Relief Capping

April 23, 2012 //
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Relief Capping

I want to examine one of the proposals in George Osborne’s recent budget which has attracted a lot of press comment – however the press discussion has ignored rather more significant aspects of the proposal.

I’m talking about the suggestion that a cap should be introduced on all forms of tax relief which do not have a separate limit.  It has been suggested that some very wealthy taxpayers are using these reliefs unfairly to minimise their taxation liability – George Osborne claimed to have been shown evidence by HMRC concerning the aggressive use of upcapped reliefs to minimise liability -

He told The Telegraph:

“I was shocked to see that some of the very wealthiest people in the country have organised their tax affairs, and to be fair it’s within the tax laws, so that they were regularly paying virtually no income tax. And I don’t think that’s right. I’m talking about people right at the top. I’m talking about people with incomes of many millions of pounds a year. The general principle is that people should pay income tax and that includes people with the highest incomes. I’m not allowed to be shown the names of the individuals but I’ve sat with the most senior people at the Inland Revenue, the people who run some of the high net worth units there. They have given me examples, anonymised examples, and so we are taking action.”

Ironically in 2007 HMRC published a report on Gift Aid which suggested that wealthy people were not sufficiently aware of Gift Aid in particular – their report states – “If Tax reliefs on charitable donations are to be used more widely by wealthy people, levels of awareness must be improved…” seems they have been improved considerably.

The Press have focussed on the impact on charitable giving but it may be important to remember that gift aid as a system has not always been an unlimited relief – in 1999 Gordon Brown announced a number of initiatives to increase charitable donation in a package entitled “Getting Britain Giving” which included removing a number of gift aid and payroll-giving restrictions.

It is true that many very wealthy people have used their own charitable trusts to shelter income which has richly endowed many charities ranging from the Sackler galleries at the Royal Academy to local church halls.  Osborne has also stated that he is “specifically looking at making sure we are still encouraging philanthropy and charitable giving.”

Interestingly this capping will not affect the ability of the charity to reclaim tax under the Gift Aid system, only the excess liability relief that the taxpayer will be entitled to.

But the impact of this proposed measure may be more significant in two other areas - loss relief and relief for interest as a charge against income.

It seems that this will not affect the carry forward of losses against future profits nor carry back against trading income in earlier years.  However relief for trading losses against other income will now be capped at £50,000 or, if greater, 25% of a taxpayer’s income.  And that will apply to all of the reliefs which may be subject to capping.

Now it may be true that some very wealthy individuals have been buying avoidance schemes to artificially generate losses to offset income – and this year’s budget contains specific anti-avoidance provisions to counter the use of some of these schemes.  But if HMRC are concerned about the very wealthy why set the limit for this capping at such a low level?  Let’s think about a practical situation.

Alan set up a trading company eight years ago and subscribed for £120,000 worth of shares at this time.  Because of adverse trading conditions the company has failed and had to be liquidated with no money to return to shareholders.  Alan has taken employment with a company at an annual salary of £140,000 and in that sense he is lucky.  Alan can claim that the loss that he suffers on the disposal of the shares can be converted into an income loss and offset against other income that he may have – but he will now be affected by capping.  No more than £50,000 can be offset against income (as 25% of £140,000 is less) and as there are no other sources against which the loss can be offset the balance will be lost.  Is this the sort of situation that that George Osborne had in mind?

Aiden has two separate trades which he pursues, one as a farmer which generates income of £140,000, the other as an active Lloyds Underwriter.  As a result of several natural disasters his underwriting syndicate suffers losses of which his share for the year is £80,000.  This will be capped at £50,000.  If he claims against the previous year he may be allowed to offset against the trading profit of the previous year but not other income, however for this to be permitted reform will be needed to the scheme for offsetting losses as well, at present this relief is against total income from all sources without distinction.

Lets look at another situation – interest relief.  Relief can be claimed for interest paid as a deduction in calculating income from certain sources, principally trading and property ownership.  These are, we are told, not affected.  Interest relief can also be given as a charge, a deduction from total income which will now be subject to capping; these reliefs apply to loans applied to a qualifying purpose, broadly relief for loans used to purchase an interest in a close company or a partnership, loans used to make loans to a close company or partnership and loans used to purchase plant and machinery for use by a company in it’s trade. Relief is also available for loans used by employees buying an interest in an employee controlled company, for investments in co-operatives by members and loans used by executors to pay inheritance tax arising on death.  These will all now be subject to capping

Brian has traded through his company for many years and recently it made a takeover bid for another trading company.  This was financed by a loan which Brian took from his bank, as it was not willing to lend to his company directly.  Brian lent the money on to his company and charges the company interest of the same amount that he pays to his bank.  Under the new proposals he runs the risk of not being able to claim full interest relief on the amount he pays to the bank even though he will still be taxable on the amount he receives from the company.  Was this the sort of situation envisaged by George Osborne?

Bill is a director of a large manufacturing company and has the opportunity, with five other directors and senior managers, to complete a management buyout.  He will mortgage his home and borrows £1,500,000 on which he will pay annual interest of £75,000.  He has agreed with the individuals involved to draw modest income for the first few years until the business is established. Unless Bill receives income of at least £300,000 pa he will be subject to capping.

Is this what George Osborne intended? – Personally I doubt that it was.

I think part of the problem is the very low level at which the restriction applies – HMRC and Osborne are complaining about the actions of multi-millionaires and yet setting a level of £50,000 is going to directly affect many taxpayers who are most certainly not millionaires and not using this device to avoid liability. There are also no exceptions envisaged for bone fide reliefs where avoidance or even mitigation of liability is the furthest thing from a taxpayer’s mind.  Loss-making multi-millionaires may have bought into artificial schemes to minimise the tax that they pay but many, many ordinary taxpayers will be adversely affected by these proposals.

Perhaps if the ceiling was set considerably higher at £500,000 it would attack the sort of abuse without significant adverse effects, and if there were exceptions permitted it would help but as it stands this is evidence of the revenue simply being unwilling to use existing measures to counteract avoidance.  It is easier for the revenue to impose this sort of limit than to have to police more specific anti-avoidance measures even though they continue to actively seek these powers as well.

This is exactly the same strategy that saw the ludicrously small £25,000 limit set on the statutory equivalent of ESC C16 that I discussed in my December podcast last year.

What can we do?  Like many suggestions in the budget which are intended to be applied in the future – this restriction is intended to be introduced in April 2013 – this will be subject to consultation later this year.  It is vitally important that we take part in the consultation process – and yet very few people do.

Here is a quote from the published results of a recent consultation – 83 representations were received from a range of interested parties including 11 individuals and 72 organisations, ranging from the professional bodies and larger firms of accountants to commercial companies and institutions affected by the measure.  11 individuals only!

If accountants and taxpayers simply sit back and do not take an active part in consultation which potentially affects them then they shouldn’t complain when these measures are subsequently introduced.

There are reliefs which know will not be affected, these include credits against liability – tax credits, double taxation relief and credits under the event gain regime and also where there is a financial limit established such as Pension Contributions and the various Venture Capital reliefs.  We are also told that it won’t apply to the Cultural Gift Scheme – this is the name now being given to the scheme introduced in the Finance Act 2012 for objects of pre-eminent interest being gifted to the nation – although the capping here is the total value from all taxpayers of objects accepted of £30million per annum – the Secretary of State for Culture, Olympics, Media and Sport will have overall accountability for ensuring that the annual limit is not exceeded.

There are also reliefs which might be affected where no clarification has yet been received – what about the payment or spreading of patent royalties for example, or the averaging provisions allowed for authors artists and farmers?

The guidance says that computational reliefs which determine how income from a particular source is measured are excluded which should mean that interest on the acquisition of buy-to-let properties will not be affected although this is often cited as an example of avoidance of this type.

In applying the cap we are told that income is measured without deduction of capped reliefs which can help to maximise the relief available but the revenue’s own example is not completely clear on this point.  In applying the limit relief such as gift aid relief which operates by extending the basic rate band will be converted into the equivalent of a relief that reduces income.

Suppose Charlie has total income of £250,000, claims qualifying interest relief of £40,000 and relief for a donation of shares to a charity valued at £25,000.  That gift of shares qualifies for gift aid relief but there is no deemed basic rate tax deducted at source, he simply claims a deduction for the value of the shares gifted.  He also invests £50,000 under the Enterprise Investment Scheme.  In calculating liability without capping his taxable income will be reduced by £65,000 and there will be a tax reducer relief of £15,000 to offset against the liability arising because of the EIS investment.  Although legally he has taxable income of £185,000, for the purpose of the cap the full income of £250,000 will be used, 25% of which is £62,500 leaving taxable income of £187,500 after capping.

Until we see the consultation document we will not know whether it is the charitable gift or the interest relief that will be practically reduced.  Taxpayers may be allowed to choose.

The document points out that if the EIS shares are disposed of at a loss there will then be a further potential loss relief claim which will also become subject to capping and in fact in this example Charlie will get no relief at all.

 

Unfortunately capping can’t be applied until the income for the whole of the year has been ascertained and that will usually be after the year has finished.  Traders with a 30 April year end, or one ending earlier in the year, will have an opportunity to know what their income for the year will be and plan accordingly.  Those with a 31 March year end, or an employee with bonus entitlements arising late in the tax year will not.

Timing of certain claims will also become critical to avoid, perhaps, two claims in a single year where capping might then apply where one claim would not be.

Remember – if you or a client of yours is likely to be adversely affected by this proposal you will only have yourself to blame if you fail to take part in the consultation later this year.

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Categories accountancy, Taxation, Uncategorized

BUDGET 2012

March 23, 2012 //
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Budget 2012

George Osborne’s budget is the first under the budgetary process in full.  This involves an announcement made in budget 1 (in this case the 2011 budget on 23 March) being subject to consultation over the summer, then the draft finance bill measures are published in December for consideration.  If adopted they are included in the budget statement No 2, this year on 21st March and then published as part of the actual finance bill, this year expected on 29 March.  The measures are considered by parliament and the final amended version emerges in the middle of July.

Meanwhile advance announcements in this budget in 2012 will be consulted on this summer, included in a draft bill next December, and then adopted in the Finance Act 2013 after next year’s budget.

One measure which was going to included in this year’s finance bill was the new statutory residence test we discussed in October last year.  This is to be postponed and will now be brought forward for inclusion in next year’s finance bill, the rules becoming operational from 6 April 2013.  We also learn that the concept of ordinary residence is to be largely abolished and it’s effect preserved in connection with certain overseas duties.

A number of measures in this year’s budget have started with consideration by the Office of Tax Simplification – and one of these seems to have backfired on the government. You’re probably aware that the office started off looking at IR35 and redundant tax reliefs.  It then went on to consider small businesses and some it’s recommendations are adopted here including allowing businesses with a turnover below the VAT registration threshold, called ‘Nano’ businesses, to use the cash basis rather than the full GAAP which, in strictness, they should be using.  OTS think that 65% of the smallest businesses, many not using accountancy services, are using this method anyway!

The OTS went on to look at two further areas, issuing initial reports but not final recommendations; one of these concerned employee shares schemes, the other taxation of the elderly. They identified the problem that the tax affairs of elderly people are quite complex, they often have several sources of pensions and income, often dealt with by different districts and, if the taxpayer’s income is below £29,000, they have been entitled to a higher tax allowance when reaching 65 and a higher allowance still on reaching 75, although if their income is just below £29,000 the higher allowance is subject to clawback.

