.  

Under the new rules this will no longer be the case, from 6 April 2016.  Apart from your personal allowance, the first £5,000 of dividend income will be tax-free, after which all further dividends will be taxed at a minimum rate of 7.5 per cent.  So somebody paying themselves £42,385 out of their own company would have £15,600 tax-free (£10,600 personal allowance and £5,000 dividend allowance) with the next £26,785 taxed at 7.5 per cent, giving a tax bill of £2,008.88. (Actually, the personal allowance for 2016-17 will be £10,800, so the tax bill will be £15 less, at £1,993.88).

This might not seem much, but it is £2,088.88 more than under the current regime.  If your income exceeds £42,385, dividends will be taxed at 32.5 per cent on top of the £5,000 allowance, and if you are a high earner with more than £150,000 a year, the rate of tax on dividends will be 38.1per cent.  This is an Income Tax rate increase   on dividends of 7.5 per cent at every level.  It is a major tax increase for everybody –particularly small business owners who have traditionally paid themselves a small salary and large dividends.

The new system has been put forward as a form of tax avoidance measure, to discourage people from incorporating their business to take advantage of lower rates of Corporation Tax.  The current headline rate of Corporation Tax is 20 per cent but set to fall to 18 per cent over the life of this Parliament, compared with Income Tax rates of up to 45 per cent with National Insurance contributions on top.  

As mentioned, most dividends are paid by small owner managed companies and represent the profits of the average entrepreneurial small business person.  So many people perceive this measure as an extra tax charge on the small business person to pay for the lower Corporation Tax rate which favours some of the very largest companies in the country.

In contrast, while the drop in Corporation Tax rates is intended to encourage inward investment by multinationals, the headline rate of Corporation Tax is actually a relatively minor part of the decision-making process when choosing whether or not to invest in a given country.  It comes well down the list after other considerations such as infrastructure and access to an educated and motivated workforce.  In any case, the UK already had the joint lowest Corporation Tax rate in the G20 group of countries and it seems unlikely that a 1 per cent drop in the rate will make a material difference as to whether or not companies invest in the UK.

What we in business would much prefer to see are tax cuts for hard-working entrepreneurial business owners, not tax rises, so that people can retain more of their hard-earned profits and spend them in a way that enhances the economy, rather than paying more tax to the government.

The Miller Partnership has many years’ experience dealing with small business remuneration issues, and Pete was the Inland Revenue’s in-house expert on dividends.

For further advice or assistance please contact Pete on 0116 208 1020 or email pete.miller@themillerpartnership.com

 

The Finance Act 2015: What its changes to entrepreneurs’ relief mean for small business growth and why the newly returned government should consider revising the rules as soon as possible.

The Finance Act 2015 has made major changes to entrepreneurs’ relief which will undoubtedly have a major impact on the growth of many small businesses.

One of its measures will restrict the availability of this relief when transferring goodwill on incorporation.

The other will limit the availability of tax deductions for the amortisation of goodwill transferred to the successor company on incorporation.

Both these changes, in our opinion, are ultimately bad for business and have been ill thought through.

When a sole businessman or woman, or a partnership, has reached a certain size, it is often sensible to transfer the business into a company (a process called incorporation).

If the trade is transferred to the company in return for shares, there is a relief to prevent any capital gains tax arising. Alternatively, if the business has a trade that could be sold to a company, the sale would generate a capital gains tax charge of just 10% (under the entrepreneurs’ relief). But why would you do that?

If you price your business’s goodwill at £100,000 and sell it into a company, the £100,000 gain will carry a tax charge of £10,000, which you won’t need to pay until January 31 2017.

The new company does not have any money, so it now owes you £100,000, which it can repay as it makes profits, and there is no further tax on the repayment of a debt. So, for the sake of paying £10,000 tax on incorporation, you are able to take £100,000 out of the company tax free – in contrast to the income tax and National Insurance contributions payable on salaries or the income tax on dividends.

