Author: Mohammed Haque

  • Delay VAT liability

    It is sometimes possible delay VAT liabilities on invoices, and extra care should be taken with the timing of invoices close to the VAT quarter end.

    VAT Act 1994

    The legislation states that VAT becomes due on the earlier of the following possible tax points:

    • the services or goods have been supplied to the customer s.6(2,3)
    • a VAT invoice is issued s.6(4)
    • payment is received s.6(4)

    14 day rule

    An exception to this is if the VAT invoice is issued within 14 days of the service/goods being provided s.6(5). For example, if you completed the transaction 7 days before the VAT quarter end, the invoice could be raised within 7 days after the quarter end. This would defer the VAT liability for 3 months until the next quarter.

    Use proforma invoice / request for payment to delay VAT

    You can also use proforma invoices or requests for payment to delay VAT. Proformas are especially useful if your business takes advance payments/deposits or if services are provided on a continual basis. This will help delay the VAT liability arising until the payment is received. If using proformas or requests for payment make sure that they don’t mention any VAT amount or VAT registration numbers, and also write that “This not a tax invoice”.

    But note that some businesses hate requests for payment as it may delay their own claim for input VAT on your invoice!

     

  • Pursuit of profit in Bangladesh

    Entrepreneurs normally become wealthy by exploiting the capital and production of the labour force. Whilst that may be true in terms of financial wealth, I believe that having an extremely imbalanced economy in which an elite minority controls a poor majority will create a host of problems, leading to low qualities of life for entrepreneurs despite their wealth. Paying higher wages to workers would reduce the financial wealth of entrepreneurs but would increase their quality of life in the long term as Bangladesh is lifted out of poverty. An even better scenario would be if the entrepreneurs created or supported social enterprises, to avoid wealth being extracted for the benefit of an elite minority.

    Why did Savar happen?

    The recent tragedy at Savar in Bangladesh in which over 1,100 people died got me thinking because there was a bank housed in the same building which sent its staff home, however, the garments factories did not.

    Why was this? I can only guess that it was in the pursuit of profit.

    If the factories were to close, production would have ceased and deadlines may not have been met. The owners could possibly have been worried about losing future contracts or maybe they could have been liable to pay damages for late delivery, breach of contract or non-performance.  In addition, each day in which physical premises are not utilised by a business  represents wasted rent and overhead costs. Possibly staff would have had to have been compensated for not working.

    In the pursuit of maximising shareholder wealth, financial profits were prioritised ahead of staff welfare.

    In economic terms, this was clearly a mistake on this occasion. The earning capabilities of the owners will be £nil if they’re imprisoned and their business in ruins.

    But what about all the other garments factories which exploit their labour forces in terrible conditions for miserable pay on a daily basis?

    Shareholder wealth is not the whole story

    I  have nothing against the traditional capitalist business model in which entrepreneurs employ capital to maximise wealth for shareholders. This model can be used to generate wealth and to help nations to grow and to keep pace with an increasing population. However, a society which cannot feed, house and clothe a significant proportion of its population will suffer from major problems.

    Looking only at shareholder wealth, therefore, ignores the non-pecuniary poverty of entrepreneurs.  In a country such as Bangladesh, even if factory owners and entrepreneurs are wealthy in terms of money, they are poor in many ways: they have to suffer from economic and political instability, poor infrastructure, high risk/rate of crime, courts which don’t function, corruption at every level and in every section of society and bureaucracy etc etc. Life is not comfortable at all and I have heard many complaints.

    Potential benefits from higher wages

    I’ve not yet studied the economics of social enterprise or the triple bottom line, but would be interested to see the impact on entrepreneurs from paying higher wages to staff and looking after their welfare. In my mind,  I would like to think that the entrepreneurs would gain overall.

    Direct impact on entrepreneur’s business: Potentially, higher costs from higher wages and running costs may outweigh any increase in productivity from satisfied/motivated staff.

