A regular tax bulletin for all ICPA members Issue 27 February 2018

Transcription

1 A regular tax bulletin for all ICPA members Issue 27 February 2018 TAXUPDATE Mark McLaughlin points out that in some cases entrepreneurs relief may be available on the disposal of business assets, but warns that the relief can be elusive Many taxpayers, such as selfemployed individuals, as well as tax advisers will be familiar with entrepreneurs relief (ER). The relief offers a reduced capital gains tax (CGT) rate of 10% on lifetime net aggregate chargeable gains of up to 10 million. ER is available on qualifying business disposals, including a material disposal of business assets. To be a material disposal of business assets an individual needs to make a disposal of certain types of business asset, constituting a material disposal (TCGA 1992, s 169I(1)). DISPOSALS AFTER BUSINESS CEASES There are three different types of business asset disposals for ER purposes. One of them is a disposal of (or of interests in) an asset or assets used for the purposes of the business when it ceased to be carried on (s 169I(2)(b)). This type of disposal was considered by the First-tier Tribunal in Amin v Revenue and Customs [2016] UKFTT 515 (TC), discussed below. As mentioned, to be eligible for ER, the business asset disposal must be a material one. There are various types of material disposal. In the case of disposals of business assets in use on cessation of the business, there are two requirements for a Blow the cobwebs away It s February and that deadline has passed; no doubt there are a few miscreant clients still hanging around, but it has now been and gone. February is a time for a few days break, and a time to start working through the pile of magazines that you promised yourself you will look at, to sort out any outstanding filing both actual and digital, and for a tidy up of the desk and office generally. In association with material disposal: firstly, the individual must have owned the business throughout the period of one year up to the date when the business ceases; secondly, that date is within the period of three years ending with the date of disposal (s 169I(4)). RELIEF NOT AVAILABLE In Amin, the taxpayer was a sole practitioner accountant, and also the sole owner of the practice premises. He sold a Most of us also use February as a time to contemplate the practice going forward, and to prioritise our actions for the year ahead. Hopefully, it isn t necessary to have to make a conscious effort to keep up-to-date because that is expected of us as professionals, and the world of taxation is ever changing. That s why February is a good month for us to publish the latest of our Tax Updates, which we issue every quarter. This one is as usual chock-full of relevant and interesting content that I know you will enjoy, especially now the January pressure is over. Tony Margaritelli, Chair, ICPA Business assets: dispose with care! 50% interest in the business premises, by means of three separate deeds (the purchasers in all three transactions were the taxpayer, his wife and son, who were the trustees of a pension scheme). The second deed dated 25 June 2008 was for the sale of a 22.7% interest in the premises, for consideration of 249,700. The taxpayer s tax return for the year ended 5 April 2009 included a CGT computation relating to this disposal, on which ER was claimed. However, HM Revenue and Customs (HMRC) considered that ER did not apply, on the basis that the taxpayer s sole practitioner business had not ceased. The taxpayer s case for claiming ER was that in addition to providing accountancy services, he also had audit clients. However, he was unable to carry out the audit work (as he was not qualified to do so), and so disposed of the goodwill associated with the audit work (which generated fees of around 70,000) to another accountant in April and May 2008 for a nominal consideration, in order that he could retain those clients for their non-audit accountancy work. He argued that he was entitled to ER on the disposal of the property interest because he had sold part of his business (i.e. the audit work element). Unfortunately for the taxpayer, the Firsttier Tribunal agreed with HMRC s interpretation of the ER rules, and dismissed his appeal. The tribunal accepted that the taxpayer had disposed of his audit practice to the other accountant, but held that the ER legislation did not allow the taxpayer to claim relief for the Continued on page 2

