MAH, Chartered Accountants

Category: limited company

  • Understanding business accounts

    Whether you are a new startup or a seasoned investor, understanding business accounts is crucial to staying on top of your business. The numbers don’t lie and will tell you if the business is profitable, if new strategies are working or if remedial action is required. They will also be able to tell you about the financial health of the business ; checking the cash balance at your bank will only tell you part of the story.

     

    http://www.youtube.com/watch?v=HYY_1xf3XPY&feature=youtu.be

    Profit & Loss (to record income and expenses)

    The Profit & Loss Statement will show the performance of the business over a period of time, usually 1 month or 1 year and will generally have the following headings:

    Turnover is the income from selling goods/services to customers.

    Cost of sales are the direct costs of materials, manufacturing,  labour and other inputs that are used to provide the goods/services)

    Gross profit is turnover less cost of sales. If this is negative (ie gross loss), something is not quite right with the business model.

    Administrative expenses are the overheads and running costs, such as rent, legal fees and marketing.

    Tax is normally due at 20% for limited companies on their profit (ie turnover less costs of sales & admin expenses)

    Net profit is the amount left from turnover after deducting all of the costs, expenses and taxes.

     

    Balance Sheet (to record assets & liabilities)

    If a property business owes less to its mortgage lender than the value of its property, they will commonly be referred to as having “equity”. Whereas, if the property is worth less than the mortgage, we would say they have “negative equity”. The Balance Sheet helps us to know if any business is in good health or if it is in negative equity.

    The Balance Sheet is a snapshot in time at the end of the accounting year and will show the financial position of the company. It will show what assets a business owns or has the rights to, and how much they owe to others in the form of liabilities. If assets exceed liabilities, they will have equity.

    The Balance Sheet will also separately show how that equity is made up, whether it is from share capital injected into the business by the owners, or whether the equity is made up from accumulated profits. Going back to the property example, if a house was purchased with 25% deposit, on day 1 the equity would relate to the owners investment. However, if at the end of the year the value has increased, the equity will now also include the unrealised profit.

    Common items on the balance sheet:

    Fixed assets computers, property, vehicles, websites, goodwill: the business uses these assets to carry out its trade and to generate revenue.

    Debtors relate to money owed by customers or other borrowers of the business

    Stock relates to unsold goods at the end of the year, as well as the value of any work in progress or incomplete projects.

    Cash shows the balance at the end of the year.

    Liabilities relate to money owed to suppliers, banks, HMRC or other creditors

    Share capital is the value of funds injected into the business in exchange for shares. This gives the shareholder a right to the profits after tax.

     

    Accounting adjustments

    The final accounts will normally look quite different to the figures you originally provide.

    This is because accounts have to comply with laws and regulations, so that they are produced fairly, reasonably and are comparable with other businesses.

    For example, if you pay for 1 quarter’s rent in advance and 2 months are after the year end, only 1/3 will be expensed in the current year. The remaining 2/3 will be held on the balance sheet as a prepayment, so that the cost is recognised in the accounts in the same year in which the benefits of the rent are received. This is called the matching principle.

    Likewise, if you received a product or service prior to the year end but the supplier didn’t raise an invoice yet, an “accrual” would be recognised to bring the cost into the accounts in the correct year.

    Another common adjustment will be for fixed assets. If something is purchased which will give benefits for many years (& it meets certain criteria) then it will normally be “capitalised” on the balance sheet as a fixed asset. For example, a computer will normally be used for at least 2-3 years, so would be a fixed asset. However, if a 6 month warranty was purchased at the same time, this would only give benefits in the current year, and so would be expensed in the P&L as normal

    Analysis

    There are many ratios and techniques which can be used when analysing and understanding business. We’ll be covering this fully in a future post and so are only briefly mentioning it in this post.

    By analysing the Profit & Loss statement you can measure the performance during the last period and also compare to previous periods & expectations. For example, you can monitor gross profit margin and other key performance indicators to check the impact of a new marketing campaign or to see if raising prices has been good for business.

    However, profit is not the same as cash. If your customers pay you in 90 days, and but your suppliers only give you 30 days, you could be making a profit but still run out of cash.

    Always consider if the liquid assets, such as cash and trade debtors are sufficient to pay back liabilities as they fall due. For example, a business could have plenty of cash and stock available. But if it made a bad choice and can’t shift its stock, it may not be able to repay a bank loan or other creditors for example.