    Indirect impact from wider society:

    • Higher wages will lead to an increase in consumer spending overall. For example, £100 earned by 1 person may spend £40 whereas £100 earned by 100 people will see £1 spent each.
    • The poor spend a disproportional level of their income on the basic goods and services needed to survive. Consequently, as their income levels rise, they will also spend more to first, fulfil their needs, and they will eventually start spending on non-essential items and luxuries. The rich on the other hand, save large proportions of their wealth and much of it will not even benefit the country as it will be saved or invested overseas.

    Effectively, by reducing the profit extracted by entrepreneurs, wealth is spread more equally through society. This should lead to more economic flows from consumers to businesses and back to workers again and the multiplier effect would take hold. I would expect both consumption and investment to increase without being funded by debt. Higher GDP/growth would increase tax revenues which could be used to invest in infrastructure, education and paying higher public salaries to eliminate corruption. Export led industry would help to control the balance of payments and support imports. In the long term, this would ultimately help society to improve as a whole, the benefits to be enjoyed by every citizen, regardless of their wealth.

    It would take a long time and would obviously need a lot of political upheaval as well, but perhaps the children of the entrepreneurs would reap the benefits, as well as the rest of society.

    Asian Miracle/Tigers

    I would also like to consider the Asian Tigers who had export led growth miracles which improved their economies and plight of the poor significantly, whilst initially employing many in sweatshops. They generally moved on to higher tech industries and the skills and wealth of workers generally increased. However, the key issue is that they generally had partially/fully functioning states with civil servants, bureaucrats, politicians and state led companies all working together for the good of their nations (although there were some tyrants and some sectors of society suffered) and significant investment in infrastructure, including FDI. Also, many companies in the Asian Miracle were not focussed on making profits but were solely focussed on increasing output and therefore, wealth, which is why they amassed great levels of debt.

    In the case of Bangladesh, the very people who could help the economy seem to be the worst and siphon off the wealth off the nation through their corruption, so unfortunately it would appear to be impossible to apply the lessons from the Asian Miracle with the current regimes.

    Possible solutions

    In an ideal world, entrepreneurs could be persuaded to extract less profit, and this could be used to pay higher wages.

    Muhammad Yunus would like to see a higher level of minimum wages in export led industries. This should be based on a living wage with which people can support their families. However, its possible that entrepreneurs would seek to protect profits and reduce the labour force whilst increasing workloads or potentially accelerate the mechanisation of production processes where feasible. In a country such as Bangladesh, I understand that there may be many companies who flout the existing regulations and the illiteracy of the workforce and incompetency/corruption of authorities makes it difficult to enforce.

    One possibility could be to encourage social enterprises which operate on sound business principles, but without profit extraction. The profits are ploughed back into the business or community. Could charities/NGOs such as BRAC create or support businesses that would compete with and defeat the major profit making garment factories? Apart from political obstacles, the main problems would appear to be the cost of investment to create factories and then to hire talent to plan/implement strategy, win contracts and to run operations. But I would like to think think that both could be surmountable with enough donations or volunteers. They could potentially start with small operations and increase in scale as more orders are sourced.

     

    Note: this blog is written without any research and I would really like to find out about the profit margins in particular!

  • IR35

    IR35

    What is IR35

    IR35 ensures that contractors who are effectively “shadow employees” pay tax like normal employees.

    There is legislation for substance over legal form of a relationship between a contractor (or freelancer or locum) and client. Some contractors use limited companies to invoice “clients”, but the overall facts suggest they are actually employees and are “inside of IR35”.

    The basic questions to ask are:

    – do you see yourself as an employee of the company or are you genuinely in business on your own?

    – would you be subject to the same rules and control as employees?

    Key factors in particular are:

    • Substitution
    • Right of control
    • Mutuality of obligation

    Take the test! http://www.hmrc.gov.uk/ir35/guidance.pdf

    This doesn’t cover all the aspects, and there are a lot of factors to consider.

    What if IR35 applies?