In the meantime the coalition have been pursuing the idea of substantially increasing the normal personal allowance to take increasing numbers of people outside of the scope of IT.  From April 2012, as was announced in 2011, the personal allowance goes up by £630 to £8,105 and to balance this the higher rate threshold is reduced by £630 from £35,000 to £34,370.  This budget provided that next year, from April 2013, the allowance would increase by £1,100 to £9,205, although the higher rate band threshold would reduce by rather more, £2,125, to limit the benefit of the allowance increase to higher rate taxpayers to 25% of what a basic rate taxpayer benefits by.

Now we know that the Lib Dems want to increase the allowance to at least £10,000 and if this allowance eventually exceeded the higher amounts of the age allowance, and of course you can’t have an allowance which is lower that the personal allowance so the age allowance can be done away with then the complexity of the age allowance and the clawback of the additional relief which gives affected taxpayers a marginal rate in excess of 20% could be done away with.

But George has jumped the gun.  Before the OTS makes its final recommendations and before the ordinary personal allowance has caught up with the age allowance George has decided to accelerate its withdrawal – this is the so-called “Granny Tax”.

The age allowance will be restricted now to those who reached the age of 65 before 6 April 1948 and the higher level of the allowance will only be available to those born before 6 April 1938.  It is also going to be frozen, which is the main complaint of the grannies, that in inflation adjusted terms they will be worse off. Although the pension may well be increased next year to compensate those persons who are affected by this ‘granny tax’, the increase in liability of those whose allowance is frozen has been seized upon by the press.  It reminds me of Gordon Brown’s ill-fated attempt to ‘simplify’ the tax system when he controversially eliminated the 10% starting rate for all income other than savings income.

It is made all the worse because George also decided to reduce the 50% rate to 45% on the grounds that the higher rate was counterproductive, it may well be that it is, HMRC figures seem to suggest it, but of course it makes it look as though he is taking from pensioners to transfer to the very wealthy.

In an historical sense this budget will be seen as the one where the government and the revenue finally accepted the need for a General Anti-Avoidance Rule or GAAR; given the number of targeted rules (TAAR) implemented since 2006 when the first one was introduced (concerning capital losses for CT purposes, and was so successful that it was extended a year later to individuals and trusts for CGT purposes) this should enable a significant reduction in the length of taxation legislation and may allow abolition of individual TAARs which now litter the legislation and account for much of the length of recent Finance Acts.

In the past HMRC have been reluctant to introduce this sort of measure, even though it is a potent one in the war against avoidance, because of the need to have a parallel clearance mechanism so that business can achieve certainty before entering into transactions.  It is claimed that Canada – who introduced a GAAR without a clearance mechanism – have suffered as a result.

Graham Aaronson QC, who suggested the GAAR in a report commissioned in last year’s budget, believes that it is possible to have such a rule as a limited GAAR, Sounds like a contradiction in terms which would allow ‘reasonable tax planning’ and so would not require new clearance mechanisms.  It remains to be seen whether it could be effective, as the arbiters of reasonability in the first instance would be – the revenue, although the final decision would be up to the Tribunals and the Courts.

Investors may have a quite unique opportunity in 2012/13 to secure 78% tax relief – it works like this…

Genuine small start-up businesses can use a scheme to raise capital called the Seed Enterprise Investment Scheme or SEIS – this offers investors a tax reducer relief of 50% which they can set against this year or last year’s liability regardless of the rate of tax they actually pay.  But they can do better than this – if they also make gains during the year 2012/13, and they would be advised to do so if they can, these can be matched against the investment into the SEIS and will be exempt from CGT.  Now the ordinary EIS offers 30% relief and deferral of gains, but this is a genuine exemption worth a further 28%.

Middlemen have already started to try to attract investors and match them with suitable small businesses.  It is obviously very high risk but the relief available may make it worthwhile.

Company cars are subject to good news and bad news – lets look at the… good news first.  From April 2013 the current scheme which gives a business 100% relief on the cost of a car which emits less than 100 g/km of CO2 was to come to an end.  It will now be extended to 2015 but at a slightly lower emission limit of 95g/km.

You can still get an Alfa Romeo Mito 1.3 diesel and claim a 100% FYA after April 2013 but if you want an Audi A1 Sportback you’ll need to be quick as it will cease to qualify after April 2013, its emission value is 99g/km – unless the manufacturer improves efficiency even further.

The Bad news? – well there’s rather a lot of it… cars which emit more than 130 g/km but less than 160 g/km will qualify for an 18% WDA until April 2013, but from that time onwards purchasing such a car will give you a writing down allowance of 8% pa only which at the moment only applies to cars with an emission figure in excess of 160 g/km.

In addition between April 2014 and April 2016 several changes are to be made to the company car benefit in kind scheme which will see the benefit in kind, in other words the tax liability, on some vehicles increasing by 25% over this short period, or indeed even more!  If you have a zero emission vehicle, which at the moment has a zero benefit in kind, from April 2015 onwards you will have a 13% benefit and in the following year this will be increased by a further 2% to 15%.  The maximum percentage for company cars is going to go up as well, it is at the moment 35% but will increase to 37%.  From April 2016 onwards you will no longer need to add the extra 3% for a diesel vehicle.

The announced reduction in the rate of corporation tax from 26% down to 24%, where last year we were told that the rate would go down to 25%, was a welcome reduction for larger companies with profits in excess of £300,000, and next year and the year after the rate will go down to 23% and 22% respectively.  But what of the lower 20% rate that applies to profits up to £300,000?  Would that be reduced as well?

The problem is that if this rate is reduced a 40% taxpayer taking a dividend from a company would be liable to a combination of corporation tax and income tax on the dividend which would be less than 40%. This was the mistake made some years ago by Gordon Brown, in reducing the rate to 19%, which he compounded by increasing national insurance so that a self-employed taxpayer was liable at 41% but dividend extraction from a small company attracted a liability of only 39.25%.

In a throwaway comment George indicated that he intended the main rate to fall even further to 20% in the future when there would then be one rate of tax applying to all companies regardless of size and the marginal relief calculation, necessary for profits between £300,000 and £1,500,000 to avoid a large jump in liability would no longer be needed and the complicated Associated Company rules, which were only reformed in last year’s Finance Act would also not be necessary.

In addition to increasing R&D relief further for small and medium sized businesses, a welcome change, he also confirmed the introduction of the idea of a “patent box”.  Originally dreamed up by his predecessor, Alistair Darling, this would mean that profits derived directly or indirectly from the exploitation of patent rights would be charged at an effective rate of 10% from April 2013 onwards and it worth noting here that this is not confined to patent royalties but also the trading profits that manufacturers derive.  As a response to this and the general reduction in CT liabilities Glaxo SmithKline have already announced a half a billion pound investment in UK manufacturing.

The CFC, Controlled Foreign Company, regime is extensively overhauled as announced last year to prevent it falling foul of EU discrimination laws and will only apply where profits are artificially diverted away from the UK by larger companies, rather than applying by default at the moment unless you benefit from an exemption.

A number of VAT anomalies have been removed from 1 October 2012 so that enjoying a hot chicken from your supermarket, drinking sport nutrition drinks, using self-storage facilities, even going to the hairdresser now that self employed stylists will not be able to rent chairs in a salon on an exempt basis could all become more expensive.

When the last government implemented SDLT, Stamp Duty Land Tax, in 2003 a number of bodies suggested they were too hasty in doing so and since then every year has seen further attempts to limit tax losses caused, at least in part, from the revenue’s Stamps Office seemingly not understanding real world property transactions. Of course, before SDLT came in, they were experienced in valuing legal documents but were not required to be aware of other transactions.

Residential properties costing more than £2,000,000 will now be subject to a 7% rate of SDLT and where companies have been used to acquire this sort of residential property there will be a 15% liability on the transfer into the company, because subsequently the shares can be transferred at a much lower Stamp Duty liability of 0.5% or outside the UK with no liability at all – other measures will include charging gains on the sale of property within these offshore companies to CGT and even a version of Vince Cable’s vaunted mansion tax where a company is used as an envelope to avoid liability.

This podcast can only skim the surface of the budget provisions and further information can be obtained from the revenue and treasury websites. There is a 206 page document “Overview of Tax Legislation and Rates” containing details of all of the budgetary changes which can be downloaded from http://www.hmrc.gov.uk/budget2012/ootlar.htm and The Chancellors full budget report, the ‘Red Book’ as it is called is available from http://www.hm-treasury.gov.uk/budget2012_documents.htm

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Categories Uncategorized, Taxation, accountancy

Bonus or Dividends?

February 28, 2012 //
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Bonuses or Dividends?

A not uncommon strategy for small companies is to take a small salary, sometimes one so small that neither tax nor national insurance will be payable and then to distribute the remaining profit as a dividend.  Because the dividend carries a tax credit a basic rate taxpayer will have no liability at all.  Before the late 1990′s there was a link between this tax credit and the corporation tax that the company paid through the medium of ACT, Advance Corporation Tax.  At that time if a company paid a dividend it had to pay this ACT over to the revenue even if it was a loss making company.

 Gordon Brown believed that there was too much abuse by companies and pension funds claiming repayment of the ACT and under some schemes it was artificially inflated. He ended the obligation on the company to pay ACT and substituted, for larger companies, an obligation to pay their CT by instalments.  Tax credits were also no longer to be repayable, for either companies, or pension funds, or even individuals.  This was the source of the allegation that Gordon ‘raided’ the pension funds, he was acting to prevent an abuse, such as that uncovered in the case of the Universities Superannuation Scheme, but pension funds that were not fiddling their tax credit repayments lost out heavily.

However the tax credit survived and is worked out as being 10/90ths of the net dividend paid, equivalent to the basic rate of tax which applies to dividends which is also 10%.

A taxpayer chargeable at 40% will find that the dividend is charged at the lower rate of 32.5% and after deduction of the dividend tax credit is effectively chargeable at 25% of the net dividend received by them.  A taxpayer liable at 50% is charged to tax on their dividends at 42.5% and after the tax credit is deducted is liable to effective tax of 36.1% of the dividend received.

The profits used to pay the dividends are of course taxable in the company’s hands and if it is a small company currently liable at 20% the effective rate for a 40% taxpayer is then 40% of those profits.  For a 50% taxpayer the liability is, of course higher, and the combination of corporation tax at 20% and excess liability at 36.1% is a grand total of 48.88%.

Woe betide a Chancellor like Gordon Brown who lowers the corporation tax rate below 20% because it creates an immediate advantage to dividend payments but…

 Dividends are not chargeable to National Insurance, but salaries and directors’ fees and bonuses can be, which is why this low salary, high dividend strategy is so popular.

Could this all change in the future?  I think the answer is certainly yes, and recent scandals involving government civil servants paying themselves through personal service companies whilst seemingly being immune from the IR35 rules that can deem a person who would have been an employee if the company were not used have not helped.

The simplest weapon would be to take a suggestion that was contained in John Smith’s shadow budget in 1992 – subject close company dividends to National Insurance!  That would put the cat amongst the pigeons and make no mistake and also, of course, it would enable IR35 to be abolished as it would no longer be needed!

This podcast is going to look at a recent case which some commentators have suggested could also be brought to bear against this sort of abuse, the PA Holdings case.  Now PA Holdings is not a low salary, high dividend case, it is a case concerning a National Insurance avoidance scheme marketed by accountants Ernst & Young who employed, at that time, a chap called Jim Yuill who was an acknowledged NIC expert, in fact probably the only one!  The secret behind the scheme which made it feasible was the abolition of ACT.  Companies who wanted to pay dividends before then were obliged to pay ACT, remember, even if they had no profits, but now they didn’t need to!  Jim’s scheme was intended to take a magic wand and wave it over a bonus, turning it into a dividend and hence minimising the income tax liability because of the tax credit and avoiding NIC to boot!

