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Main Residence Problem?

April 15, 2013 //
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Main Residence Problem?

After a winter break we’re going to look at recent developments we ought to be aware of.  The first of these relates back to an earlier podcast in November 2011 when I looked at the very important main residence relief for capital gains tax purposes.

It is noticeable that over the last few years the revenue have been looking at taxpayers trying to claim the benefit of this exemption and challenging their entitlement.  In many of these cases it is quite clear that the taxpayer had never genuinely occupied the property as a residence and so the revenue were quite right to deny the relief.

However in one recent case it seems that a taxpayer who, I believe, should have been given the benefit of the relief was denied it – and that is a worrying development.

In the earlier podcast  I explained that to be able to claim that a property is your residence you need to reside in it, obviously enough and also pointed out that the courts often looked at a comment made by the judge in the Curtis v Goodwin case which is one of the most significant judgements in this area – the judge commented – “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.”

That podcast looked at the position of two taxpayers, a Mr Favell and a Mr Metcalfe, both of whom had signally failed to show that they had resided in the properties in respect of which claims were being made by them.  Favell claimed that he had separated from his partner and so moved into another property that he owned for a period of eleven months.

Although the tribunal judge was quite happy that eleven months was a sufficient period of time to constitute a residence there was no evidence that Favell had genuinely lived there – the claim was rejected.

Metcalfe claimed to have bought a flat ‘off-plan’ which he sold 4 months later – he claimed that his girlfriend didn’t like the property and although he moved in he sold it shortly afterwards having already placed the property on the market.  Again there was little evidence that he had ever occupied the property as his residence, he had no phone connection, no TV license either and the utility bills were suspiciously low.

Neither Favell nor Metcalfe made the election discussed in my December 2011 podcast to determine which property was the main residence, so the Tribunal had to judge whether a property was the main or only residence in fact.

Now we come to the recent case which concerns a woman called Susan Bradley [Bradley v HMRC – http://tinyurl.com/cpwnay8].  Be careful not to confuse this with an earlier case reported in January 2011 concerning a woman called Alexandra Bradley – no relative I think – who I also referred to in the earlier podcast.

Susan was married but the relationship with her husband was getting worse and so in August 2007 she decided to leave him and seek a divorce after two years separation.  She owned, in her own right, two properties, one a semi-detached house in Exning Road and another small flat in Weston Way, both were normally let.  At the time she decided to leave her husband the Weston way property was vacant and so she moved into it.

Bear in mind she has moved from a marital home into a property which the tribunal judge described as “a small bedsit-type flat”.

The evidence presented to the tribunal was partly through a personal appearance by Mrs Bradley who was represented by her accountants, a revenue officer called Mr Hall and a bundle of agreed documents.  It is not clear from the Tribunal report whether legal representations were made on behalf of Mrs Bradley but the lack of any reference to them suggests that the evidence presented may have related solely to Mrs Bradley’s condition at the time of the events.

She was suffering from depression which required medical treatment and as a result, it was claimed, did not change her mailing address although she did claim single person discount for council tax purposes.  Her 16 year-old daughter, who continued to live with the husband brought her post over to her.  She continued to have a joint account with her husband but also had two bank accounts of her own which she used on a daily basis, one being used for the property business, the other her own personal money.

Then the Exning Road property became vacant and she decided to move into it – not surprising given that she was living in a ‘bed-sit’ – but made her fundamental and fatal mistake.  Although she moved into the property in April 2008 a couple of weeks earlier, on 20 March 2008 she had instructed estate agents to sell Exning Road.  No offers were received at that time, she continued to live in the property, and, said the Tribunal Judge  “even though Mrs Bradley told us that she was resigned to living permanently at Exning Road”, she never took the property off the market.  She redecorated the property at this time to make it ‘more a home’ as having been tenanted it was in poor decorative condition.

During the autumn of 2008 she became reconciled with her husband and she moved back to live with him in November of 2008.

The Tribunal Judge adds, without further detail, that Exning Road was then sold in January 2009.

Now it strikes me that we have an extended period of residing (for that is surely what, on the scant evidence quoted by the Tribunal Judge we have) in both the Weston Way property (from August 2007 to April 2008) and the Exning Road property (from April 2008 to November 2008) when compared to the bare 5 weeks of residence that was held insufficient in the Curtis v Goodwin case.

