Do you avoid these five common mistakes when you’re computing your business profits?

Avoiding common errors when computing business profits

HMRC produce a range of Toolkits for agents, which highlight errors commonly made in returns so that agents can take steps to avoid them. The business profits toolkit provides guidance on errors that are found in relation to business profits for small and medium-sized businesses. They are helpful to anyone computing taxable business profits.

Risk area 1 – Record keeping

Good record-keeping is essential for business profits to be calculated correctly. Poor records may result in sales or allowable expenditure being omitted from the accounts, with the result that the level of profit or loss is incorrect.

Risk area 2 – Business income

The profit or loss will only be correct if all income is included in the accounts. Unless the business is an unincorporated business that has opted to use the cash basis, business income should be included on an accruals basis, matching the income to the period in which it was earned.

Not all sources of business income will be immediately obvious – the income of the business may, for example, include scrap sales, contra sales or barter arrangements. Cash sales may also be overlooked.

Risk area 3 – Expenditure

To ensure that the profit is not overstated, all allowable expenditure should be taken into account. However, a deduction is only permitted for expenses which are wholly and exclusively incurred for the purposes of the business. Attention should also be paid to specific prohibitions, such as for business entertaining.

Purchases and expenses should be reviewed to ensure that they have been included.

Sole traders and partnerships comprising individuals can use simplified expenses rather than claiming actual expenses.

Risk area 4 – Stock and work in progress

Where the business is one that holds stock, care must be taken to include it at the correct value – this is the lower of cost and net realisable value. Errors will arise if stock is overlooked or valued incorrectly.

Work-in-progress can be a complex area and advice should be taken to ensure that the treatment is correct.

Risk area 5 – Miscellaneous items

Miscellaneous areas should also be considered. These may include a review of post-balance sheet events and consideration as to whether any adjustment to the accounts is required. Staff costs should also be reviewed and amounts unpaid nine months after the end of the period should be added back. As far as directors are concerned, consideration should be given to the date on which amounts are credited to the director’s loan account.

Partner note: HMRC’s Business Profits Toolkit – see www.gov.uk/government/publications/hmrc-business-profits-toolkit.

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Make sure to share this article with anyone you know who runs a family business – so they can take advantage of the many ways to lower their tax bill!

Optimising tax-free benefits in family companies

Making use of statutory exemptions for certain benefits-in-kind offers an opportunity to extract funds from a family company without triggering a tax charge.

The essential point to note is that to make the tax saving, the benefit itself, rather than the funds with which to buy the benefit, must be provided.

Mobiles

No tax charge arises where an employer provides an employee with a mobile phone, irrespective of the level of private use. The exemption applies to one phone per employee.

A taxable benefit will however, arise if the employer meets the employee’s private bill for a mobile phone or if top-up vouchers are provided which can be used on any phone

Example

John and Jan Smith are directors of their family-owned company. Their two children also work for the company. The company takes out a contract for four mobile phones and provides each member of the family with a phone. The bills are paid directly to the phone provider by the company. The bills are deductible in computing profits. Each family member receives the use of a phone tax-free, which means they do not need to fund one from their post-tax income.

Pension contributions

Pensions remain a particularly tax-efficient form of savings since nearly everyone is entitled to receive relief on contributions up to an annual maximum regardless of whether they pay tax or not. The maximum amount on which a non-taxpayer can currently receive basic rate tax relief is £3,600. So an individual can pay in £2,880 a year, but £3,600 will be the amount actually invested by the pension provider. Higher amounts may be invested, but tax relief will not be given on the excess. Any tax relief received from HMRC on excess contributions may have to be repaid.

Pension contributions paid by a company in respect of its directors or employees are allowable unless there is an identifiable non-trade purpose. Contributions relating to a controlling director (one who owns more than 20% of the company’s share capital), or an employee who is a relative or close friend of the controlling director, may be queried by HMRC. In establishing whether a payment is for the purposes of the trade, HMRC will examine the company’s intentions in making the payment.