2 Business loan interest who pays? Mark McLaughlin looks at the payment of loan interest by landlords from joints accounts between spouses or civil partners The restriction for landlords in the deduction of residential property finance costs (e.g. loan interest) to the basic rate of income tax, which is being phased in over a four year period that commenced from 6 April 2017 (ITTOIA 2005, ss 272A-272B, ss 274A-274C), has prompted new landlords to consider operating through a limited company, and many owners of existing rental property businesses to consider incorporation. FINANCING THE COMPANY One of the issues facing many such landlords is how the company s rental properties will be financed. For example, the company itself may be able to borrow funds (although the bank may require personal guarantees from the company owner(s)). Alternatively, the company owner(s) might borrow and introduce funds into the company, to enable it to finance the properties. If the company owner(s) incurs borrowings personally, a tax relief claim Continued from page 1 partial disposal of his premises as a result of the disposal of his audit practice. IN DIFFERENT CIRCUMSTANCES The tribunal in Amin contrasted the taxpayer s claim with this example: instead of disposing of an interest in the whole may be available for interest paid on a loan used (for example) to purchase ordinary shares in the company, or if the money borrowed is lent on to the company and the company uses it wholly or exclusively for the purposes of its business, if certain conditions are satisfied. Those conditions (ITA 2007, ss 383, 392) are detailed, and beyond the scope of this short article. It is relatively common for married couples (or civil partners) to borrow funds for the above purposes in joint names (indeed, the bank might require it). Alternatively, one spouse may borrow to invest in their rental property company, but the loan interest may be paid from a joint bank account. How do the loan and interest payment arrangements affect the availability of tax relief for the loan interest? JOINT LOANS In the case of joint borrowings by married couples, HM Revenue & Customs (HMRC) consider (perhaps rather generously) that if only one spouse (e.g. husband) uses the loan in a manner that meets the qualifying conditions, he is entitled to full relief for the interest paid, even though the interest is paid out of a joint account. Alternatively, if interest on the joint loan is paid from a joint account and both spouses Dispose of assets with care business premises, suppose that the taxpayer sold distinct office space in it (e.g. the second floor of the premises), because he no longer needed that office space as the result of ceasing to carry out audit work. The tribunal accepted that, in those circumstances, ER might have been due. use the loan in a manner that meets the qualifying conditions, each spouse would be entitled to tax relief on the interest paid in proportion to their investments in the company. SOLE BORROWER However, there is a trap if (for example) husband took out the loan in his sole name, the loan was used by both spouses to make otherwise qualifying investments in the company, and the husband paid the interest from his own bank account. In this case, HMRC s view is that loan interest relief is only available to the spouse taking out the loan, and only in proportion to the amount of qualifying investment by that spouse (see HMRC s Savings and Investment manual at SAIM10030). The reason given for this relief restriction is because: the loan has to be used by the same individual to whom the loan was made. Under these circumstances, the amount invested by the spouse who did not receive the loan has not been used to make a qualifying investment by the spouse who received the loan. That amount has been used to enable someone else to make an investment. HMRC s guidance (at SAIM10040) includes examples of the relief available where spouses take out joint loans (and also an example of restricted interest relief where the loan is taken out and the interest paid by the qualifying spouse only). STRUCTURING BUSINESS LOANS It is therefore important to ensure that business loans are structured in the correct way so that tax relief is maximised wherever possible. While the reason given by HMRC for the above relief restriction seems logical, it is perhaps more difficult to understand why full relief is available to one of the spouses in respect of a joint loan, despite half the loan capital arguably not being attributable to the qualifying spouse, and presumably half of the loan interest being paid by the non-qualifying spouse in respect of their share of capital in the joint bank account. Still, taxpayers these days should probably be grateful for small mercies. However, the tribunal agreed with HMRC that the partial sale of the business premises and the audit goodwill had to be seen as wholly unconnected transactions in the particular circumstances of Mr Amin s case. This presumably means the disposal of the interest in the business premises was not the result of his audit practice ceasing, but it needed to be for ER purposes.