However the Tribunal Judge decides that Mrs Bradley did not intend to reside at Exning Road with a sufficient degree of permanence because it remained on the market and was, eventually, sold.  In this he claims to be supported by the Metcalfe case where there is, to be frank, no evidence that Metcalfe really did reside in the property at all, given the very low utility bills.

Now let us consider again what the judge said in Curtis v Goodwin – there needs to be “some degree of permanence, some degree of continuity or some expectation of continuity”.

Now even if there is, on the facts as determined with the benefit of hindsight, no degree of permanence, the judgement in that case refers to “some degree” of permanence and, perhaps more significantly, “some degree of continuity”.  It seems from the evdence that having moved into the Exning Road property she did not stay elsewhere on occasion, she stayed continuously at that address, and on her own evidence which the Tribunal Judge evidently accepted, she was “resigned to live permanently at Exning Road” which would seem clearly to comply with the required “expectation of continuity”.

It would seem that the only factor that prevented the property qualifying was the mistake of having placed the property on the market and not having then instructed the estate agent to take the property off the market again when it seemed clear it would not sell, no offers having been received.  Had the property not been placed on the market at all would the Tribunal Judge have come to the same conclusion?

Does this mean that whenever a taxpayer places the house that they live in on the market on a speculative basis it ceases to be their residence?  Surely not.

It seems to me that Nicholas Alexsander, the Tribunal Judge, has erred in law in placing too great an emphasis on the word permanence and far too little on the word ‘degree’; in seeming to ignore the concept of continuity, although it seemed clearly to be present, and the expectation of some degree of continuity. He stated “it was always only ever going to be a temporary home, and therefore it was never her residence” – but surely a temporary home may still be a residence, particularly if the taxpayer has no other residence – where did Susan Bradley reside after she had separated from her husband?  A separation that lasted for more than a year and which the Tribunal Judge accepted as being itself likely to prove permanent.

The Tribunal Judge in the Favell case, Guy Brannan, pointed out that the facts in the Curtis v Goodwin case were extreme, that the 5 week occupation of the property was merely temporary, in the words of Lord Justice Millett – a ‘stop gap’.  That is hardly the case here.  Had Favell been able to show occupation of the property for the 11 month period he would, he said, “have been minded to accept that the occupation would have amounted to residence” even though Favell admitted, in evidence produced by the revenue, that he claimed to have moved out without any intention that it should be a permanent move, he moved out because of “difficulties at home”.

I do not know whether the taxpayer will wish to appeal to the Upper Tier, I hope she does as this seems to me to be the wrong decision.  Of course the Tribunal Judge’s summary does not indicate all that transpired or indeed all of the evidence that was presented, but if allowed to stand it moves the boundary of what may be considered to be or not to be accepted as  ‘residence’ a very long way from the ‘stop-gap’ referred to by Millett, and creates a degree of concern for any taxpayer who wishes to move, when appropriate, from property to property, to ascend the property ladder.

This podcast was presented, written and produced by Paul Soper who asserts copyright therein.  The full text of this 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, or maybe even sooner!…

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Categories accountancy, Taxation, Uncategorized

RTI, Employers and the inevitability of penalties

March 14, 2013 //
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RTI, Employers and the inevitability of penalties.

Categories accountancy, humour, Taxation, Uncategorized

ESC A19 – What about the Vulnerable?

July 31, 2012 //
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A19 – What about the vulnerable?

Not every taxpayer is professionally represented and I’d like us to spare a thought for one particular group of taxpayers who might be characterised as being vulnerable.

A proposal is being consulted on by HMRC at present which could massively disadvantage these vulnerable people under the guise of making an existing extra-statutory concession more ‘user-friendly’ – the reality is likely to be the opposite for the vulnerable.

The concession is the one known as A19 and it rose to particular prominence a couple of years ago when HMRC were first able to reconcile taxpayer records and discovered that many people, hundreds of thousands, had paid too little tax.

Newspapers led a campaign encouraging taxpayers to take advantage of this extra-statutory concession – whether they were entitled to benefit from it or not – and this is where the problem started.

A19 says, in a nutshell, that if HMRC have failed to make timely use of information provided to them, and they then try to recover tax more than a year later from taxpayers who have reason to believe that their tax affairs are in order – then there is a discretion under which the tax due is not collected.