  • Residential property tax planning

    residential_property_tax_planning

    Residential property can be a lucrative business, but profits or gains will be subject to tax. In this post we discuss some of the property tax planning options, including using limited companies or LLPs, trading vs investment property, capital gains tax and entrepreneurs relief. Please download the full report on residential property tax planning for full details.

    Trading stock vs Investment property tax planning

    Residential property can be purchased for different motives and this will impact upon the property tax planning:

    • to be resold in the short term at a profit (trading stock)

    • for capital appreciation whilst generating rental income (investment property)

    When trading stock is sold, it will generate trading profits which are taxable as business income. A trading business will also be eligible for additional tax reliefs such as Entrepreneur’s Relief and Substantial Shareholding Exemption to minimise tax.

    An investment property, however, will generate capital gains or losses which are taxed differently, and many of the reliefs available to trading businesses are not available to investment businesses.

    For properties held individually, higher or additional rate taxpayers will pay a much lower rate of 28% on capital gains from investment properties compared to 40% or 45% on profits from trading stock.

    Limited company vs Individual property ownership

    The tax liability will depend on whether owners are basic, higher or additional rate taxpayers.  The example in the table below shows the tax payable on a gain/profit of £80,500 for a higher rate taxpayer:

    Total tax paid using:

    Investment property (£)

    Trading stock (£)

    Ltd co. & all profits retained

    14,600

    16,100

    Ltd co. & all profits distributed

    31,075

    32,200

    Individual purchaser

    19,488

    29,845

    This clearly shows that for both investment properties and trading stock, a limited company would save tax if profits are kept within the business or are re-invested. This is because a company only pays tax at 20%.

    However, if the company were to pay out the profits as dividends, there would be another level of tax. So if the intention is to extract significant profits on a regular basis, it may better to hold the properties individually. This is especially the case for investment properties as individuals can also benefit from capital gains tax allowances and CGT tax rates are lower than income tax for higher/additional rate taxpayers.

    If multiple properties are purchased, multiple limited companies could also be used to contain risk if any 1 property runs into difficulties with mortgage repayments. Although lenders may demand cross or personal guarantees.

    A director could also give a startup loan to the company to initially purchase property and this could be repaid tax free.

    At the end of the company’s life, it could be closed down and the shareholder would pay capital gains tax on the return of capital. This may save tax compared to taking dividends out on annual basis. A company with trading stock could also claim entrepreneurs relief and so pay tax at only 10%.

    The main disadvantage of using a limited company is that there is a double level of taxation, as more tax will need to be paid when the shareholders extract profits, 

    A limited liability partnership (LLP) may offer the best of both worlds,. This is because they are transparent for tax purposes and can be structured with 1 individual partner and 1 corporate partner.  This allows capital and income to be allocated to partners in an efficient manner for property tax planning.

    The following table highlights some of the key differences in property tax planninh: 

     

    Trading stock

    (business income)

    Investment property

    (capital gains)

    Corporation tax rate

    20%*

    (*if profits > £1.5m rate is 23% in 2013 & 21% in 2014 & 20% from 2015)

    20%*

    but can also deduct indexation allowance for inflation

    Individual tax rate

    Income tax rate (20/40/45%) plus Class 4 NIC (9/2%) depending on total level of income.

    Capital gains tax at 18% for basic rate or 28% for higher rate taxpayers. (also higher personal allowance for CGT)

    Entrepreneur’s relief 

    Eligible: an individual could pay CGT at 10% on first £10m of lifetime gains, if dispose or close down a trading business

    Ineligible

    Substantial shareholding exemption

     

    Eligible: a company can get tax free gains from selling trading companies if conditions are met.

    Ineligible

    Expenses (repairs vs capital)

     

    Expenditure on the property will be added to stock, and so will normally get the tax deduction on sale.

    Immediate tax deduction for repairs which do not improve the property. Capital expenses will get relief from CGT on sale.

     

    Please download the full report on residential property tax planning for full details, including the following areas:

    Loan interest

    Substantial shareholding exemption

    Principal private residence exemption

    Investment property expenses: revenue vs capital

    Valuation of trading stock 

    Further considerations

     

  • 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.