Principles of Business Taxation - MEC · Principles of Business Taxation ‘Finance Act 2006’ Chris Jones, BA CTA (Fellow) ATT Amsterdam Boston Heidelberg London New York Oxf ord

Principles of Business Taxation

‘Finance Act 2006’

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Principles of

Business Taxation

‘Finance Act 2006’

Chris Jones, BA CTA (Fellow) ATT

Amst er dam Bost on Heidelber g London New Yor k Oxf or d Par is San Diego San Fr ancisco Singapor e Sydney Tokyo

Elsevier But t er wor t h-Heinemann Linacr e House, J or dan Hill, Oxf or d OX2 8DP 30 Cor por at e Dr ive, Bur lingt on, MA 01803

Fir st published 2007

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CONTENTS

Preface ix

A: Introduction to the UK Tax System 1

B: Computation of Taxable Trading Profit 7

B1: Tr ading I ncome and t he Badges of Tr ade 7

B2: Adj ust ment of Pr of it 14

B3: Capit al V Revenue 23

B4: Capit al Allowances – Def init ion 30

B5: Capit al Allowances – Comput at ion 37

B6: I ndust r ial Buildings Allowances 47

B7: I nt angible Fixed Asset s 64

B8: Resear ch and Development Expendit ur e 73

B9: Tax Law and Account ing Pr act ice 84

C: Taxation of Limited Companies 91

C1: Comput at ion of Cor por at ion Tax 91

C2: Associat ed Companies 102

C3: Shor t Account ing Per iods 110

C4: Long Per iods of Account 116

C5: Cor por at ion Tax Self Assessment (CTSA) 125

C6: Payment of Cor por at ion Tax 141

C7: I nt er est on Lat e Paid Tax 151

C8: CTSA Penalt y Regime 156

C9: I ncome f r om Pr oper t y 161

C10: Loan Relat ionships 167

C11: Relief f or Tr ading Losses 177

C12: Relief f or Ot her Losses 187

C13: Cor por at e Capit al Gains 192

C14: Rollover Relief 201

C15: Shar es and Secur it ies: Mat ching Rules 208

223

C17: The Pr inciples of Gr oup Relief 228

C18: Gr oup Capit al Gains 241

C19: Close Company Def init ion 252

C16: Subst ant ial Shar eholding Exempt ion

vi Cont ent s

C20a: Close Company I mplicat ions – Par t 1 261

C20b: Close Company I mplicat ions – Par t 2 266

C21: I nvest ment Companies 271

C22: Cor por at e Vent ur ing Scheme 279

D: Employee Tax Matters 288

D1: Employed or Self Employed? 288

D2: I nt r oduct ion t o Employment I ncome & Benef it s 295

D3: Company Car & Fuel Benef it s 308

D4: Living Accommodat ion – Taxable Benef it s 318

D5: Loans t o Employees & Use of Asset s 325

D6: Miscellaneous Benef it s 335

D7: Expenses of Employment 343

D8: Calculat ing t he I ncome Tax Liabilit y 353

D9: I nt r oduct ion t o PAYE 360

D10: PAYE End of Year Ret ur ns 369

D11: Class 1 Nat ional I nsur ance Cont r ibut ions 376

D12: Class 1A and 1B Nat ional I nsur ance Cont r ibut ions 388

D13: Ter minat ion Payment s 396

D14a: Occupat ional Pensions and Fur bs 408

D14b: The Ent er pr ise I nvest ment Scheme 417

E: Value Added Tax 423

E1: Over view of t he VAT Syst em 423

E2: Regist r at ion 432

E3: Def init ion of Supplies 444

E4: Liabilit y of t he Supply 451

E5: Schedule 8 VATA 1994 – Zer o Rat ing 455

E6: Schedule 9 VATA 1994 – Exempt ions 463

E7: Deemed Supplies 470

E8: Value of t he Supply 481

E9: Time of Supply 489

E10a: I nput Tax: When t o Recover 496

E10b: Par t ial Exempt ion 511

E11: VAT Recor ds and Ret ur ns 527

E12: Account ing f or VAT 539

E13: Bad Debt Relief 551

E14: Cont r ol Visit s, Appeals and Assessment s 559

E15a: Misdeclar at ion Penalt y 571

Cont ent s vii

E15b: Lat e Regist r at ion Penalt y 577

E15c: Def ault Sur char ge 583

E15d: Repeat ed Misdeclar at ion Penalt y 590

E15e: Ot her Penalt ies, I nt er est and Mit igat ion 596

E16: Ref unds, Repayment Supplement and I nt er est 611


PREFACE

This book pr ovides all t he mat er ial you need f or t he CI MA Pr of essional Development Cer t if icat e in Business Taxat ion. Wit hin each chapt er you will f ind some examples f or you t o t r y, t o t est you on t he impor t ant r ules cover ed in t he chapt er .

At t he end of each chapt er , t her e is a shor t summar y which cont ains a “pocket digest ” of t he r ules cover ed wit hin t he chapt er . These individual summar ies f or m a compr ehensive over view of t he syllabus.

As t his manual has been wr it t en specif ically t o cover all ar eas of t he syllabus we ar e conf ident you will f ind t his an invaluable t ool leading t o success in t he examinat ion.


CIMA

TAX TABLES

Income Tax rates 2006-07 2005-06 % % Starting rate 10 10 Basic rate 22 22 Higher rate 40 40

£ £ Starting rate band 1 - 2,150 1 - 2,090Basic rate band 2,151 - 33,300 2,091 - 32,400 Income Tax reliefs

2006-07

2005-06

£ £ Personal allowance 5,035 4,895

Income Tax – Pension contributions

Annual allowance

Lifetime allowance

£ £ 2006-07 215,000 1,500,000 2007-08 225,000 1,600,000 2008-09 235,000 1,650,000 2009-10 245,000 1,750,000 2010-11 255,000 1,800,000

Basic amount qualifying for tax relief £3,600

Company cars and fuel

Company cars Cash equivalent 15% of list price for cars emitting 140g/km Increased by 1% per 5g/km over the 140g/km limit Capped at 35% of list price

3% supplement on diesel cars not meeting the Euro IV emission standards or registered after 1 January 2006 (subject to 35% cap)

Van scale charge

£500 (reduced to £350 if more than four years old at the end of the fiscal year).

There is no taxable benefit where an employee takes a van home but is not allowed any other

private use.

Fuel scale benefits

For 2006-07 (& 2005-06) the benefit is £14,400 multiplied by the percentage used in calculating the car benefit (i.e. based on carbon dioxide emission rating).

xii CI MA Tax Tables

Small and medium sized enterprise limits

Small Medium (i) Turnover £5.6m £22.8m (ii) Balance sheet assets £2.8m £11.4m (iii) Employees 50 250

Corporation Tax

Financial year 2006 2005 Full rate 30% 30% Small companies' rate 19% 19% Starting rate – 0% Profit limit for lower rate – £10,000 Profit limit for lower rate marginal relief – £50,000 Profit limit for small companies' rate £300,000 £300,000 Profit limit for small companies' marginal relief £1,500,000 £1,500,000 Marginal relief fraction for profits between £10,000 and £50,000 – 19/400 Marginal relief fraction for profits between £300,000 and £1,500,000 11/400 11/400

For FY 2005 there is a minimum corporation tax charge of 19% on PCTCT distributed to non corporate shareholders. This does not apply for FY 2006.

Research and Development expenditure and transfer pricing: small and medium sixed

company limits

Medium Small

Employees 250 50

Turnover ε50m ε10 million

Balance sheet assets ε43m ε10 million

National Insurance Contributions

2006-07 2005-06

Class 1 contributions Annual Weekly Annual Weekly

Lower earnings limit £4,368 £84 £4,264 £82

Earnings threshold £5,035 £97 £4,895 £94

Upper earnings limit £33,540 £645 £32,760 £630

Employee’s contributions in 2006-07 (2005-06)

Not contracted out: 11% (11%) on earnings between £97 (£94) and £645 (£630) 1% (1%) above £645 (£630) per week

Contracted out: 9.4% (9.4%) on earnings between £97 (£94) and £645 (£630) 1% (1%) on earnings above £645 (£630) per week 1.6% rebate on earnings between £84 (£82) and £97 (£94)

Employer’s contributions in 2006-07 (2005-06) Not contracted out: 12.8% (12.8%) on earnings in excess of £97 (£94) Contracted out: Salary related: 9.3% (9.3%) on earnings between £97 (£94) and £645 (£630)

12.8% (12.8%) on earnings in excess of £645 (£630) 3.5% (3.5%) rebate on earnings between £84 (£82) and £97 (£94)

Contracted out: Money purchase: 11.8% (11.8%) on earnings between £97 (£94) and £645 (£630) 12.8% (12.8%) on earnings in excess of £645 (£630) 1% rebate on earnings between £84 (£82) and £97 (£94)

CI MA Tax Tables xiii

2006-07 2005-06Class 1A contributions 12.8% 12.8%Class 1B contributions 12.8% 12.8%Class 2 contributions Normal rate £2.10 pw £2.10 pwSmall earnings exception £4,465 pa £4,345 paClass 3 contributions £7.55 pw £7.35 pwClass 4 contributions Annual lower earnings limit £5,035 £4,895Annual upper earnings limit £33,540 £32,760Percentage rate between limits 8% 8%Percentage rate above upper limit 1% 1% Capital Gains Tax

Retail Prices Index

Where Retail Price Indices are required, it should be assumed that they are as follows.

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 1982 – – 79.44 81.04 81.62 81.85 81.88 81.90 81.85 82.26 82.66 82.511983 82.61 82.97 83.12 84.28 84.64 84.84 85.30 85.68 86.06 86.36 86.67 86.891984 86.84 87.20 87.48 88.64 88.97 89.20 89.10 89.94 90.11 90.67 90.95 90.871985 91.20 91.94 92.80 94.78 95.21 95.41 95.23 95.49 95.44 95.59 95.92 96.051986 96.25 96.60 96.73 97.67 97.85 97.79 97.52 97.82 98.30 98.45 99.29 99.621987 100.0 100.4 100.6 101.8 101.9 101.9 101.8 102.1 102.4 102.9 103.4 103.31988 103.3 103.7 104.1 105.8 106.2 106.6 106.7 107.9 108.4 109.5 110.0 110.31989 111.0 111.8 112.3 114.3 115.0 115.4 115.5 115.8 116.6 117.5 118.5 118.81990 119.5 120.2 121.4 125.1 126.2 126.7 126.8 128.1 129.3 130.3 130.0 129.91991 130.2 130.9 131.4 133.1 133.5 134.1 133.8 134.1 134.6 135.1 135.6 135.71992 135.6 136.3 136.7 138.8 139.3 139.3 138.8 138.9 139.4 139.9 139.7 139.21993 137.9 138.8 139.3 140.6 141.1 141.0 140.7 141.3 141.9 141.8 141.6 141.91994 141.3 142.1 142.5 144.2 144.7 144.7 144.0 144.7 145.0 145.2 145.3 146.01995 146.0 146.9 147.5 149.0 149.6 149.8 149.1 149.9 150.6 149.8 149.8 150.71996 150.2 150.9 151.5 152.6 152.9 153.0 152.4 153.1 153.8 153.8 153.9 154.41997 154.4 155.0 155.4 156.3 156.9 157.5 157.5 158.5 159.3 159.5 159.6 160.01998 159.5 160.3 160.8 162.6 163.5 163.4 163.0 163.7 164.4 164.5 164.4 164.41999 163.4 163.7 164.1 165.2 165.6 165.6 165.1 165.5 166.2 166.5 166.7 167.32000 166.6 167.5 168.4 170.1 170.7 171.1 170.5 170.5 171.7 171.6 172.1 172.22001 171.1 172.0 172.2 173.1 174.2 174.4 173.3 174.0 174.6 174.3 173.6 173.42002 173.3 173.8 174.5 175.7 176.2 176.2 175.9 176.4 177.6 177.9 178.2 178.52003 178.4 179.3 179.9 181.2 181.5 181.3 181.3 181.6 182.5 182.6 182.7 183.52004 183.1 183.8 184.6 185.7 186.5 186.8 186.8 187.4 188.1 188.6 189.0 189.92005 188.9 189.6 190.5 191.6 192.0 192.2 192.2 192.6 193.1 193.3 193.6 194.12006* 193.4 194.2 194.6 195.0 195.4 195.8 196.2 196.6 197.0 197.4 197.8 198.22007* 198.6 199.0 199.4 199.8 200.2 200.6 201.0 201.4 201.8 202.2 202.6 203.0

* = assumed


A: Introduction To The UK Tax System I n t his chapt er you will cover t he f ollowing ar eas in over view: - t he var ious t axes levied in t he UK; - t he per iod f or which income t ax is char ged; - t he cat egor isat ion of sour ces of income; - t he sour ces of income t hat ar e exempt f r om income t ax.

A1.1 Taxes in the UK

The UK gover nment r aises in t he r egion of 270 t o 280 billion pounds in t axat ion each year . Income tax is t he single lar gest ear ner f or t he gover nment making up 30% of t ot al r evenue. I ncome t ax is char ged on salar ies f r om employment , on r ent al income f r om pr oper t ies let out , on int er est f r om banks and building societ ies, on dividends f r om companies and on t he pr of it s of t he self employed. The second lar gest ear ner f or t he gover nment is value added t ax (VAT). This makes up about 23% of t he t ot al gover nment r evenue and is char ged by businesses t o cust omer s on supplies of goods or ser vices in t he UK. Nat ional I nsur ance cont r ibut ions (NIC) make up 21% of t ot al gover nment income. Nat ional I nsur ance cont r ibut ions ar e gener ally paid by bot h employer s and employees on ear nings f r om employment , alt hough NI C is also levied on self employed per sons on t he pr of it s of t heir t r ade. I ncome t ax, VAT and NI C ar e t he t hr ee most impor t ant t axes as f ar as r aising money is concer ned, making up about 75% or so of t ot al gover nment r evenue. A lar ge par t of t he r emainder (16%), is made up of duties, being t axes on alcohol, pet r ol and t obacco, as well as cer t ain levies on goods coming int o t he UK. Corporation tax makes up about 8% of t ot al gover nment r evenue, being t he t ax paid by UK companies on t heir t axable pr of it s. The r emaining slice consist s of t he “capital taxes” being capit al gains t ax (CGT), inher it ance t ax (I HT), st amp dut y (SD) and st amp dut y land t ax (SDLT). Capit al gains t ax is t he t ax levied when individuals sell asset s and make a pr of it .