Now in some ways the most significant part of that is the bit about belief that your affairs are in order – if you are professionally represented and you have paid too little tax you cannot really try to claim the benefit of this provision that’s why practitioners would rarely see it unless approached by a taxpayer with substantial tax demands.

However a vulnerable taxpayer is much more likely, because of their disadvantage, to have that belief and so be able to benefit from this provision – so who might we consider to be vulnerable?

One group, obviously, would be the elderly, another perhaps those who have been recently widowed where the deceased spouse may have had sole responsibility for dealing with financial matters.  Another would be those members of our society who suffer from learning disabilities of all kinds, or those suffering from a mental or physical incapacity, whether permanent or because of illness.

So what do HMRC propose and why is it a problem – and what should we, as tax professionals do about it?

They intend to remove the requirement for reasonable belief and replace it with a more objective test which recognises revenue and taxpayer responsibilities instead.

The responsibilities undertaken by HMRC are no more than what they already do, or should do, but taxpayers are expected to take an interest in and have certain responsibilities for their own taxation affairs – and it is here that the major disadvantage for the vulnerable is introduced as there is no discretion left for those who are not easily able to be involved in their own affairs.

At present the reasonable belief discretion can be applied subjectively based on the taxpayer’s personal circumstances but this cannot be done where there are objective responsibilities.

However the problems with the new proposed A19 don’t stop there.  The revenue propose time limits so that a taxpayer is expected to inform HMRC of the problem, following the issue of a P800 tax statement, within the same tax year, before the new coding is applied to collect the underpayment in the following year.

Now whilst convenient for the revenue administratively, the example they give is of a taxpayer who is issued with a statement in June and is expected to advise HMRC of the problem before the following April – seems reasonable – however as they themselves point out these documents are issued throughout the whole of the year and if one is issued in March a taxpayer may have only days to react.

Furthermore the vulnerable may not appreciate the document’s significance until the tax deduction commences in the following year, under the new rules this is too late and would deny that person the benefit of the concession.

Although the original A19 operated where at least a year’s delay in using information had occurred it also provided for exceptional circumstances and in one recent case concerning a Mr Clark the Tribunal judge observed that he had received 14 separate coding notices which were confusing and difficult to understand – even though he had been notified within the same year the Tribunal judge ruled that exceptional circumstances could be considered in isolation from the one year rule .

The new ESC A19 proposes to remove the provision concerning exceptional circumstances altogether and clearly vulnerable taxpayers will be hit by this as well.

It further proposes not to apply to CGT on the reasoning that this is operated through self assessment but it does not recognise that non self assessment taxpayers might attempt to advise HMRC of a gain, as happened in a case concerning an elderly married couple, the Henkes, some years ago.  They filled in repayment claim forms R40 and attempted on this form to notify the revenue – at that time the form R40 advised that if there was a gain to report the revenue would send a form R40(CG) – although this had ceased to exist with the introduction of self assessment.

The local district sent them a self assessment capital gains form SA108 as a standalone document which was not acceptable unless accompanied by a return.  The tribunal ruled with reluctance that no return had been made so that a discovery assessment could be raised.  But this would be a situation where revenue discretion could be applied – not any longer!

Practitioners may not feel that this is very relevant to them but in the interests of the vulnerable I think we should ALL of us take part in this consultation and make it clear to the revenue  how unacceptable it is not to make adequate provision for the vulnerable – because the vulnerable will not be able to make these representations themselves.

Mind you this isn’t the only mean-spirited announcement by the revenue recently – they have just announced the interest rates that may be applied to Save As You Earn Share Option Schemes – these used to be a very popular way of employees saving with a tax-free return that was in total better than a PEP or an ISA which could be used, if the employee chose, to take up share options which employers could issue at a discount of up to 20%.  It was risk-free because if the shares went down in value there was no obligation to take up the options simply benefit from the tax-free savings rate.

For some time now shorter term contracts – those for three years and five years  – offered a zero return but the seven year contract offered a bonus of 1.6 times a monthly payment, equivalent to an interest rate of 0.58% – from 1 August 2012 this becomes – ZERO as well.

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Categories accountancy, Taxation, Uncategorized

Olympic Torches and Taxation – Trading or not?