Unfortunately, HMRC closed down this opportunity on December 3 2014. This means that most incorporations will use the special tax reliefs. Rather more unfortunately, this legislation potentially reduces the opportunity for people to retire from a business and sell that business in a sensible way.

Let’s imagine that Paul and Art want have a song-writing partnership and Art wants to retire. Paul agrees to set up a company to buy the business from both of them. Paul incorporates using the relief mentioned above and Art agrees that the company will pay for his share out of future profits. Art will claim entrepreneurs’ relief at the 10% CGT rate. So far, so good, as the new legislation does not cause a problem.

However, difficulties arise if Art and Simon are closely related, such as brothers or father and son, for example. In such cases, because they are related, the new rules do not allow Art to retire from the trade and claim entrepreneurs’ relief. There is no apparent policy reason for this, and it is largely a problem caused by rushing the legislation through with no time for consultation.

Similarly, if Art is a sole trader and sells to his friend Paul’s company, Simon Ltd, Art can sell his business and, we hope, claim entrepreneurs’ relief at the 10% CGT rate. Again, this works unless Paul requires Art to take, say, a 5% shareholding in Simon Ltd. In that case, Art will not receive entrepreneurs’ relief, simply because he becomes a shareholder in the company, even though it is only a very small shareholding.

Again, there is no policy reason behind this restriction: it is just a lack of time to consult. In our view these changes to the Finance Act are too wide and will inhibit commercial transactions.

The other major change is that, whichever method is used to incorporate the company, it will not be allowed a tax deduction when it writes down the goodwill in its accounts if any member of the previous partnership is a shareholder in the company. In many cases, this was a generous relief that we might not be able to afford in austere times. But this change was also not adequately consulted on and leaves some major commercial unfairness that needs to be resolved.

The government responsible for these changes now has the opportunity to review them as it sets out its agenda for business for the next five years. In the interest of supporting growth of UK small businesses I sincerely hope it will revisit the Finance Act’s contents at its earliest opportunity.

In the meantime, we have been looking at ways in which the effects of these changes can be mitigated with longer term retirement planning. So, if you have clients looking to incorporate their business or to retire from partnerships, please get in touch to see if we can help.

Comment on the tax implications of the Chancellor’s Autumn Statement by Pete Miller, tax consultant with The Miller Partnership, Leicester.

The Chancellor’s Autumn Statement refers to backing business and enterprise, and to ‘taking further action to tackle tax avoidance, and to ensure that all businesses and individuals pay their fair share’ which are laudable aims. But does it deliver? Part of the answer, of course, depends on what you think is a ‘fair share.’

On the plus side, for innovative companies there is an enhancement to the tax reliefs for research and development from April 1 2015. The relief for small and medium companies will increase from 225% to 230%, and the special ‘above the line’ credit for large companies goes up to 11% from 10%. And the claim process is to be simplified by the introduction of an advance clearance procedure so that companies know in advance that they qualify. This increase should be helpful and may partly counter the recent announcement of the restriction of the patent box relief, which will close to new entrants from 2016 and close completely in 2021. But the expenditure that qualifies for Research & Development allowances is being restricted, which makes the changes look less generous overall.

We are also promised a new relief for production of children’s programmes and consultation about a relief for investment in orchestras. These may be nice things to have but they are a bit marginal in the grand scheme of things. The phrase ‘bread and circuses’ springs to mind!

There is a lot more on the minus side. Apparently, individuals and partnerships are ‘gaining an unfair tax advantage’ by incorporating businesses into a company and claiming Corporation Tax deductions for goodwill. This is abolished immediately, as HMRC says this is ‘an unintended tax benefit’, which is frankly not true. The deduction for goodwill has been in place for 12 years and has never been considered offensive or unintended and it is hard to see where this announcement has come from. It is certainly not a change that is ‘backing business and enterprise’, as it takes away an incentive to incorporate a business, which is a necessary commercial step on the growth curve.

Also with immediate effect, if you incorporate your business you will not be able to claim Capital Gains Tax Entrepreneurs’ Relief on the gain on transferring goodwill and similar assets into the company. This is another ‘anti-avoidance measure’, although it may be counter-productive, as it will reduce the immediate CGT yield as people use the CGT Incorporation Relief and do not pay any CGT on incorporating their business, instead of 10%.