PA Holdings was also a slightly unusual company, a firm of management consultants owned by the employees, today it would be called an example of a ‘John Lewis’ company.  Every employee owned shares and received an average salary for the position that they held.  This policy almost guaranteed a profit at the end of the year which was distributed to all staff by awarding points for the efforts that they put in and distributing the bonus according to the points awarded.  80% of the employees decided to join the new scheme, the remaining 20% opted to continue to receive bonuses directly.

A company was set up in the Channel Islands and the money representing the bonus was used by PA Holdings to purchase shares in this company.  The shares were then awarded to each employee according to the points accrued and then a dividend was paid of the whole of the company’s funds – this would be illegal for a UK company but it was permitted under Channel Island’s laws.  However the Channel Islands company was also for tax purposes controlled and so resident in the United Kingdom so that a tax credit attached to the dividends received.  Then in the following year a new company was established and the process repeated, all over again.

So the employees who joined the scheme received a dividend, and if they were only liable at the basic rate this was effectively tax free, if higher rate taxpayers they had a liability of 25% rather than 40%, then claimed that as a distribution, a dividend, what they received was not liable to NIC either.  Why was this so significant, was it just the abolition of ACT?  No – it was that combined with the decision to lift the upper limit from employer’s NIC – to create what was, in effect, a payroll tax.  Create a tax and somebody will look to see if it can be sidestepped.

The revenue felt that this avoidance of both income tax, because after the tax credit the liability on a dividend was significantly less than the liability on a bonus, and national insurance was unacceptable and so ruled against the workings of the scheme, raising assessments on PA Holdings to recover the tax and national insurance which they thought should have been paid.  PA Holdings appealed and it is believed that there are many other companies who used this scheme or variants of it.

When the case when to the First Tier Tax Tribunal the judge indicated that, in his opinion, there were four questions that needed to be asked:-

 First – was the amount received an emolument, did it represent reward for the work carried out by the recipient?  Earnings within Schedule E as the description of that source was then called from an income tax point of view would be taxable and also be earnings from an NIC perspective.

 Second – was it a distribution, a dividend paid by a company to which the special taxation rules then found in Schedule F, carrying a tax credit to offset against the income tax liability and not chargeable to NIC?

 Thirdly – could it be both?  If so what were the taxation and NIC rules that then applied?

Fourthly, if it was neither, what was it and how should it be taxed, if at all?

The answers to these questions did not require sophisticated analysis or application of anti-avoidance rules such as that evolved in the wake of the Ramsay decision.

Was it remuneration, a reward for work performed?  The answer was clearly yes, and a consequence of that was that the fourth question did not need to be answered.

Was it a dividend, a distribution, and the answer was again yes?  It had been paid in the form of a dividend by the channel islands’ company and to the extent that the distribution exceeded the original capital contributed it was clearly a dividend.

So that brought into play question 3 – how should it be taxed?  It was observed that there was a statutory rule which seemed to govern this situation.  Section 20(2) of the Income and Corporation Tax Act 1988 said ” No distribution which is chargeable under Schedule F shall be chargeable under any other provision of the Income Tax Acts.”  Well that seemed pretty final, from an income tax point of view, as it was a dividend it could only be taxed as a dividend under Schedule F.  However the tribunal pointed out that there was no equivalent rule from an NIC point of view and so NIC was payable.

 It may seem odd that a rule deliberately taxes this income as a dividend and so gives rise to a lower liability but you have to remember that before 1984 there was a tax called investment income surcharge and at that time dividends were taxed more heavily than earned income.  When the surcharge was abolished the legislators seemed to forget to change this rule!

If the decision of the tribunal was allowed to stand PA Holdings would have had an obligation to account for NIC and because of the way it was charged most employees receiving a bonus would already be above the upper limit for NIC contributions or if below it the bonus would take them above their upper limit so that relatively little employees NIC would be payable but, as there was no upper limit for an employer the whole sum would be chargeable to employer’s NIC.  Not surprisingly PA Holdings appealed against this ruling.

From an income tax perspective, however, it meant that employees liable at the basic rate would have no liability on the dividend at all, whereas basic rate tax would have been payable on the bonus, and 40% taxpayers would have a liability of 25% of the bonus received as a dividend rather than a full 40% liability on the bonus.  Not surprising the revenue appealed against this ruling.

The appeal was taken, in the first instance, to the Upper Tier Tax Tribunal who broadly confirmed the decision of the First Tier Tribunal and again both parties appealed to the Court of Appeal who have recently handed down their verdict.  Of the three judges in the Court of Appeal the decision was framed by Lord Justice Moses and the other two judges merely indicated that they agreed with his decision.

Moses has taken a very old-fashioned approach to the problem having stressed that the decision of the first tier determined that in fact this sum represents remuneration.  In his opinion the old case of Salisbury House Estates v Fry in 1930 stresses that the schedules of taxation are mutually exclusive and so if the sum is assessable under Schedule E as remuneration then it cannot be a distribution within Schedule F which was only created in 1965 when corporation tax was created.  He feels that the rule in s20(2) is designed to resolve the situation where a sum which is a distribution is also capable of being taxed in another way as trade profits of a share dealer.

A great result for the revenue but a worrying decision for PA Holdings, but is it also worrying for other taxpayers as well?  I feel it is quite likely that this case will go to the Supreme Court finally and Moses’ decision could well be overturned.  Consider this though, what about the small company where a low salary is taken and the profits which could have been taken as remuneration are taken in the form of a dividend.  Could the arguments in this case apply to create either an NIC liability or possibly both?

From an NIC perspective it is difficult to apply the decision to the situation where a shareholder/director exercises a choice to withdraw profit in dividend form rather than as remuneration and arguably if there could be abuse the IR35 rules limit the scope to avoid liability anyway.

However where a shareholding structure has been designed which gives a shareholding interest to employees which is designed to enable them to take dividends instead of a bonus – sometimes called ‘alphabet’ companies because each employee could hold a different class of shares, and so receive a different bonus there would seem to be a real danger that this would enable the revenue to pursue liability in older cases.

From an income tax point of view it may be much more difficult because of the way in which the law has changed in recent years.  The old-fashioned approach of identifying mutually self-exclusive schedules came to an end in 2005.  The old Schedule E was actually abolished by the Income Tax Earnings and Pension Act of 2003 but initially the old s20(2) survived.  Then in 2005 the Income Tax Trading and Other Income Act completed the process started by the tax law simplification committee of abolishing the remaining old schedules and cases in favour of an approach where the legislation simply describes each type of income.

This 2005 Act inserted a new provision into the 2003 Income Tax Earnings and Pensions Act, section 716A, described in the heading as a ‘Priority Rule for dividends etc of UK companies etc’ says that ‘any income, so far as if falls within Part 2… of this Act and Chapter 3 of Part 4 of the Income Tax Trading and Other Income Act (dividends) is dealt with under Chapter 3 as a dividend.  This seems to suggest two things, the first is that sums are no longer capable of being excluded from charge because they are also potentially taxable in another way, and secondly that the dividend treatment takes priority.   Some commentators have suggested that as dividends fall within Part 7 of the act rather than part 2 a charge could occur but a closer examination of the legislation shows that a sum which is deemed to be income by Part 7 is brought into charge under Part 2 – the dividend would still take priority.

However in 2005 legislation was passed which was designed to attack the alphabet companies referred to above and this provides that a charge can arise in connection with employment related securities where they are issued in connection with tax avoidance.  This suggests that there could be a double liability.  However Dawn Primarolo, then the Paymaster General, made it clear to parliament that this measure was designed to target only “complex, contrived avoidance arrangements that are used, mainly, to disguise cash bonuses“.

For the moment, at least, the dividend extraction strategy of the small company would seem to be unaffected, although the NIC position may still need to be watched carefully.  Attempts to use other methods to disguise bonuses as dividends would seem to effectively counteracted.

But how much longer can or indeed should small companies be permitted by the government to use this strategy of limiting the liability to income tax and avoiding NIC – often totally?

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Categories accountancy, Taxation, Uncategorized

Trusts and Main Residence Relief

January 27, 2012 //
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Trusts and Main Residence Exemption

This podcast completes our look at the rather remarkable exemption for gains arising on the sale by taxpayers of a main residence – we started by examining the nature of the exemption and saw that in recent years a lot of investors have tried to claim the relief but failed to show that the property in question had ever been a residence.

In our last podcast we looked at the election that can be made by taxpayers who own more than one residence and we saw that with careful planning it is possible to use this election to maximise the exemptions available.  Remember though it is critical that that the election is made when available it is the key to allow the significant subsequent variations to be made.

The relief is contained in sections 222 and 223 of the Taxation of Chargeable Gains Act of 1992.  This month I’m going to look at the closely related relief that allows trustees to claim the relief where a beneficiary of the trust occupies a main residence owned by the trustees.  This also permits a considerable amount of tax planning.

First consider a practical example.  Alan bought the house, that he and his wife Anne live in, in 1986 and it has always been in his sole name.   He died in 2003 leaving his estate, including the house, to a trust established to hold the property during his wife’s lifetime which, when she dies, will be divided equally between their children.

In 2012 Anne needs to go into a care home and the trustees decide to sell the house to produce sufficient funds for this purpose.  As Anne does not own the property it is not possible to claim relief under s222 and if this further relief did not exist the gain would be chargeable and would reduce the amount available to buy Anne’s new accommodation.

Section 225 of the Act gives a relief to the trustees so that the gain arising on the sale of the house will be exempt just as if Anne had owned it directly.

The condition is that the dwelling-house has been the only or main residence of a person entitled to occupy it under the terms of the settlement.  The Trust must have been written in such a way to permit the beneficiary’s occupation but this can be a discretionary power – as was decided by the High Court in the case of Sansom & Or v Peay in 1976, sometimes called the Ridge Settlement Trustees case.

It is also possible for a s222(5) election to be made in respect of the property and this is important if the beneficiary has another residence which could also be their main residence – in fact it may be prudent for the trustees to ask the beneficiary to join in making the election in any event to guarantee the relief. Where made in respect of the trust property it must be signed both by the trustees and the beneficiary in question.

The relief is extended by s225A where a private residence is held by personal representatives of a deceased person who sell a house shortly after death to satisfy, for example, the requirements of a will or the payment of debts and the property is occupied by a legatee with a relevant interest accounting for more than 75% of the net proceeds after payment of liabilities, then the gain will also be exempt.

So far it all seems a very logical pair of reliefs but before 2003 many taxpayers had used these provisions to obtain a rather surprising relief.  Let’s suppose a house had been purchased as an investment many years previously and a very large gain had been made.  It was possible, until then, to set up at trust, transfer the property over into the trust and claim a relief called gift relief.  This relief was available to postpone the gain on transfer to the trust if there was a possibility of an Inheritance Tax Liability arising, provided that the value was within the IHT nil rate band, currently £325,000, the relief could be claimed but no tax would actually be payable.

Gift relief operated by reducing the value of the gift, the house,  by the amount of the gain arising at the date of the transfer into the trust and so if the trustees sold the property the final gain that they would make would be the same as if the property had not been put in the trust in the first place.  Here comes the twist – the trustees would then allow, under a discretionary power, one of the taxpayer’s children to occupy the property as THEIR main residence, they would then make the joint election and on sale the WHOLE of the gain would be exempted, not just the gain since the property was placed into the settlement!