Pr inciples of Business Taxat ion ‘Finance Act 2006’ 2

A1.2 The tax year

I ndividuals pay income t ax by r ef er ence t o t he “t ax year ”. The UK t ax year r uns f r om 6 April to the following 5 April. For example, t he t ax year t hat begins on 6 Apr il 2006 and ends on 5 Apr il 2006 is known as t he t ax year 2006/ 07. The t ax r at es and t ax allowances f or t he 2006/ 07 t ax year , wer e set in t he Mar ch 2006 Budget . Ther e ar e t wo st ages in calculat ing an individual’s t ax liabilit y. Fir st we comput e t he individual’s t axable income f r om all sour ces in t he r elevant t ax year . Having ar r ived at taxable income we t hen apply t he 2006/ 07 tax rates and allowances t o t hat income, t o ar r ive at t he tax liability f or t he year . This t ax will be collect ed by t he HM Revenue & Cust oms (“t he Revenue”) under t he “self -assessment ” syst em. This will be dealt wit h in a lat er chapt er .

A1.3 Sources of income

The t ax legislat ion cat egor ises var ious sour ces of income. Each t ype of income has it s own special r ules. This is why we need t o decide what t ype of income an individual has r eceived. When we looked at income r eceived by individuals in t he past , t he types of

income wer e sor t ed int o Schedules and somet imes f ur t her divided int o Cases. This was called t he Schedular system. I t st ill oper at es f or companies and so we will be looking at it in det ail when we st udy companies. You may well f ind r ef er ences t o t he old syst em in past quest ions. So we will ment ion t he main point s of t he old syst em as we explain t he cur r ent way of sor t ing out t he t ypes of income. The f ir st t ype of income t hat we will t hink about is trading income. This cover s pr of it s f r om a t r ade. So, f or inst ance, a self employed per son in business as a t axi dr iver , or a mar ket t r ader , or a builder or plumber , would be t axed on his trading income. This used t o be called Schedule D Case I income. Tr ading income also cover s pr of it s f r om a pr of ession or vocat ion. For inst ance, a self employed pr of essional such as a solicit or or bar r ist er would also have trading income. This used t o be called Schedule D Case II income. Tr ading income is a ver y impor t ant t ype of income and we will deal wit h it in a separ at e module. The second t ype of income we need t o consider is property income. This is income f r om land and buildings, such as rental income. We need t o keep pr oper t y income f r om UK land and buildings separ at e f r om pr oper t y income f r om non-UK land and buildings. I ncome f r om UK land and buildings used t o be t axed under Schedule A. I ncome f r om non-UK land and buildings used t o be t axed under Schedule D Case V.

I nt r oduct ion t o t he UK Tax Syst em

3

Next , t her e is a ver y impor t ant t ype of income called income f r om earnings and pensions. Earnings cover s salaries, bonuses and non-cash benefits. We will look at t hese in det ail in lat er sessions. This t ype of income used t o be t axed under Schedule E. Ther e ar e var ious t ypes of savings and investment income. A ver y common one is int er est ar ising f r om UK banks and building societies. We call t his interest income. This t ype of income used t o be t axed under Schedule D Case III. Anot her t ype of invest ment income is dividends received from companies. These used t o be t axed under Schedule F. As we will see lat er , dividend income needs t o be kept separ at e f r om ot her t ypes of invest ment income because it has dif f er ent r at es of t ax applied t o it . These ar e t he t wo main types of savings and invest ment income. An individual may have income f r om outside the UK. We have alr eady seen t hat he may have property income f r om non-UK land and buildings. He may also have investment income f r om out side t he UK such as non-UK bank interest or non-UK dividends. All income ar ising out side t he UK is now called foreign income. For eign invest ment income used t o be t axed under Schedule D Case V. I t is impor t ant t o not e her e t hat income can st ill be taxable in t he UK, even if it ar ises f r om a sour ce outside t he UK. As a gener al pr inciple, individuals who live in t he UK and who wer e born in t he UK will pay UK income t ax on t heir worldwide

income wher ever it comes f r om. So, a UK resident will gener ally pay income t ax on f or eign income. Finally, t her e is income which is char geable t o income t ax which does not f all wit hin any of t he cat egor ies t hat we have j ust looked at . This is called miscellaneous income. I t is t he Revenue' s way of cover ing it self and making sur e t hat t axable income doesn' t f all t hr ough t he net . Miscellaneous income used t o be t axed under Schedule D Case VI.

A1.4 Exempt income

Ther e ar e a f ew sour ces of income which ar e specif ically exempt f r om income t ax. I ncome f r om National Savings Certificates is exempt f r om t ax, as ar e any winnings on Premium Bonds. Any income f r om betting, gaming or lotteries is exempt f r om income t ax.

s. 692 I TTOI A

2005

Most social security benefits ar e also exempt f r om income t ax. The not able except ions t o t his ar e t he st at e pension and any j ob-seeker s allowances. These ar e t axable income.

s.660 I TEPA 2003


Any statutory redundancy pay r eceived on t he t er minat ion of an employment is also exempt f r om income t ax.

s. 309 I TEPA 2003

Scholarship awards ar e exempt , as is any income f r om ISAs (individual savings account s).

SI 1998/ 18

70

Example 1

Which of t he f ollowing sour ces of income ar e exempt f r om income t ax: Taxable Exempt

a) I nt er est on Nat ional Savings Account b) Dividend f r om a f or eign company c) Child’s wages f r om a newspaper r ound d) I ncome f r om Nat ional Savings Cer t if icat e e) Housing benef it f ) St at e r et ir ement pension

I nt r oduct ion t o t he UK Tax Syst em

5

Answer 1

Taxable Exempt

I nt er est on Nat ional Savings Account X Dividend f r om a f or eign company X Child’s wages f r om a newspaper r ound (not e) X I ncome f r om Nat ional Savings Cer t if icat es X

Housing benef it X

St at e r et ir ement pension X

Not e: Wages ar e t axable as employment income. The f act t hey ar e paid t o a child is ir r elevant . However , in most inst ances, t he child’s income will be cover ed by Per sonal Allowances so no t ax will be due.


SUMMARY - INTRODUCTION TO THE UK TAX SYSTEM

The main t axes in t he UK ar e income t ax, VAT, NI C, cor por at ion t ax, capit al gains t ax and inher it ance t ax. I ncome t ax is paid f or a t ax year which r uns f r om 6 Apr il t o 5 Apr il. I ncome is cat egor ised int o t he f ollowing sour ces: Tr ading income Pr oper t y income - UK

- non-UK Employment income Savings and invest ment income For eign income Miscellaneous income

- int er est income - dividend income

Some income is exempt f r om income t ax such as: I ncome f r om Nat ional Savings Cer t if icat es Pr emium bonds winnings I ncome f r om Bet t ing and Lot t er ies Most social secur it y benef it s St at ut or y r edundancy pay I ncome f r om I SAs

B: Computation of Taxable Trading Profit

B1: TRADING INCOME AND THE BADGES OF TRADE

I n t his chapt er we will look at t r ading income including: - t he schedule f or t axing t r ading income; - t he def init ion of a t r ade; - t he “badges of t r ade” ar ising f r om case law; - land t r ansact ions; - t he ant i-avoidance pr ovisions; - whet her r eceipt s ar e t axable or not . St at ut or y r ef er ences ar e t o I TTOI A 2005 unless st at ed ot her wise.

B1.1 Trading Income

The cat egor y “t r ading income” encompasses bot h income from a trade, f or example plumbing or building and income from a profession or vocation. A pr of ession would include account ancy or law. A vocat ion includes act ing, ballet dancing, t heat r ical per f or ming, spor t et c.

Pr eviously, under t he old schedular syst em income f r om a t r ade was t axed under Schedule D Case I , wher eas income f r om a pr of ession or vocat ion was t axed under Schedule D Case I I . Ther e wer e no not able dif f er ences bet ween t he way pr of it s wer e t axed under DI or DI I . B1.2 The definition of trading

I ncome t ax is char ged on “t he pr of it s of a t r ade, pr of ession or vocat ion”. s. 5

A t r ade is def ined as ”ever y manuf act ur e, advent ur e or concer n in t he nat ur e of t r ade”. A “t r ade” is def ined in t he legislat ion as a “t r ade”, which is a cir cular def init ion and does not t ake us a gr eat deal f ur t her . Ther ef or e, t he int er pr et at ion of what is meant by t he t er m “t r ade” has been lef t lar gely t o t he Cour t s. The Cour t s have developed a number of t est s t o det er mine whet her somebody is t r ading. These t est s ar e known as t he “badges of t r ade”.

B1.3 The Badges of Trade

Pr of it seeking mot ive When a per son ent er s int o a t r ansact ion, we need t o ident if y whet her t her e is a pr of it seeking mot ive. I t is not t he exist ence of a pr of it t hat is impor t ant , it is t he mot ive t o ear n one. However HM Revenue and Cust oms (t he Revenue) will r eally be int er est ed in t his issue if a pr of it has act ually been ear ned, because t hen t hey have somet hing t o t ax.


A t axpayer may ar gue t hat t hey ar e t r ading in or der t o ut ilise a loss t o r educe t heir t ax bill. The t axpayer must demonst r at e t he mot ive r at her t han t he exist ence of pr of it t o est ablish t hat a t r ade is being car r ied on. Fr equency and number of similar t r ansact ions I f we do somet hing once, never t o be r epeat ed again, it is unlikely t hat we would be t r eat ed as car r ying on a t r ade. However if we keep doing it , it is mor e likely t hat we ar e t r ading. For inst ance, assume I sold my car which I had owned f or f our year s. I t hen bought myself anot her car and sold t hat one t wo year s lat er . I t is unlikely t he Revenue would consider t hat I am t r ading in car s. I f , however , I bought and sold car s ever y mont h, it is mor e likely t hat t hey will seek t o t ax t he pr of it s as t r ading income. The most not able case in t his ar ea is Pickf or d v Quir ke wher e a t axpayer pur chased a mill wit h t he obj ect of using it f or t r ading pur poses. However it t ur ned out t hat t he mill was in a much wor se st at e t han t hey had imagined and t he best t hing t he t axpayer could do was t o st r ip all t he it ems out of it and sell t hem piecemeal. He made a consider able pr of it doing t his, so he did it again and again and again. As a r esult of t he r epeat ed number of t r ansact ions, it was held t hat t he pr of it s wer e t axable as t r ading income. I f we buy somet hing, do not hing t o it t hen sell it , it is unlikely we ar e t r ading. However , if we bought a car , put a new engine in it , r espr ayed t he body and made it mor e at t r act ive t o buy, it is possible we would be consider ed t o be t r ading. Nat ur e of t he asset We cannot pin a t r ading label ont o a single one-of f t r ansact ion simply because we cannot j ust if y t hat t he par t icular asset was pur chased f or any ot her pur pose t han t o r esell it . The most not able case in t his ar ea is Rut ledge v CI R. I n t his case, a t axpayer pur chased 1 million r olls of t oilet paper in one single t r ansact ion. He t hen sold t hem on at a pr of it in anot her single t r ansact ion. This was held t o be t r ading (an “advent ur e” in t he nat ur e of t r ade) as t her e was no ot her j ust if iable r eason t o pur chase such a lar ge quant it y of t oilet paper - he could not ar gue t hat t his was simply over st ocking! Connect ion wit h an exist ing t r ade Taking an example of a car , let us say t hat as a t ax account ant I sell a car . I t is unlikely t hat I would be t r ading in car s because t her e is no link bet ween selling car s and being a t ax account ant . I f however I was a car mechanic who occasionally sold a car , t he Revenue ar e much mor e likely t o successf ully t ax t he pr of it s on t he sale of car s along wit h my exist ing t r ade as t her e is a dir ect link bet ween r epair ing car s and selling car s. Ot her badges of t r ade would also need t o apply, but such a link is somet hing t hat t he Revenue will look ver y closely at .

Tr ading I ncome and t he Badges of Tr ade

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Financing ar r angement s I f an asset is pur chased on a shor t t er m loan which t he t axpayer is unable t o f und wit hout selling t he asset again, t hen t he Revenue can successf ully ar gue t hat t he asset was pur chased specif ically wit h a view t o selling it . This was cit ed in t he case of Wisdom v Chamber lain wher e t he comedian Nor man Wisdom bought a mound of silver bullion on a shor t t er m loan. He could not ser vice t he int er est payment s f r om his exist ing money, but as soon as he sold t he bullion and r epaid t he loan he f ound he had made a subst ant ial pr of it . This pr of it was t axed as t r ading income. Lengt h of owner ship I f you have owned somet hing f or a long t ime, it is much easier t o j ust if y t hat you bought it f or it s enj oyment or f or your own pr ivat e consumpt ion. A pr of it on sale would not t her ef or e be t r eat ed as a t r ading pr of it . I f however you have only owned it f or a shor t per iod it is much mor e likely t hat t he Revenue could successf ully ar gue t hat it was pur chased wit h t he aim of selling it at a pr of it . The exist ence of a sales or ganisat ion I n t he case of The Cape Br andy Syndicat e, a syndicat e of char t er ed account ant s dist illed br andy. They dist illed f ar mor e t han t hey could act ually dr ink t hemselves and sold t he sur plus. The Revenue sought t o t ax t hem as t r ading income. They ar gued t hat t hey wer e simply selling what t hey could not physically dr ink t hemselves. However as t hey had set up a special phone line and inf or mat ion desk and published br ochur es and adver t s adver t ising t heir br andy, t he Revenue successf ully ar gued t hat t hey had commenced a t r ade. Reason f or t he acquisit ion/ sale Finally, we will look at how t he asset was acquir ed – ie, whet her pur chased or ot her wise acquir ed by gif t or inher it ance - and what is t he r eason f or t he sale of t he asset ? By way of an example, consider Maud who inher it s a war dr obe f ull of f ur coat s f r om her lat e mot her . She does not want t o wear t hem, so she put s an adver t in t he local paper t o sell t hem. The Revenue spot t his adver t and seek t o t ax Maud f or any pr of it s ear ned. As Maud inher it ed t he coat s it is highly unlikely t hat a t r ading label can be pinned t o t hese t r ansact ions. However if Maud had pur chased a war dr obe f ull of f ur coat s, adver t ised t hem and t hen sold t hem at a pr of it , it is much mor e likely t hat she would be held t o be t r ading. Simply r ealising an inher it ance f or cash is not t he commencement of a t r ade. I n some cir cumst ances, t he exist ence of one single badge is enough t o show t r ading (as in t he case of Rut ledge v CI R). However in ot her cases we need t o look at a combinat ion of t he badges of t r ade. The t r igger t o get t he Revenue int er est ed in t he t r ansact ion in t he f ir st place is t he exist ence of a pr of it .