A couple of other things worth mentioning are, firstly, a restriction on the use of trading losses by banks. The idea is that banks’ bad behaviour caused the current economic problems, so why should they be given tax relief for the losses they made? From April 1 215, banks will only be able to use losses to reduce their profits by 50%. Secondly, we have the so-called ‘Google tax’, a Diverted Profits Tax of 25% on profits diverted overseas by artificial arrangements. This might be a popular idea but it is hard to see how this will fit with the UK’s Treaty obligations, EU law, and other international factors.

Succession Planning

There comes a point in the life of every business when the owner decides to step down and sell the company.

As we saw in last month’s blog, you will want to make sure that you only pay capital gains tax at the 10% rate (the ‘entrepreneur’s relief’), when you sell a trade or trading company. But there may be further complications.

First of all, who are you selling to? You may structure a transaction differently if it is to a third party, to a management team, or to your children, or even to a mixture of any two or three of these. If a third party is willing to pay cash on day one, then you can simply walk away, worry free. But often your buyers won’t have the money to pay up-front, particularly in the case of a management buy-out or a sale to your children or other family members, so you may need some kind of structured disposal.

Typically, in these cases, the people wishing to buy the business will form a company (the ‘BidCo’). Let’s imagine the buyers are your management team:

BidCo buys your trading company for a mixture of cash, loan notes, and sometimes shares issued by BidCo. The cash element may come from the amounts subscribed for shares in BidCo by the management team, or from dividends paid by the acquired company to BidCo immediately after the acquisition. Either way, assuming you have a trading company and you otherwise qualify for entrepreneur’s relief, you will generate a 10% tax bill on the cash element, that capital gains tax being payable on January 31 after the next April 5 (so 31 January 2016 for transactions completed on or before 5 April 2015).

Generally, the CGT liability on the loan note element, or shares, only arises when the loan notes are redeemed or the shares are sold. However, it is important to ensure that redemption of the loan notes or sale of the shares in BidCo will also qualify for the 10% CGT rate. If, for example, you are only issued with loan notes and cash, the loan notes will not qualify for entrepreneur’s relief, as this relief requires you to hold at least 5% of the shares in the company. So if you are not receiving shares, you will need to make an election that says your CGT charge crystallises on the sale, not on the later redemption of the loan notes.

You must also make sure that you have the cash available to pay the January 31 tax bill. To do that the loan notes must be at least partly redeemable before that date.

This special treatment of shares and loan notes can be confirmed by a clearance from HMRC. This important process affords some degree of certainty over the tax treatment of your disposal and is best done for you by an experienced advisor.

We can also add other features to a buy-out. For example, in a case where parents were selling to their children in return for loan notes, the parents remained on the company’s board, partly to guide the children through the transition into full ownership, and partly to protect their investment until the loan notes were redeemed.

We are currently working on a phased management buy-out, with BidCo acquiring just over 25% of the company in the first instance, 25% later on, and then buying out the remainder with bank financing within about five years.

This gives just a brief overview of some of the issues that arise on structured disposals of your business, and highlights the need to speak to an experienced advisor on these matters.

Entrepreneurs’ Relief – The 10% Tax Rate!

It is a ‘well known fact’ that when you sell your business you will only pay Capital Gains Tax at 10%.

This is the so called Entrepreneurs’ Relief. Unfortunately, like all well known facts, there is more to this story. The tax rules are complex, and not entirely logical, so let’s take a look at the areas where you might be at risk of paying tax at the full rate of 28%.

Probably the most important feature of the Entrepreneurs’ Relief is that it only applies to trading companies. Unfortunately, there is no definition of what constitutes a trade and the decisions of the courts over the past 160 years have not always been helpful.

In most cases it is clear that you have a trade if, for example, yours is a retail operation or a manufacturing business, so it’s perhaps easier to discuss what does not qualify for the relief.

