To September’s Tax Tips & News, our newsletter designed to bring you tax tips and news to keep you one step ahead of the taxman.
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Latest News Round-Up
Making Tax Digital – a new penalty regime for all
The current penalty system for late payment and/or late submission of tax returns differs depending on which tax is levied. For some time HMRC has wanted a consistent approach across all taxes and the opportunity to make it so has come with the implementation of Making Tax Digital (MTD) starting with Making Tax Digital for VAT (MTD for VAT).
As the first stage of HMRC’s ‘roll out’ of the MTD initiative, all VAT-registered businesses must keep records in a digital format and use software to submit their VAT returns. What has been missing so far has been detail of the reform of the penalty rules for late submission of return and late payment to align with the new system.
HMRC has announced that a new (arguably more complicated) system of penalties for late submission of VAT returns and late payment is to apply from 1 January 2023, replacing the current default surcharge regime. Other breaches may incur one of the existing regulatory penalties. The system as announced will be of interest to all taxpayers, whether VAT registered or not, as it will form the basis of the future penalty regime for all.
A late VAT Return or payment is known as a ‘default’. Late submission or late payment are currently penalised by a single default surcharge, calculated as a percentage of the outstanding VAT due as shown on the return or of the amount unpaid. If the return is late no surcharge will be payable if the tax is paid in full.
Businesses receive a surcharge liability notice for the first default, subsequent defaults being successively surcharged at 2%, 5% and 10% up to a maximum of 15% for the fourth and subsequent defaults. Late filing or late payment means that the business enters into a 12-month probation period known as a ‘surcharge period’.
If any subsequent return or payment is late during this period a penalty/surcharge is levied and the surcharge period is reset for a further 12 months. Small businesses with a turnover of less than £150,000 do not receive a monetary penalty until they make the third late filing or late payment within the 12 months surcharge period. If the penalty is calculated at less than £400 it is not charged. The minimum surcharge charged at the 10% and 15% rates is £30.
The new regime
Penalties for late submission
The new regime will be based on a ‘points system’ with taxpayers receiving a point every time they miss a submission deadline after 1 January 2023; so for the usual quarterly VAT returns this will mean that the first return to come under the new system will be the one to 31 March 2023.
A financial penalty of £200 will be charged at certain threshold of points which will be determined by how often a taxpayer is required to submit. For the usual quarterly submissions the £200 penalty will be levied after four late submissions.
A penalty will be charged for that failure and every subsequent failure, but the total number of points will not increase. Where a taxpayer accrues points but does not reach a penalty threshold then the points will expire after two years.
After a taxpayer has reached the penalty threshold, all the points accrued will be reset to zero when the taxpayer has submitted all their returns on time within a set period of compliance (for quarterly VAT returns this will be 12 months). In addition all submissions within the preceding 24 months must have been made (it will not matter whether or not these submissions were initially late).
Penalties for late payment
In addition to the penalties for late submission outlined above, the following penalties for late payment of VAT will apply:
– 0-15 days: no penalty
– 16-29 days: 2% of the amount outstanding
– 30 days: 2% of the tax outstanding at day 15 plus 2% of the tax outstanding at day 30
Late payment interest will be charged from the day the payment is overdue to the day payment is made in full.
HMRC has confirmed that it will take a ‘light-touch’ approach in the first year of operation from 1st January 2023 until 31st December 2023 in order for taxpayers to familiarise themselves with the new system. No first late payment penalty will be charged for that first year if payment is made in full within 30 days of the payment due date (or a ‘time to pay agreement’ has been made). However there will be no ‘light touch’ for late return submissions.
Further information can be found on HMRC’s website:
One Way Of Getting Money Out Of Your Company – Charge Rent
Although dividends are generally the most tax-efficient method by which money can be extracted from a company, renting a property you own to your company can be more or as tax efficient depending on your marginal tax rate. Whether charging rent is tax-efficient needs to be looked at overall by not only taking into account the director’s immediate income tax position and the company’s tax situation, but also the future capital gains tax (CGT) position when the property or the company itself is eventually sold.
Benefit to the company
The company is allowed full corporation tax relief on payments made and there is no employer NIC cost (as not salary or a bonus).
Benefit to the director
The main benefit for the director is that, unlike dividends, there is no legal requirement for the company to have sufficient distributable profits for the payment to be made. In addition, there is no NIC cost as the payment is not a salary or a bonus. Further, should there be a mortgage on the property the only way to obtain tax relief for interest paid is against rental income.
Owning business premises outside of the company could prove beneficial should the property be sold. If the company owns the property, on sale there will invariably be a large amount deposited in the business bank account. If the director wishes to withdraw the cash then they will be charged income tax payable on the amount withdrawn at their marginal dividend tax rate, which could be as high as 39.35% for additional rate taxpayers.
In comparison, a property held personally and sold will attract CGT with an annual exemption, taxed at either 10% or 20% (assuming the property is commercial) depending on the taxpayer’s marginal tax rate.
The director will be liable for any profit made on rent received less rental expenses, taxed at their marginal tax rate. If a loss is made then the director will need other funds to cover costs. If such funds need to be withdrawn from the company in the form of salary or dividend this may negate the benefit of charging the company rent.
A downside of charging a company rent may come when all or part of the company is sold (e.g. on the individual’s retirement, or the cessation of business).
If an asset is sold at a gain owned by a shareholder in use by their ‘personal company’ at the time the business has ceased or part or all has been sold, it may be possible to claim Business Asset Disposal Relief (BADR) if the asset is associated with a qualifying disposal of shares in the company. BADR is available on disposals of business assets, reducing the rate of CGT on qualifying gains to 10%, subject to a £1 million lifetime limit.
However, by charging full market rent all BADR is lost as the property will count as an investment asset. If the company pays rent lower than the market rent or has paid rent since 6 April 2008 (when the rules changed) the proportion of gain on which BADR may be claimed is restricted in proportion to the amount of rent paid.
The payment of market rent throughout ownership will not necessarily result in relief being entirely lost as the use of the property throughout ownership is also taken into account (e.g. the property may have been purchased but not used by the company until a later date).
If rent is charged at more than the market value the excess amount will not be an allowable expense for the company and be treated as a ‘distribution’ to the director taxed at the same tax rate as a dividend.
Have you taken an ‘illegal dividend’?
Anyone who invests in a company is taking a chance, hoping that the money will not be wasted and that the directors, as representatives of the company, will use the money in such a way that the company’s profit increases. In return for taking this chance, a shareholder receives ‘payback’ usually in the form of a share in the distribution of profits via a dividend. The payment is not an absolute right and unfortunately, some directors/shareholders of family-owned companies believe that as long as there is cash in the bank then they can take the balance as a dividend.
However, this is not necessarily the case as a provision in the Companies Act 2006 states that a dividend can only be paid under set conditions. The rules state that “a company may only make a distribution out of profits available for the purpose”. ‘Profits’ in this instance are ‘accumulated realised profits less ….accumulated, realised losses’. This figure is the amount of profit made since the company was created, less any dividends already paid out by way of distribution/dividend, (or capitalised in some way), less accumulated losses not written off.
‘Illegal dividends’ are therefore dividends paid in excess of this resulting amount or made out of capital or where there are losses that exceed the accumulated profits. The best way to confirm that sufficient ‘distributable profits’ are available to cover any dividend is to prepare a draft set of basic accounts every time the directors intend to make an interim dividend. There is a statutory requirement for full accounts be prepared to back up payment of a final dividend.
If the balance sheet shows the figure designated as ‘reserves’ as a negative figure at the end of a relevant period or where the opening balance next year is in deficit but dividends have been paid then HMRC may raise enquiries. On investigation if it is found that ‘illegal dividends’ have been paid then HMRC can require the dividend to be repaid. They could go further and argue that rather than being a dividend, the payment was incorrectly designated and was, in effect, a loan or payment of salary.
In such a case, unless the ‘loan’ is repaid within nine months and one day of the company’s year end, the company will be charged 33.75% of the gross amount paid. However, should the payment be repaid in full or in part, the tax charge is fully or proportionally repayable nine months and one day after the end of the accounting period in which the repayment is made.
It is not only the company that could be affected in this situation. HMRC could argue that the repayable amount is an interest-free loan and if that loan is more than £10,000 remaining unpaid at the end of the accounting period, then a benefit in kind charge could be levied on the director. Class 1A NIC will also be charged to the employer.
Questions surrounding the legality of a dividend are more likely to arise should a company go into liquidation. As part of the liquidator or administrator’s routine it is standard practice to review the conduct of directors over the three years before insolvency.
Depending on the situation the liquidator may argue that the director of a family owned company should have known or been aware of or at least had reasonable grounds to believe that such a payment breached the conditions and require the director to repay the amount withdrawn. In a liquidation HMRC is invariably the largest and preferential creditor and will try to pursue repayment if it is financially worthwhile.
Whenever it is intended to declare a dividend a draft set of accounts should be prepared, to make sure that the rules are being followed.
Are You Trading?
Covid -19 had a devastating impact on many businesses with significant numbers closing for good. However, many workers who were made redundant or furloughed took the opportunity to set up their own businesses. According to the Government’s December 2021 report ‘Business Statistics’ an estimated 810,316 new businesses were launched in the financial year ending in 2021 — the highest number on record.