B1.4 Land transactions

The Revenue of t en look closely at t he pur chase and sale of land and buildings, simply due t o t he size of t he pr of it s involved. I t is in t he ar ea of land t r ansact ions t hat t he most cases involving t he badges of t r ade have been t aken t o t he Cour t s. One of t he impor t ant quest ions t o ask is whet her t he t axpayer is “invest ing in land” or “dealing in land” – “dealing” is t r ading. This quest ion which was posed in t he case of Mar son v Mor t on. Her e a t axpayer pur chased some land wit h t he int ent ion of holding on t o it as an invest ment f or at least t wo year s. I n or der t o incr ease t he value of t he land, t he t axpayer applied f or planning per mission. Looking at t he badges of t r ade, t his will be r egar ded by t he Revenue as a modif icat ion t o an asset t o make it mor e saleable. I t was held in t his case t hat because t he or iginal int ent ion was t he pur chase of an invest ment , no t r ade was being car r ied on. I t is not what t he t axpayer says which det er mines int ent ions, it is what t he sur r ounding evidence suppor t s. Document ed int ent ions made t he dif f er ence. Anot her quest ion t hat we must ask is, is whet her our t axpayer is a r esident in t he pr oper t y, or a developer who is r ef ur bishing a pr oper t y f or onwar d sale. I n t he case of Kir kby v Hughes, a builder pur chased a r un-down house. He car r ied out a lot of r epair and r ef ur bishment wor k and sold t he house at a healt hy pr of it . He t hen pur chased a st r ip of land and built a house on it , again selling it at a subst ant ial pr of it . He t hen pur chased a bar n and conver t ed it int o a house. The Cour t s believed t hat he was t r ading because t hey could apply enough of t he badges of t r ade t o him. Ther e clear ly was a pr of it seeking mot ive, he had modif ied t he asset s he pur chased, t her e was a connect ion wit h an exist ing t r ade, and t he lengt h of owner ship in each case was f air ly shor t . The pr of it s on t he f ir st house wer e held t o be t axable as t r ading income along wit h all of t he ot her pr oper t ies he had bought and sold. Looking specif ically at one of t he badges of t r ade we should also ident if y a r eason f or t he pur chase and a r eason f or t he sale. I n t he case of Taylor v Good, a husband pur chased a pr oper t y t o be used as a f amily home. However on seeing t he house, his wif e r ef used t o live in it . As a r esult he had no opt ion but t o sell t he house. Despit e it being a one-of f t r ansact ion, t he Revenue f elt t hat t he badges of t r ade applied because t he asset was only owned f or a ver y shor t per iod of t ime. However , t her e was clear ly anot her r eason f or t he acquisit ion and subsequent sale – t her e was a genuine int ent ion by t he t axpayer t o live in t he house r at her t han simply t o make a quick pr of it . Ther ef or e t he t r ansact ion was held not t o be a t r ading t r ansact ion.

B1.5 Frequency of transactions

Michael buys unpr of it able r est aur ant s, t ur ns t he businesses ar ound and sells t hem at a pr of it . He has done t his 12 t imes. The idea came t o him when he sold his f ir st r est aur ant which he had r un as t he owner and manager f or 10 year s.


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The quest ion we ar e asking is whet her he is char geable t o t ax on t r ading income, f ir st in r espect of t he r est aur ant s in gener al, which he had r un f or a shor t per iod, but also in r espect of t he f ir st r est aur ant which he had r un f or a long per iod. We must look closely at t he badges of t r ade. Clear ly t her e is a pr of it seeking mot ive which is r eadily ident if iable. The f r equency of t r ansact ions which Michael is under t aking point s t owar ds a t r ade. Modif icat ions t o t he asset pur chased (t aking an unpr of it able r est aur ant and t ur ning it ar ound), t he lengt h of owner ship (he owns t hem f or a r elat ively shor t per iod of t ime) and t he r eason f or t he sale (t o make money), lead us t o dr aw t he conclusion t hat t hese t r ansact ions will clear ly be t r ading t r ansact ions. The next quest ion is – do t he f ut ur e t r ansact ions t aint t he f ir st one? Unf or t unat ely t he answer t o t his quest ion is yes. I n t he case of Leach v Pogson, an individual had owned a dr iving school f or a long per iod of t ime bef or e he sold it at a pr of it . He t hen pur chased, t ur ned ar ound and sold numer ous ot her dr iving schools in t he f ut ur e. I t was held by t he Cour t s t hat not only wer e pr of it s f r om sales of t he lat er dr iving schools char ged t o t ax as t r ading income, but t he or iginal disposal, alt hough or iginally t r eat ed as a capit al t r ansact ion, will be t ur ned int o a t r ading t r ansact ion because of lat er event s.

B1.6 Share Dealing

Mur iel t hinks she has an inf allible syst em t o pr edict shar e pr ice movement s. Over a t wo year per iod she ent er ed int o over 100 t r ansact ions buying and selling shar es. She made a pr of it on some but over all she made a loss, so her syst em was not as inf allible as she t hought ! Will she manage t o obt ain loss r elief against her gener al income? I n or der t o set a loss against ot her income, t he loss must be a t r ading loss – we will come t o losses lat er in t his cour se. The quest ion is whet her Mur iel is dealing or invest ing. I n t he case of Salt v Chamber lain it was held t hat all shar e t r ansact ions ar e capit al in t heir nat ur e unless t hey ar e under t aken by a pr oper ly r egist er ed shar e dealer . Ther ef or e if a pr ivat e individual (not a shar e dealer ) buys and sells shar es many many t imes, he can never have t he badges of t r ade pinned on t o t hose t r ansact ions. Such pr of it s will be t axable as capit al gains and subj ect t o CGT wit h all t he advant ages of indexat ion and t aper r elief .


B1.7 Taxable and Non-Taxable Receipts

I f r eceipt s ar e wholly unexpect ed and unsolicit ed, t hey ar e not t axable. This is highlight ed in t he case of Simpson v J ohn Reynolds & Co., in which a t axpayer r eceived a volunt ar y payment f r om an ex-cust omer when t hey wer e asked t o cease t o act as t heir insur ance br oker . Because t he payment was not invoiced, not expect ed and was pur ely an unsolicit ed gif t , it was not held t o be par t of t he t axable t r ading income. I n Mur r ay v Goodhews, an ex-gr at ia payment given t o a pub landlor d as a r esult of t he cancellat ion of his pub t enancy was held not t o be t axable. The r eason f or t his was t hat t he r eceipt of t he compensat ion had not hing t o do wit h him buying and selling alcoholic dr inks and r unning a pub – it was as a r esult of t he t er minat ion of t he pub t enancy. However , if amount s ar e expect ed t hen t hey will be t axable. I n t he case of Cr eed v H & M Levinson Limit ed, a t axpayer was of f er ed an ex-gr at ia amount f r om an ex-cust omer and successf ully sued f or mor e. As t he r eceipt was clear ly solicit ed and expect ed, it was t axable. I n t he case of McGowan v Br own & Cousins, an est at e agent who r eceived compensat ion f or not being appoint ed as let t ing agent , was t axed on t he income as it r elat ed specif ically t o t he t r ade and was solicit ed and expect ed.


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SUMMARY - TRADING INCOME AND THE BADGES OF TRADE Tr ading income encompasses bot h income f r om a t r ade and income f r om a pr of ession or vocat ion. The st at ut or y def init ion of a t r ade includes t he wor d “t r ade”, so t est s known as t he “badges of t r ade” have developed f r om case law. These include:

- pr of it seeking mot ive - f r equency and number of similar t r ansact ions - modif icat ions t o sell an asset - nat ur e of t he asset - connect ion wit h an exist ing t r ade - f inancing ar r angement s - lengt h of owner ship - exist ence of a sales or ganisat ion - how t he asset was acquir ed and t he r eason f or sale.

Land t r ansact ions have f eat ur ed in many cases and t he quest ions t o ask also include: - is t he t axpayer invest ing or dealing? - is t he t axpayer r esident in t he pr oper t y or a developer ?

I f a ser ies of t r ansact ions ar e t r eat ed as t r ading t his will t aint t he f ir st t ime such a t r ansact ion was car r ied out so it can no longer be r egar ded as a capit al t r ansact ion. I f a t axpayer has deliber at ely t aken st eps t o t ur n a t r ading t r ansact ion int o a capit al one, t he pr of it s may be t axed as miscellaneous income. Wholly unexpect ed and unsolicit ed amount s ar e not t axable, however if amount s ar e expect ed t hen t hey will be t axable.

B2: ADJUSTMENT OF PROFIT

I n t his chapt er you will cover t he r ules t hat apply f or adj ust ing account ing pr of it s t o obt ain t he t axable t r ading pr of it s. I n par t icular you will cover : - depr eciat ion; - capit al expendit ur e; - t he wholly and exclusively r ule; - ent er t aining; - gif t s; - luxur y car r ent al payment s. St at ut or y r ef er ences ar e t o I TTOI A 2005 unless st at ed ot her wise.

B2.1 Introduction

Assume a t r ader pr epar es a set of account s and t hose account s show a pr of it . However , in comput ing t his pr of it t he t r ader could have deduct ed expendit ur e which t he Revenue may not like. Consequent ly we ar e r equir ed t o make a number of adj ust ment s in ar r iving at t he t r ader ’s t axable pr of it . We start wit h t he profit per accounts. We t hen add certain disallowed

expenditure, and deduct items which are not taxed as trading income. This gives us t he “t ax adj ust ed pr of it ”, which is accept able t o t he Revenue.

Pr of it per account s X Add: Disallowed expendit ur e X Deduct : I t ems not t axed as t r ade pr of it s (X) Tax adj ust ed pr of it X

I t is t his pr of it which is t axable as t r ading income.

B2.2 Depreciation

Depr eciat ion is not allowed f or t ax pur poses. This is because t her e ar e so many r at es and met hods of depr eciat ion t he Revenue f eel t hat t r ader s will be encour aged t o choose depr eciat ion r at es which maximise t ax r elief .

Instead businesses are able to claim capital allowances (CAs). CAs ar e nor mally given at a r at e of 25% on a r educing balance basis on asset s t hat qualif y as plant and machiner y. CAs ar e cover ed in a lat er chapt er .

Adj ust ment of Pr of it

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B2.3 Items not taxed as Trading Income

Tr ader s might include all of t heir income in t heir account s, but it is only t r ading income which is t axed as t r ade pr of it s. Ther ef or e all other sources of income

are deducted in ar r iving at t he pr of it f igur e. This ot her income will t hen be br ought back in t he main income t ax comput at ion and t axed accor dingly. Typical examples of non-t r ading income ar e:

s.4

• rental income;

• interest income;

• dividends received;

• any sundry miscellaneous income.

Illustration 1

A t r ader has t he f ollowing r esult s;

Profit & Loss Account; £ ’000 Tur nover 850 Cost of sales (400) Gr oss Pr of it 450 Rent al income 50 I nt er est r eceivable 20 Gr oss pr of it 520 Of f ice expenses (80) Pr emises expenses (100) Depr eciat ion (60) Profit before tax 280

Tax Computation; £ ’000

Pr of it per account s 280 Add: Depr eciat ion 60 Deduct : Rent al income (50) I nt er est (20) Tr ading I ncome 270

I t is t his Tr ading I ncome which is br ought int o t he t r ader ’s income t ax comput at ion as ear ned income.

B2.4 Disallowed expenditure

Ther e ar e t hr ee main cat egor ies in t his ar ea. • Capital expenditure - t his is any expendit ur e which gives an “endur ing

benef it ” t o t he business. Ther e is a lar ge amount of case law in t his ar ea which we will cover shor t ly.

s. 33


• Expenditure which has not been incurred “wholly and exclusively” f or t he pur poses of t he t r ade. Again t her e is a lar ge amount of case law in t his ar ea.

s. 34

• Specific disallowables given by t ax st at ut e and case law.

We shall examine each of t hese in t ur n.

B2.5 Capital expenditure

The pur chase of capital equipment should be included on a trader’s balance sheet, as t he balance sheet shows all t he f ixed asset s of t he business. These would include:

• mot or car s;

• pr emises;

• ot her equipment (phot ocopier s, comput er s et c).

These it ems ar e eligible for capital allowances or industrial buildings

allowances (I BAs) and t hese r ules will be cover ed in lat er chapt er s. I f t he t r ader has included any capital additions in t he Pr of it and Loss Account , t hey should be disallowed and added back in ar r iving at t he Tr ading I ncome. Wher e capit al addit ions qualif y as plant or machiner y, capit al allowances will be given inst ead. We also disallow profits or losses on the sale of assets. Losses on sales of asset s ar e a disallowed expense and should t her ef or e be added back. Pr of it s on sales of asset s ar e not t axable as Tr ading I ncome and should t her ef or e be deducted in ar r iving at t r ading pr of it s.

The t r ader may have also incur r ed legal fees on the acquisition of capit al asset s. These ar e disallowed as t hey relate to a capital item. However , legal f ees incur r ed on t he renewal of a short lease are specifically allowed. A shor t lease in t his cont ext is a lease of less t han 50 year s.

B2.6 Wholly and exclusively

Expenses ar e only deduct ible if t hey ar e incur r ed “wholly and exclusively” f or t he pur poses of t he t r ade.

s. 34

Private expenditure When pr epar ing account s, t r ader s of t en include it ems which r elat e in whole or in par t t o t heir own pr ivat e af f air s (ie not t o t he business). For example a t r ader may decide t o deduct a “salary” which he pays t o himself out of t he pr of it s of t he business. This “salar y” is not t axable on him as employment income since his pr of it s ar e char ged t o t ax as a self -employed individual (he is not an employee).


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Consequent ly we add back any salar y or wages dr awn f r om t he business by t he pr opr iet or in ar r iving at t he t ax adj ust ed pr of it . Salaries paid to employees

are allowable as t her e is a cor r esponding char ge t o income t ax on t he employment income.

Mortgage interest r elat ing t o t he t r ader s pr ivat e r esidence is clear ly a pr ivat e expense and is not incur r ed “wholly and exclusively f or t he pur poses of t he t r ade”. I t should t her ef or e be added back. However , int er est paid on a loan t o buy business premises (shop, of f ice et c) will be allowed as a deduct ion.