In general terms, concerns such as property investment businesses or, indeed, any other business which relies solely on passive investment income, would be exempt. Cases on the margins would include enterprises such as caravan parks, which HMRC generally considers to be investment businesses, even where the owners carry out related activities, such as providing utilities or other facilities.

If you’re a sole trader or carry out your trade through a partnership, then when you sell your trade or the partnership rights you should qualify for Entrepreneurs’ Relief.

The situation gets more complicated, however, if you trade through a company.

To be eligible for the relief, firstly you must own at least 5% of the company’s ordinary shares and hold at least 5% of the voting power in the company. Secondly you must be an employee or officer (director) of the company, or of a company within the group, if you have more than one company. As long as these conditions have been satisfied for a full year immediately before the sale, selling the shares, or any proportion of them, you should qualify for the 10 per cent tax rate.

However, problems can arise in instances where employees receive shares that were not voting shares, or where the company is co-owned by both husband and wife but where the wife has never been a director or employee of the company.

Another pitfall can emerge when accepting a loan document rather than an immediate cash payment from the purchaser of your business. This type of “share exchange”, can lead to difficulties, as any cash you receive when you sell the shares may qualify for the Entrepreneurs’ Relief, but the later redemption of the loan notes will not – so you might end up paying tax at 28% every time you redeem a loan note.

Breaking up’s not hard to do!

Apologies to Neil Sedaka, but have you got clients in business together who would like to separate their interests?  They may have fallen out or want to take the businesses in different directions, or perhaps they just want to split the businesses because of different risk profiles.  At the Miller Partnership we have extensive experience of splitting companies and groups into two or more parts, taking advantage of all the relevant tax reliefs and obtaining clearance in advance from HMRC.  We can carry out these demergers by any of the known mechanisms – distribution in specie, liquidation or reduction of capital – and we can advise you which one best fits your commercial needs.

Recently successes include:

  • Splitting an interior design trade, where the owners wanted to take the business in different directions, one domestic and the other focussing on international assignments
  • Separating a multi-million pound property portfolio between the shareholder families, so that one could concentrate on the rental business and the other could move into development
  • Breaking up a retail group to allow the owner to develop the different businesses in different ways, depending on the local market for his products.

Whither Partnerships?

There has been a huge amount of publicity about HMRC’s attack on partnerships in this year’s Budget, but the biggest question is what to do about the inevitable changes?

The first major change treats certain members of LLPs (limited liability partnerships) as employees, with major tax and cash-flow consequences. This will apply to ‘partners’ who have fixed income, or income that isn’t partly based on the partnership’s profits, who do not have significant influence and whose partnership fixed capital is insufficient. If you have clients that have partners who fail all 3 of these conditions, we can help you resolve the problems so that the impact of the new legislation is minimised.

The other change affects ALL partnerships that have mixed memberships of individuals and non-individuals. Usually, this means corporate members, although the new rules apply to trusts and other non-individuals in partnership, and the rules may apply to partnerships with only corporate partners, too. If there is no commercial reason for allocating profits to the company partner, HMRC can treat those profits as belonging to the individual, who will then have to pay income tax at up to 45% and Class 4 NICs on the profits, instead of the company only paying 20% corporation tax. We have a great deal of experience helping people decide how best to deal with these changes and how to unwind the structures efficiently, if that’s appropriate.

The new rules have applied since 6th April 2014, so you may need to act quickly!

Call or email Pete right away.

 

EFRBS Settlement Offer

HMRC has started an initiative to settle outstanding EFRBS cases, by issuing an EFRBS Settlement Offer under the Litigation and Settlement Strategy.  Further details of the offer can be found on HMRC’s website, here.  Your clients may well have received an offer letter from HMRC, and the obvious question is whether to settle.  HMRC’s letter requires an expression of interest by 31 December and for the settlement to be completed by 30 June 2014, so the timescale for making a decision is very short.  That said, we do not believe that an expression of interest is binding on your clients.  So if they decide not to settle as the discussions with HMRC proceed, they can withdraw from the initiative.