From 10 December 2003 onwards trustees cannot claim main residence relief where gift relief had been claimed at any time in respect of the property – does this mean that trusts can no longer be used in main residence tax planning?

No – it doesn’t – the main residence relief is only lost if gift relief was also claimed.  If there is no need to claim gift relief there is then no problem with using a trust – let’s look at some practical examples:

Benny’s son Brad is about to enter his second year at university and must move out of halls of residence into privately rented property.  Benny decides to buy a house that Brad can live in and then, when he leaves university, can then be turned into a buy-to-let investment property.  Simply buying the house will not allow Benny to claim main residence relief as it is not his residence.  Suppose, on purchase, he transfers the property into a trust and allows Brad, under a discretionary power, to occupy it as his main residence, they jointly make the election.  Now on later sale the exemption will be available because gift relief had NOT claimed, and that will include the usual last three years of ownership in any event AND the letting exemption of £40,000 as well!  Provided that the cost of the house does not exceed the IHT threshold there will be no IHT to pay either.

Clearly interesting but here is another – until 1988 every taxpayer could claim a second exempt residence if it was occupied rent free by a dependent relative – today that relief only continues whilst the house is still being occupied by the same dependent relative who occupied in before 1988.

Charles’s mother is 88 and she needs to enter sheltered accommodation which Charles buys and allows her to live in it – on sale, after her death, the gain will be fully chargeable.  However Charles could, like Benny, transfer the property into a trust, allowing his mother to occupy it as a beneficiary and on sale the gain will be fully exempt.  Theoretically there is no limit to the number of dependent relatives that could be housed in this way – except for Inheritance Tax of course.  However if the intended beneficiary can be shown to be disabled the gift into the trust will not trigger a lifetime liability but it will be counted as part of the estate of the disabled person when they die.

Here is another practical example… Danielle obtained a divorce from her husband Dick and the court made an order that she be allowed to live in the property until their children reached the age of majority at which time it should be sold and the proceeds divided between them.  Danielle’s half of the gain will be exempt as it is her main residence but Dick’s share of the gain on sale is unlikely to be covered by the exemption.  There is an extra statutory concession which would allow him to claim the gain as exempt but only if he has no other main residence, and this is not very likely.  However, where the court orders this to be done it is called a Mesher Order and is treated as though a trust arose and as a result of that Dick’s gain will not be chargeable.

Suppose, seeking to avoid unnecessary legal expenses, Danielle and Dick do not obtain a court order?  The gain will be chargeable unless – and you guessed it, unless a trust is used.  Furthermore, as long as this is reasonable provision for Danielle it will not be chargeable when the trust is set up as there is an IHT exemption for settlements made between persons who are, or who have been married – the house here could be valued in the millions and the relief would still be available!

I think we can now see how trusts can be used in connection with property to further maximise our exempt gains but there is a ticking time-bomb here which the unwary may not realise could catch them out.

Suppose Ernie had purchased a property as an investment in 1990 and then in 1999 needed a property to house an elderly dependent relative, Aunt Ethel.  He set up a trust, made Ethel a beneficiary and claimed gift relief which, at the time, was perfectly normal tax planning as outlined above.  However – having claimed gift relief – the main residence relief stops on 10 December 2003 and if that house were to be sold now the gain from 2003 onwards would be chargeable with no last three years and no letting exemption either.  I wonder how many taxpayers realised in 2003 when the relief was taken away that they could lose it by having claimed another relief many, many years previously?

Another example – Fred, a single man in his 60′s lived with and looked after his elderly parents so that his two younger sisters did not have to.  After the death of the parents, who left their estates to be divided equally between the three children, the sisters allowed Fred to continue to live in the property for the next 5 years until he died.  The house was then sold and a substantial gain arose.  The valuer acting on behalf of the executors when Fred’s parents died negotiated a reduced value because Fred was living in it, although not as a tenant with rights of occupation.

Fred’s third of the gain on sale will be exempt and the sisters will be fully chargeable unless…

Unless they executed a deed of variation within two years of the death of the second spouse which altered that person’s will to create a trust for the benefit of the three allowing any one or more of them to occupy the property.  Now Fred’s occupation satisfies the condition and the whole of the gain will be exempt, not just the third that relates to him personally – it will also not alter the IHT payable which would be the same whether the estate was left directly or in trust.

This is a fantastically flexible relief which, if used properly, can save many, many thousands of pounds of CGT liabilities.  Equally if the appropriate conditions are not satisfied the revenue can, of course, deny the relief.  Anyone planning to use the relief should include, in their tax returns, a full explanation of what is being done and it’s commercial reasons to protect the taxpayer from the possibility of discovery assessments in later years if the revenue decide to disagree.

Bear in mind that there will be legal expenses, especially in setting up appropriately worded trusts as discussed here, you may also find that local family solicitors are reluctant to set up these devices.  Once established the running costs should be very low and a tax return only required when the property is sold unless other income arises to the trustees.

This podcast was presented, written and produced by Paul Soper who asserts copyright therein.  The full text of the podcast can be read at my site taxationpodcasts.com.

For further details of podcast production, particularly if you would like me to create them for you, contact me at Paulsoper, all one word, at mac dot com.

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Categories Taxation, Uncategorized

CGT Main Residence Election

January 5, 2012 //
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The Main Residence Election

Last month we looked at the incredibly valuable exemption for taxpayers who own their own home which means that the largest investment made by most taxpayers during their lifetime is exempt from CGT.  However we also saw that it is the gain that is exempted, not the house itself, so there are circumstances in which part of that gain may be chargeable if the house was not occupied as a person’s main residence throughout the whole of the period of ownership.

We also saw that a lot of taxpayers in recent years have tried to claim that a property that they own as an investment has been their residence, but they often fall short by being unable to demonstrate that they have actually resided in the property at some time.

We also saw that it is possible to own more than one residence at the same time – consider our dear Queen’s many residences – and this brings us on to what I’m going to focus on in this podcast – the Main Residence Election which can be one of the most valuable weapons that a wise taxpayer can bring to bear if they own more than one property.

Let’s consider a common situation where this problem arises – husbands and wives and civil partners can only have ONE main residence between them.  Yet when they get married they may each own a residence – what happens then?

Last month we saw that the last three years of ownership is considered to qualify as exempt “in any event” so following marriage the couple could decide to sell one of the two properties and, as long as it didn’t take more than three years for them to sell it, it would still qualify as an exempt gain.

What happens if they decide to retain the properties and occupy both properties as a residence and then sell one of them at a much later date?  On sale you would expect part of the gain to be chargeable as both properties cannot benefit from the exemption at the same time – it would possibly no longer be covered by the exemption – but which one will be exempt and which chargeable and for what periods?

There are two ways to decide which of two properties is the “only or main residence”.  The first is simply fact – which of the two properties was in fact the main residence – that will then give the exempt gain and the other will be chargeable.

Before self assessment came in it was the revenue who could decide which property was to be treated as exempt but it is now a question of fact.

Now comes the interesting bit – the second is that a taxpayer with more than one residence can elect to decide which one, at any point in time, will be treated as the main residence, and this leads to some quite remarkable tax planning opportunities.

The election is found in section 222 subsection 5 of the Taxation of Chargeable Gains Act 1992 and it is worth considering the actual wording…

“So far as it is necessary for the purposes of this section to determine which of 2 or more residences is an individual’s main residence for any period… the individual may conclude that question by notice to an officer of the Board given within 2 years from the beginning of that period but [and this is where it gets really interesting] subject to a right to vary that notice by a further notice to an Officer of the Board as respects any period beginning not earlier than 2 years before the giving of the further notice.”

So two or even more residences can be involved and the revenue have no power to interfere with the giving of the notice or its subsequent variation provided that the original election was made.  It is, of course, necessary to show that the property has been the taxpayer’s residence and as we saw last month this is more than just sleeping in the property occasionally.

But – if we can demonstrate that, then we have these two valuable rights – yes two – and the second is the more important in planning terms but it is conditional on the first.

You cannot vary a notice that has not been given and so the first job is to make the first notice even if you do not think it is necessary – let’s look at an example:

Alan bought the house that his family lives in in 2002 and then, on the 13th of May 2010 bought a seaside cottage in which they planned to spend five or six weeks each year and as many weekends as they could.  It is obvious that the house bought in 2002 is still their main residence IN FACT and so Alan might not think it necessary to make the election under s222(5), probably he won’t even be aware of the fact that he can make the election.

Let’s suppose he didn’t make the election and they sell the cottage in May 2015 realising a gain of £60,000 which he intends to plough back into buying a larger cottage in a more select resort.  That gain will be chargeable and even though he is using the proceeds to buy another house there is no relief available on sale.

But what if he did make the election?

He needs to elect that one of the two properties is the main residence by 12th May 2012 (so that the original notice is WITHIN two years of the second or subsequent property becoming available) because this is the key which unlocks the right to make the subsequent variation.

Having given that notice Alan can now give a notice to the revenue to vary the original notice so that the seaside cottage becomes the main residence, and then he can vary that notice so that the main house becomes the main residence again.

The revenue publish manuals on taxation on their website which give their own interpretation of the legislation and the example which explains how this election works used  to point out that the interval between the two notices could be quite short – in their own example ONE WEEK only – but it would still be sufficient to qualify for the last three years of ownership in any event. http://www.hmrc.gov.uk/manuals/cgmanual/cg64510.htm

So Alan can send two letters to the revenue a week apart making the two variations and then, having owned the seaside cottage for five years three of those years would drop out of account – more than 60% of the gain would now be exempt – a tax saving of £10,080 for the price of two postage stamps!

The variation can be made retrospective by up to two years and so Alan has until May 2017 to give the necessary notices – two years after the property was sold!  This is one of the vary rare instances where elections can be made to vary liability even though the subject of the election is no longer owned.

He could elect for a longer period than one week to be exempt and that would increase the period that would be exempt, given at the right time the whole of the gain could be exempted in this way, although for Alan the optimum might be about 80% of the gain – so four years or so would become exempt out of five as the remaining gain would be covered by his annual exemption which is currently £10,600.

But Alan needs to think about the effect which the election will have on his other residence – the one which is his main residence… by making the election in respect of the cottage the main residence becomes chargeable for a corresponding period.  Now that might not be a problem – after all on sale that will also be entitled to the last three years exemption which could cover that period.

You should also note that this period of three years was originally two years and was extended to three when in earlier years there was a period of property recession and properties were hard to sell, the legislation does give the power to the government to reduce the last three years back to only two years.

This now begs the following question – can a landlord of a buy-to-let property use this election?

The answer is a qualified yes! – the property in question must have been, at some time, a residence for that person, simply staying in it overnight won’t be enough, even five weeks might not be enough as we saw, but it is the quality of using it as a residence which counts, not the length of time, and it will be necessary as well to have adequate evidence of the property having been a residence.

Let’s suppose that Mick and Mary own a main residence which they live in with their family and then Mick inherits a house in another town which is let to an elderly tenant at a reduced rent.  He decides to put this house into the joint names of himself and his wife, this is an exempt disposal because they are married and Mary’s period of ownership will be deemed, by s222(7), to start when Mick inherited the house, so they will be treated as jointly owned throughout the whole period of ownership.

After a year the old lady dies so the property is now available to be occupied as a residence.  Mick and Mary realise the advantage of the property having been their own residence and so they arrange to spend time in it, sufficient for it to be considered another residence, and then give the first notice in respect of their actual main residence.  This must be done within two years of the tenant’s death as it was not available to be a residence until she died and the property became vacant.