Motor expenses ar e a good example of a pr ivat e expendit ur e. Assume a t r ader dr ives a car , and he agr ees wit h t he Revenue t hat t he car is used 70% of the

time for business purposes. However , he deduct s all of t he cost s of r unning t he car in his pr of it and loss account (eg, all f uel, r epair s, insur ance, r oad t ax et c). I f 70% of t he cost s ar e incur r ed f or business pur poses, 30% of the costs

must be disallowed as t hey r elat e t o pr ivat e expendit ur e which has not been incur r ed wholly and exclusively f or t he pur poses of t he t r ade. 30% of the

motor expenses should be added back t o t he pr of it . Pr ovided t he t axpayer pr oposes a per cent age which r easonably r ef lect s t he pr ivat e element of t he expense, t he Revenue will usually accept it . The pr ivat e use adj ust ment can apply t o any expenditure. For example, if a t axpayer uses, say, 20% of his house as an of f ice f or t he pur poses of t he t r ade, he will be able t o deduct 20% of t he mor t gage int er est in ar r iving at his t axable pr of it . I f he has deduct ed t he f ull amount in his account s, we would need t o add back 80%. Travel expenses Ther e has been a lar ge number of cases going bef or e t he Cour t s wit h r egar d t o t he “wholly and exclusively” t est f or t r avel expenses. I n t he case of Newsom v Rober t son, a self employed bar r ist er claimed t he cost s of travel from his home in Surrey to his Chambers in Cent r al London. The bar r ist er ar gued t hat he wor ked in bot h locat ions – f r om t ime t o t ime he needed t o pr epar e cases and r ead t hr ough client f iles at home. However , he was not list ed in t he t elephone dir ect or y as a bar r ist er at his home addr ess, and he did not want his client s visit ing him at his home. He could have car r ied out his paper wor k in Chamber s, it was j ust t hat he chose t o wor k f r om home. As a r esult , t he Cour t s wer e not satisfied t hat t he t r avel expenses had been incur r ed wholly and exclusively f or t he pur poses of his pr of ession and t her ef or e disallowed t he cost s. I n Hor t on v Young, a br icklayer wor ked at a number of dif f er ent sit es. He negot iat ed his cont r act s and kept his r ecor ds at his home. I n or der t o lay br icks he obviously had t o travel to the site at which t he br icks needed laying. Ther ef or e t he Cour t s wer e sat isf ied t hat any t r avel cost s wer e incur r ed wholly and exclusively f or t he pur poses of t he t r ade. The builder ’s fixed place of

business was his home, therefore travel costs to the site were allowed.


I n Sar geant v Bar nes, a dent ist t r avelled f r om his home ever y mor ning t o his sur ger y. Cost s of t r avelling f r om home to work are not allowed as a deduct ible expense f or self -employed individuals as t hey ar e not incurred for the purposes of the trade. However , t he dent ist would st op of f at t he lab on his way t o wor k t o pick up bit s and pieces of equipment he r equir ed t o inser t int o his pat ient s’ mout hs. He t hen dr ove on t o t he sur ger y. The dent ist ar gued t hat t he cost s of t r avel bet ween t he lab and the surgery wer e allowed, ef f ect ively saying t hat his wor k st ar t ed on r eaching t he lab. However t he Cour t s wer e not sat isf ied t hat t he cost s wer e deduct ible as t he dent ist would have passed t he lab in any event as it was on his nor mal r out e int o t o wor k. Ther ef or e as he did not incur any extra travel costs, t he expenses wer e not deduct ible. Clothing

I n Mallalieu v Dr ummond, a bar r ist er claimed t hat t he cost s of her dar k Cour t r oom dr ess wer e allowable as an expense against her pr of essional income because she was r equir ed t o wear t hem in Cour t and would not ot her wise wear such clot hing in her ever yday lif e. However t he Cour t s wer e not satisfied t hat t his was t he case, as t hey ar gued t hat she would be wearing clothing in Court in

any event in or der t o pr ovide her wit h warmth and normal decency. The clot hing cost s wer e t her ef or e disallowed as t hey sat isf ied a pr ivat e pur pose. Ther ef or e, an account ant who only nor mally wear s his suit when he is act ing as an account ant , would not be able t o claim t he cost s of t hat suit as a t r ading expense because he would have t o wear somet hing when meet ing client s. However , t he Revenue do accept t hat protective clothing (har d hat s, over alls, chef s apr ons et c) is an expense incur r ed wholly and exclusively f or t he pur poses of t he t r ade and will allow such items. The same applies f or act or s’ cost umes. Children’s wages I n Dollar & Dollar v Lyon, t he pr ecedent was set t hat wages paid t o t he childr en of t he t r ader ar e only deduct ible pr ovided t hey can sat isf y t he “wholly and exclusively” t est . We t her ef or e need t o demonst r at e t hat if we did not employ our own childr en, we would need t o employ somebody else’s childr en t o per f or m t hose j obs (f or inst ance, wor king in t he shop on a Sat ur day or doing a paper r ound). The wages paid should be at a reasonable market rate, nowadays bear ing in mind t he Nat ional Minimum Wage. I f in t he Revenue’s view t he childr en’s’ wages put t hr ough t he account s ar e simply t heir pocket money (as in t he Dollar & Dollar case), t he cost s would not be deduct ible.


19

Accountancy fees I n Smit hs Pot at o Est at es Limit ed v Bolland, t he costs of a tax appeal, even t hough it was successf ul, wer e not allowed as t hey wer e not incur r ed wholly and exclusively f or t he pur poses of t he t r ade. The company had incur r ed t he cost s in its capacity as a taxpayer, not in it s capacit y as a t r ader . Ther ef or e t he cost s did not r elat e specif ically t o it s trade. Following on f r om t his case, t he Revenue will not accept a deduct ion f or t he cost in pr epar ing an individual’s per sonal t ax r et ur n even t hough t he r et ur n will include det ails of t he Tr ading I ncome. This is because t he cost is being incur r ed in t he individual’s capacit y as a taxpayer, not in his capacit y as a t r ader . So how do we t r eat account ancy f ees levied f or dealing wit h a tax enquiry? The Revenue has issued a St at ement of Pr act ice st at ing t hat if t he enquir y r elat es specifically to the trading income and as a r esult of t he enquir y no additional profits are brought within the charge to tax, any cost s incur r ed in dealing wit h t hat enquir y will be allowed f or t ax pur poses.

SP 16/ 91

Finance lease assets The r ule on f inance lease asset s der ives f r om t he case of Gallagher v J ones. Pr ior t o t his case, many t axpayer s claimed act ual r ent als payable under f inance leases r at her t han t he commer cial char ges which had been put t hr ough t he account s. However in t he case of f inance leased asset s, a deduct ion is given f or the depreciation element together with the interest charge. This is t he only exception to the rule that depreciation is not allowed f or tax purposes. This r ule is r ef er r ed t o in t he Revenue’s St at ement of Pr act ice 3/ 91.

SP 3/ 91

B2.7 Specific disallowables

Cost s incur r ed by a t r ader in entertaining anyone except the trader’s own

staff ar e specif ically disallowed by t ax legislat ion.

S.45

Gifts of it ems ar e also gener ally disallowed unless; (i) t he asset s gif t ed cost under £50; and (ii) t he gif t must bear t he business name, logo or a clear advertisement; and (iii) t he gif t should not include food, drink or tobacco.

The Revenue ar e r eluct ant t o give f ull r elief f or t he leasing cost s of luxur y car s. A luxury car in t his cont ext is a car cost ing more than £12,000. I n t his inst ance, we only allow r ent al payment s given by t he f or mula below:

s. 48

Allow: £12,000 + P x Rental payment

2P

wher e P = r et ail pr ice of t he car when new

This f or mula can be f ound at s.48(2) I TTOI A 2005.


The luxur y car r est r ict ion does not apply t o t he leasing of car s which:

(i) ar e elect r ically pr opelled; or

(ii) have car bon dioxide emissions less t han or equal t o 120g/ km. This exempt ion applies t o expendit ur e incur r ed on or af t er 17 Apr il 2002 on t he hir ing of a car which is f ir st r egist er ed on or af t er t hat dat e.

Example 1

A Mer cedes SLK is leased f or £ 6,000 p.a. The car cost £ 25,000

Calculat e t he amount of t he expense t hat would be allowable and t he amount t hat would be disallowed.

Example 2

St at e whet her t he f ollowing expenses incur r ed by a sole t r ader ar e allowable or disallowable f or t ax pur poses: Allowable Disallowable

a) Loss on sale of a comput er

b) Amor t isat ion of goodwill

c) Employee st eals t he pet t y cash

d) Ent er t aining t he local vet

e) Legal f ees incur r ed on pur chase of a new building

f ) I nt er est on lat e paid VAT

g) Depr eciat ion on a f inance leased asset

h) Pur chase of a new washing machine


21

Answer 1

Allow: £ 12,000 + £ 25,000 x £ 6,000 = £4,440 2 x £ 25,000

Disallow: £ (6,000 – 4,440) = £1,560 i.e. £ 1,560 would be added back in t he adj ust ment t o pr of it s calculat ion.

Answer 2

Allow

Disallow

a) Loss on sale of comput er (Capit al) X b) Amor t isat ion of goodwill

(Type of depr eciat ion)

X

c) Employee t hef t of cash

(Business r isk – wholly and exclusively)

X

d) Ent er t aining t he local vet

(Not st af f )

X

e) Legal f ees on new building

(Capit al)

X

f ) I nt er est on lat e paid VAT

(Fine)

X

g) Depr eciat ion on f inance leased

asset

(Gallagher v J ones SP3/ 91)

X

h) Pur chase of a new washing

machine

(Capit al it em)

X


SUMMARY - ADJUSTMENT OF PROFIT

Adj ust ment s must be made t o t he pr of it per account s t o ar r ive at a t ax adj ust ed f igur e. I t ems not t axed as t r ading income must be deduct ed in ar r iving at t he t ax adj ust ed pr of it and include: r ent al income int er est income dividend income sundr y income pr of it s on sales of f ixed asset s

Disallowed expendit ur e must be added back and includes: - depr eciat ion (except on f inance leased asset s) - capit al expendit ur e - losses on sales of f ixed asset s

- legal f ees on acquisit ion of asset s (except r enewal of lease < 50 yr s) - expenses not incur r ed wholly and exclusively f or t he t r ade - pr ivat e expendit ur e - t r avel expenses f r om home t o wor k - nor mal clot hing (but not pr ot ect ive clot hing which is allowable) - childr en’s wages if r eally pocket money - cost s of a t ax appeal - ent er t aining (unless st af f )

- gif t s (unless < £ 50, bear ing t he business name and not f ood, dr ink nor t obacco) - a pr opor t ion of luxur y car r ent als (not “gr een” car s)

£ 12,000 + P x Rent al payment (P = r et ail pr ice of new car ) 2P

A measur e of r elief f or capit al expendit ur e is available f or t r ader s inst ead of depr eciat ion. Cer t ain it ems will be eligible f or capit al allowances or indust r ial buildings allowances (cover ed lat er ).

B3: CAPITAL v REVENUE

I n t his chapt er we shall look mor e closely at t he r ules f or dist inguishing whet her expendit ur e is capit al in nat ur e (and t her ef or e disallowable) or r evenue in nat ur e and hence would not lead t o any adj ust ment t o pr of it s. You will lear n about : - t he gener al pr inciples; - init ial r epair s; - r epair s v r eplacement s; - st af f cost s; - t r aining cost s; - one-of f cost s St at ut or y r ef er ences ar e t o I TTOI A 2005 unless st at ed ot her wise.

B3.1 General Principles

Sect ion 33 I TTOI A 2005 disallows any sum employed as capital in t he business. This would include it ems such as loan repayments. I f f or inst ance, a t axpayer bor r ows money t o pur chase a business pr emises, any r epayment s he makes back t o t he bank r elat ing t o t he capit al of t he loan will not be t ax deduct ible. However any int er est element will be allowable.

s. 33

The cost of capital acquisitions is also disallowed. A capit al acquisit ion f or t hese pur poses is any expense which gives an enduring benefit t o t he business. The cost of improvements t o business pr emises is disallowed. The r eplacement of a par t of t he pr emises wit h t he near est moder n equivalent , r ef lect ing t echnological impr ovement s, is allowable. However , if an it em is subst ant ially upgr aded, t he whole expendit ur e may be capit al. Specif ically t he Revenue now accept s t hat r eplacing single glazed windows by double glazed equivalent s count s as a r epair . The Revenue’s pr evious view was t hat such expendit ur e would ‘nor mally’ be an impr ovement and t her ef or e disallowed.

B3.2 Initial repairs

I f a t r ader pur chases an asset and t hen spends money on it , is t his expense capit al? I n Law Shipping Company v I RC, a company pur chased a ship which needed some immediat e r epair wor k as it did not possess a cer t if icat e of sea-wor t hiness. They spent t he money and claimed t he r epair s as a r evenue expense in t he pr of it and loss account . However , t he Cour t s held t hat t he r epair s wer e par t and par cel of t he acquisition costs of t he asset as t hey enabled the ship to be used for the very first time. As a r esult , t hese “r epair s” wer e held to be capital – i.e. linked t o t he capit al acquisit ion of t he ship.


Could we ar gue t hat t he cost s ar e r evenue? I n t he case of Odeon Associat ed Theat r es Limit ed v J ones, a number of cinemas wer e pur chased j ust af t er t he war in a ver y r un down st at e. However , Odeon kept t hem open t o t he public and cont inued t o show f ilms. Over a per iod of t ime t hey gr adually r epair ed and r enovat ed t he cinemas and br ought t hem up t o a much smar t er st at e. As much of r epair wor k r elat ed t o dilapidat ions ar ising pr ior t o Odeon’s pur chase, t he Revenue ar gued under t he Law Shipping pr ecedent t hat t he r epair s expenses wer e par t and par cel of t he acquisit ion cost – ie, t hey wer e capit al. However , as t he repairs took place to useable assets, t he Cour t held t hat t he costs were

revenue in nature and therefore allowable. The most impor t ant f act or wit h r egar d t o r epair s on newly acquir ed asset s, is whet her t he asset was purchased in a useable state and was actually used in t hat st at e.

B3.3 Repair v Replacement

A repair t o an it em is nor mally allowed as a revenue expense wher eas replacing an ent ir e it em is nor mally consider ed a capital acquisit ion. Ther e ar e t wo cont r ast ing cases her e. I n Bullcr of t Main Collier ies v O’Gr ady, a business owned a f act or y. On t he same sit e t her e was a f r eest anding chimney. The chimney was in a poor st at e of r epair and t he most economic t hing t o do was t o knock it down complet ely and r ebuild it . This was held t o be a replacement of an entire asset and capital in nat ur e – i.e. a capit al acquisit ion of a br and new chimney. However , in Samuel J ones & Co (Devondale Lt d) v CI R, a company owned a f act or y which had a chimney act ually at t ached t o it . The chimney was demolished and r eplaced wit h anot her one. The t axpayer successf ully ar gued t hat t his was a repair to a subsidiary part of the factory and not t he r eplacement of an ent ir e asset . The cost s wer e revenue in nat ur e and t her ef or e allowable. Ther ef or e as f ar as r epair s ar e concer ned, if a t r ader act ually r epair ing a part of an asset , t hat is a genuine r epair and t he cost s will be allowed. However , if a t r ader is r eplacing an asset in it s entirety, t hat is a capit al it em.

B3.4 Staff costs

St af f cost s ar e gener ally a revenue expense unless they relate to a capital project. For example, if a f ir m of builder s employs it s own st af f t o const r uct a new head of f ice, we would capit alise t hose par t icular st af f cost s on t he balance sheet as t hey ar e par t of t he acquisit ion cost s of t he new head of f ice (t he new of f ice being a capit al asset employed in t he business). Anot her example would be a f ir m of account ant s employing st af f who have developed a new int er nal account ing sof t war e package t o be used long-t er m in t he business. The st af f cost s her e ar e likely t o be linked t o a capit al t r ansact ion and t hey should be disallowed. Capit al allowances should inst ead be claimed on t he sof t war e development cost s. We will deal wit h capit al allowances in a lat er session.

Capit al v Revenue

25

I n I RC v The New Zealand For est I nst it ut e Limit ed, t he company pur chased a number of r esear ch under t akings f r om t he New Zealand Gover nment . When t he under t akings wer e pur chased, t he company t ook over all of t he employees’ cont r act s of employment . Some of t he st af f wer e ent it led t o accr ued holiday pay, which was duly paid by t he company who claimed it as a r evenue expense. However , t he Pr ivy Council held t hat t his was capital, r elying on t he decision of Law Shipping. The holiday pay f or med par t of t he acquisition costs of the

undertakings, and wer e cont r act ual obligat ions. The company had pur chased an asset (t he new r esear ch under t akings) and wer e immediat ely r equir ed t o spend money on it . That is a capit al t r ansact ion. J ames Snook & Co Limit ed v Blasdale involved a company owned by a number of dir ect or s. The dir ect or s wer e also shar eholder s. The buyer was pur chasing t he shar es in t he company in r et ur n f or a cash payment t o t he shar eholder s. The acquisit ion of shar es is nor mally t r eat ed as a capit al t r ansact ion and t he pur chaser would t her ef or e not be able t o obt ain t ax r elief in ar r iving at t heir t axable pr of it s. However , t wo of t he boar d dir ect or s (who wer e also shar eholder s) wer e t o be made r edundant as well as selling t heir shar es. The pur chaser negot iat ed wit h t hese t wo member s t hat t he cash t hey r eceive would be t r eat ed as compensation for loss of office. This way t he pur chaser could t r eat t he payment as par t of staff costs (ie, as an allowable r evenue expense). However , t he Cour t s did not agr ee. The t r ansact ion was t r eat ed as capit al as t her e was a direct link between the cash and the sale of shares.

The Revenue will t r y t o link a payment t o a capit al t r ansact ion wher ever possible. I n t his sit uat ion, it would have been bet t er f or t he pur chaser t o buy t he shar es (at a discount ed pr ice), keep t he boar d member s on f or , say, 6 mont hs, t hen make t hem r edundant . The r edundancy payment in t his inst ance payment would most likely be t r eat ed as a r evenue expense.

B3.5 Training costs

The acquisit ion of new exper t ise is t r eat ed as capit al. For example, assume an individual want s t o t r ade as an account ant . The cost s incur r ed by t hat individual t o acquir e t he r elevant exper t ise and pass t he account ancy exams will not be t r eat ed as an expense in ar r iving at his t axable pr of it but will simply be a cost incurred to enable him to trade in t he f ir st place. I n a similar sit uat ion, t he cost s incur r ed by an individual put t ing t hemselves t hr ough t r aining t o become a dr iving inst r uct or would also be treated as capital as t hese ar e cost s t o put t hat per son in t he position to trade, and ar e not incur r ed as part of actually trading. Ongoing, update or development training, once qualif ied, will be allowed as a r evenue expense because t her e is a dir ect link bet ween t he expense being incur r ed and t he income being r eceived as an account ant or dr iving inst r uct or .


Staff training costs are always allowable as a t r ading expense whet her t his is f or t he st af f t o acquir e new exper t ise or simply keep up t o dat e. I n addit ion, such t r aining is a t ax f r ee benef it f or t hose member s of st af f because t he Gover nment is keen t o encour age employer s t o t r ain and impr ove t heir employees.

B3.6 One-off costs

A one-of f payment may eit her be capit al or r evenue, depending on t he nat ur e of it . A one-of f payment will be capit al if it r esult s in t he purchase of either a tangible or an intangible asset. An example of an int angible asset would be somet hing like a licence agr eement or a pat ent r oyalt y. This was given in t he case of Mor gan Cr ucible Company Limit ed v I RC. I f t he payment affects the value of a capital asset it will also be t r eat ed as capit al as decided t he case of Tucker v Gr anada Mot or way Ser vices Limit ed. Her e a payment t o r educe f ut ur e r ent als on a lease was held t o be capit al in nat ur e because it increased the value of the lease on t he balance sheet . A one-of f payment will be r evenue (and allowable) if it is made to reduce future

revenue obligations and does not r esult in eit her t he acquisit ion or t he incr ease in value of a capit al asset . This was given in t he case of Hancock v The Gener al Rever sionar y and I nvest ment Co Limit ed.

Capit al v Revenue

27

Example 1

You ar e r equir ed t o st at e which of t he f ollowing ar e r evenue or capit al it ems f or t ax pur poses.

Capit al Revenue

a) Replacement of a phot ocopier

b) New r oller s on a phot ocopier

c) Repair s t o a second hand phot ocopier t o

enable it t o be used.

d) Redecor at ion of a new of f ice building in

line wit h t he business’s “cor por at e image”.

e) Redundancy payment s made t o st af f as a

r esult of t he t akeover of t he company

f ) Redundancy payment s made t o a dir ect or / shar eholder as a r esult of a t akeover .

g) CPE t r aining f or a self -employed account ant .

h) A one-of f payment t o r educe r ent al

payment s on a leased building.

i) Pur chase of an annuit y t o enable a business

t o make pension payment s t o r et ir ed st af f .


Answer 1

Capit al Revenue

a) Replacement of a phot ocopier X

b) New r oller s on a phot ocopier X

c) Repair s t o a second hand phot ocopier t o

enable it t o be used. X

d) Redecor at ion of a new of f ice building in

line wit h t he business’s “cor por at e image”.

X (see Not e)

e) Redundancy payment s made t o st af f as

a r esult of t he t akeover of t he company

X

f ) Redundancy payment s made t o a dir ect or / shar eholder as a r esult of a t akeover . X

g) CPE t r aining f or a self -employed account ant .

X

h) A one-of f payment t o r educe r ent al payment s

on a leased building.

X

i) Pur chase of an annuit y t o enable a business

t o make pension payment s t o r et ir ed st af f .

X

Not e: We will assume t hat t he t r ader pur chased a useable of f ice block, and t her ef or e it is likely we could t r eat t his as a r evenue expense given t he Odeon decision. However we might end up wit h a bat t le f r om t he Revenue if t hey could ar gue t hat t he asset was act ually unusable - i.e. because t he walls wer e not decor at ed in t he cor por at e ident it y.

Capit al v Revenue

29

SUMMARY - CAPITAL v REVENUE I f expendit ur e is capit al in nat ur e it must be disallowed f or t ax pur poses. Capit al acquisit ions giving an endur ing benef it t o t he t r ade and impr ovement s t o business pr emises must be disallowed. Loan r epayment s must also be added back alt hough int er est is allowable. I nit ial r epair s t o an asset t o enable it t o be used ar e disallowed. However init ial r epair s t o a useable asset ar e allowable. Repair s t o a subsidiar y par t of an asset ar e allowable but r eplacement of an ent ir e asset is capit al expendit ur e. Replacing single glazed windows wit h double glazed equivalent s count s as a r epair . St af f cost s ar e allowable unless t hey r elat e t o a capit al pr oj ect . I f on t akeover of a company a cash payment is made t o shar eholder s being made r edundant t his will be linked t o t he sale of t he shar es and will be disallowed. Tr aining cost s t o enable an individual t o t r ade will be disallowed alt hough CPE and st af f t r aining cost s ar e allowable. A one-of f payment t o pur chase an int angible asset is also disallowable, as ar e payment s t hat af f ect t he value of a capit al asset .

B4: CAPITAL ALLOWANCES – DEFINITION

I n t his chapt er you will cover t he r ules f or det er mining whet her plant and machiner y qualif y f or capit al allowances – t he t ax deduct ion available inst ead of depr eciat ion. You will lear n about : - t he st at ut or y def init ion of non-qualif ying expendit ur e; - t he exclusion f or buildings; - t he exclusion f or st r uct ur es and land; - t he over r ide t o t he exclusions; - case law t est of f unct ion v set t ing. St at ut or y r ef er ences in t his chapt er ar e t o CAA 2001 unless ot her wise st at ed.

B4.1 Introduction

Capit al allowances ar e a tax deductible allowance given when a trader incurs

qualifying capital expenditure. The t r ader would not get a r evenue deduct ion f or t he expendit ur e because it has an enduring benefit f or t he t r ade and is t her ef or e r egar ded as capit al. I t will however be a business cost and t her ef or e t he t r ader should be able t o claim a deduct ion against t axable pr of it s. This is done by means of a capit al allowance.

s. 2

The amount of t he capit al allowances available depend on t he t ype of qualif ying expendit ur e. All allowances ar e laid down in st at ut e. The allowance could be as lit t le as 4%, it could be as high as 100% - it depends on t he t ype of expendit ur e and t he t ype of business incur r ing t he expendit ur e. Capit al expendit ur e f alls int o 3 br oad cat egor ies:

- expendit ur e on plant and machinery (by f ar t he most common); and - expendit ur e on industrial buildings (ver y common); and. - other expendit ur e (less common), such as on agr icult ur al buildings..

s. 1(2)(a)

s.. 1(2)(b)

I n t his chapt er we will look at t he def init ion of plant and machiner y. I n subsequent chapt er s we will look at how we calculat e t he var ious t ypes of allowances. You should not e t hat capit al expendit ur e will include any ir r ecover able VAT. This is VAT which t he t r ader is unable t o claim back f or var ious r easons - t his will become clear er once you have st udied t he VAT par t of your cour se.

B4.2 Definition of “Plant and Machinery”

The def init ion of plant and machiner y is f ound in t he Capit al Allowances Act of 2001 (CAA 2001). Ther e is also a significant body of case lawdiscussing what is and what is not plant .

s. 21- s. 33

CAA 2001 def ines what is non-qualif ying expendit ur e. Ther ef or e if an it em is not wit hin t he non-qualif ying expendit ur e, by eliminat ion it is likely t o be r egar ded as plant .

Capit al Allowances - Def init ion

31

The non-qualif ying expendit ur e is br oken down int o “buildings”, and “structures and land”. The non qualif ying expendit ur e included under buildings can be f ound wit hin S.21 CAA 2001. Ther e is a list called List A in t his sect ion. I f a par t icular it em is wit hin List A, it is specif ically excluded and is therefore

unlikely to qualify as plant and machiner y

s. 21

Similar ly wit hin S.22 CAA 2001, t her e is a list (List B), which ident if ies expendit ur e in connect ion wit h st r uct ur es and land which should not be

regarded as plant or machinery. So you can see t hat t he legislat ion is ver y usef ul in det er mining whet her somet hing is plant or not .

s. 22

Ther e is also a ver y impor t ant override wit hin t he legislat ion. This can be f ound at S.23 CAA 2001 wit hin List C. Essent ially if expendit ur e is within List C it is likely to qualify as plant and machiner y.

s. 23

I t could t her ef or e be t hat expendit ur e looks as t hough it f alls wit hin S.21 CAA 2001 (and would t her ef or e not qualif y f or allowances), but if you can specif ically f ind it wit hin S.23, t hen S.23 over r ides t he or iginal exclusion, and t he expendit ur e will pr obably be t r eat ed as plant and will qualif y f or allowances Even if an it em in included wit hin List C, it must st ill sat isf y t he case law t est of “f unct ion ver sus set t ing”. This ver y impor t ant t est asks whet her ; (i) t he asset in quest ion f or ms par t of t he set t ing in which t he t r ade is car r ied on?; or (ii) t he asset in quest ion is somet hing which a t r ader act ively uses in his t r ade, i.e. does t he asset per f or m a f unct ion in t he business? I f t he asset has a f unct ion, it will be plant and capit al allowances can be claimed. However , if expendit ur e has been incur r ed by t he t r ader on par t of t he set t ing wit hin which he r uns his business, it will not be plant and no allowances can be claimed. This was est ablished of J Lyons & Co v At t or ney Gener al and has been r evisit ed many t imes by t he Cour t s in deciding what is or is not “plant ”.

B4.3 Buildings – s. 21 CAA 2001 s. 21

Under t he buildings exclusion wit hin S.21 CAA 2001, t he t er m “building” includes: - an asset which is incor por at ed in t he building; - an asset which, alt hough not incor porat ed in t he building (because per haps it is moveable), is in t he building and is of a kind which would nor mally be incor por at ed in t he building; - an asset t hat is in or connect ed wit h t he building and is in List A. You can see t hat if an it em is incor por at ed in t he building, or it is nor mally incor por at ed, but on t his par t icular occasion it is moveable, it is likely t o be excluded under (a) or (b).


List A pr ovides f ur t her clar if icat ion as t o it ems included wit hin t he t er m “building”, specif ically det ailing t he f ollowing: Walls, f loor s, ceilings, door s, gat es, shut t er s, windows, st air s. Mains ser vices and syst ems f or wat er , elect r icit y and gas. Wast e disposal syst ems. Sewer age and dr ainage syst ems. Shaf t s or ot her similar st r uct ur es. Fir e saf et y syst ems. No gr eat sur pr ises t her e, but List A does clar if y t hat expendit ur e on t hese par t icular it ems (unless lat er over wr it t en by List C), would be r egar ded as expendit ur e on “buildings” and t her ef or e would not qualif y as “plant ”. B4.4 Structures and Land – s.22 CAA 2001 s. 22

Under S.22, plant and machiner y does not include expendit ur e on t he f ollowing: The pr ovision of a st r uct ur e or ot her asset in List B; or Any wor ks involving t he alt er at ion of land. Land is not plant , but List B is wor t h a close look and cont ains t he f ollowing: Tunnel br idge, viaduct et c. Pavement , r oad, car par k. Canal or basin. Dam, r eser voir s et c. Docks, har bour s, whar f s. Dykes and sea walls. Again no gr eat sur pr ises her e. You would have t o be f air ly opt imist ic t o ar gue t hat a t unnel, f or example, was a piece of plant . However , t o be saf e do check t hat your it em is not wit hin List C as anyt hing in List C over r ides List B.

B4.5 Override – s. 23 CAA 2001 s. 23

S.23 t ells us t hat t hat S.21 and S.22 do not apply t o t he f ollowing: Ther mal insulat ion of indust r ial buildings. Fir e saf et y. Saf et y at designat ed spor t s gr ounds. Saf et y at r egulat ed st ands at spor t s gr ounds. Saf et y at ot her spor t s gr ounds. Per sonal secur it y. Sof t war e and r ight s t o sof t war e. List C it ems. Ther ef or e expendit ur e on any of t he it ems above will be t r eat ed as expendit ur e on “plant ” and will qualif y f or capit al allowances. List C is a long list of ver y specif ic it ems. The maj or it y of t hese it ems have been der ived f r om case law. I ndeed List s A, B and C have lar gely been const r uct ed as a


33

summar y of case decisions r egar ding whet her asset s const it ut e plant or not . Ther ef or e, in t his ar ea, we no longer need t o r ef er t o much case law as case pr ecedent s have now been put on t he st at ut e books and incor por at ed int o t he Capit al Allowances Act . The new legislat ion is ver y compr ehensive and is a gr eat help in det er mining whet her a par t icular it em is plant or not . Taking a closer look at List C, which compr ises some 33 it ems, it should be not ed t hat whilst List C it ems nor mally qualif y as plant , it does not aut omat ically mean t he asset is plant . The asset must also f ulf il t he case law t est of f unct ion v set t ing. I n t he maj or it y of cases t he “f unct ion” t est will be passed. However you should be awar e t hat j ust because an asset appear s on List C, it does not aut omat ically mean t hat capit al allowances can be claimed. I f a “List C” asset f or ms par t of t he “set t ing” in which a business is car r ied on, a capit al allowances claim will be denied.

Illustration 1

Consider a dr y dock. A dr y dock is ment ioned in S.22 List B, it em 5 (ie a dock, har bour , et c). These ar e t he it ems which ar e consider ed t o be par t of a st r uct ur e or land, t her ef or e you would t hink it would not be plant and would not qualif y f or capit al allowances. Now t ake a look at List C in S.23. I n List C, it em 23, we have t he pr ovision of dr y docks. I n t he case of CI R v Bar clay, Cur le & Co Lt d, a dr y dock was held t o per f or m a f unct ion in t he business, ie, r emoving a ship f r om t he r iver , holding it upr ight whilst it was being r epair ed and t hen r et ur ning it t o t he r iver when t he r epair s wer e complet e. Consequent ly t he dr y dock f ulf illed a f unct ion in t he business r at her t han j ust being par t of t he set t ing in which t he business was car r ied on. Ther ef or e t he dr y dock will qualif y as plant , pr oviding of cour se t he f unct ional t est has been met , which it should do f ollowing t he Bar clay Cur le case. Fr om t his exer cise we see an it em t hat init ially looked as t hough it was excluded f r om being plant because it was in List B. However , on an inspect ion of over r ides in List C we f ind it specif ically ment ions t he it em concer ned. Ther ef or e we can assume t hat we ar e a long way t o est ablishing t hat a dr y dock is plant .


B4.6 Case Law

Var ious cases on t he “f unct ion v set t ing” t est demonst r at e t his ver y impor t ant pr inciple. I n Dixon v Fit ch’s Gar age Lt d (1975), it was held t hat a gar age canopy over a pet r ol f illing st at ion did not act ually help in t he supplying of pet r ol. I t was t her ef or e held t o be par t of t he set t ing, and t her ef or e not plant . However , if t he canopy was mor e t han j ust a canopy (ie, it per f or med a gr eat er r ole in t he business such as at t r act ing cust omer s t o t he gar age), t hen t he Revenue may accept t hat t he canopy f ulf ils a f unct ion and capit al allowances could be claimed. I n an I r ish case (O’Culachain v McMullan Br ot her s) t he t axpayer succeeded in such a claim as t he canopy car r ied adver t ising in illuminat ed let t er ing. I n Schof ield v R & H Hall Lt d (1975), dockside concr et e gr ain silos wer e held t o be plant as t hey f ulf illed a f unct ion in t he t r ade. They held t he gr ain in a posit ion f r om which it could be dischar ged t o pur chaser s. This was a f unct ion, and t he silos wer e t her ef or e plant . This has now been specif ically included in List C - I t em 28 st at es t he pr ovision of silos pr ovided f or t empor ar y st or age or st or age t anks ar e specif ically included as plant .

I n Cooke v Beach St at ion Car avans Lt d (1974), a car avan par k wit h leisur e f acilit ies, claimed t hat t he const r uct ion of t heir swimming pool f ell wit hin t he “f unct ion” pr ovisions, and was t her ef or e plant . The Revenue ar gued it was set t ing. The Cour t s agr eed t hat t he pool per f or med a f unct ion, i.e. t he car avan par k used t he swimming pool f or car r ying on it s t r ade, and it was a maj or at t r act ion t o t he car avan par k. Again t his case has now been included in t he legislat ion at List C, it em 16. I n J ar r old v J ohn Good & Sons Lt d, moveable par t it ions in an of f ice t o sub-divide f loor space wer e consider ed not t o be par t of t he st r uct ur e. The Revenue cont ended t hat t hey wer e par t of t he set t ing, i.e. par t of t he building in which t he t r ade was car r ied on. The Cour t of Appeal agr eed wit h t he t axpayer and decided t hat t he par t it ions per f or med a f unct ion as t hey wer e moveable and wer e int ended t o be moved in t he cour se of t he business. The par t it ions wer e t her ef or e plant . This is now included in List C at it em number 13. As you can see, a lot of case law is now incor por at ed int o List C in S.23 CAA 2001. I t is cer t ainly wor t h looking t his up if you have not alr eady done so.

Example 1

Which of t he f ollowing t ypes of expendit ur e do you f eel qualif ies as plant ? Gener al light ing in a r et ail st or e Display light ing in st or e windows Decor at ive t apest r ies in a hot el Ship used as a f loat ing r est aur ant Adver t ising hoar dings Suspended ceiling over a st air well Suspended ceiling over eat ing ar ea


35

Answer 1

Plant ? Gener al light ing in a r et ail st or e X Display light ing in st or e windows R

Decor at ive t apest r ies in a hot el � Ship used as a f loat ing r est aur ant X Adver t ising hoar dings � Suspended ceiling over a st air well X Suspended ceiling over eat ing ar ea �

Gener al light ing in a r et ail st or e does not nor mally qualif y f or plant . I t is j ust consider ed t o be par t of t he set t ing. When acquir ing a building, gener al light ing is an int egr al par t . I n List A it em 2, mains ser vices such as elect r icit y syst ems ar e not r egar ded as plant . Display light ing in st or e windows can be r egar ded as plant . The light ing is nor mally much mor e specialised and wit h t hat it f ulf ils a f unct ion, i.e. t o at t r act cust omer s int o t he shop. I n List C it em 2, elect r ical syst ems which meet t he r equir ement s of a par t icular act ivit y ar e t r eat ed as plant . I n Cole Br ot her s v Phillips, capit al allowances claims wer e made in r espect of light ing in a r et ail shop (par t of t he J ohn Lewis Gr oup). Gener al light ing was held not t o be plant whilst mor e specialised light ing (eg, f or window displays et c) was held t o per f or m a f unct ion. This est ablished t he pr inciple t hat t he Revenue could r eview capit al allowance claims on a “piecemeal basis” (ie, consider ing each piece of “plant ” on it s own mer it s). Decor at ive t apest r ies in a hot el ar e r egar ded as plant . I n List C it em 14, decor at ive asset s pr ovided f or t he enj oyment of t he public in a hot el, r est aur ant or similar t r ade will be t r eat ed as plant . This was est ablished in t he case of CI R v Scot t ish & Newcast le Br ewer ies Lt d wher e t apest r ies and mur als f it t ed t o t he walls of pubs and hot els cr eat ed an “ambience and at mospher e” wit h which t o at t r act cust omer s. Ther ef or e such expendit ur e had a f unct ion r at her t han being par t of t he set t ing. A ship used as a f loat ing r est aur ant was not r egar ded as having a f unct ion, it was act ually t he set t ing in which t he t r ade was car r ied on. (Benson v Yar d Ar m Club Limit ed (1979)). Adver t ising hoar dings ar e specif ically wit hin List C, it em number 15. Ther ef or e it will be saf e t o assume t hat t hey qualif y as plant . A suspended ceiling over a st air well is not r egar ded as plant . I t does not f ulf il a f unct ion, but inst ead is mer ely par t of t he set t ing. Hampt on v For t es Aut ogr ill Lt d (1980). A suspended ceiling over an eat ing ar ea however , could be r egar ded as plant as it f ulf ils a f unct ion in t he t r ade cr eat ing a gener al at mospher e. Exposed wir ing over an eat ing ar ea is not at t r act ive f or cust omer s!


SUMMARY - CAPITAL ALLOWANCES – DEFINITION Depr eciat ion is not allowable f or t ax pur poses. I nst ead a deduct ion in r espect of some t ypes of qualif ying expendit ur e is available. Capit al allowances ar e given on plant and machiner y. Dif f er ent allowances ar e available f or cer t ain buildings such as indust r ial buildings and agr icult ur al buildings. Not e t hat no allowances ar e available f or of f ice buildings. I n t he legislat ion t he def init ion of non-qualif ying expendit ur e includes buildings and st r uct ur es and land. Two list s, List A and List B, t ell us what is meant by t hese t er ms and hence what does not qualif y f or plant and machiner y allowances. Ther e ar e some except ions t o t he exclusions given in List C which must t her ef or e always also be checked. The f inal t est which comes f r om case law and must always be sat isf ied is ‘f unct ion v set t ing’. To qualif y f or capit al allowances t he asset must f ulf il a f unct ion in t he t r ade r at her t han be simply par t of t he set t ing in which t he t r ade is car r ied on.

B5: CAPITAL ALLOWANCES - COMPUTATION

I n t his chapt er you will lear n t he r ules f or comput ing capit al allowances on plant and machiner y including: - t he basic layout ; - pooling of expendit ur e; - t he FYA pool; - t he gener al pool; - cheap car s; - long lif e asset s; - expensive car s; - shor t lif e asset s. St at ut or y r ef er ences in t his chapt er ar e t o CAA 2001 unless ot her wise st at ed.

B5.1 Basic computational layout

Capit al allowances comput at ions ar e pr epar ed f or account ing per iods, eg f or t he year ended 31 December 2006. Capit al allowances ar e a t r ading expense f or a business and should be deduct ed in ar r iving at t he t r ading income f igur e f or t he account ing per iod.

s. 6

Year ended 31 December 2006:

£ Adj ust ed pr of it s bef or e CAs X Less: capit al allowances (CAs) (X) Tr ading I ncome X

The t r ading income (i.e. af t er CAs) would t hen be t axed in 2006/ 07 under CYB. To calculat e t he CAs we st ar t wit h t he t ax wr it t en down values br ought f or war d f r om t he pr evious per iod. We t hen add in any addit ions in t he per iod (t he pr ice paid f or any plant or machiner y) and t ake of f any disposals (t he sale pr oceeds). When deduct ing pr oceeds we r est r ict t he deduct ion t o t he or iginal cost s of t he asset (see lat er ). This gives us t he t ot al amount on which we can claim allowances.

Allowances ar e calculat ed at 25%. These ar e deduct ed leaving t he wr it t en down value t o car r y f or war d t o next year .

s. 56

£ Wr it t en down value (WDV) br ought f or war d X Addit ions (pur chase pr ice) X Disposals (sale pr oceeds – r est r ict ed t o cost ) (X) X Allowances @ 25% (X) Wr it t en down value (WDV) car r ied f or war d X


B5.2 Pooling of expenditure s. 53

Wit hin t he capit al allowance comput at ion t her e will be var ious “heads” of expendit ur e. These ar e: Fir st year allowance pool Gener al pool Long lif e asset s Expensive car s Shor t lif e asset s

B5.3 The first year allowances pool s. 39

The f ir st year allowance (FYA) pool will include expenditure on plant &

machinery qualifying for first year allowances. FYAs ar e nor mally available at 40% on qualif ying pur chases. This 40% r at e has been in f or ce since J uly 1998. However , f or some businesses a 50% r at e applies (which we shall look at in t he next session). Qualif ying pur chases excludes car s - mor e on t his lat er .

s. 52

s. 46

Addit ions qualif ying f or f ir st year allowances ar e ent er ed int o t his FYA pool. The FYA is deduct ed and t he balance is t r ansf er r ed t o t he gener al pool at t he end of t he per iod. Ther e will never be a balance car r ied f or war d or br ought f or war d on t he FYA pool.

Illustration 1

Assume a t r ader has a wr it t en down value br ought f or war d on t he gener al pool of £ 100,000. I n t he year asset s qualif ying f or 40% FYAs ar e pur chased f or £ 50,000. The capit al allowances comput at ion will be:

FYA Pool Gener al Pool Allowance WDV b/ f

£ £ 100,000

£

Addit ions 50,000 FYA (40%) (20,000) 20,000 WDA (25%) (25,000) 25,000

Tr ansf er t o gener al pool (30,000) 30,000 WDV c/ f 105,000 ______ Tot al allowances 45,000

B5.4 The general pool

The gener al pool includes anyt hing which is not specif ically included elsewher e. For example, plant and machiner y would go int o t he gener al pool if it did not qualif y f or a f ir st year allowance.

Capit al Allowances - Comput at ion

39

B5.5 Cheap cars s. 74

For account ing per iods ending bef or e 1 Apr il 2000, all car s pur chased which cost £ 12,000 or less wer e pooled t oget her in t he “cheap car pool”. The cheap car pool has now been abolished. Addit ions of “cheap” car s now go int o t he gener al pool and obt ain wr it ing down allowances (WDAs) at 25%. Ther e ar e no FYAs on car s.

B5.6 Long life assets s. 91

Long lif e asset s ar e asset s wit h a pr edict ed usef ul lif e of at least 25 year s. We ar e looking at ver y dist inct ive expendit ur e her e – eg, in power st at ions et c, wher e t he expect ed usef ul lif e of asset s used in t he business is a long t ime.

Long lif e asset s ar e kept in a separate pool - t hey do not qualif y f or FYAs and do not go int o t he gener al pool. Expendit ur e on long lif e asset s will qualif y f or a writing down allowance of only 6%. This is subst ant ially lower t han t he nor mal 25% because t he lif e of t he asset is longer t han a nor mal asset – 25 year s is longer t han you would expect a nor mal piece of plant or machiner y t o last .

s. 102

However , t hese rules will not apply (i.e. t he asset will not be t r eat ed as a long lif e asset ), where expenditure in the year on such assets does not exceed £100,000 in t ot al. These special “6%” r ules will t her ef or e most commonly apply t o lar ge companies.

s. 99

I f t he special r ules do not apply, t he asset would qualif y f or FYAs and any r esidue would be t r ansf er r ed t o t he gener al pool at t he end of t he per iod. This £ 100,000 limit is adj ust ed f or shor t account ing per iods. For example, if a t r ader dr aws account s f or a six mont h account ing per iod, t he long lif e asset limit would be £ 50,000. The £ 100,000 limit is also adj ust ed f or t he number of associat ed companies – mor e on t hat when you cover associat es wit hin your Cor por at ion Tax st udies. I f an asset is acquir ed second-hand and had or iginally r eceived a 25% wr it ing down allowance, it will cont inue t o obt ain r elief at 25%. I f an asset has been t r eat ed as a long lif e asset by a seller , t he buyer (r egar dless of how much he buys t he asset f or ) will also have t o t r eat t he asset as a long lif e asset - once a long lif e asset , always a long lif e asset . B5.7 Expensive cars

An expensive car is any car cost ing more than £12,000. Each expensive car must be shown separ at ely in it s own capit al allowances column. Expensive car s ar e not pooled with any other assets.

s. 74


The annual writing down allowance is r est r ict ed t o t he lower of: 25%; or £ 3,000

s. 75

When t he car is sold, a balancing allowance or char ge will ar ise.

Illustration 2

A t r ader dr aws account s t o 31 December . At 1 J anuar y 2005, t he wr it t en down value br ought f or war d is £ 90,000 on t he gener al pool and £ 20,000 on a BMW 735. I n t he year t he t r ader bought an Audi A6 f or £ 24,000 and sold t he BMW f or £ 12,000. The capit al allowances comput at ion will be: Y/ e 31.12.05

Pool BMW 735 Audi A6 Allowances £ £ £ £ WDV b/ f 90,000 20,000 Addit ion 24,000 Disposal (12,000) Balancing Allowance 8,000 8,000 WDA (25%) (22,500) 22,500 WDA (r est r ict ed) ______ (3,000) 3,000 WDV c/ f 67,500 21,000 33,500

A balancing adj ust ment is made ever y t ime a “non pooled” asset (such as an expensive car ) is sold. I n t his inst ance, as t he car has been sold f or less than its “tax value”, a balancing allowance ar ises. The balancing is allowance is t r eat ed in t he same way as a nor mal capit al allowance, i.e. it incr eases t he t ot al CAs due f or t he per iod. I f t he car had been sold f or more than its “tax value” (ie f or mor e t han £ 20,000 in t his example), a balancing char ge would have ar isen. A balancing char ge is ef f ect ively a “negat ive” allowance and will r educe t he t ot al CAs available f or t he per iod. The wr it t en down values br ought f or war d at 1 J anuar y 2006 ar e £ 67,500 and £ 21,000. The capit al allowances comput at ion f or t he next per iod (y/ e 31 December 2006) will be:

Y/ e 31.12.06 Pool Audi A6 Allowances £ £ £ WDV b/ f 67,500 21,000 WDA (25%) (16,875) 16,875 WDA (r est r ict ed) ______ (3,000) 3,000 WDV c/ f 50,625 18,000 19,875


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B5.8 Short life assets s. 83 – s. 84

An elect ion can be made t o depool cer t ain asset s which have a pr edict ed useful life of no more than 4 years. The ef f ect of t he elect ion is t hat t he asset s ar e dealt wit h separ at ely, i.e. t hey ar e not put int o t he gener al pool but inst ead st and on t heir own in a separ at e column.

s. 85

A balancing allowance will usually ar ise if t he asset is sold wit hin t he 4 year per iod. I f t he asset is st ill in use mor e t han 4 year s of t he end of t he year of acquisit ion (i.e. af t er 5 lot s of WDAs have been claimed on it ), t he wr it t en down value is t r ansf er r ed t o t he gener al pool.

s. 86

Ther e is no downside t o making a shor t lif e asset elect ion (ot her t han having t o do t he associat ed paper wor k). We deal wit h t he asset separ at ely f or 4 year s. I f it is sold wit hin 4 year s of t he end of t he per iod of acquisit ion and pr oceeds ar e less t han t he wr it t en down value br ought f or war d, a balancing allowance will ar ise. I f t he asset is st ill owned af t er 5 wr it e-downs, t he balance in t he shor t lif e asset column is t r ansf er r ed acr oss t o t he gener al pool.

Illustration 3

A t r ader dr aws account s f or t he year ended 31 Oct ober 2004. The wr it t en down value br ought f or war d on t he gener al pool was £ 30,000. A comput er was bought f or £ 12,000 in t he per iod (no f ir st year allowances wer e available on t he comput er ). A shor t lif e asset elect ion has been made in r espect of t he comput er . The capit al allowances comput at ion will be:

Y/ e 31.10.04 Gener al pool Comput er Allowances WDV b/ f

£ 30,000

£ £

Addit ion 12,000 WDA (y/ e 31.10.04) (7,500) (3,000) 10,500 22,500 9,000 WDA (y/ e 31.10.05) (5,625) (2,250) 7,875 16,875 6,750 WDA (y/ e 31.10.06) (4,219) (1,688) 5,907 12,656 5,062 WDA (y/ e 31.10.07) (3,164) (1,266) 4,430 9,492 3,796 WDA (y/ e 31.10.08) (2,373) (949) 3,322 7,119 2,847 Tr ansf er t o pool 2,847 (2,847) 9,966 WDA (y/ e 31.10.09) (2,492) 2,492 7,494


I f t he comput er had been sold at any t ime dur ing t he f ir st f our year s f or less t han it s wr it t en down value, a balancing allowance would have been available. I f however t he or iginal expendit ur e had been put int o t he gener al pool, t he pr oceeds would simply be deduct ed f r om t he gener al pool and no balancing allowance would be given. The ef f ect of “depooling” an asset int o it s own column is t o give t he t r ader t he oppor t unit y of realising the balancing allowance sooner t han would ot her wise be t he case.

Example 1

Below is a pr of or ma capit al allowance comput at ion f or t he year ended 30 J une 2005. Ther e is a wr it t en down value br ought f or war d on t he gener al pool and a BMW car . We ar e t hen given t he nor mal headings - addit ions, disposals, f ir st year allowances at 40%, wr it ing down allowances at 25%, balancing allowance, t r ansf er and wr it t en down value car r ied f or war d. Assume t hat t he BMW car is sold f or £ 11,000 in t he year , a Skoda car is bought f or £ 8,000 and some equipment is pur chased f or £ 6,000. Compute the allowances due and complete the computation.

FYA Pool Gener al Pool BMW car Allowances £ £ £ £ WDV b/ f 102,000 15,000 Addit ions: Disposals: FYA ( ) WDA ( ) BA ( ) Tr ansf er t o gener al pool

( )

WDV c/ f Tot al allowances


43

Example 2

Ted owns an engineer ing business in Shef f ield. I n t he year t o 30 Sept ember 2005 t he f ollowing inf or mat ion is given:

WDV b/ f £ Gener al pool 60,000 Expensive car 10,000 Long lif e asset 104,000 Shor t lif e asset (acquir ed 1.7.00) 20,000 Addit ions: Plant and equipment (40% FYA due) 12,000 Renault Clio 9,000 Disposals – plant (or iginal cost £ 2,000) 2,800

Calculate the total allowances due for the year.


Answer 1

FYA Pool Gener al Pool BMW car Allowances £ £ £ WDV b/ f 102,000 15,000 Addit ions:

Car 8,000 Equipment 6,000 ______

110,000 Disposals (11,000)

FYA (2,400) 2,400 WDA (27,500) 27,500 BA (4,000) 4,000

Tr ansf er t o gener al pool

(3,600)

3,600

WDV c/ f 86,100

Tot al allowances

£33,900

I t is best t o appr oach t hese pr of or ma comput at ions by dealing with additions

and disposals in the year first. The BMW was sold f or £ 11,000. Disposals pr oceeds of £ 11,000 ar e t her ef or e deduct ed in t he BMW car column. A Skoda was pur chased f or £ 8,000, so it will be ent er ed int o t he gener al pool. Remember £ 8,000 is not enough f or t he Skoda t o be r egar ded as an expensive car . Also first year allowances are not available on cars – 25% WDAs are

given on cars. Finally, equipment pur chased f or £ 6,000 goes int o t he FYA pool. Now deal wit h t he allowances. The BMW car has a balancing adjustment as it is in it s own column - t he wr it t en down value is £ 15,000, t he disposal pr oceeds ar e £ 11,000, t her ef or e we have a balancing allowance of £ 4,000. We t ake t hat acr oss t o t he allowances column. I n t he gener al pool t her e ar e qualif ying cost s of £ 110,000 on which WDAs ar e available at 25%. WDAs of £ 27,500 ar e deduct ed and t hese allowances ar e t aken acr oss t o t he allowances column. Finally, t he expendit ur e in t he FYA pool will qualif y f or 40% f ir st year allowances of £ 2,400 (again t he amount claimed is t aken acr oss and r ef lect ed in t he allowances column). Tot al allowances f or t he per iod ar e £ 33,900. This is a t r ading expense f or Tr ading I ncome pur poses. I n or der t o complet e t he comput at ion, £ 3,600 is transferred from the FYA pool

into the general pool. The wr it t en down value car r ied f or war d on t he gener al pool is £ 86,100.


45

Answer 2

FYA

Pool Gener al Pool

Expensive Car

Long lif e asset s

Shor t lif e asset s

Allowances

£ £ £ £ £ £ WDV b/ f 60,000 10,000 104,000 20,000 Tr ansf er 20,000 (20,000) Addit ions 12,000 9,000 Disposal (2,000) 87,000 FYA (40%) (4,800) 4,800 WDA (25%) (21,750) (2,500) 24,250 WDA (6%) (6,240) 6,240 Tr ansf er (7,200) 7,200 ____ _____ _____ WDV c/ f 72,450 7,500 97,760 35,290

The shor t lif e asset was acquir ed on 1 J uly 2000. This means t hat by t he st ar t of t his year we would have already taken 5 WDAs t o dat e, so we must transfer that short life asset to the general pool. The Renault Clio bought f or £ 9,000 goes int o t he gener al pool. Remember t her e ar e no f ir st year allowances ar e given on car s. We also have a disposal in t he year . We restrict the disposal proceeds to the actual cost of the asset. So £ 2,000 is deduct ed in t he gener al pool. This leaves us wit h £ 87,000 of expendit ur e in t he gener al pool which will qualif y f or t he 25% wr it ing down allowance. Next we will deal wit h t he f ir st year allowance of 40% on t he equipment cost ing £ 12,000. £ 4,800 goes acr oss int o t he allowances column. We also have WDAs of 25%. These ar e £ 21,750 on t he gener al pool and £ 2,500 on t he expensive car . That means we put a f ur t her £ 24,250 in t he allowances column. The long life asset get s a 6% WDA. £ 6,240 goes int o t he allowances column. We t r ansf er t he balance on t he FYA pool int o t he gener al pool at t he year end and show t he car r ied f or war d values f or complet eness.


SUMMARY - CAPITAL ALLOWANCES - COMPUTATION Capit al allowances ar e given on t he gener al pool of plant and machiner y at 25% p.a. on a r educing balance basis. The WDV b/ f is incr eased by addit ions, decr eased by disposals and t he balance is wr it t en down at 25%. Some addit ions will qualif y f or a higher allowance in t he f ir st year pr ior t o being added int o t he gener al pool. Car s cost ing less t han £ 12,000 go int o t he gener al pool. Expensive car s cost ing mor e t han £ 12,000 ar e not pooled but have t heir own column. The 25% WDA is limit ed t o £ 3,000 p.a. Asset s cost ing at least £ 100,000 in aggr egat e and wit h a pr edict ed usef ul lif e of 25 year s or mor e ar e pooled separ at ely. Such long lif e asset s ar e only wr it t en down at 6% p.a. I f asset is expect ed t o be sold at a loss wit hin 4 year s, an elect ion can be made t o depool it t o cr yst allise a balancing allowance on sale. I f st ill in use 4 year s af t er t he end of t he per iod of acquisit ion, a shor t lif e asset is t r ansf er r ed int o t he gener al pool.

B6: INDUSTRIAL BUILDINGS ALLOWANCES

I n t his chapt er you will cover t he r ules f or allowances on indust r ial buildings including: - def init ion of an indust r ial building; - qualif ying t r ades; - r elevant int er est ; - qualif ying expendit ur e; - t he allowances; - disposal of an indust r ial building; - pur chasing a used building; - buildings in Ent er pr ise Zones.

St at ut or y r ef er ences in t his chapt er ar e t o CAA 2001 unless ot her wise st at ed.

B6.1 Introduction s. 271

The def init ion of an indust r ial building is impor t ant because only t hose buildings qualif ying as “industrial” buildings will be ent it led t o indust r ial buildings allowances (I BAs). I BAs ar e available if ; (i) t he expendit ur e concer ned is incur r ed in t he cour se of const r uct ion of a

qualif ying building; and (ii) t he expendit ur e is qualifying expenditure. Not all cost s incur r ed in t he

const r uct ion of a building ar e qualif ying expendit ur e f or I BA pur poses. B6.2 Qualifying building

A qualif ying building is a building used in a qualif ying t r ade or a qualif ying hot el.

The specif ic cr it er ia f or a qualif ying hot el can be f ound at S.279 CAA 2001. A qualif ying hot el should have at least 10 let t ing bedr ooms, be open f or at least 4 mont hs dur ing t he per iod Apr il t o Oct ober and pr ovide a ser vice of t he making of beds, cleaning of r ooms and of f er ing br eakf ast and dinner as a nor mal par t of t he hot el’s business.

s. 279

A qualifying sports pavilion is also a qualif ying building. I n t his inst ance it does not mat t er what t he t r ade or t he business is. For example, a bank could have a spor t s club wit h a spor t s pavilion which is made available f or st af f - t hat spor t s pavilion would qualif y f or indust r ial buildings allowances.

s. 280

Finally, a qualif ying building would also be a building in an Enterprise Zone. The st r ict cr it er ia ar e laid out at S.281 CAA 2001.

s. 281


B6.3 Qualifying expenditure

The def init ion of “qualif ying expendit ur e” is f ound at S.292 CAA 2001. Br oadly t his will include capit al expendit ur e on t he const r uct ion of a qualif ying building.

s. 292

I t should be appr eciat ed t hat allowances ar e given t o t he per son wit h t he relevant interest in t he building. This is nor mally t he freeholder - we will look at t his lat er on in t his chapt er .

s. 286

All t he det ailed r ules ar e laid out logically in t he legislat ion.