July 2, 2012 //
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Olympic Torches, Taxation and more

I have recently set up a separate blog at taxationpodcastmusings.wordpress.com and intended to record some slightly lighter-hearted points there – I recently added one concerning Olympic Torches and their taxability – but on reflection this raises one of those perennial subjects in taxation – whether an activity is or is not a trade.

Firstly lets remind ourselves about the Torch Story…

8,000 people are taking part in the flame relay, some are celebrities, some connected with olympic sponsors but many ordinary people chosen though schemes like that established by Lloyds Bank.

After their part of the relay the person selected can keep the torch and tracksuit on making a payment of £215 which is roughly half, so we are told, the actual cost of the torches themselves.  Now some will keep the torch as a souvenir but many have already found their way onto the online auction sites.

HMRC decided to get in the act by issuing a press notice pointing out that the torch is a chattel – tangible moveable property – the significance of this being that if sold for more than £6,000 a capital gains tax liability might arise.  They also pointed out that online traders and others might have an income tax liability even if sold for less than the chattel exemption.

An argument which HMRC do not explore is that if the torch could be said to be machinery then it would be deemed to be a wasting asset and so would be exempt, unless used in a business, regardless of what it was sold for.  The torch does convert gas into a flame thereby providing illumination which should satisfy at least some definitions of what a machine is.

At the moment there doesn’t seem to be much chance of a CGT liability as the market price on eBay seems to be about £3,000 although some vendors are holding out for more!

A number of people have raised a question though – is it possible that a person who buys their own torch because they immediately plan to sell it on is trading and so would be chargeable to income tax on the profit?  Trading as a concept in tax law includes not only the obvious act of regularly buying and selling goods but also can be a one-off transaction, or ‘an adventure in the nature of trade’.  Lawyers look at what are called the ‘badges of trade’ in trying to decide whether such a liability is likely to exist – these are concepts derived from many taxation cases that have been considered in the past – one problem is that they often refer to circumstances that arose many years ago.

One case that is often advanced by HMRC in arguing that an ‘adventure in the nature of trade’ has been conducted in the Rutledge case.  This case, heard in the 1930’s, concerned a man who supposedly bought and then resold 1 million toilet rolls, the courts concluding that this was an adventure in the nature of trade as the subject matter of the transaction was such that a purchase and resale of household goods, unless surplus to personal requirements, could only be explained as an ‘adventure in the nature of trade’.  There is a suggestion that the toilet rolls never existed, that they were a convenient fiction to conceal the real, and illegal, nature of the goods that were being traded in!

A Royal Commission looked at the nature of trading some 40 years ago but even their conclusions – the so called badges of trade, have been expanded and altered over the years.  One problem was applying them to new types of transactions – for example – property development, in the UK before the second world war this was normally a process of expansion as cities grew and developers bought farming land and constructed suburban housing estates – usually clearly trading.

With the advent of the second world war large parts of our inner cities were destroyed and needed post-war rebuilding, but when this process had been largely completed developers didn’t go back to expanding the suburbs, planning laws and the green belt movement ruled this out.  Instead they looked to acquire city centre sites, assembling a larger site from many smaller ones and REdeveloped – often changing the use of the land from residential to commercial and making substantial fortunes in the process.  Harry Hyams who developed the Centre Point Tower in Central London specialised in keeping property empty on the grounds that that building value was a function of rental yield and future rental values would be make the building worth more empty than immediately selling the building on – was this trading?

In the 1970’s and 1980’s the courts considered this problem in the cases of Taylor v Good and Marson v Morton.

Taylor v Good in 1974 concerned a greengrocer who purchased a large landed estate at auction in 1959 before post-war building controls were removed – he had grown up in the house as his parents were servants on the estate – he then, claiming that he wanted to occupy the property as his residence, applied for and obtained planning permission to convert the estate into 93 individual dwelling units.  Before carrying out this programme he sold the property to an established developer for a very substantial sum as the restrictions had then been lifted.   The courts applied the traditional badges and concluded that his motive had been to live in the property until he received an offer he couldn’t refuse – if he formed an intention to trade it was when the offer was received and this would cause the special rule on appropriation to be invoked.  If you acquire an asset for a non-trading purpose and then decide to bring it into a trade it is ‘appropriated’ at it’s current market value not the original cost, this would be a deemed disposal for CGT purposes and probably the greatest part of the increase in value would have been taxed as a gain.