Now they can let this property and at the optimum time make the necessary variations in respect of it as a result of which not only will it qualify for the last three years of ownership in any event but it will also, as we saw last time, qualify for the letting exemption of a further £40,000 each!

As the house is jointly owned the notices must be signed by both of them.  There is no special form for this purpose it is sufficient to write a simple letter explaining that it is a notice, or a variation of a notice and signed by the joint owners.

What if you miss the deadline of two years for the first notice?  Remember it applies where there are 2 OR MORE properties involved – each time a further property is acquired [or indeed sold] the right to give the notice is revived and then, once given, can be varied as many times as you choose.

Clearly a buy-to-let landlord cannot simply buy a property, live in it overnight and then claim it as a residence, but with careful planning it is feasible that a person’s affairs could be arranged to gain the benefit of these provisions.

This is also one of the situations where unmarried partners arguably have an advantage over the married or those in civil partnerships as each is then entitled to a separate residence and can have two residences simultaneously, both exempt.

There is also special provision in the act where a property is owned by a trust and occupied as a main residence by the beneficiary of the trust under provisions contained in the trust – in a future podcast I’ll look at some of the many opportunities that arise with trusts and main residences, particularly for dependant relatives and children.

This podcast was presented, written and produced by Paul Soper who asserts copyright therein.  The full text of the podcast can be read at my site taxationpodcasts.com.

For further details of podcast production, particularly if you would like me to create them for you, contact me at Paulsoper, all one word, at mac dot com.

Until next year!… 2012 that is!

Categories Uncategorized

ESC C16 and BVC 17

December 14, 2011 //
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ESC C16 & BVC 17

Hello – I’m Paul Soper and this is an extra edition in the series of Podcasts as usual intended primarily for practitioners – especially small practitioners, but, as ever, if you are a reasonably financially literate taxpayer or an accounting student you should enjoy it too – if enjoy is the right word! You can read the text of this podcast at my website www.Taxationpodcasts all one word.com.

There has been a considerable amount of confusion in the last couple of weeks over changes to two Extra-statutory Concessions – one, BVC17 being withdrawn, and the other ESC C16 being translated into legislation with significant new restrictions being attached.  The concessions came from different government departments and as they are both concerned with the same basic situation it is probably not surprising that this confusion has occurred.

First of all here are a couple of examples of situations where the concessions might be relevant.

John is a computer consultant and has worked for the last 10 years through a company.  He now wishes to retire.  The Company has two £1 shares in issue, both owned by John.  The company has accumulated reserves amounting to £55,000 and all outstanding debts have now been paid.

Fred has a small technology company which he started 10 years ago with a friend, and he has recently accepted a very well paid offer to work for a multinational, one of the conditions of which is that he works exclusively for them.  He wants, with the consent of his friend, to extract the reserves that he has built up in the company, currently amounting to £140,000 in total.  There are 10,000 £1 shares in issue, 8,000 owned by John and 2,000 by the friend. No claim had been made under the Enterprise Investment scheme.

Both John and Fred could appoint a liquidator to bring their companies to an end, and the sums that they extract will be treated as part-disposals from a Capital Gains Tax perspective, both will be entitled to Entrepreneurs’ Relief and these gains will be chargeable at 10%.  The problem is that liquidation does not come cheap – the liquidator assumes a personal liability in the winding up and so must make quite detailed investigations before distributing what is left.  In recent years government estimates of the cost of a straightforward liquidation have been made in the region of £4,000 to £7,500.

But there is an alternative course of action that John and Fred could have used to get the money out of their companies – it is called ESC C16 and is a revenue concession, at the moment, which recognises the cost of liquidation and allows the taxpayer who applies for the relief, provided they give certain assurances to the revenue, to pay a dividend, which would normally be taxable as income, but treat it instead as though it was a liquidators’ distribution which would only be subject to CGT at the Entrepreneurs’ relief rate of 10%.

They have to assure the revenue, amongst other things, that the company is ceasing to trade and will not carry on a business in future, that all outstanding debts have been or will be paid, that the information required by the revenue to determine the outstanding corporation tax liability will be provided and that the shareholders will accept the CGT liability.  Increasingly HMRC have also been asking for assurances that the trade is not going to continue inside another company or group.  Oh – and one more thing – the company must allow itself or present itself to be struck off by the Registrar of Companies under (in the words of the concession) section 652 or 652A of the Companies Act of 1986.

The most recent company legislation is found in the Companies Act of 2006, this became fully operational in late 2008, and the equivalent provisions are sections 1000 and 1003 of this later Act.  The published revenue concession has not been updated for the change in statutory references.

So both John and Fred could use this mechanism, even though Fred’s company has considerably more to distribute, but there is one fly in the ointment.  For John it is not very important as there are only two shares in issue but for Fred it is more of a problem.  C16 depends on the payment of a dividend, and a dividend cannot legally exceed the distributable reserves of the two companies, in John’s case this will leave £2 inside the company, hardly a concern, but in Fred’s case £10,000 – share capital in a limited company is not distributable.  To get this out would have required a formal liquidation – that is until October of 2011.

First let’s consider what would have happened before October to Fred’s money.  He could have walked away from the company leaving £10,000 inside it and it would then have become the property of the Crown under the Bona Vacantia principle, Bona Vacantia is also the name of a department of the Treasury Solicitor’s Office which deals with ownerless property.

Fred could have paid a dividend of the whole of the company’s reserves including the share capital but the excess of £10,000 would have been an illegal dividend and the same Bona Vacantia department would have the right to pursue Fred and his friend for that money on behalf of the Crown.

A couple of years ago the Bona Vacantia department tried to help out by reaching an agreement with the accounting bodies that an amount not exceeding the cost of a straightforward liquidation, which they estimated at £4,000, could be extracted and they would not pursue the Crown’s rights if the company had permission under ESC C16.  This was contained in an extra statutory concession document called BVC17 and available on their website.

At the time they also pointed out that as a result of the Companies Act 2006 there were other courses of action open which would avoid the problem anyway.

Fred couldn’t use BVC17 because his sum exceeded £4,000 but he could make a declaration of solvency under the 2006 Act and reduce his share capital to a figure of less than £4,000 and then apply for C16 approval.  He could apply to have his company reregistered as an unlimited company in which case all of it’s reserves would become distributable – non-distributability is the price paid for limited liability.

Even if he had, in error, walked away from the company and had allowed it to be struck off the 2006 Act allows a company to be resurrected within 6 years (previously 12 months only) and so put this right and legally extract the money.

Bona Vacantia clearly then thought long and hard about the ease with which a legal distribution could be engineered and in October 2011 announced that they were withdrawing the concession BVC17 with immediate effect because it was no longer necessary – as they made clear in a frequently-asked-questions section of their website they were no longer going to pursue these sums on behalf of the Crown regardless of the amount involved, £4,000 or £4,000,000 it didn’t matter.  So good news for Fred.

However the revenue were also thinking about their concession C16 and the necessity to make it a legislative provision because of a House Of Lords decision in the Wilkinson case suggesting that these concessions were not within the revenue’s power except in cases where they had care or management of the tax system.  Recently the Supreme Court have ameliorated this ruling in the Gaines-Cooper case and indicated that concessions can be made if they increase the potential sums accruing to the exchequer.

In December of 2010 HMRC announced that a number of concessions would be made law including C16, however they designed the legislation so that the amount that could be extracted in this way would be limited to £4,000 – coincidentally the same as the BVC17 limit.

Implementation of this was then postponed because of objections made which required reconsideration but on 6 December 2011, at the same time as they released draft legislation for inclusion in Finance Bill 2012, the revenue announced that the legislation of C16 would go ahead but with a limit of £25,000 rather than £4,000 and this would take effect from 1 March 2012 – it was to be introduced by delegated legislation under powers conferred on them a couple of years ago.  If the distribution exceeded £25,000 the WHOLE amount would now be taxed as income not gain.

Now this will cause problems for both John and Fred.  John’s problem is greater than Fred’s because he has less money locked up inside his company and this is the patently unfair aspect of the proposal, it affects smaller taxpayers proportionately greater than it does taxpayers with greater sums to extract.

If John goes ahead after 1 March and extracts the whole of the amount available as a distribution he will be liable to income tax, not CGT at all.  To the extent that he is a basic rate taxpayer this is an advantage as the dividend will carry a tax credit which will extinguish his basic rate tax liability.  However, to the extent that he is a higher rate taxpayer, he will be liable to income tax at a rate of effectively 25% on the amount extracted – a 15% surcharge on top of the CGT liability which would have been further reduced by his annual CGT exemption of £10,600.  He could pay an initial dividend sufficient to bring his reserves down to £25,000 and then proceed using the new rules, but that would still be a 15% surcharge on £30,000 worth of reserves – a cost of £4,500.

In the document explaining what they proposed to do HMRC comment that they believe the cost of a straightforward liquidation to be £7,500 so John would not have the luxury of using a liquidator to extract his money as capital because it would be even more expensive.  If Bona Vacantia are right and the cost is closer to £4,000 (or even less as some commentators have suggested) he is still being required to incur a cost which before March 2012 he would not be required to bear at all.

Fred on the other hand has a much larger sum to deal with but although he is better placed to afford the services of a liquidator he will still be suffering additional expense which before March 2012 he would also not be required to incur but the effect on him is less.

Normally when HMRC legislate for concessions they undertake that the effect of the legislation is not to change the rules and when the draft legislation was put before parliament a year ago that is exactly what parliament was told – but that is clearly not the case.

 This is a fundamental change, and one that affects less well-off taxpayers to a greater extent than richer ones – this cannot be fair can it?

What’s the rationale behind the change?  HMRC claim that C16 was being used for avoidance or even evasion purposes – but a much greater problem according to Richard Murphy of Tax Research UK is companies being struck off without having made any returns or approaches to HMRC at all, a problem he estimates to be costing the Treasury BILLIONS!

HMRC will have the advantage of making this a self-assessment procedure as they will no longer have to consider applications under C16 but surely this will simply lead to more disgruntled taxpayers presenting empty shell companies for striking off and simply walking off with the cash without having paid either CGT or income tax on the distribution?

It is not too late to affect this proposal, write to the revenue pointing out how unfair this is for less well-off taxpayers, write to your MP who may object to the statutory instrument so that parliament has to debate the proposal, register your disapproval using my online petition at epetitions.direct.gov.uk/petitions/25190 – if you make your voice heard it may do some good, if you do not many of your smaller clients will be adversely affected by this proposal when they retire or cease trading.

Is there a solution?  Surely, other than abandoning the proposal, which is not realistic, raising the limit to a point at which the tax surcharge equated with cost of liquidation would be a first step – if the cost of liquidating is £7,500 then that would equal reserves of £75,000 not £25,000, perhaps increasing it to say £100,000 would allow a little extra advantage.

It cannot be to the revenue’s advantage in the long run to encourage yet more taxpayers to extract money and avoid all liability on it because the alternative is to deny them the benefit of a relief, entrepreneurs’ relief, which parliament has already decided should apply to taxpayers with lifetime gains of up to £10million.

This podcast was presented, written and produced by Paul Soper who asserts copyright therein.  The full text of the podcast can be read at my site taxationpodcasts.com. For further details of podcast production, particularly if you would like me to create them for you, contact me at Paulsoper, all one word, at mac dot com.

My next podcast, available next week, continues the examination of the Main Residence Exemption available for home-owners and some, I stress some, landlords.