Pension contributions will be viewed in the light of the overall remuneration package and if the level of the package is excessive for the value of the work undertaken, the contributions may be disallowed. However, HMRC will generally accept that contributions are paid ‘wholly and exclusively for the purposes of the trade’ where the remuneration package paid is comparable with that paid to unconnected employees performing duties of similar value.

Other tax-free benefits

Subject to certain conditions being satisfied, other tax-free benefits that a family company may consider include:

  • bicycles or bicycle safety equipment for travel to work
  • gifts not costing more than £250 per year from any one donor
  • Christmas and other parties, dinners, etc, provided the total cost to the employer for each person attending is not more than £150 a year
  • one health screening and one medical check-up per employee, per year
  • the first £500 worth of pensions advice provided to an employee (including former and prospective employees) in a tax year
  • medical treatments recommended by employer-arranged occupational health services. The exemption is subject to an annual cap of £500 per employee

Employing family members, and providing them tax-free benefits, often enables a family-owned company to take advantage of the lower tax rates, personal allowances and exemptions that may be available to a spouse, civil partner, or children. In turn, this arrangement can help reduce the household’s overall tax bill.

Partner Note: ITEPA 2003, s 244, s 308C, s 319; BIM46035, BIM47105

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If you need help on how to time dividends, read our short article that explains the basics

Timing dividends right could help save tax

Timing the date of a dividend payment from a company can determine both the amount and the due date of the tax payable. This may be a particularly useful strategy in a close- or family-owned company.

The dividend allowance, which was originally introduced from 6 April 2016, was cut from £5,000 a year to £2,000 from 6 April 2018. Fortunately, the tax rates on dividend income, above the allowance, remain at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.

The amount of tax payable on dividend income is determined by the amount of overall income an individual receives during a tax year. This includes earnings, savings, dividend and non-dividend income. The amount of dividend tax paid depends primarily on which tax band the first £2,000 falls in.

Accelerating payment

The timing of the dividend payment may have a marked impact on the directors’ and shareholders’ personal tax situation. A dividend is not paid until the shareholder receives the funds direct or the dividend amount is put unreservedly at his or her disposal, for example by a credit to a loan account on which the shareholder has the power to draw. If the personal tax allowance and basic rate band for a tax year have not been fully utilised towards the end of the tax year, payment of a dividend may mean that the unused portion can be mopped up.

Example

Graham is the sole director and shareholder of a limited company.

He is considering whether to pay a dividend before the end of the 2019/20 tax year. In that tax year he has other income of £25,000. He has retained profits in the company of £100,000.

For 2019/20 the personal tax allowance is £12,500 and the basic rate tax band is £37,500. The dividend allowance is £2,000.

If Graham pays a dividend of £27,000 before the end of the 2019/20 tax year, he will fully utilise his basic rate band, and will be liable to tax at 7.5% on the £25,000 of the dividend income (the first £2,000 of the dividend being covered by the dividend allowance).

Delaying payment

Where the shareholder already has income exceeding the basic rate band in one tax year, delaying the dividend until the start of the next tax year could save tax.

Example

Following on from the above example, say Graham has already paid himself a salary of £50,000 in the 2019/20 tax year, thus fully using up his basic rate band. If he pays the £27,000 dividend before the end of the tax year, he will pay tax on it of £8,125 (£27,000 – £2,000 allowance x 32.5%). This tax will be due for payment on 31 January 2021.

If he waits until the start of the next tax year (2020/21) to pay the dividend, and also receives a salary of £25,000 during that year, the tax due on the dividend will be £1,875 (£25,000 x 7.5%) – a potential saving of £6,250. Graham will also benefit from a delay in the due date for payment of the tax until 31 January 2022.

Fluctuating income

Dividend payments can often be timed to smooth a director/shareholder’s earnings year-on-year. Broadly, where profits fluctuate, a company could consider declaring and paying dividends equally each year, or by declaring a smaller dividend in the first year (when profits are higher) and treating the remainder of the payment as a shareholder loan. At the start of the next tax year, a further (smaller) dividend can be declared, which will repay the loan. Care must be taken with this type of arrangement, not least because the loan must be repaid within nine months of the company’s year-end to avoid a tax charge arising on the company.

The family business potentially offers considerable scope for structuring tax-efficient payments to family members using a mixture of both salary and dividends. A pre-dividend review may be particularly beneficial towards the end of the company’s year-end.

Partner Note: ITA 2017, s 8 and s 13A; F(No 2)A 2017, s 8;  CTA 2010, s 455

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A quick summary of the new tax bands for CO2 car emissions which will be introduced from April next year:

Are low emissions cars tax efficient?

Significant changes are being made from 2020-21 to the company car tax benefits-in-kind bands affecting ultra-low emission vehicles (ULEVs).

The taxable benefit arising on a car is calculated using the car’s full manufacturer’s published UK list price, including the full value of any accessories. This figure is then multiplied by the ‘appropriate percentage’, which can be found by reference to the car’s CO2 emissions level. This will give the taxable value of the car benefit. The employee pays income tax on the final figure at their appropriate tax rate: 20% for basic rate taxpayers, 40% for higher rate taxpayers and 45% for additional rate taxpayers. This formula means that in general terms, the lower the C02 emissions of the car, the lower the resulting tax charge will be.

For 2019-20, the appropriate percentage for cars (whether fully electric or not) is 16% for those emitting 50g/km CO2 or below, and 19% for those emitting CO2 of between 51 and 75g/km. This means that the taxable benefit arising on a zero-emissions car costing, say £30,000 is £4,800, with tax payable of £960 for a basic rate taxpayer – for a higher rate taxpayer this equates to tax payable of £1,920

By way of comparison, a 2001cc petrol-engine car with a list price of £30,000, will attract an appropriate percentage of 37% in 2019-20. This equates to a taxable benefit charge of £11,100, and a liability of £2,220 a year for a basic rate taxpayer.

New bands

In April 2020, new ULEV rates will be introduced, and the most tax efficient cars will be those with CO2 emissions below 50g/km. There will also be additional financial incentives for electric only cars

From 2020-21, five new bandings are being introduced for full and hybrid electric cars. Fully electric (zero emissions) cars will attract an appropriate percentage of just 2%. This means that the tax benefit arising on an electric car costing say, £30,000 will be just £600. The resulting tax payable by a basic rate taxpayer will be £120 a year and £240 for a higher rate taxpayer.

For cars emitting CO2 of between 1 and 50g/km, the appropriate percentage will depend on the car’s electric range figure:

MileagePercentage
130 miles or more 2%
70 – 129 miles5%
40-69 miles8%
30-39 miles12%
Less than 30 miles14%

ULEVs with CO2 emissions of between 50g-74g/km CO2 will be on a graduated scale from 15% to 19% (as is currently the case, diesel-only vehicles will continue to attract a further 4% surcharge) as follows:

CO2 emissionsPercentage
51 to 54g/km15%
55 to 59g/km16%
60 to 64g/km17%
65 to 69g/km18%
70 to 74g/km19%
75 or more20%
Plus1% per 5g/km
Up to a maximum37%

Whilst the journey towards ‘greener’ driving has been, and continues to be, a rocky one, in 2014/15 a sub-130g/km petrol car was considered green enough to merit an 18% appropriate percentage. However, by 2020/21, the appropriate percentage on such a car will have risen to 30%. A sub-100g/km band car that was only subject to a 12% charge in 2014/15 will also have risen to 24% by 2020/21. On the other hand, clean air all-electric cars will finally plummet to 2% under the new company car tax incentives from April 2020.

The incentives in the new tax bands are clearly designed to encourage ULEVs as a company car driver’s car of choice, and with around 1 million company car drivers in the UK, this benefit is likely to remain one of the most popular and potent perks of a job.

Partner Note: ITEPA 2003, ss 139-142; Finance Act (2) Part 1 s2

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If you use the property rental toolkit, do you think it’s useful?

Using the property rental toolkit to avoid common errors in returns

HMRC’s property rental toolkit highlights errors commonly found in tax returns in relation to property income. The toolkit can be used to help avoid those errors, some of which are discussed briefly below.

Computation

For unincorporated property businesses, the default basis is the cash basis where the qualifying conditions are met and the landlord does not elect to use the accruals basis. Where the business has moved into or out of the cash basis, transitional adjustments may be needed.

In some circumstances, a trade of providing services may be carried on in addition to the let of the property; and in some cases, the letting may amount to a trade.

It is important the correct computational rules are used.

Record keeping

Poorly-kept records may mean that things are overlooked – income may not be taken into account and allowable expenses not claimed. Property disposals may also be missed.

Property income receipts

All income which arises from an interest in land should be included as receipts of the property rental business. Receipts can include payments in kind (maybe work done on the property in lieu of rent). It should be noted that casual or one-off letting income is still treated as income from a property rental business.

Profits and losses from overseas lets, from furnished lettings and from properties let rent-free or below market rent should be dealt with separately. For other UK lets owned by the same person or persons, income and expenses are combined to work out the overall profit or loss for the property rental business.

Deductions and expenses

Expenses incurred wholly and exclusively for the purposes of the property rental business can be deducted in the computation of profits. Problems may arise where an expense has both a business element and a private element (for example, a car or phone used both privately and for the business). A deduction can be claimed only for the business part where this can be identified and meets the wholly and exclusively test.

The way in which relief for finance costs is being given is shifting from relief by deduction to relief as a basic rate tax reduction. Ensure that the split is correct for the tax year in question and relief given in the right way.

Allowances and reliefs

There are various reliefs that may be available to those receiving rental income.

Rent-a-room relief is available where a room is let furnished in the taxpayer’s own home, enabling receipts of £7,500 a year to be enjoyed free of tax.

The property income allowance of £1,000 means that rental income below this level does not need to be returned to HMRC. Where income exceeds this level, the allowance can be deducted instead of actual expenses where this is beneficial.

Capital allowances can be claimed in certain circumstances. They are available on certain items that belong to the landlord and which are used in the business, for example, tools, ladders, vehicles, etc. However, they are not available for domestic items in a residential property for which a replacement relief is available instead. Capital allowances are similarly not available for plant and machinery in a residential property unless it is a furnished holiday let.

Losses

Property rental losses must be treated correctly. They can only be carried forward and set against future property profits of the same property rental business.

Checklist

The checklist within the toolkit can be used to ensure that everything has been taken into account and that nothing has been overlooked.

Partner note: HMRC’s property rental toolkit (see www.gov.uk/government/publications/hmrc-property-rental-toolkit).

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Who the phone contract is billed to makes a big difference in tax.

Tax-free mobile phone

Mobile phones are ubiquitous – they are also subject to a tax exemption which enables employees to enjoy a mobile phone provided by their employer without suffering a benefit in kind tax charge. However, as with all exemptions there are conditions to be met for the exemption to apply.

Nature of the exemption

The exemption applies where an employer provides an employee with a mobile phone for his or her use. However, ownership of the phone must not be transferred to the employee. The exemption covers the use of the phone and the cost of all calls, including private calls. It also applies to the provision of a SIM card for use in the employee’s own phone.

The exemption is limited to one phone or SIM card per employee. Phones or SIM cards provided to members of the employee’s family or household by virtue of the employee’s employment are treated as if they were provided to the employee.

If the employee is provided with more than one mobile phone or SIM card, second and subsequent phones or SIM cards are taxed as a benefit in kind (as an asset made available for the employee’s use).

If the exemption does not apply, the employer can meet the cost of business calls without triggering a tax charge.

Contract between employer and supplier

While the end result may seem to be the same if the employer contracts with the phone supplier or if the employee takes out the contract and the employer either pays the bill or reimburses the employee, from a tax perspective the outcome is very different.

The mobile phone exemption only applies if the contract is between the employer and the phone supplier. If the contract is between the employee and the phone supplier and the employer meets the cost, the employer is meeting a personal bill of the employee rather than providing the employee with a mobile phone. This is an important distinction and can mean the difference between the exemption being available and the employee suffering a tax hit.

Smartphones count

The exemption applies to smartphones. To count as a phone, the device must be capable of making and receiving voice calls. Tablets, such as iPads, do not qualify (even if calls can be made via What’s App or similar services). The fact that a device has telephone functionality does not in itself qualify it as a mobile phone. As a general rules, devices that use Voice Over Internet Protocol (VOIP) systems will not qualify.

Beware the OpRA rules

The exemption is lost if the mobile phone is made available to the employee under a salary sacrifice or other optional remuneration arrangement (OpRA). Where this is the case, the alternative valuation rules apply and the benefit is valued by reference to the salary foregone instead.

 Partner note: ITEPA 2003, s. 319.

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Are you prepared for the dividend allowance cut on your January 2020 tax return?

Dividend complexities

The dividend allowance, which was originally introduced from 6 April 2016, was cut from £5,000 a year to £2,000 from 6 April 2018. The cut is likely to have a significant impact on employees and directors of small businesses who receive both salary and dividend payments.
Many family-owned companies allocate dividends towards the end of their financial year and/or the tax year, so it was not until March/April 2019 that the impact of the reduction first started to hit home. Unfortunately, many other taxpayers may not become aware of the change until they complete their 2018/19 tax return, which in most cases, will be due for submission to HMRC by 31 January 2020.
How much tax is paid on dividend income is determined by the amount of overall income the taxpayer receives. This includes earnings, savings, dividend and non-dividend income. The dividend tax will primarily depend on which tax band the first £2,000 falls in.

The tax rates on dividend income, above the allowance, remain at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.
For a basic rate taxpayer, the reduction in the allowance means an increase in tax paid on dividends of £225. For a higher rate taxpayer, the reduction increases the annual tax bill on dividends by £975, and for additional rate taxpayers, the increase is £1,143. Note that if dividend income falls between multiple tax bands, these figures will be different.
Dividend income is taxed at the taxpayer’s highest rate. This can often work in the taxpayers favour, particularly where a mixture of salary and dividends is received. For example, if a director receives a salary of £40,000 and a dividend of £12,000, their tax liability for 2019/20 will be as follows:

 

In this example, personal allowances are deducted first against the salary, leaving £27,500 of other income falling within the basic rate tax band (£37,500 for 2019/20). Dividend income falling within the basic rate band is £10,000 (£37,500 minus £27,500 used), with the remaining £2,000 falling above the basic rate limit. The dividend nil rate is allocated to the first £2,000 of dividend income, falling wholly within the basic rate band, leaving £8,000 within the basic rate band and taxable at the lower 7.5% rate. The remaining £2,000 of dividend income is taxable at the dividend upper rate of 32.5%.

Individuals who are not registered for self-assessment generally do not need to inform HMRC where they receive dividend income of up to £2,000. Those with income between £2,000 and £10,000 will need to report it to HMRC. The tax can usually be paid via a restriction to the PAYE tax code number, so that it is deducted from salary or pension. Alternatively, the taxpayer can complete a self-assessment tax return and the tax can be paid in the usual way (generally 31 January following the end of the tax year in which the income was received). Those receiving more than £10,000 in dividends will need to complete a tax return.

The allocation of various rate bands and tax rates can be complicated, even in situations where straight-forward dividend payments are made. Family business structures may be particularly vulnerable to the impact of the reduction in the dividend allowance, especially where multiple family members take dividends from the family company. A pre-dividend review may be beneficial is such cases.
Partner Note: ITA 20017, s 8 and s 13A

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Don’t lose out on tax reliefs for start-ups

Just starting out
As long as HMRC can be satisfied that a business is being run on a commercial basis with a view to making a profit, they will usually allow taxpayers to claim tax relief for a trading loss in one tax year against other taxable income (for example PAYE income or a pension) from the same year, or the preceding year. This can be quite beneficial as the claimant can choose which year to claim the losses against. However, HMRC will usually restrict loss relief claimed by individuals who carry on a trade but spend an average of less than ten hours a week on commercial activities.
Early days
The provisions for tax relief on business losses can be particularly useful in the early years of trading. Broadly, this is because a loss incurred in any of the first four tax years of a new business may be carried back against total income of the three previous tax years, starting with the earliest year. Therefore, if tax has been paid in any of the previous three years, the taxpayer should be entitled to a repayment of tax, which may be especially welcome in those often difficult first few years of running a business.
The rules for this carry back stipulate that the maximum amount of the loss must be offset each year – it is not permissible to offset just a proportion of the loss in order to spread the loss across three years to take advantage of beneficial tax rates. Again, relief will not be available unless the taxpayer was trading on a commercial basis with a view to making a profit within a reasonable timescale. In practice, this requirement may be difficult to prove in the case of a new business and the taxpayer may need a viable business plan to support a claim.
Cap on relief
A cap now restricts certain previously unlimited income tax reliefs that may be deducted from income. Trade loss relief against general income, and early trade losses relief, as outlined above, are two areas where this restriction might apply. The cap is set at £50,000 or 25% of income, whichever is greater. ‘Income’ for the purposes of the cap is calculated as ‘total income liable to income tax’. This figure is then adjusted to include charitable donations made via payroll giving and to exclude pension contributions – the adjustment is designed to create a level playing field between those whose deductions are made before they pay income tax, and those whose deductions are made after tax. The result, known as ‘adjusted total income’, will be the measure of income for the purpose of the cap.
The cap applies to the year of the claim and any earlier or later years 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.
No need to lose out
Where a loss is made in a tax year, but the trader does not have any other income against which it can be set, the loss can be carried forward indefinitely and used to reduce the first available profits of the same business in subsequent years.
Finally, losses arising from a business may be set off against any chargeable capital gains. Relief may 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.

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For grandparents wanting to help out their children or grandchildren, habitual gifts can be made free of inheritance tax. Read more on our blog post.

Give from income to save inheritance tax

Within a family scenario, there are many situations in which one family member may make a gift to other family members. However, the way in which gifts are funded and made can make a significant difference to the way in which they are treated for inheritance tax purposes.

Not all gifts are equal

There is no inheritance tax to pay on gifts between spouses and civil partners. A person can make as many lifetime gifts to their spouse or civil partner as they wish (as long as they live in the UK permanently). There is no cap on the value of the gifts either.

Other gifts may escape inheritance tax if they are covered by an exemption. This may be the annual exemption (set at £3,000 per tax year), or a specific exemption such as that for gifts on the occasion of a marriage or civil partnership or the exemption for ‘gifts out of income’.

Gifts that are not covered by an exemption will counts towards the estate for inheritance tax purposes and, if the donor fails to survive for at least seven years from the date on which the gift was made, may suffer an inheritance tax bill if the nil rate band (currently £325,000) has been used up.

Gifts from income

The exemption for ‘normal expenditure out of income’ is a useful exemption. The exemption applies where the gift:

  • formed part of the taxpayer’s normal expenditure;
  • was made out of income; and
  • left the transferor with enough income for them to maintain their normal standard of living.

All of the conditions must be met for the exemption to apply. Where it does, there is no requirement for the donor to survive seven years to take the gift out the IHT net.

What counts as ‘normal’ expenditure?

For the purposes of the exemption, HMRC interpret ‘normal’ as being normal for the transferor, rather than normal for the ‘average person’.

To meet this condition it is sensible to establish a regular pattern of giving –for example, by setting up a standing order to give a regular monthly sum to the recipient. It is also possible that a single gift may qualify for the exemption if the intention is for it to be the first of a series of gifts, and this can be demonstrated. Likewise, regular gifts may not qualify if they are not made from income.