3 Beware unpaid deductions Mark McLaughlin warns that company owners can become personally liable for payment of the company s unpaid PAYE and NIC liabilities Owner-managed and family businesses (among others) often fail. Unfortunately, the business owner s problems do not necessarily end there. For example, an owner-managed company may have owed HM Revenue and Customs (HMRC) substantial amounts of PAYE income tax and National Insurance contributions (NIC) when it ceased trading and was liquidated. Those company liabilities may relate to remuneration paid to its owners. HMRC can pursue the individuals for the unpaid tax, broadly if there has been a failure to deduct PAYE, and HMRC considers that the company wilfully failed to make the deductions from relevant payments to them (SI 2003/2682, reg 72). A similar provision applies for NIC purposes in respect of the individual s primary contributions, if there is a wilful failure to pay by the company (SI 2001/1004, reg 86). Whether the company owner(s) are liable for the unpaid PAYE and NIC of the business under the above rules will depend on the particular facts and circumstances. PERSONALLY LIABLE For example, in Marsh & Anor v Revenue and Customs [2016] UKFTT 539 (TC), two individuals were directors and equal shareholders of a trading company. The company eventually experienced cashflow problems. Historically, the individuals received small amounts by way of salary from the company. Most of their income was received in dividends. However, for the tax year 2010/11, the director shareholders increased their salaries. The company had outstanding income tax and NIC, most of which related to the director shareholders. In April 2011, the company went into administration. HMRC sought to transfer the liabilities to the individuals. The First-tier Tribunal noted that the individuals drew substantial salaries when the company s profits could not support them. It was clear to the tribunal that the company was already in financial difficulties when the director shareholders decided to take salaries instead of dividends. The failure to make deductions from their salaries was held to be wilful, and the tribunal concluded that the director shareholders were personally liable to pay the relevant tax and NIC. NOT LIABLE By contrast, in West v Revenue and Customs [2016] UKFTT 536 (TC), the appellant was the sole director and shareholder of a trading company. For a number of years, the appellant drew money from the company as director s loans. However, the director s loans remained outstanding and increased over a number of years. Following advice from an insolvency practitioner, the appellant s accountant was instructed to prepare accounts showing an amount of director s remuneration which, after deducting PAYE and NIC, would be sufficient to offset the drawings on the director s loan account. Subsequently, a resolution was passed for the winding up of the company. PAYE and NIC liabilities were still outstanding. HMRC sought to formally transfer the liabilities from the company to the appellant, on the basis that he received payments from the company knowing that it had wilfully failed to deduct sufficient tax. The tribunal judge noted that the PAYE obligations fell on the employer, and this basic rule was set aside only in limited circumstances: (1) The employer did not deduct PAYE; (2) The failure was wilful and deliberate; and (3) The employee received the remuneration knowing that the employer had wilfully failed to deduct the tax. HMRC had to show that all three circumstances were present. On the first condition, the tribunal judge found that tax was deducted from the remuneration provided by the company to the appellant; the total amount of PAYE and NIC liabilities was shown in the company s records. Thus the first condition was not satisfied. As all three conditions must be fulfilled, there was no basis for transferring the company s PAYE liability to the appellant. Furthermore, the tribunal judge found, on the facts and evidence, that the company s failure to pay the NIC liability was not wilful or deliberate. The appellant s appeal was allowed. MOVING THE GOALPOSTS? The decision in West begs the question whether it leaves the door open for company owners to pay themselves large amounts of remuneration, and allow the company to be liquidated owing substantial PAYE and NIC liabilities. In West, the tribunal panel reached different decisions (but the tribunal judge had the casting vote). The other tribunal member expressed concerns on this point. The tribunal judge commented: Although I have concerns as to the consequences of allowing Mr West s appeal, I do not consider that the legislation in its current state is sufficient to deal with the problems to which [the disagreeing tribunal member] refers. A change in the law therefore seems a distinct possibility.

4 They told me to do it! Mark McLaughlin highlights penalties for tax return errors, and considers whether a taxpayer s reliance on advice from a professional adviser is taking reasonable care if that advice turns out to be incorrect and eventually results in the error Errors are sometimes made in tax returns. This can result in HM Revenue and Customs (HMRC) seeking to impose penalties in respect of the errors. The calculation of penalties for errors etc. is beyond the scope of this article, but there is guidance in HMRC s Compliance Handbook manual (including a table of standard maximum penalties at CH82120). If the tax return error has resulted (for example) in a tax liability being understated, HMRC will generally consider whether the error was careless or deliberate. An error is careless if it arises due to a failure to take reasonable care (FA 2007, Sch 24, para 3(1)(a)). Thus no penalty can be charged if the error arose despite reasonable care having been taken. This article considers tax return errors other than those relating to tax avoidance arrangements, to which special rules apply (see FA 2007, Sch 24, paras 3A-3B). IS IT REASONABLE OR NOT? Unfortunately, there is no statutory definition of reasonable care for these purposes. This has resulted in case law over the years on the distinction between reasonable care and careless (or negligent) behaviour. For example in Collis v Revenue & Customs [2011] UKFTT 588 (TC), the First-tier Tribunal commented: We consider that the standard by which [reasonable care] falls to be judged is that of a prudent and reasonable taxpayer in the position of the taxpayer in question. HMRC considers that reasonable care depends on the particular taxpayer s abilities and circumstances. However, HMRC generally expects higher standards of taxpayers with professional advisers. INCORRECT ADVICE However, has a taxpayer taken reasonable care