It is easy to fall into the trap of assuming that legal and professional costs can be computed in calculating taxable profits if they are incurred wholly and exclusively for the purposes of the business; however this is only part of the story.  

Legal and professional fees – Capital or revenue?

At some point, a landlord is likely to incur legal and professional fees in connection with the running of their property rental business. It is easy to fall into the trap of assuming that these costs can be computed in calculating taxable profits if they are incurred wholly and exclusively for the purposes of the business; however this is only part of the story. The landlord must also determine whether the costs are revenue or capital in nature. The rules also differ depending upon whether the accounts are prepared on the cash basis or using traditional accounting under the accruals basis.

The rule

The nature of the legal fees follow that of the matter to which they relate – so if the fees are incurred in relation to an item which is itself revenue in nature, the legal and professional fees are also revenue in nature. Likewise, legal fees that are incurred in connection with a matter that is capital in nature are also capital in nature.
Legal fees that are revenue in nature would include, for example, fees incurred to recover unpaid rent, while legal fees that are capital in nature would include fees incurred in connection with the purchase of a property.

Cash or accruals basis

Revenue items are deductible in computing profits regardless of whether they are prepared under the cash or accruals basis, although the time at which the relief is given will differ. Under the cash basis, the deduction is given for the period to which the expenditure relates, for the cash basis the deduction is given for the period for which the expenditure is incurred.
For capital expenditure different rules apply. No deduction is allowed for capital expenditure under the accrual basis, whereas under the cash basis, the treatment depends on the nature of the item – capital expenditure is deductible under the cash basis unless the expenditure is of a type for which a deduction is expressly forbidden. Items of the forbidden list include expenditure in or in connection with lease premiums and the provision, alteration or disposal of land (which includes property).

Example of allowable revenue items

A deduction for legal and professional fees will normally be allowed where they relate to:
• costs of obtaining a valuation
• normal accountancy costs incurred in preparing accounts of the rental business and agreeing the tax liabilities
• costs of arbitration to determine the rent
• the costs of evicting an unsatisfactory tenant to re-let the property

Example of capital expenses

The following are examples of legal and professional fees which are capital in nature:
• legal costs incurred in acquiring or adding to a property
• costs in connection with negotiations under the Town and Country Planning Act
• fees incurred in pursuing debts of a capital nature, such as the proceeds due on sale

Leases

Leases can be tricky. The expenses incurred in connection with the first letting or subletting for more than one year are deemed to be capital and therefore not deductible – this would include the legal fees incurred in drawing up the lease, surveyors’ fees and commission. However, if the lease is for less than one year, the associated expenses can be deducted. Normal legal and professional fees on the renewal of a lease are also deductible if the lease is for less than 50 years; although any proportion of the fees that relate to the payment of a premium are not deductible.
If a new lease closely follows the previous lease, a change of tenant will not render the associated fees non-deductible. However, if the property is put to other use between lets, or a long lease, say, replaces a short lease, the associated costs will be capital and non-deductible.

Partner note: HMRC’s Property Income Manual PIM 2120

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In this blog we set out the three conditions property must meet to be considered a furnished holiday let and to access all the advantages they bring, and top tip – letting to family or friends at a reduced rate doesn’t count! 

Many Airbnb lets are used as holiday accommodation. From a tax perspective, furnished holiday lettings enjoy some tax advantages over other lets. So, is it possible for an Airbnb let to benefit from these advantages and what conditions must be met?

Qualifying conditions

Simply letting a property as furnished holiday accommodation is not in itself sufficient to qualify for the furnished holiday letting (FHL) treatment. As with other lets, Airbnb lets must meet the conditions set out in the legislation.

The first point to note is that the FHL treatment is only available to properties which are in the UK or the EEA and which are let furnished.

Occupancy conditions

There are three occupancy conditions which must be met for a property to be treated as FHL.

Condition 1 – the pattern of occupancy condition

The pattern of occupancy condition is met if the total of all lettings in the tax year exceeding 31 days is 155 days or less. The nature of holiday letting is multiple short lets rather than longer lets and this condition seeks to recognise this.

