Category: Tax

  • 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

     

  • 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!

     

  • 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].