    If IR35 applies, the consequences are that:

    • Income in form of deemed payment under Sch E
    • S.336 expenses can be claimed for travel, subsistence, PII, benefits in kind (& E’ers NI) etc
    • An additional 5% of turnover can be claimed as expenses
    • Deduct salaries + E’ees NI + E’ers NI paid in yr
    • The income left over will be subject to income tax and national insurance at the same rates as normal employees, ie 20/40% tax and 12/2% NI
    • E’ers NI also has to be paid 13.8% by contractor (client doesn’t pay)

    Factors suggesting IR35

    • No Substitution 
      • Worker cannot delegate or substitute without client’s consent
      • One person companies, unless evidence to contrary
    • Lack of control
      • Worker engaged for period, not specific tasks
      • Client can move worker to other tasks
      • Client directs, supervises and quality controls work
    • Mutuality of obligation
    • Engager obliged to pay a wage/remuneration
    • Worker obliged to provide own work or skill
    • Notice period irrespective of breach could be an indicator

    Potential indicators of employment:

    • work on the client’s premises
    • use the client’s equipment
    • work standard hours
    • be paid at an hourly rate or use of timesheets, no fee retention for performance
    • be subject to a right of control & take direct orders
    • Part and parcel of organisation
    • No financial risk, client obliged to give work, worker has to accept work given
    • Notice period to terminate, not at end of project
    • Right to receive e’ee benefits: sick pay, holiday, staff canteen, Xmas party

    Contract should reflect reality

    The actual working practices are the most important factor. So if the written contract does not reflect these, it will be ignored. HMRC have been known to interview both the contractor and the client to verify the working practices.

    Contract terms should be consistent, eg use company & supplier, not alternate with agency and contractor. HMRC may also have previously made a Status ruling at the client.

    Need help?

    MAH are well versed in the key issues surrounding IR35 and can advise contractors, freelancers and locums on how to proceed. Get in touch!

  • Using a holding company

    Holding company

    Many businesses will structure their affairs by using a group of companies. There will be a parent or holding company at the top, and this will hold 1 or more trading subsidiaries.

    Advantages of using a holding company

    There is no tax on dividends from subsidiaries to the holding company, so you could build up funds to invest without suffering additional tax.

    The holding company could sell shares without suffering tax if eligible for substantial shareholdings exemption (eg hold >10% of a trading company for at least 12 months).

    In my experience, a key reason for using holding companies is to enable losses and assets to be transferred around the group to minimise corporation tax or capital gains. You could also use the holding company to charge “know how” or management fees to the subsidiaries, which could save tax if the holding company is registered in a lower tax jurisdiction (& managed and controlled offshore).

    The major downside to using a holding company is that it may create “associates” for tax purposes which means that the corporation tax limits get split by the number of companies in a group. Although, when the full rate comes down to 20% in 2015 this won’t make any difference.

     

  • Use deferred income to save tax

    Year end

    Use deferred income to save tax

    Sales invoices need to be recognised in the correct accounting period.

    An invoice can sometimes be deferred when preparing the annual accounts, thereby deferring corporation tax for another year also.

    If an invoice has been raised prior to the year end it is imperative to analyse any supporting contract or sales order and to consider whether the sale has been made prior to the year end.

    If the sale is found to occur after the year end, it should be included next year and would be deferred income.

    Goods

    In the case of goods, the key issue will be whether the significant risks and rewards of ownership have been transferred to the customer. For example, if goods have been shipped prior to the year end this would normally indicate that the risks and rewards of ownership have been delivered.

    However, if the seller is responsible for insuring the goods during transit, they would still have the risks of ownership if the goods reach their destination post year end.  The goods should be recorded in stock and sale occurs post year end, so there would be deferred income.

    Services

    With regards to services, the key issues are whether the contractual obligations have been fulfilled and the period to which the services relate. For example, annual services or subscriptions should be recognised over the whole year. eg an annual invoice raised on 30 Nov’12 by a company with a 31/12/12 year end should have 11/12 months deferred income until the following year.

    If a business provides services over a length of time it is also important to consider if there are any  contractual obligations which need to be fulfilled before the income can be fully recognised in the accounts, but are subject to critical events outside of their control. For example, a business may raise sales invoices on a stage by stage basis eg 40% upfront, 40% on hitting a milestone, 20% on completion.