Condition 2 – the availability condition

To meet this condition the accommodation must be available for letting for at least 210 days in the tax year. Days where the owner stays in the property do not count as days when the property is available for letting.

Condition 3 – the letting condition

The letting condition is met if the property is let commercially as furnished accommodation to the public for at least 105 days in the tax year. Only commercial lets count towards this total – any days when the property is let to family or friends at a reduced rate or where they are allowed to use the property for free are ignored.

Longer term lets of more than 31 days are also ignored (unless a let which was supposed to be less than 31 days is extended due to unforeseen circumstances, such as a delayed flight or the holidaymaker becoming ill).

Averaging election

If a person has more than one property let as holiday accommodation (whether via Airbnb or similar or otherwise), an averaging election can be made where the letting condition of 105 days is not met. As long as the average let across all properties is at least 105 days in the tax year, the condition is treated as met. Thus, if a person has three holiday properties which were let commercially for periods of 31 days or less for at least 315 (3 x 105) days in the year, the average let would pass the test.

Period of grace election

A second election, a period of grace election, can be made if the landlord genuinely intended to meet the letting condition but was unable to do so, as long as the condition was met in the previous tax year. This will allow the property to continue to be treated as a FHL. If the condition is not met the following year, a second period of grace election can be made. However, if the condition is not met in the fourth year after two consecutive period of grace elections, the property will no longer qualify as a FHL.

Advantages

Qualifying as a FHL offers a number of advantages. It opens the door to various capital gains tax reliefs for traders, including entrepreneurs’ relief. The landlord is also eligible to claim plant and machinery capital allowances if the cash basis is not used. Profits also count as earnings for pension purposes.

Partner note: ITTOIA 2005, Pt. 3, CH. 6 ss. 322 – 328B).

 

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Joint tenants v tenants in common – Which you choose will depend on whether you’d like flexibility in allocating property income, and how you want your property to be passed on.

Joint tenants v tenants in common – Does it matter?

There are two different ways of owning property jointly – as joint tenants or as tenants in common. The way in which the property is owned determines exactly who owns what and also what happens when one of the joint owners dies and how any income is taxed.

Joint tenants

Where two or more owners own a property as joint tenants, they jointly own the whole property rather than owning individual shares. Each owner has equal rights to the whole property. When one of the joint owners dies, the remaining joint owners own the whole property. The deceased is not able to pass his or her share on to someone else.

Example

Helen and Harry are married and own their family home as joint tenants. The couple have three children. If, for example, Harry dies first, his share of the property automatically passes to Helen. Harry cannot leave his share of the property to his children.

Where a property that is owned as joint tenants is rented out, the income is treated as arising in equal shares as all owners have an equal stake in the property. For spouses and civil partners this is the default position; however, there is no possibility of making a Form 17 election (see below) as the property owned as joint tenants can only be owned equally.

Tenants in common

Tenants in common own individual shares in the property and have more flexibility than joint tenants as to what they do with their stake in the property. On death, their stake does not automatically go to the other joint owners; rather it will follow the provisions of the will (or, if there is no will, the intestacy provisions).

It will be beneficial to own property as tenants in common if you want to leave your share of the property to someone other than the other joint owner.

Example

Jack and Jane are married. Each have children from previous relationships. They own a holiday cottage as tenants in common. In their wills, they have each made provision for their share to pass to their own children.

Where the property is let out, owing the property as tenants in common provides more flexibility as to how the income is allocated for tax purposes. Where the joint owners are spouses or civil partners, the income is treated as arising equally. However, where the actual beneficial ownership is unequal, they can elect (on Form 17) for the income to be taxed in accordance to their ownership shares where this is beneficial. If the tenants in common are not married or in a civil partnership, the income is taxed by reference to their actual stake in the property.

Changing ownership status

It is relatively easy to change the type of ownership, for example, if the property is owned as joint tenants it may be desirable to own it as tenants in common to enable each owner to leave their share to someone else. A property can also be changed from sole ownership to joint ownership – ether as tenants in common or joint tenants.