The report also noted that there had been a distinct fall in the number of employees and said that it was believed that the decline was ‘due to the growth in self-employment’. You may have been one of those who started selling one or two items possibly online and if so are you ‘trading’ in the eyes of HMRC?
Badges of trade
The answer to that question can be found in looking for the presence or absence of common features or characteristics of trade. These are the ‘badges of trade’ that have been identified by case law as follows:
– profit-seeking motive — is the intention to make a profit or just sell items no longer needed?
– the number of transactions – systematic and repeated transactions;
– the nature of the asset – an asset that can be turned to an advantage;
– similar trading – transactions that are similar to those of an existing trade;
– modification of the asset — repairing, modifying or improving an asset to make it more saleable or saleable at a greater profit;
– method of sale – selling an asset in a way that would be typical of other trading organisations;
– method of finance – selling an asset to repay funds borrowed to purchase the item (s);
– interval of time between purchase and sale – the shorter the interval between both, the more likely trading has taken place;
– method of acquisition – an item acquired by inheritance or gift, for example, is less likely to indicate a trading transaction.
It is important to note that no one ‘badge’ designates a trading activity — the activity needs to be looked at as a whole although HMRC has stated that one of the more important ‘badges’ is the second one which considers the ‘nature of the asset’. HMRC quotes items such as investments and works of art as not necessarily purchased with a view of trading.
When should HMRC be advised?
Even if the activity could be deemed as ‘trading’ there may be no requirement to notify HMRC; this would be particularly relevant should the gross annual trading income in the tax year from one or more trades is £1,000 or less under the ‘Trading Allowance’. However, there is a proviso that should you already be self-employed in another activity and separately sell items as a trading activity (e.g. on e-bay) then this allowance cannot be used for the separate trading activity.
It may be possible to make use of the Trading Allowance if by doing so the calculation produces a bigger reduction than the usual income less expenses figure to ascertain the taxable profit. Be aware that if the calculation using actual expenses produces a loss then it would be more beneficial to not claim under the Trading Allowance as its deduction cannot create a loss.
Class 2 and/or Class 4 National Insurance contributions may be payable should the profit exceed the limit of £6,725 for Class 2 NIC and £11,908 for Class 4 NIC.
September Questions And Answers
Q. I am a self employed dentist wanting to expand my knowledge and specialise in a particular branch of dentistry. I have discovered that there is a part time course at my local university which will enable me to continue working. The cost is £25,000 and it will take three years to get the qualification. Can I claim the cost of the course against my self employed earnings?
A: The real question to consider is whether the expenditure is capital or revenue. Expenditure incurred by the proprietor of a business on training courses for themselves is revenue expenditure if the course merely updates existing expertise or knowledge. Expenditure on a course which provides new expertise or knowledge is capital. The course appears to be for the acquisition of new skills, rather than the updating of existing ones and if this is the case then the expense is capital and disallowable.
Q. My husband and I are joint partners in a business for profit sharing purposes. The work requires me to do a lot of travelling on business and my husband accompanies me occasionally. As my husband is not involved in the business purpose of these trips (e.g. meetings) can any travel expenses be claimed?
A: To be allowable the cost must be ‘wholly and exclusively’ for the purpose of the trade. As your husband does not take any active role in the business you should be disallowing 50% of any travel costs, eating out, accommodation etc.
Q. We have had a rental property for some years and now that we are retired, we wish to live there and rent out our (original) main residence. How long must we live in a property before it becomes our main residence?
A: There is no set number of months or years before principal private residence can be assured to apply but what needs to be shown is that you are moving to the property and intending to stay for the long term. Possibly six months to a year would be a reasonable time. You should also register on the electoral role for the area of the country where you intend to reside and ensure that HMRC is aware of your change of address. Once the property is established as your main residence should you ever wish to sell the property you will be able to benefit from the final nine months exemption under principal private residence relief.
September Key Tax Dates
1 – Corporation Tax payment 30 November 2021 year end
New rates published for Advisory fuel rates for company car drivers
Trust Registration Service: deadline to register non-taxable trusts in existence on 6 October 2020, some non-taxable trusts created after 6 October 2020, and some taxable trusts created on or after 6 April 2021.
7 – Electronic VAT return and payment due for VAT quarter ended 31 July 2022.
19 – CIS return for payments made to subcontractors in the month to 5 September 2022
22 – PAYE, NIC and CIS payment (electronic): month-end 5 September 2022
30 – Corporation Tax returns submission: 30 September 2021 year ends