There are two alternative offers: one is to settle on the basis that no CT deduction is due, so that the CT is paid on the contribution and the professional fees; the other is to pay the income tax and NICs in respect of the contributions to the EFRBS, in which case a full CT deduction is given for the contributions to the EFRBS and for the professional fees.  Both have their advantages and disadvantages.

 

Settlement for CT only

The first version is not at all generous, as, in effect, HMRC want you to revert to the way they see the legislation, so that the CT deduction is not due until someone pays income tax and NICs on the amounts contributed.  This means that HMRC will not then press for the income tax and NICs until amounts are formally paid out of the trusts to the beneficiaries.  HMRC also say that they will disallow the deduction for professional fees incurred in setting up the EFRBS.  But we cannot see that this is justified under the normal corporation tax rules, as setting up an EFRBS is a business expense incurred wholly and exclusively for the purposes of the trade, and the legislation does not specifically disallow these costs, only the contributions.

If your clients are keen to settle, this is arguably a low-cost option, as the CT is a smaller amount than income tax and NICs.  On the other hand, it still leaves the trust in place and the trustees will need to operate PAYE / NICs as and when any payments are made out of the trust to employees or former employees.  That said, it might be possible for sums to be paid out of the trusts in future with lower tax charges.  For example, if the fund were to be used to pay pensions to the employees or directors when they retire, the rates of income tax may be lower or the pensioners might have retired abroad, so that there is no PAYE or NICs charge in the UK (the pensioner would, of course, have to consider whether there are any tax charges in their country or territory of residence).

 

Income tax and NICs settlement

This offer is on the basis of treating the contributions to the EFRBS as being earnings, subject to PAYE and NICs at the time the contributions were made.  The contributions, the income tax and NICs and the professional fees, would all then be deductible for CT purposes (there is no CT deduction for interest paid on settlement).  The settlement of income tax and NICs would inevitably involve larger numbers than a settlement for CT only but the idea is to clear the whole thing up and allow you to unwind the trusts by distributing the trust funds to beneficiaries post-settlement free of any further tax (save for any tax on overseas income in offshore EFRBS).

Our concern with this approach is that HMRC has had numerous attempts at persuading the Courts that contributions to EBTs should be taxed as earnings, and the Courts have rejected the argument every time.  So it seems likely that HMRC would be reluctant to litigate on this basis and would prefer to litigate cases on the basis of refusing the CT deduction, instead.

On the other hand, although such a settlement might lack a statutory basis, it can provide finality and closure for all concerned, which might be something your clients want.

If the company pays the income tax and NICs, these should be repaid to the company by the trustees or the employees (the exact requirements will depend on the wording of the trust Deed).  Otherwise, the income tax and NICs are treated as additional ‘earnings’ of the employee, so that more tax and NICs would be due.  We understand that HMRC has been quite helpful in this area, when considering settling EBT cases.

 

Other thoughts

There are a number of entirely legitimate uses of the funds in an EBT that do not or may not carry a charge to tax or, a lower ‘effective rate’ of tax.  As mentioned, paying out pensions might be an efficient way of using the funds, either through lower tax rates in the future or because the individuals concerned are no longer UK resident.  Other thoughts include selling assets to the trust, licensing assets through the trust, etc. We would be happy to discuss these in more depth, if they might be of interest to your clients.

 

Conclusions 

While neither route to settlement is entirely satisfactory, both have their potential upsides, including getting HMRC to go away.  That said, if your clients are comfortable with their current position, they could arguably be no worse off settling later, with the only downside being a greater charge to interest. However, there could be an increased risk of incurring tax charges on additional earnings if the trustees do not reimburse the company for any income tax and NICs which are subsequently held to be due on the contributions and which are paid outside the EFRBS Settlement Initiative.

To a very large extent, it comes down to how your clients feel, whether they want closure or partial closure, whether they are prepared to wait and see, and so on.  While HMRC suggest that they will litigate every case that doesn’t offer to settle, we don’t believe that they can litigate every single case, so they will have to use the lead case procedure, which may allow others to adopt a wait-and-see approach.