Partner note: Law of Property Act 1925, ss. 34, 36;. ITA 2007 ss. 836. 837.

 

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Have you heard of a SIPP? They can be a useful tool for investments.

Using a SIPP to save for retirement

A SIPP is a self-invested personal pension which is set up by an insurance company or specialist SIPP provider. It is attractive to those who wish to manage their own investments. Contribution to a SIPP may be made by both the individual and, where appropriate, by the individual’s employer.

Investments

The range of potential investment is greater for a SIPP than for a personal pension or group personal pension scheme.

The SIPP can invest in a wide range of assets, including:

  • quoted and unquoted shares;
  • unlisted shares;
  • collective investment schemes (OEICs and unit trusts);
  • investment trusts;
  • property and land (but excluding residential property); and
  • insurance funds.

A SIPP can also borrow money to purchase investments. For example, a SIPP could take out a mortgage to fund the purchase a commercial property, which could be rented out. The rental income would be paid into the SIPP and this could be used to pay the mortgage and other costs associated with the property.

Making contributions

Tax-relieved contributions can be made to the SIPP up to the normal limits set by the annual allowance. This is set at £40,000 for 2019/20. The annual allowance is reduced by £1 for every £2 which adjusted net income exceeds £150,000 where threshold income exceeds £110,000, until the minimum level of £10,000 is reached. Anyone with adjusted net income of £210,000 and above and threshold income of at least £110,000 will only receive the minimum annual allowance of £10,000. Where the annual allowance is unused, it can be carried forward for three years. Any contributions made by the employer also count towards the annual allowance.

SIPPs operate on a relief at source basis, meaning that the individual makes contributions from net pay. The SIPP provider claims back basic rate relief, with any higher or additional rate relief being claimed through the self-assessment return.

Drawing a pension

A SIPP is a money purchase scheme and the value of benefits available to provide a pension depend on contributions that have been made to the scheme, investment growth (or reduction) and charges.

It is possible to draw retirement benefits at age 55. A tax-free lump sum can be taken to the value of 25% of the accumulated funds. Withdrawals in excess of this are taxed at the individual’s marginal rate of tax.

To prevent recycling contributions, where pension benefits have been flexibly accessed a reduced money purchase annual allowance, set at £4,000 for 2019/20, applies.

Partner note: www.pensionsadvisoryservice.org.uk

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Closing a business can be a difficult time. Be tax efficient with this beneficial liquidation strategy.

Closing a business – when a member’s voluntary liquidation is beneficial

Although it is possible to strike off a company and for distributions made prior to dissolution to be treated as capital rather than as a dividend, this is not an option where the amount of the distributions exceeds £25,000.

Where the taxpayer’s personal circumstances are such that it is beneficial for the remaining funds to be taxed as capital (and liable to capital gains tax), rather than as a dividend, a member’s voluntary liquidation (MVL) can be an attractive option, as depending upon the level of funds to be extracted the costs of the liquidation may be more than covered by the tax savings that can be achieved.

What is an MVL?

An MVL is a process that allows the shareholders to put the company into liquidation. This route is only an option if the company is solvent (i.e. its assets are greater than its liabilities). The directors must sign a declaration of solvency confirming that the company is able to pay its debts in full within the next 12 months and 75% of the members must agree to place the company into liquidation. The shareholders must pass a special resolution to wind up the company. They will also need to pass an ordinary resolution to appoint liquidators. The liquidator must be a licenced insolvency practitioner.

What are the tax implications?

Under an MVL the capital extracted from the company is treated as a capital distribution and is liable to capital gains tax, rather than being taxed as a dividend. Where entrepreneurs’ relief is in point, the rate of tax will only be 10%, assuming enough of the entrepreneurs’ relief lifetime limit remains available. If significant funds are available for distribution, this can generate considerable tax savings.

Example

Edward and Oliver are directors of a company in which they both own 50% of the shares and 50% of the voting rights. Each is entitled to 50% of the profits available for distribution and 50% of the assets on a winding up.