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Main Residence Exemption and CGT

November 28, 2011 //
0

CGT and the Main Residence Election

Hello – I’m Paul Soper and this is the November 2011 edition in the series of Podcasts focussing on recent developments in Direct Taxation in the UK intended primarily for practitioners – especially small practitioners.  But if you are a reasonably financially literate taxpayer or an accounting student you might enjoy it too – if enjoy is the right word!

You can read the text of this podcast at my website www.Taxationpodcasts all one word.com.

In the last couple of years there have been lots of Tribunal cases concerning the Capital Gains Tax main residence exemption – often being claimed by speculators or buy-to-let landlords trying to claim this enormously valuable exemption on rather shaky grounds.

For taxpayers generally the house they live in if owned or rented on a longer lease is the most costly investment asset they will buy in their lifetime and in most cases on disposal it will be completely exempt from CGT – but larger properties may be partly liable and, if let, there is a second valuable exemption that can be claimed as well.

This is the first of two podcasts where I am going to focus on aspects of this incredibly important exemption, first of all focussing on these recent cases by buy-to-let owners and speculators.  In the second podcast, next month, I’m going to look at a valuable election which anyone who acquires a second or subsequent home should think about making.

How does the basic exemption work?  Note it is not the property which is exempt, it is that part of the gain that relates to a period of exempt occupation which is exempted.

If they did not occupy it as their residence for the whole of the period of ownership the gain exempt is found by time-apportionment of the total gain, although certain periods are exempt in any event, or exempt by concession.  The most significant of these is the last three years of ownership in any event.

If a taxpayer owned a house for 10 years, and for the last five years had let the property, having moved into another larger house, this means that 8 years in total will be exempt out of the 10 years of ownership, five of actual residence plus the last three years, and so 80% of the gain will fall out of account under this relief.

Unfortunately the legislation, which is found in the Taxation of Chargeable Gains Act, dating back to 1992 is far from clear.  When CGT was first created in 1965 there were many defects in the structure of the act and when it was consolidated in 1992 no one tried to correct the problems that poor drafting can bring.  The Act talks about disposals, without defining what a disposal is, by a vendor, without defining who a vendor is, giving rise to a gain, well at least we know how to calculate that (maybe not) and allowing exemptions for businesses (without defining a business) and residences – you’ve guessed it, without defining what residence is.  The legislators thought that all of these terms were so obvious that they did not need a technical definition but over the years case after case exposes the problems that a lack of clear definition can bring.

The basic exemption for the family home is contained in section 222 of the Act, headed “Relief on disposal of private residence” and is actually in two parts.  It exempts “a gain accruing to an individual so far as attributable to the disposal of, or of an interest in

a) a dwelling house or part of a dwelling house which is, or has at any time in his period of ownership been, his only or main residence, or (which here means and/or)

b) land which he has for his own occupation and enjoyment with that residence as its garden or grounds up to the permitted area – this is defined as being an area, inclusive of the site of the dwelling house, of half a hectare, roughly 1.2 acres.

It is two separate reliefs which means that if the house is sold first, the grounds are retained and then sold later the house will be exempt but on disposal the grounds will then be chargeable.

However if the land is sold at the same time as the house, or the grounds are sold first, then the gain will be exempt.  It is important to get this in the right order.

It is possible for an area larger than half a hectare to qualify if ‘the area required for the reasonable enjoyment of the dwelling house’, having regard to it’s size and character, is greater than half a hectare.

A Mr and Mrs Henke sold two houses with individual grounds of 0.54 acres each out of a total area of 2.66 acres – the land sold could not be required for the enjoyment of the property as they were able to sell it!  They had also owned the land for some years before erecting their own house and this could not be exempt until that first house on the plot had been built.

If you are building or acquiring a property the revenue will, by concession, also exempt a period of up to 12 months when the newly acquired property was unavailable because of building works or alterations being carried on.

Mr Longson tried to claim an area of 18.68 acres  on the grounds that he owned horses and rode them on the land.  Given the size of the house the revenue had been prepared to grant relief on 2.61 acres – this was upheld by both the Special Commissioners and the High Court where Judge Evans-Lombe observed “it is not objectively required, ie necessary, to keep horses at a house in order to enjoy it as a residence.”

There is also a relief, referred to as a letting exemption, where the gain arises in respect of property which has been the taxpayer’s only or main residence at any time during the period of ownership and the dwelling house, or any part of it is or has been at any time wholly or partly let as residential accommodation.  This was a measure introduced in the 1970′s originally to encourage people to let empty property and empty rooms that they owned.  The relief is limited to the smallest of three figures – these are – the amount that is exempt as a residence gain, the amount of the gain which relates to the letting, and a maximum of £40,000.  For a husband and wife this means a maximum of £80,000 if the house is jointly owned, as it often will be!

In our earlier example, a property owned for 10 years was 80% exempt but the remaining 20% of the gain will be subject to this further £40,000 exemption.  So it is no surprise that ‘buy-to-let” landlords are attracted to the idea of claiming that they had, at some time, resided in the property as their main residence, in order to benefit from the exemption for the last three years and the further £40,000 of letting exemption.

But what is a residence?

How long do you have to live in a property for it to be considered to be a residence?

Can a buy-to-let landlord also get the main residence exemptions?

And what happens if you have more than one residence?

A residence is, according to the dictionary – a person’s home; the place where someone lives – by itself this suggests at least some degree of permanence, and of course the concept of residence is also encountered in a taxation sense when considering whether a person is resident in the UK – and from those cases there is also the suggestion that it is not just where one sleeps, but where one’s home is.

For the vast majority of taxpayers it is self-evident where they reside and, indeed, may have resided for many, many years.  This is recognised in the legislation which, in addition to the last three years of ownership also permits a further absence or absences from the home, the residence, of up to three years for any reason, permits an absence of up to four years where the individual works in an office or employment elsewhere in the UK or is self employed elsewhere in the UK which reasonably requires him or her to be absent from their residence to be able to perform the duties, and also permits any period of absence where a person has an office or employment outside the UK – note self employment is not a reason for this absence.

Now the word to stress here is absence, and absence implies return.  If a person leaves their residence to work elsewhere in the United Kingdom, but sells the property without having returned to live in it they would not normally be able to take advantage of these further exempt periods.  By concession, however, where the duties of employment prevented a person from returning to occupy the property before sale the relief can still be given.  Unfortunately this does not permit the taxpayer to build up a property empire as the legislation also states that these periods of absence only qualify if you have no other place of residence which could qualify as a main residence.

So – if called to work elsewhere in the UK and you stay in hotels, boarding houses, or rented accommodation that you do not own or have a longer leasehold interest in, the further reliefs can be claimed.  But if it is cheaper to buy a house than rent whilst you are away then these further periods of absence cannot qualify.

In a recent case a Mr Moore and his partner, a Miss Archer, bought a property in December 1999, originally intending to live it, she took a dislike to the property and sold her interest in the property to him and he then sold it in 2004.  On the evidence presented to the tribunal it never became his residence even though allegedly he had stayed in the property whilst carrying out improvements.

A taxpayer called Springthorpe acquired a house, renovated it and claimed to live in it whilst this was being done, but then moved into another house with his new partner and let the former property to students.  Again there was no real evidence that he occupied the property as his residence at this time, his post was addressed to his partner’s property, the utility bills during this period averaged £1.90 per week and although an estate agent confirmed that he had been sleeping in the property – “remember the state of your bedroom… covered in pieces of stripped wallpaper… I commented that in the morning you must look like a paper mache man – there wasn’t an item of clothing or bed-linen unaffected by the mess.”

The Revenue obtained information that during this period no council tax had been paid as the local authority regarded it as uninhabitable.  The Tribunal accepted that Springthorpe stayed overnight in the property but that there was no evidence that it had become his residence.

So – how long do you need to live in a property for it to be regarded as your residence? -

Since 1998 the leading case on this topic is Goodwin v Curtis where a man, in the process of selling another property which was accepted as having been his main residence as part of his marriage breaking down had moved into a farmhouse that he had recently acquired from a company he controlled and which he had already placed on the market.  He moved into it and stayed there for 32 days, a little under 5 weeks – the commissioners rejected this and found that he had not intended to occupy it as his permanent residence and this was upheld, on appeal, by the Court of Appeal.  So living in a property for five weeks is probably not enough.

Mr Favell, in a 2010 case, had intended to acquire a house for his son, although did not transfer it to his son until some four years had elapsed when a gain arose on disposal.  Favell claimed that he had lived in the property for a period of 11 months when separated from his partner.  The revenue were able to show that throughout this period it was his son who was shown in Council Tax records as the occupant and had claimed a 25% reduction as the sole occupant, meanwhile housing benefit had been paid to Favell at his partner’s residence and also to a person who was a tenant in the property sold at the time that Favell claimed he lived it.  There was no evidence that he had moved to the property although the Tribunal ruled that had there been evidence of residence the period of 11 months would have been sufficient to make it a main residence.  So – five weeks is not enough but 11 months certainly is.

In another case at this time a Mr Metcalfe owned three properties, claimed that he moved into one in November 2002, although it was furnished he did not install a phone, did not have a TV license as the TV there ‘did not work’, he sold it four months later, and during that period the only outgoing was for electricity of £39.09 – almost all of it a standing charge. The tribunal ruled the evidence fell short of establishing that it had been his residence and there was no indication of permanence.  Note that the legislation does not, itself, require a degree of permanence, but this factor is regarded, by the courts, as implicit in the concept of residence.

In the most recent case, reported a couple of months ago, a Mr Lowrie had bought a property intending to construct two houses on the site, having obtained planning permission in early 2003.  He bought the property in May 2003, installed his household goods there in June 2003, but lost interest in the property because of his sister’s death in Wales.  The property was advertised for sale with vacant possession in December 2003 and sold on 20 January 2004.  On his own admission he spent most of his time with his sister’s family in Wales.  The revenue quoted the following from the judgment in Curtis v Goodwin that I referred to previously – “the principle is that in order to qualify for the relief a taxpayer must provide evidence that his residence at a property showed some degree of permanence, some degree of continuity or some expectation of continuity.”

Can you occupy a property as a residence without living in it?  Occupy is a legal term which is concerned with rights over property to enter into it.  A Ms Bradley claimed that a house her father gifted to her in 1998 in Preston, Lancashire,was occupied by her as a residence even though she never stayed in it as she went to university in Leeds, Yorkshire, the other side of the Pennines.  After qualifying she took a job as a Newly Qualified Teacher in the Leeds area and then sold the house in Preston.  It had been occupied during term-time, by students.  She had never stayed in it, even when it was vacant during vacations. Ownership, by itself, is not sufficient to establish a property as a residence.

What if you own more than one residence at the same time? (Fanfare) – our own dear Queen has some nine different residences which she, or members of her household occupy, at the same time, from Buckingham Palace and Windsor Castle through to Holyroodhouse in Edinburgh, Balmoral in Aberdeen, and Sandringham in Norfolk where the Royal Family spend each Xmas.

If you have more than one residence there are two ways of exempting them – either claim that you live in job-related living accommodation which is a residence provided to you by your employer, in which case another house can be owned and exempted so long as you merely intend at some future time to occupy it.  Ms Bradley had also tried to claim this but her accommodation as an NQT was not provided by her employer and so the house in Preston could not be exempt under this provision.

In my next podcast in December I am going to look in greater detail at this valuable election where taxpayers do own more than one property which is often overlooked but which may be incredibly valuable if used in the right way.

This podcast was presented, written and produced by Paul Soper who asserts copyright therein.  The full text of the podcast can be read at my site taxationpodcasts.com.

