MAH, Chartered Accountants

Category: Corporation tax

  • Setting up company structure

    Factors involved in setting up company structure

    There are different factors involved in setting up company structure and it depends on the type of business, circumstances of the shareholders and their aims for the business.

     

    Shareholders:

    • if you may sell the company and re-invest the profits a holding company may be useful
    • otherwise, the co-founders can be the shareholders
    • for contractors and family owned businesses, husband/wife can be shareholders to maximise dividends
    • ambitious startups looking to grow should setup a share cap table
    • leave an option pool for key staff
    • eg 2 co-founders setup a company owning 45% each and leave 10% option pool

    Multiple trades:

    Clients often have more than 1 business. The simple and efficient solution is to have 1 company and run the different businesses as divisions of this company.

    For tax purposes, the different trades need to have separate profit and loss calculations. This is because losses from a trade can be set against the profits from another trade in the same year. But if losses are carried forward against future profits they can only be used against profits from the same trade.

    If you’ll be expecting to sell a business/trade, it can be hived out into a separate company before sale. If its held for at least 1 year before sale, then there is no tax due to Substantial Shareholding Exemption.

    Sometimes its better to start off with a group structure, so 1 holding company and 3 subsidiaries for the different businesses/trades, although this can also be achieved later on.

    Dividends:

    Profits after tax can be given to shareholders, and this is normally the most tax efficient way to extract profits.

    Dividends have to be paid according to shareholding. So if a husband and wife hold 50% each, they have to receive equal dividends. Sometimes, it may make sense for 1 spouse to hold 100% shares and shares can be transferred between spouses without tax at any time (with the right paperwork) to maximise differences in tax rates and allowances.

    If you’ll be receiving investment, the investors will also be able to receive dividends. So if you have a separate side business operating out of the same company, it will normally be better to hive this out before receiving investment.

    Need help?

    If you need more help on setting up company structure then please contact us for a free consultation.

  • Diverted Profits Tax

    Draft legislation has just been released  for the diverted profits tax, which was recently announced in the Autumn Statement 2014

    https://www.gov.uk/government/publications/finance-bill-2015-draft-legislation-overview-documents

    Effective date

    The new rules will be effective in respect of profits arising on or after 1 April 2015.

    1st Rule

    The first rule is designed to address arrangements which avoid a UK permanent establishment (PE) and comes into effect if a person is carrying on activity in the UK in connection with supplies of goods and services by a non-UK resident company to customers in the UK, provided that the detailed conditions are met.

    This only applies where the UK person and foreign company are not small or medium-sized enterprises (SMEs).:

    Maximum number of staff And less than one of the following limits: Annual turnover Balance sheet total
    Small Enterprise 50 €10 million €10 million
    Medium Enterprise 250 €50 million €43 million 

    There will also be an exemption based on the level of the foreign company’s (or a connected company’s) total sales revenues from all supplies of goods and services to UK customers not exceeding £10 million for a twelve month accounting period.

    2nd Rule

    The second rule will apply to certain arrangements which lack economic substance involving entities with an existing UK taxable presence. The primary function is to counteract arrangements that exploit tax differentials and will apply where the detailed conditions, including those on an “effective tax mismatch outcome” are met.

    This only applies where the two parties to the arrangements are not SMEs (the SME test will apply to the group).

     

    For more details, please look at the pdfs at the link above, or get in touch with us if you need advice.

  • Pre trading expenses

    Pre trading expenses: summary

    You can get a tax deduction for pre trading expenses incurred upto 7 years before your business started trading.

    Pre-trading

    Under CTA2009 s.61, if a company incurs expenses for the purposes of a trade before (but not more than 7 years before) the date on which the company starts to carry on the trade and a deduction would be allowed for them if they were incurred on the start date, then the expenses are treated as if they were incurred on the start date (and therefore a deduction is allowed for them).

    Pre-incorporation

    Note that CTA2009 s.61 mentioned above relates to pre trading expenses incurred by the company. If a company doesn’t yet exist, how can it buy goods or services?

    There could be a risk that this legislation technically may not apply to pre-incorporation expenditure, as this has been incurred by a person who is intending to incorporate.

    However, a pre-incorporation contract could potentially be used which states that the founder/director will be acquiring fixed assets and incurring expenses on behalf of a new company yet to be incorporated, not on behalf of themselves.

    This would then need to have been ratified after incorporation, in accordance with Companies Act 2006 s.51 “A contract that purports to be made by or on behalf of a company at a time when the company has not been formed has effect, subject to any agreement to the contrary, as one made with the person purporting to act for the company or as agent for it, and he is personally liable on the contract accordingly.“ (this legislation normally applies to contracts with external parties, but should be relevant to this context).

    When does “Trading” start?

    Just in case you’re interested in the details behind commencement of trading or tax periods:

    Under CTA2009 s.9 (1) an accounting period of a company begins when the company comes within the charge to corporation tax.

    S.9(2) also mentions a company is treated as coming within the charge to corporation tax when it starts to carry on business.

    Therefore, if a startup has not started to carry on its business by the end of its accounting year, it would not have come within the charge to corporation tax, and therefore there would not be any accounting period for corporation tax purposes.

    BIM70505 provides guidance that the House of Lords judgements in Ransom v Higgs [1974] 50TC1 stress the active nature of trading – the need to be providing goods or services, to be trading with someone.

    The courts have distinguished between preparing to commence business and actually commencing business. As a general rule a trade cannot commence until the trader:
    – is in a position to provide those goods or services which it is, or will be, his or her trade to provide, and
    – does so, or offers to do so, by way of trade.

  • 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

     

  • 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].