They wish to wind the company up, but as they have cash and assets of £10 million to distribute, they opt for an MVL, to allow them to take advantage of the capital gains tax treatment. Both are additional rate taxpayers, and both meet the qualifying conditions for entrepreneurs’ relief.

Edward and Oliver each receive £5 million on the winding up of the company. They both have the full amount of the entrepreneurs’ relief lifetime limit (£10 million) unused, and it is assumed for simplicity that the annual exempt amount has been used elsewhere. The gain is therefore taxed at 10% and each will pay tax of £500,000 on their distribution of £5 million.

Had they not opted for an MVL and the extracted funds taxed as a dividend, they would have each paid £1,905,000 in tax on the £5 million distribution (£5m @ 38.1%).

Anti-avoidance

Anti-avoidance provisions apply which are designed to target ‘moneyboxing’ (where the company retains more funds than it needs in order to extract them as capital when the company is liquidated) and ‘pheonixism’ (where the company is liquidated, the value extracted as capital and a new company is set up to carry on what is essentially the same business). Liquidation distributions which are caught by the rules are treated as income rather than capital.

Partner note: Insolvency Act 1986, Pt. IV, Ch. III.

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Government Incentives

Do you think electric cars are worth the tax-free benefits?

Electricity for electric cars – a tax-free benefit

The Government is keen to encourage drivers to make environmentally friendly choices when it comes to choosing a car. As far as the company car tax market is concerned, tax policy is used to drive behaviour, rewarding drivers choosing lower emission cars with a lower tax charge, while penalising those whose choices are less green.

The use of the tax system to nudge drivers towards embracing electric cars also applies in relation to the taxation of ‘fuel’. As a result, tax-free benefits on are offer to those drivers who choose to ‘go electric’.

Company car drivers

Electricity is not a ‘fuel’ for the purposes of the fuel benefit charge. This means that where an employee has an electric company car, the employer can meet the cost of all the electricity used in the car, including that for private journeys, without triggering a fuel benefit charge. This can offer significant savings when compared with the tax bill that would arise if the employer pays for the private fuel for a petrol or diesel car. However, it should be noted that a fuel charge may apply in relation to hybrid models.

Example

Maisy has an electric company car with a list price of £20,000. Her employer meets the cost of all electricity used in the car, including that for private motoring. As electricity is not a fuel for these purposes, there is no fuel benefit charge, and Maisy is enabled to enjoy her private motoring tax-free.

By way of comparison, the taxable benefit that would arise if the employer meets the cost of private motoring in a petrol or diesel company car with an appropriate percentage of 22% would be £5,302 (£24,100 @ 22%) for 2019/20. The associated tax bill would be £1,060.40 for a basic rate taxpayer and £2,120.80 for a higher rate taxpayer.

However, the rules do not mean that an employee loses out if they have an electric company car and initially meets the cost of electricity for business journeys and reclaim it from their employer. There is now an advisory fuel rate for electricity which allows employers to reimburse employees meeting the cost of electricity for business journeys at a rate of 4p per mile without triggering a tax bill. However, amounts in excess of 4p per mile will be chargeable.

Employees using their own cars

Currently, there is no separate rate for electric cars under the approved mileage payments scheme. This means that the usual rates apply where an employee uses his or her own electric car for business. Consequently, the employer can pay up to 45p per mile for the first 10,000 business miles in the year and 25p per mile for subsequent business miles tax-free. If the employer pays less than this, the employee can claim a deduction for the shortfall. Payments in excess of the approved amounts are taxable.

Employees with their own electric cars can also enjoy the benefit of tax-free electricity for private motoring – but only if they charge their car using a charging point provided by their employer at or near their place of work. The exemption also applies to cars in which the employee is a passenger, so would apply, for example, if an employee’s spouse drove the employee to work, charging their car when dropping the employee off or picking the employee up.

Partner note: ITEPA 2003, ss. 149, 237A; www.gov.uk/government/publications/advisory-fuel-rates/advisory-fuel-rates-from-1-march-2016

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