In deciding whether a gift constitutes normal expenditure from income, HMRC will consider a number of factors, including:

  • the frequency of the gift;
  • the amount;
  • the identity of the recipient; and
  • the reason for the gift.

The amount of the gift is an important factor – to meet the test the gifts must be similar in amount, although they do not have to be identical. Where the gift is made by reference to a source of income that is variable, such as dividends from shares, the amount of the gift may vary without jeopardising the exemption.

Gifts will normally be in the form of money to the recipient, or a payment on the recipient’s behalf, such as school fees or a mortgage. The reason for making a gift may indicate whether it is made habitually – for example, a grandparent may makes a gift to a grandchild at the start of each university term to help with living costs. It is also important that having made the gift, the donor has sufficient income left to maintain his or her lifestyle.

When making gifts from income, check that they may meet the conditions to ensure that the exemption is available.

Partner note: IHTA 1984, s. 21.

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Today’s blog covers the things you need to know about entrepreneur’s relief to reduce capital gains tax.

Entrepreneurs’ relief is intended to reduce the rate of capital gains tax to a flat rate of 10% on certain qualifying business disposals. Certain aspects of the relief have recently changed, and this may affect any subsequent tax liability.

A qualifying business disposal must include a material disposal of business assets. For these purposes, a disposal of business assets is a disposal of:

  1. the whole or part of a business;
  2.  of (or of interests in) one or more assets in use, at the time at which the business ceases to be carried on, for the purposes of the business; or
  3. one or more assets consisting of (or of interests in) shares or securities of a company.

Formerly, to qualify for relief, the assets or shares had to be held by the individual for at least 12 months to the date of disposal. However, the length of ownership condition has recently been increased such that, for disposals made on and after 6 April 2019, the taxpayer will have to have held the assets or shares for at least 24 months for the relief to apply.

Shareholders

In order for a shareholder to claim on the disposal of shares, the following conditions generally need to be met:

  1. the company in which those shares are held must be the individual’s personal company;
  2. the shareholder must be an employee or officer of the company, or of a company in the same trading group; and
  3. the company must be a trading company or a holding company of a trading group.

All three of these conditions must be met for the whole of a 24-month period (for disposals from 6 April 2019) that ends with the disposal of the shares, cessation of the trade, or the company leaving the trading group and not becoming a member of another trading group.

Personal company

A company is the personal company of the individual at any time when all of the following conditions apply:

  1. the individual holds at least 5% of the ordinary share capital of the company;
  2. the individual can exercise at least 5% of the voting rights of the company which are associated with ordinary share capital;
  3. the individual is entitled to at least 5% of the profits available for distribution to the equity holders; and
  4. the individual would be entitled to at least 5% of the assets available on a winding up of the company.

Conditions numbered 3, and 4 were added for disposals made on and after 29 October 2018. However, the way the law was drafted would have made it difficult for some taxpayers to determine whether those conditions had been met for the full qualifying period. Therefore, the original draft legislation was modified before enactment to include an alternative test to both those, namely that in the event of a disposal of the whole of the ordinary share capital of the company, the individual would be beneficially entitled to at least 5% of the proceeds.

Shareholding threshold

Where an individual’s shareholding has fallen below 5%, as a result of a fundraising event involving the issue of additional shares which takes place on or after 6 April 2019. The equity funding share issue must be made wholly for cash and be made for commercial reasons, and not as part of arrangements driven by tax avoidance.

In these circumstances the shareholder will be entitled to the relief which would otherwise be lost, by making one or both of the following elections:

  • claim the relief on a deemed sale and reacquisition at market value at the point immediately before the additional shares are issued which removes the personal company qualification; or
  • defer taxation of the gain made on this deemed sale until the actual disposal of the shares.

The second election will generally be required as the taxpayer will make a deemed sale with no sale proceeds with which to pay the CGT due.

If neither of the elections is made the taxpayer will pay the CGT on the gain with no entrepreneurs’ relief at the time it arises.

Partner Note: FA 2011 s 9; FA 2019, s 39 and Sch 16; TCGA 1992, s 169ff

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