in relying on professional tax advice, if that advice results in a tax return error? The answer seems to be it depends. For example, in Gedir v Revenue & Customs [2016] UKFTT 188 (TC), the First-tier Tribunal held that the taxpayer took reasonable care despite a tax return error. In reaching that conclusion, the tribunal noted the following essential elements : The taxpayer consulted an adviser he reasonably believed to be competent; He provided the adviser with the relevant information and documents; He checked the adviser s work to the extent that he was able to do so; and He implemented the advice. The tribunal noted the earlier case Hanson v Revenue and Customs [2012] UKFTT 314 (TC), and considered that the decision in that case sets out the correct basis for establishing whether a taxpayer who uses an agent to complete his tax return has taken reasonable care to avoid an inaccuracy in the return. In Hanson, the First-tier Tribunal considered that there was carelessness on the part of the taxpayer s advisers. However, the taxpayer had taken reasonable care to avoid the error. In the circumstances, the taxpayer was entitled to rely on his accountants advice without the taxpayer consulting the legislation or any HMRC guidance. On the other hand, a taxpayer s reliance on professional advice does not represent a get out of jail card in all circumstances. For example, in Shakoor v Revenue and Customs [2012] UKFTT 532 (TC), the tribunal found that an accountant s incorrect advice was obviously wrong, and that the taxpayer realised, or ought to have realised, that it was obviously wrong, or so potentially wrong, that it called for further explanation or justification. The taxpayer therefore incurred a penalty. A DIFFERENT VIEW Taking a different view from HMRC on a technical point is not necessarily careless behaviour, if the taxpayer s adviser s view turns out to be incorrect. Provided that the view is reasonable, the adviser is entitled to advise the taxpayer on that basis. The First-tier Tribunal decisions in Gedir and Hanson on reasonable care do not create a binding precedent, but may be persuasive in cases where the taxpayer has made a tax return error concerning a point on which professional advice has reasonably been taken, and HMRC is contending that the error was careless. The above article was first published by

5 Individual taxpayers who are residential property landlords will be aware that a profit on disposal of a property will normally be subject to capital gains tax (CGT). For disposals in 2017/18, the basic and standard rates of CGT are 10% and 20% respectively. However, gains on the disposal of interests in residential properties (that do not qualify for private residence relief) are subject to higher CGT rates of 18% and/or 28% instead. DOES IT QUALIFY? However, the commercial letting of furnished holiday accommodation is subject to special tax treatment, if certain conditions are satisfied (ITTOIA 2005, ss B). The requirements for a furnished property to be qualifying holiday accommodation are beyond the scope of this article, but the three basic conditions are broadly (s 325): Availability The property must be available for commercial letting as holiday accommodation to the public generally for at least 210 days during the relevant period. Letting The property must be commercially let as holiday accommodation to the public for at least 105 days during the relevant period (but a period of longer term occupation does not count as a letting of it as holiday accommodation). Pattern of occupation The total of all lettings that exceed 31 continuous days (i.e. periods of longer term occupation ) is not more than 155 days during the relevant period. For CGT purposes, if the property satisfies the conditions for the commercial letting of furnished holiday lettings, the special tax treatment available for individual landlords (compared with the general treatment of rental property) includes certain CGT reliefs, such as business asset rollover relief and gift relief (TCGA 1992, ss 241(3A), 241A(5)). ENTREPRENEURS RELIEF A further CGT relief available to individual landlords of commercial furnished holiday lettings is entrepreneurs relief (ER). A CGT rate of 10% broadly applies to qualifying gains, up to a lifetime limit of 10 million. Certain conditions must be satisfied to be eligible to claim ER, which are beyond the scope of this article. However, the relief applies (among other things) to the disposal of the whole or part of a business carried on by a sole trader or partnership. The business must be owned for at least one year ending with the date of disposal. The disposal of an asset used (in a sole trader or partnership business) upon cessation is also a material disposal if the one-year ownership requirement is met and the disposal takes place within three years after the business has ceased (TCGA 1992, s 169I). Rental property: is it special? Mark McLaughlin points out a potential capital gains tax advantage of a qualifying furnished holiday lettings business compared with other rental property businesses ER is not generally available on the disposal of a buy-to-let property business. For ER purposes, a business is defined as anything which is a trade, profession or vocation, and is conducted on a commercial basis and with a view to the realisation of profits (s 169S(1)). A buy-tolet property activity is capable of amounting to a business, but will not normally be a trade. There is case law authority (Salisbury House Estates Ltd v Fry [1930] 15 TC 266 and Griffiths v Jackson [1982] 56 TC 583) to support HMRC s general view that income derived from rights of property in land is very unlikely to be trading income (except perhaps in a hotel or guesthouse activity, where profits are usually chargeable as trading income). However, a qualifying furnished holiday lettings business is treated as a trade for certain tax purposes, including ER. This potentially provides individual furnished holiday lettings business owners with the opportunity to sell the business and claim ER, if the relevant conditions are satisfied. PART OF A BUSINESS? By ensuring that the furnished holiday lettings and ER conditions are both satisfied, the CGT rate on disposal can be reduced from 28% to 10%. If the qualifying furnished holiday lettings business consists of a single property that is sold, the business has clearly ceased as there has been a disposal of the whole business. However, if the furnished holiday lettings business contains several let properties and there is a disposal of only some of the properties, a claim for ER may be challenged by HMRC on the basis that there has been no disposal of part of the business (see HMRC s Capital Gains manual at CG64015 and following).