The courts were looking at a type of transaction that was quite new and the existing badges could be made to fit, but only with a struggle.  Marson v Morton in 1986 concerned four brothers who bought a plot of land on the advice of a property developer – they were told “it would be a good thing” and sold it three months later. After repaying the overdraft they used to finance they acquisition they had doubled their money in this short period of time.  One of them admitted that they purchased the land as a ‘speculation’ although another claimed that they intended to keep it as an investment – even though it would not produce any income and could only generate a profit by sale and it was financed by short-term borrowing.

The court in this case decided to restate the ‘badges of trade’ to make them relevant to property transactions of this type and added factors such as the method of financing, and previous expertise in a particular type of transaction.  Notwithstanding this the commissioners found as a fact that the land was bought as an investment and the High Court found that they could not disturb this finding, the speculation was not an adventure in the way of trade.

A runner in the torch relay, particularly if a sponsored one, did not acquire the torch as an adventure in the nature of trade and if they formed an opinion that they did wish to sell it even this would probably not be an adventure in the nature of trade.  Even if it were the torch would be appropriated at current market value, presumably close to what it was eventually sold for.  Of course if a trader purchased a torch from a participant and then sold it on that would almost certainly be a trading transaction, but they would pay a lot more than £215 to acquire the torch – one would hope!

But this question, whether a trade is being carried on or not, can be relevant in other areas – consider a case earlier this year concerning a tax-avoidance scheme based upon film exploitation – Eclipse Film Partners LLP no 35 v HMRC.  The idea behind the scheme was that a syndicate of investors would borrow a substantial sum of money by way of loan and that these funds were to be used to acquire, for a very short period, the rights to distribute two films made by the Disney Corporation.  The rights would then be sold back again although if the films were very, very successful further profits might accrue.  The two films were called Enchanted and Underdog.

On 3 April 2007 the rights to the films were acquired for sums close to £790 million and then leased back again to Disney for £784 million.  The members had injected £50 million into the scheme but the bulk of the finance was provided by those diamond bankers – Barclays – on loan terms which would be repaid out of the proceeds, no member would be liable to pay any part of the loan back. As part of the agreement a substantial sum of interest was “prepaid” with the intention that the film partnership members should obtain interest relief to offset against their income for 2006/07 – in effect the £50 million they injected was to be turned into a tax deduction worth substantially more – but this could only work if the partnership was trading in the year in which the interest was paid in advance.  The Tribunal held that this was not an ‘adventure in the nature of trade’, merely a speculative investment and as a result the participants did not benefit from the interest relief they thought they could claim.  It was a business, but a ‘non-trade’ business.

So whether a trade is being carried on can be seen to be a quite complex issue – we don’t have time to examine each of the many badges of trade individually, but sometimes whether a trade is being carried on can lead to arguments not dissimilar to those of the middle ages when theologians would discuss the number of angels that could dance on the head of a pin!

A taxpayer might buy an asset, whether it is an Olympic Torch, a plot of land, a million toilet rolls or a commercial film and imagine on sale they have made a capital gain, in which case their CGT liability would be a maximum of 28% – it would be a nasty shock if HMRC successfully contend that it was an adventure in the nature of trade and they have an income tax and NIC liability at a rate which could be 52% or even higher!

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Categories accountancy, Taxation, Uncategorized

Child Benefit Clawback

May 28, 2012 //
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Child Benefit Clawback

Last month I looked at the relief capping proposal and tried to encourage you all to take part in the consultation process- that still hasn’t commenced and on the treasury website that tracks all consultations it is merely scheduled for the summer.  Keep watching this space or… listening to these podcasts…

This month I’m going to consider another part of the budget proposals intended to claw back part or all of the Child Benefit from certain taxpayers – but before I do I think we need to consider some taxation history.

Until 1973 when a couple married the wife lost her independent status as a human being – I know that sounds awfully dramatic but if a wife wrote to the revenue pointing out that she had paid too much tax on her earnings under the PAYE system the reply was addressed to her husband and the cheque making the repayment was made out to him and not her! 

This was not misogyny on the part of the tax officials, because the revenue could not legally write to a wife at that time. From 1973 onwards they were permitted to write to a wife directly but our taxation system was still based on the family unit and the husband had the legal obligation to return his wife’s income and the overall liability was still his and his alone.

This caused enormous practical problems for a minority of taxpayers – I remember a young man who’d received a letter from the revenue pointing out that he had not returned bank interest – except… he didn’t have any.  Eventually he was pointed in the right direction and asked his wife to provide him with the details that needed to be returned to the revenue – she refused and he was visited by his father-in-law threatening violence if he continued to ask his wife these inconvenient questions!

It was possible for taxpayers to elect to submit separate tax returns and pay their own share of liability but the assessments that were issued were still based on total family income with personal allowances and reliefs being apportioned.  I can remember the practical difficulties of acting for a wife who submitted her own return but her husband used a different firm of accountants and was considerably in arrears in submitting his actual figures.  To make matters worse both firms of accountants were under strict instructions not to correspond with each other and so we had no way of checking the revenue’s calculations!  The only solution was to surreptitiously take the file down to the pub on a Friday night , unofficially meet an opposite number from the other firm and check the figures unofficially!

These practical difficulties came to an end in 1990 with the advent of independent taxation – at last spouses submitted their own returns, were responsible for their own taxation liabilities, and these idiocies of the old system disappeared – that is until the idea of clawing back child benefit was floated.

Child benefit is one of the fundamental building blocks of the benefit system and has been paid, as of right, to individuals resident in the UK for more than six months with responsibility for children – in a couple usually the wife will receive it – it was at one time paid on a weekly basis through vouchers that were cashed in at post offices but is now normally paid 4 weekly into the claimant’s bank account.

It used to be paid only for second and subsequent children but when the special tax allowance for children was abolished many years ago the value of that relief was incorporated into this benefit.  It has never before been subject to taxation.

That it is unfair that a higher rate taxpayer gets the same benefit as a basic rate or even a non-taxpayer seems to have been a suggestion made at a Conservative Party conference which has been subsequently taken up as coalition government policy – and it clearly creates an enormous headache for the revenue who have to implement this idea.

Given the constraints of independent taxation it was decided that the clawback would take place in the hands of the spouse with the highest income where this exceeded the initial threshold, as set in the budget, of £50,000.  1% of the benefit would be clawed back from this person whether they were the actual recipient of the benefit or not for every £100 of their income in excess of £50,000.

Therefore if a taxpayer had income for this purpose of, say, £53,500 then they would suffer a clawback of 35% of the child benefit received.  If the income exceeded £60,000 the whole of the benefit will be clawed back.  Instead of restricting the benefit actually payable it was decided that the clawback would take place through the tax system.

With one child the benefit currently payable is £20.30 per week, for each subsequent child the amount payable is £13.40 per week. The clawback starts, strangely, from 7 January 2013, some people have suggested that this is a needless complexity but for most claimants the amount payable will be known.  If you have three children you will be paid a total of £47.10 per week or £188.40 each 4 weeks.  7th January is simply the first Monday of 2013 and the benefit paid 4 weekly during the remainder of the that tax year would be £565.20, exactly the same for every taxpayer with three children.  The clawback would then be 35% of this figure – £197.82.

For the following year assuming total income was now, say, £56,500 the clawback would be 65% of the benefit.  The benefit has been frozen until 2014 so we know that the amount payable for the year would be £2,449.20 and the clawback £1,591.98.

Now this is income which has already been taxed at 40% and if earned income is also subject to NIC of a further 2%.  The more children a taxpayer has the greater the benefit they will have received and so the larger the clawback they will be subject to. With three children the effective total tax rate at this level is 66.5%, with eight children the effective tax rate is 101.34%!

If the income is derived from a company which the taxpayer controls the effective liability is even greater when employers’ NIC get added into the equation.

Income is measured in the same way that it is measured for the clawback of personal allowances that takes place at £100,000 worth of income.  This means that the gross equivalent of pension contributions, personal pensions, stakeholder pensions etc and the gross equivalent of gift aid donations, reliefs usually given by extending the taxpayer’s basic rate band will actually be deducted from income for the purpose.  Incidentally if the effective tax rate is more than 100%, as it can be for very large families, then the effective tax relief available for these payments is in excess of 100% as well!  It is possible, by careful planning, to keep income just below the clawback figure and so avoid the liability.

It is unfair that where one taxpayer earns substantially more than the other the one with the higher income is subject to the clawback.  Where a couple each have income of £49,999 their joint income will be £99,998 and yet as neither has income in excess of £50,000 no clawback will occur, whereas a taxpayer with income of £50,500 will suffer a 5% clawback.

Taxpayers with their own companies or partnerships may be able to divide income between themselves to avoid or at least minimise the clawback that may occur.  They could also transfer income producing assets to the other partner to avoid the clawback.  Of course this is only possible if you know what your income is going to be in the tax year.  Pension contributions cannot be carried back to the year before but interestingly gift aid donations can be.

Lets look at some of the other practicalities involved…

The clawback will be recovered through the self-assessment system which may mean that having attempted, successfully, to reduce the number of taxpayers subject to self assessment there will now be a dramatic increase in the number of taxpayers subject to self assessment.  The clawback could also take place through the PAYE system for certain taxpayers but this would often involve delay in determination and collection of the liabilities involved.

It will be applied to single parents of course but couples will have to decide who is the one with highest earnings – fine if they are prepared to sit down and discuss their financial affairs with each other but if they don’t, or won’t… This brings back the spectre of couples deliberately not revealing their income to each other or even simply getting it wrong.

Suppose Alan earns £57,000 per annum and his wife, Zena, earns £54,000 – it seems clear that Alan is subject to the clawback.  Suppose he was encouraged by a financial adviser to pay £2,880 into a stakeholder pension some years ago and this is paid through a direct debit.  When they are talking about this Alan forgets this and so he becomes subject to clawback until he puts the premium paid on his return, this is grossed up to £3,600 and Alan’s income is now £53,400 and so it is Zena who should have been subject to clawback. She can be penalised for failing to make this adjustment to her liability.

To make matters worse still the legislation says that it applies to couples who are married to each other and also to civil partners.  But it will also apply to people who live together as though they were married and also to couples who live together as though they were civil partners.  This is a potential minefield.

Let’s suppose that Beatrice is a single mother earning £20,000 as a teaching assistant, her best friend Charlotte is also single and earns £65,000 and has her own house.  Knowing how tough life is for Beatrice Charlotte asks her to come and live with her and Beatrice gladly accepts.  Are they living together as though they were civil partners?

This is not as straightforward as it may seem.  The law permits any two persons of the same sex as each other to register a civil partnership provided that they are not already married to someone else, or in a civil partnership with someone else, and are not within the prohibited degrees of relationship – close relations like brothers and sisters.  Civil partnership resembles civil marriage in all respects bar one.

And this is why people have advocated so-called “gay marriage” even though a civil partnership is treated as though it were marriage for all practical legal purposes.  You do not need to be homosexual or to have a homosexual relationship to enter into a civil partnership so – are Beatrice and Charlotte living together as though they are civil partners?  I am not sure that anyone would like to have to answer this question or even ask it, but this legislation may make this unavoidable.

To satisfy an off-the-cuff political statement the revenue have been forced to create a considerable trap for the unwary, a deeply unfair and potentially divisive system – this is what happens when we let politicians dabble in our taxation system.  It may see the return of the crazier aspects of taxation that applied before independent taxation was created. Oh dear!

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Categories Taxation, Uncategorized

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.  This entry is now amended to reflect the Chancellor’s announcement on 31 May 2012.

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.

31 May 2012 – update:  George Osborne apparently stated today (although there is as yet no confirmation on either the Treasury of the HMRC websites) this:

Mr Osborne said: “I can confirm that we will proceed next year with a cap on income tax reliefs for wealthy people, but we won’t be capping relief for giving money to charity.  It is clear from our conversations with charities that any kind cap could damage donations, and as I said at the Budget that’s not what we want at all. So we’ve listened.”

The point is that the capping of losses and interest relief will go ahead despite the damage that this is likely to cause to the SME sector – this measure, remember, is supposedly aimed at multi-millionaires but the limit, £50,000 or 25% of income is set so low that it WILL affect many smaller businesses – Consultation is likely to start in June or July and it is still critical that that taxation professionals and their clients make it quite clear how damaging this proposal may 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 accountancy, Taxation, Uncategorized

Bonus or Dividends?

February 28, 2012 //
0

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

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 http://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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