For further details of podcast production, particularly if you would like me to create them for you, contact me at Paulsoper, all one word, at mac dot com.

Until next month…

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Residence – Gaines Cooper and a Statutory Test

October 25, 2011 //
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Residence – Gaines-Cooper and a Statutory Test

Some years ago I produced a couple of podcasts, the first on Residence and Non Residence and the second on Domicile.  They were prompted by the case of Robert Gaines Cooper, an international business man who claimed to have become non-resident in the 1970′s and to have taken domicile in the Seychelles.  This was on the advice of his parents who were both tax inspectors!

Gaines Cooper’s case has just reached the Supreme Court so it is time to look at it again.

The dispute which involves Gaines Cooper is a very protracted one and is a precursor to allegations by the revenue that he had established settlements in which he, or his wife, retained an interest and that he had transferred assets abroad whilst retaining the right to the benefit of the assets transferred.

Where are we now – four years on from the first case?  It was considered that his residence status was a simple fact on which a ruling of the Special Commissioners, who heard that appeal, would be binding unless it could be shown to be absurd following the ruling in Edwards v Bairstow so that no reasonable body of commissioners could have arrived at that decision.

His domicile status was a question of law and further appeal was made, first to the High Court, who found that there were more than 20 different connections which he still enjoyed with the UK so that they considered him to have UK domicile in 2004 and by extrapolation backwards in time to 1992/93, the first year under appeal.  Gaines-Cooper claimed he had taken Seychelles domicile in 1976 and had not subsequently altered it.  Domicile is concerned with allegiance and a taxpayer can only have one domicile in English Law at any point in time – had Gaines Cooper not been domiciled he would only have been liable, even if resident in the UK, on sums brought to the UK under the remittance basis.  Remember from 2008 onwards it is now quite costly to use the remittance basis as those who are not domiciled but have been resident for 7 out of the past 9 tax years must pay £30,000pa for the privilege, and from next April may have to pay £50,000pa if resident for more than 12 out of the previous 14 years.

Gaines Cooper did take an appeal on his domicile to the Court of Appeal but they felt that his counsel was simply rearguing the same issues that had been raised in front of the High Court and dismissed his appeal and refused him the right to appeal to the House of Lords.

In the meantime Gaines Cooper had sought a judicial review of the residence issue and if he could show that he was not resident he would not be caught by the anti-avoidance provisions.  To obtain a judicial review it is necessary to show that there is a matter of public interest, not merely private interest, concerning maladministration or the legitimate expectation that government departments must act fairly.

The High Court initially rejected this application, but he was successful in a later application to the Court of Appeal who then joined his application with another from two other taxpayers, a Mr Davies and a Mr James who were Swansea-based property developers who moved to Belgium (probably to seek to avoid CGT) and began to work full-time for a Belgian company which they established.  Unlike Gaines Cooper they had never appealed to the Commissioners and had no binding determination of fact against them, they had sought their judicial review directly from a determination by the revenue.  Their initial application to the High Court had also been unsuccessful.

Although the reviews were heard at the same time the factual reviews are, or rather were, different, Gaines Cooper claiming that he had left the UK to take up permanent residence abroad; Davies and James originally arguing that they left the UK to take up full time employment overseas – however both claim that the revenue had not properly applied the booklet IR20 which summarises the revenue’s approach to the issue of residence and that the revenue had in fact altered their attitude so that although all of the claimants say that they followed the guidance in the booklet they were denied the tax treatment they sought.

However Davies and James had a further problem, because although they claimed they left the UK to take up duties of a full time employment overseas they now accept as a question of fact that they left the UK to go on holiday in Italy and it was only after the beginning of the tax year that they took up the duties of the employment and so were not employed for a full tax year overseas in that tax year in which the gains arose. This means that their arguments now resemble Gaines Cooper’s rather more, that they had left the UK, like him, to permanently reside for a period overseas.

The Court of Appeal had ruled that taxpayers, and the revenue, could indeed rely on IR20 (subsequently replaced by a revenue document HMRC6 to which one hopes the same comments apply?) but accepted the revenue’s argument that they had not changed their approach to the issue but simply had stopped accepting claims for non-residence on the face of it and had looked at the claims more closely.

The Taxpayers now seek a ruling in their favour from the Supreme Court, however they were only able to convince one judge of the validity of their claim, the other four found for the revenue and in doing so emphasised some very important points for those who seek to leave the UK and become non-resident.

To cease being resident in the UK requires a taxpayer to leave, but the Court of Appeal decided that this meant something slightly different if you were leaving the UK to take up employment – there it simply implies that you get on a plane and go, but that a person seeking, like Gaines Cooper, to permanently cease residence must have a sufficiently distinct break in the pattern of his life to show that he has left the UK, the same word but a very different meaning.  Lord Manse who found for the claimants noted that IR20 did not emphasise this distinction, did not explicitly state that a taxpayer should have this distinct break, and was, in his opinion, therefore misleading - “the primary issue in each appeal is how on a fair reading IR20 would have been reasonably understood by those to whom it was directed.”  However the view of the other four judges was not in the taxpayer’s favour.

They found that the ordinary law, founded on past cases, requires such a break and IR20 should be interpreted in the light of this requirement even though it may not be expressly stated in the booklet.  They also felt that the taxpayers had failed to establish that there had been a change in the way in which the revenue approached the issue, despite taking evidence from leading accountancy firms which pointed towards a change having taken place.

The judgement now makes it clear that where a taxpayer relies on having left the UK there must be a distinct break – something which has been identified quite separately in other cases such as the airline pilots Sheppard and Grace but this is, of course, a binding ruling of the Supreme Court.

The old ‘belt and braces approach’ was to suggest that a taxpayer leaves the UK for at least one complete tax year, does not set foot in the UK at any time and, like Dave Clark the drummer, in his case in 1986 [Reed v Clark], relocates his home outside the UK.  It may be extreme but it should give a greater degree of certainty.

It is probably not a surprise that the revenue now want to introduce a statutory test of residence – remarkable as it may seem the word residence is nowhere defined in statute, hence the very many cases on the subject and, of course, the uncertainty that stems from this.  The revenue would like, it seems, to have an intelligent agent, in computer speak, on their website so that any taxpayer could input their circumstances and have, because it is founded in statute, an authoritative statement of residence status.  The current proposals which were put out to consultation in the summer of 2011 will probably become law from April 2012.  If they do they will sweep away all previous cases in this area and establish statutory certainty, or so it is hoped.

The legislation seeks to identify three classes into which a taxpayer may fall.  The First Class (Class A) are those taxpayers who are conclusively non-resident.  The Second Class (Class B) are those who are conclusively resident.  Where a person satisfies conditions in both classes non-residence takes priority over residence.  There will then be a Third Class (Class C) where they do not fit into either of the first two categories.  Here the revenue approach will be to identify ‘connection factors’ and to look at the number of days spent in the UK.

Let’s look at the First Class – Taxpayers who satisfy any one or more of these conditions will conclusively NOT be resident in the UK.

So Either:

* A person who is not resident in all three preceding years and is present for less than 45 days in the current year.

* Or a person who is resident in one or more of the previous 3 years but present for less than 10 days in the current year.

* Or a person who left the UK for full-time work abroad if they spend less than 90 days in the UK and do not spend more than 20 days working in the UK.

This suggests that visitors can only come for up to 45 days without fear of being classed as resident whereas they could come up to 182 days under the current approach.  Exceeding the 45 day limit will place them in the third class where the number of connection factors will become relevant.

However the 10 day rule for a person who had been resident is helpful as it suggests that it is no longer necessary to take the belt and braces don’t set foot at all approach.

Note also that each year can be taken in isolation rather than over a four year period as applied at present using the 90 day average rule.

The Second Class are those who are, like most of us, conclusively resident in the UK

So – Either

* Present in the UK for more than 182 days in a tax year – no change there…

* Or only has one home and that home is in the UK, or has a number of homes all of which are in the UK

* Or works full-time in the UK for more than 9 months with no more than 25% of the duties outside the UK.

The home condition takes in people like sea farers who leave the UK for several years at a time but who remain technically resident in the UK – at present they would be resident but this could now change…

Clearly you could have a situation where a person has a home in the UK but spends less than 10 days in the UK, satisfying a condition in each Class – this is when non-residence takes priority over residence.

The condition concerning full-time work refers to a period of 9 months which could straddle two different tax years, conceivably the taxpayer might spend 4 months in one year and 5 in the next, at present they would not be resident in either, now they might be resident in both – however…

Where a person arrives in or leaves the UK that year will be subject to statutory split year treatment to prevent it operating unfairly.

Where a taxpayer does not satisfy any of the conditions in the first class, Class A, or the second class, Class B, they fall into the third class – Class C and now it is necessary to identify connection factors.

These are applied in a slightly different way depending on whether you are arriving in the UK or leaving the UK.

For people arriving the connection factors are:

* Having a family resident in the UK

* Accessible accommodation where use is made of it

* Substantive, but not full-time work, employment or self-employment, in the UK

* Presence in the UK for more than 90 days in either of the two preceding years.

For people leaving the UK these factors are also identified together with a fifth:

* Spending more time in the UK than in other countries

Then having determined how many factors apply in a particular case we count the number of days spent in the UK – hence – if arriving in the UK

* Less than 45 days – not resident

* At least 45 days but Less than 90 days – resident if all four of the factors are satisfied

* At least 90 days but Less than 120 days – resident if 3 or more factors are satisfied

* At least 120 days but Less than 183 days – resident if two or more factors are satisfied.

* And of course 183 days or more you are resident anyway.

If you are leaving the UK all five factors come into play:

* Less than 10 days – non-resident of course

* Up to 44 days – resident if you satisfy four or all five factors

* Up to 89 days – resident if you satisfy three or more factors

* Up to 119 days – resident if you satisfy two or more factors and finally

* Up to 182 days – resident if you satisfy one or more factors.

Whilst this should provide greater certainty taxpayers who are not in the first two Classes may find it difficult to manage the permutations of connections and days.

At present if a person leaves the UK and returns within 5 years a liability to CGT arises on the disposal during that period of assets owned when leaving the UK.  It is proposed to extend this to certain sources of investment income, particularly dividends from close companies – companies small enough to be manipulated to obtain a tax advantage – however this will not apply to earnings from employment or self employment.  Surely there is a simple way round this – pay remuneration from the close company rather than a dividend?

The consultation suggested that as only a very small number of people use the remittance basis it may not be necessary to retain a concept of ordinary residence, and this clearly needs further exploration.

You should note that the Gaines Cooper case and the proposals for a statutory residence test do not affect the issue of domicile even though 23 years ago the Law Commission suggested that the UK concept of domicile was so out of date it needed urgent reform.

This podcast was presented, written and produced by Paul Soper who asserts copyright therein.

 For further details of podcast production, particularly if you would like me to create them for you, contact me at Paulsoper@mac.com

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Podcast Two – Residence Updated

October 21, 2011 //
0

Residence and Non-residence – Click Here

Hi – I’m Paul Soper and this is one a series of Podcasts focussing on recent developments in Direct Taxation in the U K intended primarily for practitioners – especially small practitioners.  But you know if you are a reasonably financially literate taxpayer should enjoy it too – if enjoy is the right word!

[This was the second podcast and dealt with the issue of residence in the light of the Gaines-Cooper case - which has just reached the Supreme Court.  In this transcript of the podcast my comments in red update the case in preparation for a later podcast which will look at the Supreme Court Ruling in greater detail and the proposed Statutory Residence test. The podcast has been scripted and will be released very soon.]

The recent case concerning Mr Robert Gaines-Cooper has focussed attention on the quite common ploy of seeking to reduce UK liabilities by ceasing to be resident, ordinarily resident and domiciled in the UK.  It also suggests that a new interpretation of one the fundamental principles of residence is about to emerge [although the revenue would deny this as we shall see - but then changed the law anyway].  This podcast is going to look at the consequences of this case for residence and ordinary residence, the next podcast is going to look at the concept of domicile.

Lets remind ourselves of the concepts that apply here and how they can affect liability to tax – Residence is usually considered in the light of two tests,

• the 183-day test – if you are present in the UK for the greater part of a tax year you are resident

• but where taxpayers tried to avoid the 183 day test by limiting their visits to the UK the courts evolved a second test – the 90 or 91-day test as it is variously called, designed to treat taxpayers as being resident if they spend regular substantial periods in the UK in consecutive tax years – this means maintaining an average of more than 90 days in the UK over any 4 year period

Before 1993 there was a third test – now redundant but perhaps with some relevance still – maintaining a place of abode in the UK and spending as little as 24 hours in the UK.  A Belgian multi-millionaire in the case in the 1930s of De Lowenstein v Sallis spent 36 hours in Southampton because of bad weather whilst crossing the Atlantic by ocean liner and also owned a hunting lodge in the Yorkshire moors – enough to make him resident.

A fourth consideration – rarely mentioned these days – is technical residence – originating in cases concerning master mariners who set off to circumnavigate the globe, taking more than a year, but leaving their families behind.  One modern case which considered this concept concerned the entertainer Dave Clark – he of the Dave Clark 5 – he wanted to avoid a liability on $500,000 worth of song rights he’d sold and so moved to California from 1 April 1977 to 30 April 1978 – not setting foot in the UK.  The House of Lords indicated that technical residence might have applied but didn’t in Dave Clark’s case because he moved his home to California.  I bet he was feeling – [Glad All Over - groan!]

So what difference does it make? – From an income tax perspective a person who is not resident in the UK would normally be liable to tax only on sources of income which originate in the UK, whereas a person who is UK resident is liable on their global sources of income.

There is also a concept of ordinary residence – the place where a person habitually resides – this could be considered over a number of years unless someone intends to permanently change their residence status in which case ordinary residence will change as well.  Where a person is ordinarily resident in the UK they remain liable to CGT even though they may not be resident and so no longer liable to tax on overseas income.  You need to watch out for a rule which says that even if you leave the UK and become not ordinarily resident – so avoiding a CGT liability, if you return back to UK within 5 years the assets you owned at the date of ceasing to be resident remain chargeable to CGT.

Robert Gaines-Cooper is a multi-millionaire with business interests spread across the globe.  By his own reckoning he has established some 100 or so businesses in different parts of the world building on the initial success he had in the late 50’s and early 60’s importing juke boxes into the UK.  From here he got involved in a company called MAM, an early music industry conglomerate, becoming one of their directors.  In 1973 he visited the Seychelles for the first time (seagulls sound effect) and fell in love with the place.  He applied for and obtained residence status there in 1976 and on the advice of his parents, who were both tax inspectors, registered himself as not being UK resident.

The Seychelles government wanted new industries and Gaines-Cooper established a plastics factory there, although later nationalised, it was subsequently returned back to him and today manufactures plastic surgical masks.

He purchased an estate in the Seychelles ( seagulls again!) and planted a Coco de Mer tree in the garden of the property

His first wife was Indonesian but following their divorce he married a senior employee of his business empire, a girl born in the Seychelles whom he had known for many years.  She is younger than him and in 1998 they had a son.  He may have fallen in love with the Seychelles but she is, it seems, in love with England, she lives here, has permanent residence status and has applied for British Nationality, their son is on the list to be educated at Eton and Gaines-Cooper has paid his fees in advance.

The case is, in fact, only a preliminary hearing in front of the Commissioners to establish whether Gaines-Cooper is, as the revenue allege, resident, ordinarily resident and domiciled in the UK for the years from 1992/93 onwards.  The main action, not yet commenced, will then focus on his potential liability under two anti-avoidance provisions – s739 – the provisions that apply where a taxpayer transfers assets abroad and s660A (now s617 ITTOIA) where as a settlor of a trust you retain an interest in it, either personally or through your spouse or civil partner.

S739 applies where a person who is ordinarily resident in the UK transfers assets abroad so that the income is received by a person who is not-resident or not domiciled in the UK so placing it beyond the territorial reach of the UK tax authorities.  It was introduced as a reaction to a case where the Vestey family had placed their wealth in a trust which made the governor of the Cayman Islands their principal beneficiary.  He received the income and every year made gifts, which were not assessable as income, back to the family.  The House of Lords held that it was not a sham.

Both s739 and s660A create a self-assessment obligation to return the income under the self-assessment regime where they apply.

Gaines-Cooper, like a lot of taxpayers seeks to rely here on the revenue’s booklet IR20.  Residence and ordinary residence is not defined in statute – it is derived from dozens and dozens of cases over the years from 1873 onwards, and a significant number of these cases date back to the 20’s and 30’s following the introduction of higher rates of tax, at that time called Super Tax.

IR20 seeks to establish a consensus of the law as it applied to residents and non-residents and as a guide for the revenue, practitioners and taxpayers alike is normally referred to by the Commissioners as a reasonable statement of the legal position.

However in attempting to rely upon it there are problems – it was last updated in 1999 so is now some 8 years out of date. [Since this podcast was written the revenue created a new resource called HMRC6 to replace IR20 and may introduce a statutory definition of residence from April 2012 onwards]  It also indicates that it is no more than general guidance and stresses that  “a concession will not be given in any case where an attempt is made to use it for tax avoidance”

As with many taxpayers in a similar situation Gaines-Cooper is relying on the so-called 91 day rule to show that he is not resident in the UK and in doing so he relies on a concession in IR20 which says that in counting these days, those of arrival and departure may be ignored.

Reasonable enough in the 1920’s perhaps when travelling would take the better part of a day or more – but in the 21st century?  Gaines-Cooper would claim that if he comes to the UK on a Tuesday and leaves on the Wednesday that by this principle he has spent no time in the UK at all.  The revenue argue that it is more realistic to look at the nights spent in the UK.  The commissioners said “we are of the view that the revenue’s figures are to be preferred”.  In fact he spent more time in the UK, even on his own count, than he spent in the Seychelles where he claimed to reside, although much time was spent in other parts of the world too.

Gaines-Cooper admits that he was resident in 1992/93, the first year under appeal, because of the place of abode rule that we talked about earlier, which was then abolished.

The Commissioners accept, in accordance with the Lysaght case of 1928, that residence means “to dwell permanently or for a considerable time, to have one’s settled or usual abode, to live in or at a particular place.”  A person can reside in two places simultaneously – in fact that is what Double Tax Agreements are for – and if one of those places is the UK he is chargeable here.  There is a difference they said, between the case where a British Subject has established residence in the UK and then has absences from it, and the case where a person has never been resident in the UK at all.  The presence of Mr Gaines-Cooper was not for a temporary purpose and they found him to be resident from 1993/94 onwards – he had never ‘left’ the UK.

Turning to ordinary residence, Gaines-Cooper claimed that he could not be ordinarily resident in a year when he was not resident in the UK, but as they found that he was resident, and in accordance with precedent, ordinary residence means residence in a place with a degree of continuity as part of normal and everyday life,  the commissioners said “…his residence here was continuous in the sense that it continued from year to year… it was ordinary and a part of his everyday life bearing in mind that his everyday life was far from ordinary. He would still be ordinarily resident in the UK even if there was an occasional year when he was not resident here”.

It’s a pity that the case failed to examine the notes to SA109, the supplementary pages to the self-assessment return to be completed by a person who claims not to be resident, or not to be ordinarily resident, or not to be domiciled in the UK, where not being domiciled makes a difference to one’s income tax or CGT liability. In a series of questions designed to help a taxpayer self-determine their status,  Q7 asks if the taxpayer is resident in a particular year, if the answer is “no” it states that the person is NOT ordinarily resident!  It is contradicted by later tables in the same document that indicate that it is possible not to be resident but to remain ordinarily resident.  No-one has yet sought to establish whether the revenue might be bound by the conclusion drawn from the answer to this question.  [When the tax return was redesigned in 2009 this controversial question was quietly dropped in favour of an approach which simply describes what is thought to be meant by residence and ordinary residence]

Now does this case undermine the 91-day rule as set out in IR20?  Immediately after the case a number of commentators thought that it did – and the comments of commissioners indicating that they preferred the revenue approach of counting nights spent in the UK seems to point in that direction.

However revenue and customs have subsequently issued a statement in the wake of this case which indicates that in their opinion the commissioners found that Gaines-Cooper had never left the UK in the first place.  They say that the 91 day rule is relevant to two sorts of taxpayer described in the booklet in Chapter 2 – leaving the UK and Chapter 3 – temporary visits to the UK.  They will continue to apply the 91 day rule as set out in IR20, including ignoring days of arrival and departure, but it will be necessary before that to determine, given the facts of a case, whether a taxpayer has left the UK.  [Since the podacst was written the law has now changed and 'day-counting' IS now based on nights spent in the UK unless the taxpayer is simply in transit from one part of the world to another]

Before 1993 it was considered essential, for all purposes other than employment income, that if a taxpayer wanted to secure non-resident status they should spend at least one complete tax year outside the UK, relocating their residence as well, and not setting foot in the UK at all.

When the residence rule concerning a place of abode came to an end in 1993 it seems that many people , presumably including Gaines-Cooper, assumed that it would be sufficient to merely limit the time spent in the UK – this case clearly indicates that that is not sufficient – the complete year abroad may still be essential to establish non-residence after which the visits to the UK can recommence on a limited basis – it would certainly be very desirable.

[Gaines-Cooper subsequently tried to take a judicial review of the residence issue to the High Court.  This is because it was question of fact not one of law and so a normal appeal could not be made.  The High Court declined to hear the application but he then made an application to the Court of Appeal who agreed to hear the application together with a request for a judicial review by two taxpayers who had not previously gone through the appeal system.  As we shall see the Court of Appeal decided in favour of the revenue and the Supreme Court have confirmed this in a decision handed down on October 18th 2011.]

This podcast was presented, written and produced by Paul Soper who asserts copyright therein.  Some accompanying illustrations are taken from Revenue publications and are crown copyright.  I’m sorry I couldn’t treat you to one of the Dave Clark 5’s hits but you can access these on www.Daveclarkfive.com – but I warn you it is very loud!

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Categories Taxation, Uncategorized

Archived Podcasts

September 30, 2011 //
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I have been talking to Apple today about changes they are proposing to implement over the next year which includes the withdrawal of the web.me.com service which I currently use for posting podcasts online.  This has already had the effect that some of my earlier podcasts are no longer available, although, of course, they did not notify me directly.

In the near future I shall investigate making my podcasts, both current and past (where they are still relevant) available here through the single portal Taxationpodcasts.com.  As a result they will probably change to an audio alone format as the accompanying slides will still be available through iTunes, whilst that facility continues and, of course, the full text of the podcast, with all of the examples, will be found here anyway.  I shall experiment with the older podcasts first and if successful I will then make them all available in this way.  In doing so I’ll update them where necessary.


This has now been done with the second podcastand the others will follow shortly.

Watch out for further announcements very soon.

Categories Taxation, Uncategorized
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