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7 A free (of IHT) property gift? Mark McLaughlin notes a useful and potentially generous inheritance tax exemption The inheritance tax (IHT) regime includes various useful reliefs and exemptions. Furthermore, certain categories of relief and exemption are not subject to a fixed upper monetary limit, if the relevant conditions are satisfied. Some of them are better known than others. Perhaps one of the less well-known IHT exemptions (i.e. whereby a disposition is not treated as a transfer of value for IHT purposes) relates to the maintenance of family members. This applies broadly to the following: Maintenance of the spouse (or civil partner), or former spouse (e.g. on divorce); Maintenance etc. of the transferor s children; Maintenance etc. of other people s children; Care or maintenance of a dependent relative; or Maintenance etc. of the transferor s illegitimate children. The exemption is subject to certain conditions in each case (see IHTA 1984, s 11). IS THAT REASONABLE? For example, the exemption in respect of a dependent relative (as defined) applies to the extent that the disposition represents a reasonable provision for care and maintenance of the relative. But what is a reasonable provision? This point was considered in McKelvey (Personal Representative of McKelvey Deceased) v Revenue and Customs Commissioners [2008] SpC 694. In that case, the deceased (D) was a spinster who lived with her widowed mother (M), who was 85 years old, blind and in poor health. D was diagnosed with terminal cancer, and in 2003 gave away two houses she owned to M. D died in 2005, and M died in HM Revenue and Customs (HMRC) sought to charge IHT on the value of D s gift of the houses to M of 169,000. D s executor appealed, on the grounds that the gifts were exempt transfers, being a reasonable provision for the care and maintenance of a dependent relative (within s 11(3)). The executor contended that D gave the houses to M so that they could be sold to pay for nursing care. The executor s appeal was allowed in part. The Special Commissioner held that it was reasonable for D to assume that M would need residential nursing care, and concluded that reasonable provision at the time the transfers were made amounted in all to 140,500. This amount qualified for exemption under s 11 (nb the balance of 28,500 was a chargeable transfer). HMRC s guidance on what represents reasonable provision for the care or maintenance of a dependent relative (at IHTM04177) indicates that regard needs to be given to the financial and other circumstances of the transferor and the relative and the degree of incapacity of infirmity of the latter. HMRC will enquire into the recipient s financial incapacity, and will refuse the exemption to the extent that the recipient had sufficient income or capital to make adequate provision for their own maintenance (IHTM04179). DEATHBED PLANNING? The exemption may be potentially useful if (for example) the transferor s life expectancy is less than the seven year period necessary for a potentially exempt transfer to become exempt, or the normal two year ownership period normally required for business property relief. For example, suppose that Susan (age 38), the single mother of Jacob (age 6), has been diagnosed with a terminal illness. Her assets (which include a property and investment funds inherited from her parents) are worth over 1.4 million. Susan s estate would be liable to IHT on death, subject to her available nil rate band. Her main concern is to provide for Jacob. Consideration could be given for IHT purposes to the legislation in IHTA 1984, s 11(4) (dealing with the maintenance, education or training of an illegitimate child of the person). The exemption applies to lifetime dispositions, so provision for Jacob would need to be made prior to his mother s death. Such provision (to the extent that it falls within s 11) would not become chargeable to IHT on Susan s death. BE CAREFUL Care must be taken, such as in quantifying how much might fall within the IHT exemption and (particularly in the case of minor children) how the funds will be held and applied for the recipient. Expert professional advice is recommended. Tax Update is produced for the ICPA by Armstrong Media ( ). Written by Mark McLaughlin of Mark McLaughlin Associates ( ). Published in February, May, August and November. For details contact The ICPA, Imperial House, 1a Standen Avenue, Hornchurch, Essex RM12 6AA. Call: info@icpa.org.uk Web: