CAPITAL GAINS TAX
Marriage breakdown - move quickly to avoid a tax trap
Some years ago you transferred shares in your company to your spouse. Sadly, you’re about separate and so need to take steps to sort out the assets. It’s vital that priority is given to the company shares, but why?
Dividing the assets
In February 2017 we looked at capital gains tax (CGT) planning involving the marital home in the course of separation. But the home isn’t the only major asset which needs special consideration. If your spouse doesn’t play an active role in your company but is a shareholder, you’ll want them to give up their shares to avoid possible conflict.
Timing is important
A value will, of course, need to be put on the shares. The trouble is that valuation can be a long and tricky process for shares in private companies. If discussions over valuation take too long, and so delay the transfer of shares, it can result in a CGT liability for the spouse making the transfer. Inevitably this will be factored into the overall financial settlement meaning it ends up costing both spouses, while HMRC reaps the reward.
Example. Tim is a director shareholder of Acom Ltd. His wife Shelly owns 100 shares in Acom which were allotted to her at £1 each when the company was set up ten years ago. Tim and Shelly separated in July 2016 but aren’t yet divorced. In May 2017, when the shares are valued at £150,000, she transfers them to Tim. Shelly will have to pay CGT on £149,900, i.e. the difference between the cost and current value. The tax will run to tens of thousands of pounds.
Transfers of shares and other assets between married spouses don’t trigger a CGT bill. Instead, HMRC treats these deals as if the transferring spouse sold them to the other at a price which results in neither a CGT gain nor a loss; this is the so-called “no gain, no loss” rule. In our example, this would mean, irrespective of what value was put on the shares, they would count as having been sold by Shelly to Tim for £100, i.e. what they cost, but only if the transfer took place in the tax year in which they separated.
Trap. The no gain, no loss rule only applies in a tax year where, for at least some time, a couple are living together as husband and wife, in a civil partnership or same sex marriage. That means the rule will apply to transfers in the tax year you separate, but not a later one. For the rule to have applied to Shelly and Tim, she would have had to transfer the shares by no later than 5 April 2017.
Note. It’s the date of separation that’s important for CGT (and most other) tax purposes and not the date of divorce. As soon as you separate you’re not considered married by HMRC.
Plan of action
Tim and Shelly could have avoided the massive tax bill if they had acted just a little sooner.
Tip. In case of separation, shares and other assets liable to CGT should be transferred between spouses by no later than the following 5 April. You can argue about their value for divorce purposes later and make balancing payments if necessary. But it’s to no one’s financial advantage, except HMRC’s, to delay.
Assets transferred between separated spouses can count as if they were sold at their full value, and so result in a capital gains tax bill. This trap is avoided where the transfer is made in the same tax year as the separation. If necessary make it quickly and discuss the value of the asset later.
How to correctly handle VAT errors and adjustments
Honest mistakes in your VAT returns are bound to happen, even HMRC acknowledges this. What steps must you take to put them right and what other tax adjustments might you need to consider?
How to correct errors
Making a mistake is easy, but putting it right can be quite the opposite. That’s true for VAT returns as it is for anything else and different types of error require different actions to correct them:
o if the correction requires you to issue an amended invoice or credit note to your client, as long as your bookkeeping is carried out correctly the VAT adjustment in the corresponding return will be taken care of without further action
o if the correction doesn’t involve issuing a revised invoice or credit note, for example, where you’ve reclaimed too much or too little VAT for a purchase, you’ll need to make a manual adjustment to your bookkeeping records.
No further action is required as long as the adjustments are within the same VAT return period or, if not, their total value doesn’t exceed the limits allowed by HMRC.
Trap. Where the total value of the errors exceeds £10,000, or if greater, 1% of the turnover figure shown in Box 6 of the return in which the correction is made (up to a maximum of £50,000), you must send a separate report (voluntary disclosure) to HMRC.
Tip. Even if the corrections don’t require a voluntary disclosure, it’s sometimes advisable to make one anyway as this will give you extra protection from penalties.
VAT corrections can increase or decrease business profits and so affect corporation tax and income tax bills. For example, where a business incorrectly fails to charge VAT on a sale and, for whatever reason, it’s not possible to issue a corrective invoice to the customer. When the error is corrected, the extra VAT paid to HMRC will reduce the business’s profit. As long as the error and the correction fall in the same financial year there’s no problem, but if they don’t the business will need to revise its accounts to reflect the adjustment to profit.
Tip. Take care with VAT corrections which fall in a later financial year than the original transactions as you may need to make an adjustment to the annual accounts in which the error arose.
Bad debt relief
A similar situation occurs, if having claimed bad debt relief against your profits in your business’s annual accounts, you later claim VAT bad debt relief. The VAT reclaimed results in an increase in profits. However, it won’t usually be necessary to amend the past financial accounts. Instead the adjustment can be made in the accounting period in which the VAT bad debt relief was claimed.
Capital goods scheme
Another thing easily overlooked is that if you reclaim the VAT on the purchase of an asset within the capital goods scheme (CGS), e.g. a building or IT system, and later have to repay some of it, the effect is to increase the cost of the asset for capital gains tax (CGT) and capital allowances (CAs) purposes. You might therefore be able to claim further CAs or a reduced CGT bill.
If corrections are made by issuing a revised invoice or credit note, normal bookkeeping procedures are sufficient, unless the mistakes exceed £10,000 or 1% of turnover for the VAT period. Adjustments made in other ways can affect your business profits, so make sure they are reflected in your accounts.
Don’t get taxed twice on the same income
IR35 applies to some of your company’s income and so PAYE tax and NI has to be accounted for on a deemed payment of salary. The trouble is that you’ve also drawn the income as dividends. How can you avoid being taxed twice?
Where your business consists of providing your personal services to clients through a company, special tax rules, known as IR35 can apply. These say that if the terms and conditions of your work would count as an employment if the contract with your client was with you direct instead of through your company, you must pay PAYE tax and NI on the income as if it were salary. The trouble with these tax rules is that they sometimes conflict with company law.
Dividends as well
If your company makes a profit, company law says it can pay it to the shareholders as dividends. Naturally, HMRC expects you to pay tax on these too. This means tax can be payable under two different rules on the same income; once as employment income and secondly as dividends.
Example. Hal’s company, Acom Ltd, provides his services as an IT consultant to his only client. The arrangement is caught by IR35. In Acom’s financial year ended 31 March 2017 the IR35 income was £110,000. In 2016/17 Hal draws £8,000 from Acom as salary and £50,000 as dividends. He also takes another £10,000 of the income as dividends in 2017/18. After the deductions allowed by IR35, Acom must apply PAYE tax and NI to £95,000 as if it had paid Hal that much in salary. This forms part of Hal’s taxable income for 2016/17, but so does the £50,000 dividends, which was paid out of the same income.
Trap. If Hal did nothing he would face a tax bill of up to £16,250 (£50,000 x 32.5%) on the dividends having already paid £20,000 tax through PAYE.
Tip. Hal can avoid double taxation by claiming a special deduction, known as s.58 relief, for the income potentially liable to double taxation.
The special deduction reduces the amount of dividends on which Mal pays tax. In our example all of the £50,000 dividends are subjected to IR35 tax therefore s.58 relief for 2016/17 would be £50,000. Therefore, the taxable dividends would be reduced to zero. Plus, Mal could make another s.58 claim for 2017/18 of £10,000 in respect of the dividends paid out of the IR35 income in that year. However, if, say, IR35 PAYE tax applied to just £30,000 of Acom’s income, the s.58 relief Hal can claim would be capped to that amount.
The company’s position
IR35 rules also conflict with other legislation; this time the corporation tax (CT) rules. A company can deduct the salaries it pays from its taxable profits. In our example Acom only paid £8,000 salary to Hal in its financial year to 31 March 2017, the other payments to him were dividends, which aren’t deductible for CT. So by applying the normal rules Acom could only obtain CT relief on £8,000, even though £95,000 had in effect been treated as salary.
Tip. Another special rule allows Acom to claim a CT deduction for the £95,000 as if it were an actual salary.
A special claim can be made that reduces the amount of dividend liable to tax by up to the amount of deemed payment. Claims can be made for the year of the deemed payment or later years. A different claim can be made by your company to obtain corporation tax relief for the deemed payment.
Are you too late to make a claim?
If you forget to claim an allowance or deduction on your tax return you have a relatively short time in which to put it right. The good news is that if you miss the deadline all is not lost as a different type of claim can be made. What’s involved?
Stake your claim
As a general rule, the deadline for claiming tax reliefs and deductions is four years from the end of the tax year to which the claim relates for personal taxes, and four years from the end of the accounting period for corporation tax. In some situations, essentially where you haven’t been asked to submit a tax return by HMRC, the time limit is extended beyond four years, but this loophole closes on 5 April 2017.
In normal circumstances, i.e. where you’ve submitted a tax return and the four year limit applies, a late claim involves one of two methods:
1. Amending your self-assessment return.
2. Submitting an overpayment relief claim.
The first method will be modified slightly from 6 April 2017 to fit in with the introduction of a new system of tax assessments.
Amending your tax return - individuals
If you’ve submitted a tax return and want to amend the figures, that includes making or increasing a claim for a tax deduction, say job expenses, or claiming an allowance, such as pension contributions, you have one year from the normal filing date for the tax return, i.e. one year after 31 January that follows the end of the tax year. For example, the deadline for amending your 2015/16 tax return is 31 January 2018.
Amending your tax return - companies
The deadline for increasing or making additional claims for companies follows a similar pattern. It’s one year from the normal filing date of the return. For example, for an accounting period ended on 31 March 2016, the deadline is 31 March 2018.
Where you’re too late to amend your tax return you can make a claim for overpayment relief, as long as it reaches HMRC within the four-year time limit.
Trap. The format of the claim must be spot on otherwise HMRC can, and often will, reject it. If you’re running close to the deadline, by the time HMRC rejects your claim it might be too late to send another in the required format. It seems unfair, but it has happened. Tip. When making an overpayment claim it must be in writing and signed by you, not your accountant and state:
o that it’s being made under sch 1AB Taxes Management Act 1970 for personal taxes or para. 51 schedule 18 Finance Act 1998 if it’s for corporation tax
o the tax year the overpayment relief is for
o why the overpayment arose
o the amount of tax that has been overpaid
o if you’ve previously made an appeal in connection with the overpayment; and
o that you have included documentary proof of the tax paid for the year in question.
If you make an error on your tax return which results in your tax bill being too high you can amend it within a limited time. After that you must claim overpayment relief instead. You have four years from the end of the tax year or accounting period to do it. Claims must be in the correct format or HMRC can reject them.
Two businesses, one car, how many tax bills?
Our subscriber and her husband run separate companies. They want a new car and plan to use the wife’s company to pay for it. Because of her income she’ll pay little or no tax. As the husband will pay more tax can HMRC tax him instead?
New rules for perks
Until 6 April 2016 certain benefits in kind, including company cars, were only taxed on employees who earned over £8,500 per year, including the value of the benefit, and all directors. Since then tax applies to all employees and directors regardless of their rate of pay. Nevertheless, one of our subscribers wants to use her company to pay for a car for her and her husband to use, and wants to know whether it can be done tax and NI free.
High income and low income
Currently, the husband’s company pays for and provides a car on which he is taxed. As he’s a higher rate taxpayer he pays around £2,800 per year for their joint use of an Audi A4. The wife’s level of income means she currently pays no tax. If it were her company car she would be taxable on it, but after knocking off her personal allowances she would pay nothing. It seems mad not to rearrange things so that the car benefit falls on her instead of her husband. But surely HMRC will object and use some anti-avoidance rule to scupper the plan?
There are anti-avoidance rules which can prevent companies reducing the tax by providing cars to directors’ spouses and other members of their family instead of them. However, the good news for our subscriber is that these don’t apply where the car is provided to a director and he or she is liable to tax on it. The fact that no tax is actually payable is irrelevant.
The news is not so good for NI. An employer must pay Class 1A NI contributions at 13.8% on the taxable value of a company car regardless of whether the director has to pay tax on it. As the new company car has a taxable value of £6,200, NI will be payable whichever company provides it and whoever is taxed on it.
The corporation tax position is also neutral. Whichever company provides the car can claim tax deductions for the purchase, running costs and the Class 1A NI bill. However, because our subscriber’s company has far less income than her husband’s they need to watch this. If the car expenses start to outweigh the company’s profit she should consider whether it’s still tax efficient to keep the car in her company. Tip. In that event it won’t save tax overall to sell the car to her husband’s company so that he becomes taxable on the benefit again, but it might be worth taking the car out of the business altogether. The only way to check this is to crunch the numbers at the time. This is probably a job for their accountant as the numbers can be tricky.
While not a tax issue, our subscriber should make sure that when her company takes on responsibility for the new car that the insurance policy covers use by both her and her husband. If they stick with the same insurer her husband’s company currently uses that shouldn’t be an issue.
Where a company provides a car to a director the taxable benefit falls on them alone even if because of their financial circumstances they don’t actually have tax to pay. This means it can be especially tax efficient to provide a company car through a company where the director has a low income.
IHT tax break for second homes
For a few years you’ve owned a seaside apartment as a holiday getaway. You’re now trying to reduce your estate to save inheritance tax. Can you keep the apartment for your use while shifting the value out of your estate?
It’s no give-away
As you probably know, where you make a gift to another individual there’s no inheritance tax (IHT) as long as you survive at least seven years. However, if you give away an asset, such as a holiday home, say, to your adult children, but continue to use it (this is known as reserving a benefit), anti-avoidance rules mean it remains part of your estate for IHT purposes. The seven-year clock only starts ticking when you stop using the asset.
Tip. If you gave away your second home to your children the anti-avoidance rules don’t apply if you only pay them a brief visit, or maybe even stay the occasional night. The law says that as long as you’re “virtually entirely” excluded from using the property, you’re OK. Of course, your idea of virtual exclusion might differ from HMRC’s.
You can’t rely on the “virtually entirely” get-out clause to achieve what you want, i.e. to get the property out of your estate, so you need a more robust strategy, especially if you want to be able to continue to use the property for your holidays.
Tip. If you pay rent to your children at a commercial rate when you stay (other than for brief visits when your children are using it), HMRC accepts there’s no reservation of benefit.
Pros and cons of rent
If you’re trying to reduce your estate then paying rent to your children for use of the property of, say, £2,000 a year, isn’t a bad idea. This means your estate is reduced further, but the downside is that the rent is income for your children on which they must pay income tax.
Possible tax exemption
There’s a proposal in the pipeline to allow people to receive up to £1,000 per year in rental income tax free. If this comes into force in April 2017 as planned, your children could use the tax-free allowance to avoid or significantly reduce their tax liability on the rent you pay. However, there might be an even better option.
Tip. By only giving your children a joint share of the property and keeping a share for yourself, you won’t have to rely on the “virtually entirely” exclusion rule or pay rent. Subject to just two simple conditions, you can continue to use the property when you like and the value of the share you give away will cease to be part of your estate for IHT purposes after seven years.
As long as you and your children can use the property and you all share the running costs, there will be no reservation of benefit for you. The simplest way to prove to HMRC that expenses are being shared is for you and your children to contribute equally to a joint bank account set up to meet property running costs. Note. There could be capital gains tax payable when you give away assets, such as a second home, so check this before you go ahead.
Either pay a commercial rent each time you use the property, or only give away a share of it. In the latter situation as long as you and the new joint owners share running costs, you can continue to use it as much as you like. The value of the joint share will cease to be part of your estate after seven years.
LOSSES - CASE LAW
When can share losses be set against income tax?
If you’re unlucky enough to have bought shares in a company which has gone bust you can claim a tax deduction for the loss. However, the Upper Tribunal had to decide for which year it could be claimed. What was the outcome?
If you buy shares in a company and then sell them for less than you paid for them, the difference counts as a capital gains tax (CGT) loss. This can be set against capital gains you make for the same or later years. What’s more, in some circumstances you can claim a CGT loss even where you don’t sell the shares.
A special rule allows you to claim a CGT loss where the value of the shares has become negligible; there’s no requirement to actually sell them to claim the loss. It’s a sort of “have your cake and eat it” clause because if, and hopefully when, the share value increases, there’s no clawback of the loss relief claimed.
Tip. You can claim the loss for the year in which the share value became negligible, or any subsequent year, as long the shares remain worthless at the time. This gives you some useful flexibility when setting the loss against capital gains.
Income tax relief
Where conditions are met, broadly that you subscribed for the shares, i.e. bought them direct from the company, and the company carries on a trade, you can convert the capital loss into an income tax one. The chances are that you’ll be able use this more tax efficiently than a CGT loss. For example, the maximum rate of CGT for 2016/17 is 28% (in most situations the maximum is only 20%), whereas the highest income tax rate is 45%.
It’s against this background that Mr and Mrs Dyer (D) made a claim for negligible value in respect of shares in their trading company for 2007/8, which they converted to an income tax loss for the same year. HMRC refused the claim, and so D argued their case at the First-tier Tribunal (FTT), but lost. They appealed to the Upper Tribunal (UT).
Questions of timing
The UT confirmed the FTT’s ruling. Its decision turned on a single word in the negligible value rules - “become”. A loss can only be claimed if the shares have become of negligible value after you have bought them. The company was already worth virtually nothing when D bought the shares so the value could not become negligible because it already was. It’s a small but vital point.
Were losses lost?
Ultimately, D’s company went into liquidation and they received nothing for their shares. This meant they had an actual CGT loss, rather than one created by the negligible value rules. So they could have claimed the loss at that time, but this was not what happened and so their claim for 2007/8 loss relief failed.
Tip. Before making a high risk investment in a company where CGT or income tax loss relief is an important factor in your decision, first make sure the conditions are met.
The Tribunal ruled that if you buy shares in a company, which are worth
little or nothing at the time, you can’t later claim a capital gains tax loss
for your investment because the shares are of negligible value. You can only
claim a loss when you sell the shares for less than you paid or receive less as
a result of liquidation.
New pensions exemption takes shape
The 2016 Budget proposed a new tax exemption for pension’s advice. A
recent HMRC document about it contains one or two surprises. What’s the full
New exemption. In September 2016 HMRC published a consultation paper that spells out in more detail the pensions advice allowance (PAA), which is scheduled to take effect from 6 April 2017. The PAA will be tax-free money you can take from your pension fund to pay for pension’s advice by an authorised financial advisor.
Defined contribution schemes only. The PAA will apply to defined contribution schemes, also known as money purchase schemes, such as personal pension plans. These involve investing money which you can draw or use to buy a pension when you reach 55. Defined benefit schemes, also called final salary schemes, already offer a means of providing for tax-free pensions advice so the PAA won’t apply to these.
How much? The Budget announcement indicated that the PAA would be set at £500. While the consultation paper confirms this, it also proposes that it should be available more than once up to the age of 55, although the precise number of PAAs hasn’t been decided on.
Two allowances. The 2016 Budget also proposed a £500 exemption for employer-paid-for pension’s advice. An exemption of £150 has existed for many years, so the increase is just to give it parity with the PAA. The really good news, especially for financial advisors, is that the government intends to allow you to combine the increased exemption and the PAA to pay for up to £1,000 worth of tax-advantaged financial advice. This could be really beneficial as pensions advice can more than pay for itself.
Tip. It’s intended that, as an employer, you’ll be allowed to pay up to £500 for pensions advice for employees using a salary sacrifice arrangement, despite the new restrictions which will apply to these).
The new exemption can be combined with a similar one for employer-paid-for pension’s advice. This means that from 6 April 2017 you’ll be able to obtain up to £1,000 of tax-advantaged pensions advice.
Question of the month
Q. I have a client that runs a delivery service and two of his staff members have the use of a van in order to make those deliveries. The employees in question take the vans home at night and return to work the next morning. They are concerned that by doing so they will be taxed on the use of the van. What are the tax rules for employees using vans?
A. A van which is made available to an employee is deemed to be available for his private use unless the terms on which the van is provided prohibit its private use and no such use is actually made of it. This means that the mere prohibition of private use is not in itself sufficient to prevent a tax charge; it is also necessary to show that a van is not used for private motoring.
The charge is nil if both the following requirements are satisfied throughout the year (or part of the year depending on when the van is available to the employee):
• The van must only be available to the employee for business travel and commuting – it must not in fact be used for any other private purpose except to an insignificant extent, and
• The van must be available to the employee mainly for the employee’s business travel
If one of the requirements is not met the charge for 2015/16 is £3,150 and for 2016/17 the benefit increases to £3,170 per van.
The word ‘insignificant’ is not defined, so takes its normal meaning of ‘too small or unimportant to be worth consideration’. Private use is to be considered insignificant if for example an employee who uses a van:
• Takes an old mattress or other rubbish to the tip
• Regularly makes a slight detour to stop at a newsagent on the way to work
• Calls at the dentist on the way home
Private use by an employee that is not insignificant is for example:
• Using the van to do the supermarket shopping each week
• Taking the van away on a week’s holiday
• Using the van outside of work for social activities____________________________________________________________________________________________