    Deferred income for entire contract? (eg Events)

    If the entire contract is subject to final delivery or a critical event then it may not be correct to recognise the invoice beforehand. For example, a business organising/planning events wouldn’t have distinguished all its obligations until the event is successfully delivered.

    In this case the income, and therefore tax, should only be recognised once the event occurs.

    Further help

    If this sounds complicated, MAH would be happy to help and we have lots of experience with dealing with issues around deferred income. Contact us now!

    Background to tax/accounting rules:
    HMRC guidance mentions:
    BIM31019 – courts reluctant to override generally accepted accounting practice.
    BIM40080 – case law generally supports the accruals concept.
    BIM40075 – mentions no general standard for revenue recognition.

    BIM40075 appears to be out of date as FRS 5 was amended in 2003 to cover Revenue Recognition and UITF 40 also gives the following guidance:

    p(26) Where the substance of a contract is that the seller’s contractual obligations are performed gradually over time, revenue should be recognised as contract activity progresses to reflect the seller’s partial performance of its contractual obligations.  The amount of revenue should reflect the accrual of the right to consideration as contract activity progresses by reference to value of the work performed.

    p(27) Where the substance of a contract is that a right to consideration does not arise until the occurrence of a critical event, revenue is not recognised until that event occurs.

    p(28) The amount of revenue recognised on any contract for services should reflect any uncertainties as to the amount that the customer will accept and pay.  [p(19)… This only applies where the right to consideration is conditional or contingent on a specified future event or outcome, the occurrence of which is outside the control of the seller].

  • Sole trader vs limited company tax

    New and old businesses should all consider the pros and cons of sole trader vs limited company tax:

    http://www.youtube.com/watch?v=uByIoxZ6598&feature=youtu.be

    Sole trader

    When starting a business, being a sole trader  is the easiest way to do business as this involves much less administration than a limited company. Its easy to register with HMRC at https://online.hmrc.gov.uk/registration/newbusiness

    The main task is then prepare a self assessment every year by 31 January. If you make a profit, you need to pay the tax and national insurance to HMRC.

    In addition, if you make a loss you can carry this back against your income for the past 3 years, which is useful if you were in employment before setting up your own business.

    Limited company

    Once you start to make profits it is normally beneficial to create a limited company to take advantage of dividends. This allows you to avoid national insurance and so the tax saving can be significant.

    The downside to a limited company is the administrative burden as there is much work and many different forms/filing involved.

    From a legal perspective, a limited company is a separate legal entity in the eyes of the courts and so this will normally insulate you and your personal assets from the company’s debts and liabilities, for example in case of any litigation or if the business fails.

    Please take a look at our guides for further information:

    Using dividends to save tax

    Administration in running a limited company

    Comparison of sole trader vs limited company tax

    The attached file shows a comparison between registering as a sole trader and using a limited company. If your profit is £20,000 you would only save £894. This would probably not be worthwhile from a tax perspective due the hassle involved and accountancy fees. However, as you start to make more profit, a limited company would save you more tax and the saving would make the administrative burden worthwhile. For example, if you had £60,000 profit, the total saving would be £4,039.

    Comparison_sole trader_vs_limited company

     

    Need help?

    Please contact us to discuss your requirements and for help with dealing with self assessments or the administration involved in running a limited company.

     

  • Capital reductions to pay out dividends

    Sometimes a company has cash but no distributable reserves, so it can’t pay dividends. Capital reductions can be used in certain circumstances to create distributable reserves which can then be paid in dividends.

    For example, a company may have issued shares at a premium but initially made losses. Once it becomes profitable and cash generative it may wish to reward shareholders. However, the company cannot pay dividends if it doesn’t have sufficient retained earnings.

    eg
    Cash £1m
    Share premium £5m
    P&L account deficit (£2m)

    This company could use a capital reduction to reduce its share premium by £3m and transfer it to the P&L account, giving £1m retained earnings. It could then use its cash to pay £1m in dividends. 

    This is just a simple example, however please contact us to find out more information, or for references to Companies Act 2006 etc.

    Refer to Reduction of capital for more details.