Category: Finance & Accounting

Director’s loan accounts: recording personal expenses

HMRC commonly find errors in relation to directors’ loan accounts when making routine reviews of company tax returns. This article looks at the importance of maintaining proper records of cash and non-cash transactions between the company and the directors.
Directors’ personal expenses
A statutory rule states that a company may not deduct expenditure in computing its taxable profits unless it is incurred ‘wholly and exclusively’ for the purposes of the trade. As companies are separate legal entities that stand apart from their directors and shareholders they do not incur ‘personal’ expenses. However, many companies, particularly ‘close’ companies (broadly, one that is controlled by five or fewer shareholders (participators)), pay the personal expenses of the directors. It is important to note that where payments, either made to or incurred on behalf of a director, do not form part of their remuneration package, these amounts may not be an allowable company expense and may not therefore be deductible for corporation tax purposes. In such circumstances it may be appropriate for these items to be set against the director’s loan account. However, establishing whether a payment forms part of a director’s remuneration package can be complex.
Accounting disclosure requirements for directors’ remuneration include sums paid by way of expense allowance and estimated money value of other benefits received other than in cash. The money value is not the same as the taxable amount, although this is often used in practice. This means the onus is on the director to justify why amounts not disclosed in accounts should be accepted as part of the remuneration package rather than debited to his or her loan account.
Where the expenditure forms part of the remuneration package it will be an allowable expense of the company and the appropriate employment taxes (PAYE income tax and NICs) should be paid. Where the expenditure does not form part of the remuneration package the relevant amount should normally be debited to the director’s loan account.
Cash transactions
Cash transactions between the company and directors may have tax consequences. Broadly, at the end of an accounting period, if the director owes the company money, a tax charge may arise. Subject to certain conditions, a charge may arise where a director’s loan account is overdrawn at the end of the accounting period and remains overdrawn nine months and one day after the end of that accounting period. The tax charge (known as the ‘s 455 charge’) is the liability of the company and is calculated as 32.5% of the amount of the loan. The tax charge can potentially be avoided if the loan is cleared by the corporation tax due date of nine months and one day after the end of the accounting period.
Record-keeping
Good record keeping of all cash and non-cash transactions between a company and its directors is essential. Poorly kept records can mean that information provided is not accurate, which in turn may result in non-business expenditure incurred by the directors being incorrectly recorded or mis posted in the business records and claimed in error as an allowable expense. Conversely, justifiable business expenditure incurred by the directors may not be claimed or claimed inaccurately. Consequently, directors’ loan account balances may be incorrect resulting in s 455 tax being underpaid, or corporation tax relief not claimed by the company at the appropriate time.

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Year-end tax planning tips

As the end of the 2018/19 tax year approaches, it is worthwhile taking time for some last-minute tax planning. Here are some simple tips that may save you money.

  1. Preserve your personal allowance: the personal allowance is reduced by £1 for every £2 by which income exceeds £100,000. For 2018/19, the personal tax allowance is £11,850, meaning that it is lost entirely once income exceeds £123,700. Where income falls between £100,000 and £123,700, the effect of the taper means that the marginal rate of tax is a whopping 60%. Where income is over £100,000, consider making pension contributions or charitable donations to reduce income and preserve the personal allowance. Where this is an option, consider also deferring income until after 6 April 2019 to reduce 2018/19 income.
  2. Claim the marriage allowance: the marriage allowance can save a couple tax of £238 in 2018/19. Where an individual is unable to utilise their personal allowance, they can make use of the marriage allowance to transfer 10% of their personal allowance (rounded up to the nearest £10) to their spouse or civil partner, as long as neither pay tax at the higher or additional rate. The marriage allowance must be claimed.
  3. Pay dividends to use up the dividend allowance: family and personal companies with sufficient retained profits should consider paying dividends to shareholders who have not yet used up their dividend allowance for 2018/19. The dividend allowance is set at £2,000 and is available to all individuals, regardless of the rate at which they pay tax. The use of an alphabet share structure enables individuals to tailor dividend payments according to the individual’s circumstances.
  4. Make pension contributions: tax relieved pension contributions can be made up to 100% of earnings, capped at the level of the annual allowance. The annual allowance is set at £40,000 for 2018/19 (subject to the reduction for high earners). Where the annual allowance is not used up in year, it can be carried forward for up to three years.
  5. Transfer income-earning assets to a spouse or civil partner: where one spouse or civil partner has unused personal allowances or has not fully utilised their basic rate band, considering transferring income earning assets into their name to reduce the combined tax liability (but non-tax considerations such as loss of ownership should be taken into account).
  6. Put assets in joint name prior to sale: spouses and civil partners can transfer assets between them at a value that gives rise to neither a gain nor a loss. This can be useful prior to selling an asset which will realise a gain in order to take advantage of both partners’ annual exempt amount for capital gains tax purposes.
  7. Make gifts for inheritance tax purposes: individuals have an annual exemption for inheritance tax of £3,000, allowing them to make gifts free of inheritance tax each year. Where the allowance is not used, it can be carried forward to the next year, but is then lost.

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Salary v dividend for 2019/20

A popular profits extraction strategy for personal and family companies is to extract a small salary, taking further profits as dividends. Where this strategy is pursued for 2019/20, what level should be the salary be set at to ensure the strategy remain tax efficient?
Salary
As well as being tax effective, taking a small salary is also advantageous in that it allows the individual to secure a qualifying year for State Pension and contributory benefits purposes.
Assuming the personal allowance has not been used elsewhere and is available to set against the salary, the optimal salary level for 2019/20 depends on whether the employment allowance is available and whether the employee is under the age of 21. The employment allowance is set at £3,000 for 2019/20 but is not available to companies where the sole employee is also a director (meaning that personal companies do not generally benefit).
In the absence of the employment allowance and where the individual is aged 21 or over, the optimal salary for 2019/20 is equal to the primary threshold, i.e. £8,632 a year (equivalent to £719 per month). At this level, no employee’s or employer’s National Insurance or tax is due. The salary is also deductible for corporation tax purposes. A bonus is that a salary at this level means that the year is a qualifying year for state pension and contributory benefits purposes – for zero contribution cost. Beyond this level, it is better to take dividends than pay a higher salary as the combined National Insurance hit (25.8%) is higher than the corporation tax deduction for salary payments.
Where the employment allowance is available, or the employee is under 21, it is tax-efficient to pay a higher salary equal to the personal allowance of £12,500. As long as the personal allowance is available, the salary will be tax free. It will also be free of employer’s National Insurance, either because the liability is offset by the employment allowance or, if the individual is under 21, because earnings are below the upper secondary threshold for under 21s (set at £50,000 for 2019/20). The salary paid in excess of the primary threshold (£3,868) will attract primary contributions of £464.16, but this is outweighed by the corporation tax saving on the additional salary of £734.92 – a net saving of £279.76. Once a salary equal to the personal allowance is reached, the benefit of the corporation tax deduction is lost as any further salary is taxable. It is tax efficient to extract further profits as dividends.
Dividends
Dividends can only be paid if the company has sufficient retained profits available. Unlike salary payments, dividends are not tax-deductible and are paid out of profits on which corporation tax (at 19%) has already been paid.
However, dividends benefit from their own allowance – set at £2,000 for 2019/20 and payable to all individuals regardless of the rate at which they pay tax – and once the allowance has been used, dividends are taxed at lower rates than salary payments (7.5%, 32.5% and 38.1% rather than 20%, 40% and 45%).
Once the optimal salary has been paid, dividends should be paid to use up the dividend allowance. If further profits are to be extracted, there will be tax to pay, but the combined tax and National Insurance hit for dividends is less than for salary payments, making them the preferred option.

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Tax-free investments using Premium Bonds

Premium Bonds (PBs) are an investment product issued and maintained by National Savings and Investments (NS&I), which in turn, is backed by HM Treasury. With a return rate comparable with regular savings accounts (currently 1.40%), it is not difficult to see why PBs remain one of Britain’s favourite ways to save – around 21 million people currently have almost £72 billion invested in PBs.
The Autumn Budget on 29 October 2018 included a range of enhancements to PBs, aiming to encourage a stronger savings habit and boost the opportunity for young people to save. The changes should also help make PBs more accessible to everyone.
Currently the minimum amount of PBs that can be purchased is £100 (or £50 by standing order). This minimum investment limit will be cut to £25 by the end of March 2019. This will apply to both one-off purchases and regular savings and should help make this product more accessible for a wider range of people.
In addition, the rules on who can purchase PBs are being changed. Currently, only parents and grandparents can buy PBs for children under 16. Although the timescale is yet to be confirmed, it has been announced that in future it will be permissible for other adults to buy PBs on behalf of children. The person purchasing the bonds for children will have to be over 16 and must nominate one of the child’s parents or guardians to look after the bonds until the child turns 16.
Once held for a full month, bonds are included in a monthly draw and the investor stands a chance of winning a cash prize. The larger monthly prizes currently include two £1 million prizes, five £100,000 prizes and eleven £50,000 prizes.
The maximum Premium Bond holding is £50,000 and there do not appear to be any current plans to increase this limit.
Weighing up the pros and cons
Before making or increasing an investment in PBs, it may be worthwhile taking time to consider a few pros and cons, including:
Pros
• All investments are effectively government-backed, so all money put into PBs is secure.
• A married couple or civil partners may invest a sizeable £100,000 between them.
• There is a very small chance that the holder could receive a very high return on an investment.
• Any prizes won are free from income and capital gains tax.

Cons
• No regular interest payments are made on investments in PBs.
• Most people who buy PBs will earn only a small amount as a percentage of the money they contribute.
• Unless the investor wins one of the bigger prizes, their return is unlikely to beat inflation.
• It can take up to eight working days for the money to reach the investor’s account when PBs are cashed in.
Electronic investments
NS&I has confirmed that it will be launching a new PB app, which is designed ‘to make saving easier’. Following the success of the NS&I Premium Bonds prize checker app, the new app will allow customers to buy and manage their PBs as well as most other NS&I accounts.
Summary
Although Premium Bonds are not strictly an ‘investment’, they can be encashed at any time with the full amount of invested capital being returned – and in the meantime, any returns by way of ‘winnings’ will be tax-free. The odds on winning a prize in any one month are currently 24,500 to one, and there is a negligible chance of winning a million. With the full facts in mind – investing in PBs stills presents a half-decent option for many.

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Make the most of your allowances

The tax system contains a number of allowances which enable individuals to enjoy income and gains tax free. In seeking to maximise your tax-free income, it makes sense to take advantage of available allowances. The following are a selection of some of the allowances on offer.
Personal allowance
Individuals are entitled to a personal allowance each year, set at £11,850 for 2018/19, rising to £12,500 for 2019/20. However, not everyone can benefit from the allowance – once income reaches £100,000 it is reduced by £1 for every £2 by which income exceeds more than £100,000 until it is fully abated. Reducing income below £100,000 will help preserve the allowance.
The personal allowance is lost if it is not used in the tax year – it cannot be carried forward (although in certain circumstances it is possible to transfer 10% to a spouse or civil partner). To prevent the allowance being wasted, various steps can be taken depending on personal circumstances, including:
• paying dividends to use up both the dividend allowance and any unused personal allowance;
• transferring income earning assets from a spouse to utilise the unused allowance;
• paying a bonus from a family or personal company;
• accelerating income so that it is received before the end of the tax year.
Marriage allowance
The marriage allowance can be beneficial to couples on lower incomes, particularly if one spouse or civil partner does not work. The marriage allowance allows one spouse or civil partner to transfer 10% of their personal allowance (as rounded up to the nearest £10) to their spouse or civil partner, as long as the recipient is not a higher or additional rate taxpayer. The marriage allowance is set at £1190 for 2018/19 and £1250 for 2019/20, saving couples tax of, respectively, £238 and £250. The allowance must be claimed: see www.gov.uk/apply-marriage-allowance.
Trading allowances
Individuals are able to earn income from self-employment of up to £1,000 tax-free and without the need to declare it to HMRC. Where income exceeds £1,000, the allowance can be claimed as a deduction from income in working out the taxable profit, rather than deducting actual costs. Where allowable expenses are less than £1,000, claiming the treading allowance instead will be beneficial.
Property allowance
A similar allowance exists for property income, allowing individuals to receive property income of up to £1,000 tax-free without the need to tell HMRC. Where property income is more than £1,000, the individual can deduct this rather than actual costs when computing profits for the property rental business if this is more beneficial.
Rent-a-room
The rent-a-room scheme allows individuals to earn up to £7,500 tax-free from letting a furnished room in their own home. The limit is halved where two or more people receive the income.
Savings allowance
Basic rate taxpayers are entitled to a savings allowance of £1,000, while higher rate taxpayers benefit from a savings allowance of £500. Additional rate taxpayers do not get a savings allowance. ISAs provide the opportunity to earn further savings income tax free.
Dividend allowance
All taxpayers regardless of the rate at which they pay tax are entitled to a dividend allowance, set at £2000 for both 2018/19 and 2019/20. This can be useful in extracting profits from a family company in a tax-efficient manner.
Capital gains tax annual exempt amount
Individuals can also realise tax-free capital gains up to the exempt amount each year – set at £11,700 for 2018/19 and at £12,000 for 2019/20. Spouses and civil partners have their own annual exempt amount. Time sales of assets to make best use of the annual exemption.

The above is only a small selection of the allowances available.

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Abatement of the personal allowance

Not all taxpayers are able to benefit from the personal allowance – once income exceeds £100,000 the allowance is gradually reduced until it is eliminated in full. However, there are steps which can be taken to reduce income and preserve entitlement to the personal allowance.
The personal allowance is set at £11,850 for 2018/19, rising to £12,500 for 2019/20.
When is it abated?
Once an individual’s ‘adjusted net income’ exceeds £100,000, their personal allowance is reduced by £1 for every £2 by which ‘adjusted net income’ exceeds £100,000.
The measure of income for these purposes is ‘adjusted net income’. This is an individual’s total taxable income before personal allowances and after deducting certain reliefs, such as:
• relief for trading losses;
• donations to charity through the Gift Aid scheme (deduct the grossed-up amount of the donation); and
• pension contributions (deduct the gross amount).
Example
Polly has taxable income for 2018/19 of £120,000. She makes pension contributions paid gross of £5,000.
Polly’s adjusted net income for £2018/19 is £115,000 (£1250,000 – £5,000).
As her income is more than £100,000, her personal allowance is reduced. The personal allowance for the year of £11,850 is reduced by £1 for every £2 by which her income exceeds £100,000.
The reduction in her personal allowance is therefore £7,500 (1/2(£115,000 – £100,000).
Her personal allowance for 2019/20 is therefore £4,350.
Assuming her income remains the same for 2019/20 and she continues to make gross pension contributions of £5,000, she will receive a personal allowance of £5,000 for 2019/20.
When is the personal allowance lost?
With a personal allowance of £11,850 for 2018/19, individuals with income in excess of £123,700 do not receive a personal allowance for that year. For 2019/20, the personal allowance is £12,500, and the personal allowance is lost once adjusted net income exceeds £125,000.
Beware 60% tax in the abatement zone
Where adjusted net income falls within the zone in which the personal allowance is reducing – from £100,000 to £100,000 plus twice the personal allowance – the marginal rate of tax is 60%. This is the combined effect of the application of the higher rate of tax and the reduction in the personal allowance.
Reduce the 60% band and preserve the allowance
To reduce the income falling in the abatement zone (taxed at a marginal rate of 60%) and to preserve as much as the personal allowance as possible, it is necessary to reduce adjusted net income.
There are various ways in which this can be achieved.
The first point to consider is the timing of income – can income be deferred to the next tax year, or, if income for the current tax year is less than £100,000 but is expected to be above £100,000 in the following year, can income be brought forward to the current tax year. In a family company scenario, it may be possible to achieve this by adjusting the timing of dividends and bonuses.
Consideration could also be given to putting income earning assets into the name of a spouse or civil partner to reduce income and preserve the allowance.
Adjusted net income is income after pension contributions. Making pension contributions is tax effective, both in terms of benefitting from the relief available and reducing net income to preserve personal allowances.
Alternatively, a person can make charitable donations under gift aid to reduce their adjusted net income. Although they will lose the benefit of their income, the cost will be offset slightly by the preserved personal allowance, and their chosen charity will be benefit from the donation plus the associated gift aid.

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Does the marriage allowance apply to you?

The marriage allowance can be beneficial to married couples and civil partners on lower incomes. Claiming the marriage allowance is worth up to £238 in 2018/19 and £250 in 2019/20.
Nature of the allowance
The marriage allowance allows one spouse of civil partner to transfer 10% of their personal allowance (rounded up to the nearest £10) to their partner if they are unable to utilise the full allowance. However, it is only available where the recipient pays tax at the basic rate – couples where one party has no income and the other party is a higher or additional rate taxpayer cannot benefit from the allowance.
A personal can transfer 10% of their personal allowance to their spouse or civil partner if:
• they are married or in a civil partnership;
• they have not used up all of their personal allowance (set at £11,850 for 2018/19 and at £12,500 for 2019/20);
• and their partner pays tax at the basic rate.
For Scottish taxpayers, the marriage allowance is available if the recipient pays tax at the Scottish starter, basic or intermediate rates.
For 2018/19 the personal allowance is £11,850 and the marriage allowance is £1,190. For 2019/20, the personal allowance is £12,500 and the marriage allowance is £1,250.
Impact of the marriage allowance
Where the marriage allowance is claimed, the transferor’s personal allowance for the year is reduced by the amount of the allowance and the transferees personal allowance is increased by the amount of the allowance. Instead of that portion of the personal allowance being wasted, it is set against the transferee’s income, saving tax at the basic (or relevant Scottish) rate.
Example
Lauren is a stay-at-home mum. She has no income in either 2018/19 or 2019/20.
Her husband Joe works as an electrician earning £20,000 a year.
They claim the marriage allowance for both 2018/19 and 2019/20.
For 2018/19, the allowance is £1,190. By claiming the allowance, Lauren’s personal allowance is reduced to £10,660 (£11,850 – £1,190) and Joe’s personal allowance is increased to £13,040 (£11,850 + £1,190). Their combined personal allowances remain at £23,700, but utilising the marriage allowance to increase Joe’s allowance while reducing Lauren’s saves them £238 (£1,190 @ 20%) in tax.
If they claim the marriage allowance of £1,250 for 2019/20, Lauren’s personal allowance will fall to £11,250 (£12,500 – £1,250), while Joe’s personal allowance will increase to £13,750. Claiming the allowance will save them tax of £250 (£1,250 @ 20%) for 2019/20.
The allowance will still be effective where the partner with the lower income does not fully utilise the allowance, even if as a result, they have some tax to pay as a result of making the claim.
Example
In 2018/19, Max has income of £11,000 and his wife Amy has income of £17,000. Claiming the marriage allowance will reduce Max’s personal allowance to £10,660, meaning he will pay tax of £68 ((£11,000 – £10,660) @ 20%). However, Amy’s personal allowance will increase to £13,040, saving her tax of £238. As a couple they are £170 better off (£238 – £68).
How to claim
The marriage allowance can be claimed online: see www.gov.uk/apply-marriage-allowance. Once a claim is made it will apply automatically for subsequent tax years, unless cancelled or circumstances claim. A claim can be backdated to include any tax year since 5 April 2015 for which the qualifying conditions are met.
The allowance can also be claimed for the year in which one partner dies.
Impact on tax codes
Where the marriage allowance is claimed, both the transferor’s and transferee’s tax code are amended as a result. A code with a ‘M’ suffix denotes that the individual has received the marriage allowance, whereas a ‘N’ suffix denotes that the individual has transferred 10% of their personal allowance to their spouse or civil partner.
In the above example, Lauren would have a tax code of 1066N for 2018/19, while Joe’s tax code would be 1,304M. For 2019/20, Lauren’s tax code would be 1125N, while Joe’s tax code would be 1375M.

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Employee Benefits, Tax free

More than 25 million working days are lost annually due to work-related ill health matters, including the two leading causes of workplace absence, namely back injuries and stress, depression or anxiety. There are however, several areas where employers can use tax breaks and exemptions to help promote health and fitness at work.

Gym facilities and memberships

In-house gym facilities may be offered to employees at a convenient location to fit in around work and there will be no tax or NIC liability arising if the following conditions are satisfied:

  • the facilities must be available for use by all employees, but not to the general public;
  • they must be used mainly by employees, former employees or members of employees’ families and households (employees of any companies grouped together with to provide the facilities also count);
  • the facilities must not be located in a private home, holiday or other overnight accommodation (including any associated sporting facilities); and
  • they must not involve use of a mechanically propelled vehicle (including road vehicles, boats and aircraft).

For employers who cannot practically provide in-house gym facilities, it may be possible to negotiate favourable membership rates with a local gym or leisure centre. Whilst this may lead to a tax liability for employees, the preferential rate can often be up to 20% – 30% cheaper than the normal price, so this is still an attractive offer for employees.  Depending on how the cost of the gym membership is funded, the fees will either be taxed as earnings or as a taxable benefit-in-kind. So, for example, if an employer gives the employee additional salary to pay for their gym membership, the money is taxed as earnings through PAYE. If the employer pays the gym membership direct, a taxable benefit-in-kind arises on the employee and should be reported to HMRC on form P11D, or through the payroll.

Where an employer pays for a gym membership and the employee contributes towards the cost from their net pay (after tax and NICs), this is referred to as ‘making good’. The amount of the benefit (cost of gym membership) is reduced by the amount of the contribution.

Health-screening, check-ups and recommended treatments

A tax and NIC-free exemption allows employers to fund one health-screening assessment and/or one medical check-up per year per employee.

Subject to an annual cap of £500 per employee, employer expenditure on medical treatments recommended by employer-arranged occupational health services may be exempt for tax and NICs. ‘Medical treatment’ means all procedures for diagnosing or treating any physical or mental illness, infirmity or defect. Broadly, in order for the exemption to apply, the employee must have either:

  • been assessed by a health care professional as unfit for work (or will be unfit for work) because of injury or ill health for at least 28 consecutive days;
  • been absent from work because of injury or ill health for at least 28 consecutive days.

Employer-funded eye, eyesight test, and ‘special corrective appliances’ (i.e. glasses or contact lenses) may also be exempt for ta and NICs, providing certain conditions are satisfied.

Many employees struggle to fit physical activity into their busy working days but research shows that being active for just one hour can offset the potential harm of being inactive. As fitness and health issues become increasingly popular, anything an employer can do to help is likely to be most welcomed by employees.

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Directors’ NICs – the correct way to pay

The non-cumulative nature for calculating National Insurance Contributions (NICs) makes it possible to manipulate earnings to reduce the overall amount payable by taking advantage of the lower rate of primary Class 1 contributions payable once the upper earnings limit has been reached. For example, an employee who is paid £3,000 each month of the year will pay considerably more in primary contributions than someone who is paid £600 for 11 months and £29,400 for one month, even though their total earnings for the year are the same.

Company directors often have greater scope to influence the time and amount of payments they receive as earnings, which potentially gives them the ability to avoid primary Class 1 contribution liability by astute use of the earnings period rules. For this reason, therefore, special rules exist which provide that a director’s earnings period is a tax year, even if he or she is paid, say, monthly or leaves the company during the year.

The only exception to the above rule is where a director is first appointed during the course of a tax year. Where this happens, the earnings period is the period from the date of appointment to the end of the tax year, measured in weeks. The calculation of the earnings period includes the tax week of appointment, plus all remaining complete weeks in the tax year (i.e. week 53 is ignored for this purpose). This is known as the pro rata earnings period.

Example

Frank is appointed to the board of directors of Widgets Ltd in week 44 of the tax year. The primary threshold and upper earnings limit are calculated by multiplying the weekly values by 9, because the earnings period starts with the week of appointment. This means that in 2018–19, Frank will pay NIC at the main rate of 12% on his director’s earnings between £1,458 (9 × £162) (the primary threshold) and £8,028 (9 × £892) (the upper earnings limit) and at the additional 2% rate on all earnings above £8,028 paid up to 5 April 2019.

The significance of being a company director is that an annual earnings period must be applied for NIC purposes. It is therefore important to be clear as to who the directors of a company actually are. For example, there may be persons within the organisation who are called directors, but for whom that is just an honorary title.

The definition of ‘director’ is wide and extends beyond someone registered as a director with Companies House. For these purposes a director means:

  • in relation to a company whose affairs are managed by a board of directors or similar body, a member of that board or similar body;
  • in relation to a company whose affairs are managed by a single director or similar person, that director or person; and
  • any person in accordance with whose directions or instructions the company’s directors (as defined above) are accustomed to act.

However, a person giving advice in a professional capacity is not treated as a director.

Companies can save time and money by calculating directors’ NIC in a similar way to other employees. Instead of paying very high levels of NIC on a short-term basis, directors who are paid regularly (e.g. directors who have contracts of service with their companies) can spread their contributions evenly throughout the tax year. The earnings period remains an annual earnings period, but contributions are made on account throughout the tax year. A recalculation on an annual basis is performed when the last payment is made and any outstanding National Insurance due is paid at that time.

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What can be done with business losses?

Providing a business is being undertaken on a commercial basis with a view to making a profit, it is generally possible to claim relief for trading losses.

Relief for trading losses may be obtained in a variety of ways, including:

  • set-off against other income in the same or preceding tax year, for example against employment or pension income;
  • carry-forward against subsequent profits of the same trade;
  • carry-back in the early years of a trade;
  • set-off against capital gains of the same or preceding tax year; or
  • carry-back of a terminal loss.

It is worth noting here that anti-avoidance rules mean that loss relief will be restricted for individuals who carry on a trade but spend an average of less than ten hours a week on commercial activities.

Cap on relief

Trade loss relief against general income, and early trade losses relief are two areas where claimable relief is capped. The cap is set at £50,000 or 25% of income (as defined in the legislation), whichever is greater.

The cap applies to the year of the claim and any earlier or later year in which the relief claimed is allocated against total income. The limit does not apply to relief that is offset against profits from the same trade or property business.

Early years of trade

Where a loss is incurred in any of the first four tax years of a new business, the loss can be carried back against total income of the three previous tax years, starting with the earliest year.

This relief often helps new businesses in the first few years of trading. If tax has been paid in any of the previous three years, for example from a previous employment, the taxpayer should be entitled to a repayment of tax.

Set against total income

Relief for the trading loss of a tax year can be claimed against the taxpayer’s total income of that tax year and/or the preceding tax year, in any order. This gives a certain amount of scope to maximise loss relief in the most beneficial way.

Where a claim is made to relieve profits in one basis period by losses of both the same basis period and a subsequent period, the claim for the loss in the same period takes precedence.

Where basis periods overlap, and a loss would otherwise fall to be included in the computations for two successive tax years (e.g. in the opening years of a business), it is taken into account only in the first of those years.

Relief is not normally available for farming and market gardening losses, where losses were also incurred in the previous five years (calculated before capital allowances).

Carry forward of losses

Where a trader makes a loss in a year, but does not have any other income against which the loss can be set, he or she can carry it forward indefinitely and use it to reduce the first available profits of the same business in subsequent years.

Setting losses against capital gains

A taxpayer can also set any losses arising from a business against any chargeable capital gains. The relief can be claimed for the tax year of the loss and/or the previous tax year. However, the trading loss first has to be used against any other income the taxpayer may have for the year of the claim (for example, against earnings from employment) in priority to any capital gains.

Incorporation

Where incorporation is being considered, it is usually permissible to carry forward any unused losses of the pre-incorporation business and set them off against the first available income derived from the new company.

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