“Const r uct ion cost s” do not include the cost of acquiring the land or any planning f ees t hat may be incur r ed. Const r uct ion cost s will include preparing,

cutting, tunnelling or levelling t he land and any architects, quantity surveyors and engineers fees, pr oviding t hat t he building is act ually const r uct ed.

s. 273

B6.4 Qualifying Trade s. 274

I n or der f or a building t o be qualif ying, it must be used in a “qualifying trade”. The def init ion of a “qualif ying t r ade” is ext r emely impor t ant and is and def ined at s.274 CAA 2001. A qualif ying t r ade means a trade of a kind described in Table A or an undertaking of a kind described in Table B, if t he under t aking is car r ied on by way of a t r ade. Table A trades ar e t he mor e impor t ant of t he t wo and ar e mor e common.

S.275 CAA 2001 includes an ext ension t o nor mal qualif ying t r ade buildings and st at es t hat a building is also in use f or a qualif ying t r ade if it is a staff welfare

building. This could be a canteen or a social club of a manuf act ur ing company.

s. 275

St af f welf ar e buildings ar e dif f er ent t o spor t s pavilions because t o qualif y as a st af f welf ar e building, the building has to be used by a company with a

qualifying trade. Spor t s pavilions, as we saw ear lier , did not need a qualif ying t r ade at t aching - any trade wit h a spor t s pavilion would qualif y f or I BAs on t hat spor t s pavilion.

B6.5 “Table A” trades

Table A qualif ying t r ades ar e impor t ant and ar e laid out at S.274 CAA 2001. Qualif ying t r ades ar e st r ict ly def ined as: - manufacturing goods or mat er ials; - processing, i.e. t he subj ect ion of goods or mat er ials t o some sor t of

pr ocess; - storage of goods or mat er ials; - agr icult ur al cont r act ing, f or example cont r act har vest ing. - wor king f ar m plant at ions, f ishing and miner al ext r act ion.

I ndust r ial Buildings Allowances

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The most common ar eas ar e manufacturing, processing and storage.

B6.6 Processing

The legislat ion st at es t hat pr ocessing is t he “subjection of goods or materials

to a process”. This def init ion has been t est ed in var ious cases wher e t r ader s f elt t hey had buildings which wer e used f or t he subj ect ion of goods or mat er ials t o a pr ocess. The case of Bour ne v Nor wich Cr emat or ium Limit ed (1964) concer ned a cr emat or ium. The t r ader f elt t hat he was “subj ect ing goods t o a pr ocess”, t her ef or e his cr emat or ium should qualif y as an indust r ial building. I n t his case it was held t hat human bodies ar e not goods and t her ef or e no I BAs wer e available. Kilmar nock & Equit able Co-oper at ive Societ y Lt d v CI R (1966) involved a t r ader scr eening and packing coal. I t was held t hat t his was subj ect ing goods or mat er ials t o a pr ocess. Consequent ly t he building in which t his t ask was under t aken was an indust r ial building and I BAs wer e due. Buckingham v Secur it as Pr oper t ies Lt d (1980) concer ned wage packet ing. This involved coins and not es being count ed and put int o pay packet s. Alt hough it was held t hat a pr ocess was being under t aken, not es and coins wer e not held t o be goods, t her ef or e t his was not an indust r ial building. Anot her case involved unpacking, r elabelling and r epacking. This could quit e conceivably be a super mar ket wher e labelled br ands ar e r eceived, unpacked and t hen put int o boxes wit h t he super mar ket ’s own br and. I n t his par t icular case it was held t hat unpacking, r elabelling and r epacking was not a pr ocess - it was a mer e pr eliminar y t o a sale.

B6.7 Storage

The ot her impor t ant ar ea of qualif ying t r ades is st or age. Wit hin S.274 CAA 2001, “st or age” could be a trade which consists of the storage of goods or mat er ials which ar e t o be used in the manufacture of ot her goods or mat er ials. St or age could also mean t he st or age of goods or mat er ials which ar e t o be subjected in the course of trade to a process. I n t his lat t er case, goods or mat er ials could be st or ed by one t r ader and be subjected to a process by

another trader. The most r elevant case her e is Cr usabr idge I nvest ment s Lt d v Casings I nt er nat ional Lt d (1979). I n t his case, a building was used t o st or e used t yr es which wer e t o be sent t o manuf act ur er s t o be r emoulded. “Remoulding of t yr es” was consider ed t o be an industrial process. Consequent ly, t he building storing the tyres was an industrial building. I t did not mat t er t hat t he t yr es wer e not t o be subj ect t o a pr ocess by t he t r ader - t hey wer e t o be subj ect t o a pr ocess by another t r ader and t hat is suf f icient f or t he building t o qualif y f or I BAs.


The Revenue t hought t his was t oo gener ous a pr ovision and have t r ied t o clar if y t he limit at ions of t his legislat ion. They saw t his pr ovision as pot ent ially opening all kinds of door s f or claims, f or example I BA claims f or t he st or age f acilit ies of builder s’ mer chant s. Following t he Cr usabr idge decision, t hese st or age f acilit ies would qualif y f or I BAs as t he goods st or ed and sold by a builder s mer chant wer e t o be used in a f ur t her pr ocess. Consequent ly - accor ding t o a Revenue int er pr et at ion - st or age should f or m a significant, separate and identifiable part of the trade and it should be conducted as a purpose and end in itself, not j ust a necessar y and t r ansit or y incident of t he business. I n t he Cr usabr idge case, t he building would st ill qualif y f or I BAs as t he collect ion and st or age of t yr es was deemed t o be an essential part of the business in itself. However , f ollowing t his int er pr et at ion, it is unlikely t hat st or age f acilit ies used by builder s mer chant s and similar t r ades would qualif y f or I BAs. Par t C of t he legislat ion says st or age will also include t he st or ing of goods or mat er ials which have been manuf act ur ed, or pr oduced or subj ect ed in t he cour se of a t r ade t o a pr ocess, but have yet t o be deliver ed t o any pur chaser . Not e her e t hat we must have a pur chaser . Ther ef or e if a t r ader is involved in a r et ail t r ade and has a war ehouse st or ing goods pr ior t o t heir being sold t hr ough his own r et ail out let s, t hat war ehouse is unlikely t o qualif y as an indust r ial building as t he goods ar e not being deliver ed t o a pur chaser . Finally t he st or age of goods or mat er ials on t heir ar r ival in t he UK f r om a place out side t he UK also qualif ies.

B6.8 “Table B” trades s. 286

Going back t o S.274 CAA 2001, a qualif ying t r ade also means an under t aking of a kind descr ibed in Table B if t he under t aking is car r ied on by way of a t r ade. The t r ades list ed ar e elect r icit y, wat er , hydr aulic power , sewer age, t r anspor t , highway under t akings, t unnels, br idges, inland navigat ion and docks. They ar e not as common as manuf act ur ing t r ades, and if you ar e st udying f or exams it is unlikely t hat you will be asked quest ions concer ning t hese kinds of t r ades. I t is much mor e likely you will be dealing wit h t r ades as laid down in Table A.

B6.9 Relevant Interest

I BAs will be available t o t he per son who has t he “r elevant int er est ” in t he par t icular pr oper t y. Relevant int er est is def ined wit hin S.286 CAA 2001. The relevant interest is t he int er est in t he building t o which t he per son who incur r ed t he expendit ur e on t he const r uct ion of t he building was ent it led when t hey incur r ed t he expendit ur e. Ther ef or e if a per son owns t he f r eehold and spends money on t he const r uct ion of a building, t hen t he r elevant int er est is t he f r eehold - t hat is t he int er est t he per son had when he spent t he money.


51

I f a t r ader (individual or company) owns t he f r eehold of a f act or y, in all pr obabilit y t hat f r eeholder will claim I BAs on t hat f act or y as he has t he “r elevant int er est ” in a building and car r ies on a qualif ying t r ade. I f t he t r ader wer e t hen t o build an ext ension t o t he f act or y, t his is t r eat ed as a separ at e “pot ” of expendit ur e f or I BA pur poses, ie, as a separ at e asset wit hin t he I BA comput at ions. The r elevant int er est in t he extension expenditure is t he int er est t hat t he per son had when t hey spent t he money. So in t his example, t he r elevant int er est is t he freehold as t hat is t he int er est t hat t he t r ader had when he incur r ed t he expendit ur e. Relevant int er est becomes mor e complicat ed when we ar e dealing wit h lessor s and lessees. Assume, f or example, a t r ader has a f r eehold f act or y which cost £ 1m. The f r eeholder does not act ually use t he f act or y himself . He gr ant s a lease t o anot her t r ader and it is t his t r ader (t he”lessee”) who uses t he f act or y in his t r ade. Who has t he r elevant int er est ? I n t his example, it will be t he freeholder. The f r eeholder spent £ 1m on t he f act or y and when he spent it he owned t he f r eehold. The r elevant int er est t her ef or e lies wit h t he f r eeholder . I t is t he freeholder who may be ent it led t o I BAs. These allowances will be set against t he f r eeholder ’s rental income from the letting of the factory and would t her ef or e be an allowable expense f or Pr oper t y I ncome pur poses. The availabilit y of I BAs depends on what t he lessee is using t he building f or . I f t he lessee uses t he building f or a qualif ying t r ade, I BAs can be claimed by t he f r eeholder (ie, t he landlor d). So alt hough t he freeholder may be entitled to

IBAs, his entitlement is based on the lessee’s use of the building. Accor dingly, clauses ar e of t en inser t ed int o r ent al agr eement s t o ensur e t hat lessees must use t he building f or a qualif ying t r ade. I f t he lessee built an ext ension and paid f or t he ext ension t hemselves, t he lessee would hold the relevant interest in the extension, i.e. when t hey spent t he money on t he ext ension t hey owned t he lease, so t her ef or e t he r elevant int er est f or t he ext ension is t he lease. The lessee would be ent it led t o I BAs on t he extension expenditure.

B6.10 Granting a long lease s. 290

Ther e is one quir k t o r elevant int er est and long leases. This is highlight ed in S.290 CAA 2001. “Long leases” in t his case ar e leases of more than 50 years

duration.

Consider a f r eeholder who gr ant s a 60 year lease on his f act or y t o a lessee f or a pr emium of £ 200,000. Cur r ent ly t he r elevant int er est is owned by t he f r eeholder . However , t he f r eeholder may not need t he I BAs - f or example t he f r eeholder may be a non-t axpayer , such as a local aut hor it y (such or ganisat ions ar e not gener ally liable t o t ax). Ther ef or e I BAs could go t o wast e.


When a long lease is gr ant ed, it is possible f or t he f r eeholder and lessee t o j oint ly elect t o t r ansf er t he r elevant int er est f r om t he f r eeholder t o t he lessee. The lessee is deemed t o have acquir ed an indust r ial building f or t he pur chase pr ice of £ 200,000 - t he lease pr emium. Ther ef or e t he lessee will obt ain I BAs on t his £ 200,000 - he now owns t he r elevant int er est by elect ion and can claim I BAs t o set against t r ading pr of it s.

Example 1

Which of t he f ollowing buildings may qualif y as an indust r ial building?

Yes ? No ?

Building used f or t he mechanical pr ocessing of cheques.

Plant hir e depot used f or r epair and maint enance of plant bet ween hir ings.

War ehouse st or ing bought -in goods f or onwar d sale t o t he public.

A spor t s pavilion owned by Bank Plc f or employee use.

A hot el wit h eight let t ing bedr ooms B6.11 Industrial buildings allowances

I n summar y I BAs ar e available on: - gener al indust r ial buildings; - qualif ying hot els ; - buildings in ent er pr ise zones; and - spor t s pavilions. Specif ically excluded ar e: - dwellings; - r et ail shops; - showr ooms; - non-qualif ying hot els; and - of f ices.

B6.12 Qualifying expenditure s. 292

Qualif ying expendit ur e is based on t he const r uct ion cost of t he building. Land is always excluded but t he pr epar ing, cut t ing, t unnelling or levelling of t he land, t oget her wit h t he ar chit ect s f ees ar e included. Legal f ees do not qualif y.

Qualif ying expendit ur e also includes the non-industrial parts if t oget her t hey amount t o less than 25% of t he t ot al const r uct ion cost . The per cent age was 10% f or buildings const r uct ed bef or e Mar ch 1993. Ther ef or e if a t r ader builds a f act or y which has some of f ice space in it , we look at t he t ot al const r uct ion cost . I f t he cost s of t he of f ices ar e less t han 25% of t ot al cost , I BAs ar e given on t he t ot al const r uct ion cost , including t he of f ices.

s. 283


53

Example 2

Clar ke Kent pur chased some land on 1 Oct ober 2003 f or £ 200,000. I n t he year t o 30 J une 2004 he spent t he f ollowing:

£Levelling and cut t ing t he land 35,000Ar chit ect s f ees 15,000Fact or y const r uct ion (including of f ices £ 160,000) 600,000

Calculat e t he qualif ying expendit ur e f or I BA pur poses.

B6.13 The allowances

The allowances t hat can be claimed on indust r ial buildings ar e: a) The initial allowance

I nit ial allowances used t o be available in t he per iod in which t he expendit ur e is incur r ed. Cur r ent ly, however , t her e is no init ial allowance available.

b) The writing down allowance

This is a 4% straight line allowance – i.e. 4% on cost ever y year .

s. 309 - s.310

Wr it ing down allowances ar e given if t he building is in industrial use on the last day of the accounting period. What t he building is used f or t hr oughout t he account ing per iod is not r elevant – it is t he use on that last day which is impor t ant . I f a building is in non-industrial use at the end of the accounting period, no IBA will be given. I nst ead a notional 4% writing down allowance is deduct ed f r om t he pool of qualif ying expendit ur e. The notional WDA does not r educe t axable pr of it s f or t hat year – it mer ely r educes t he balance of qualif ying expendit ur e going f or war d.

Empty periods (ie, when t he building is vacant and not being used f or any pur pose) t ake on t he same form as the immediate preceding use. Ther ef or e if on t he last day of an account ing per iod t he building was empt y, we look back t o t he immediat ely pr eceding use and t r eat t he “empt y” per iod exact ly t he same as t hat pr eceding use. You may see t his r ef er r ed t o as “t empor ar y disuse”.

s. 285

The WDA is time-apportioned f or shor t account ing per iods. I f t he business has a 7 mont h AP, t he WDA would be 7/ 12 x 4%.

s. 310(2)

Ther e is no writing down allowance in the year of sale. Balancing allowances / char ges may apply inst ead as we shall see lat er .


Illustration 1

Clar ke Kent incur r ed qualif ying expendit ur e of £ 650,000 on a building in t he year t o 30 J une 2004. The building was br ought int o use on 1 August 2004. I t was used f or indust r ial pur poses unt il 30 Sept ember 2007. The pr oper t y r emained empt y unt il 31 August 2008. The pr oper t y was in non-indust r ial use f r om 1 Sept ember 2008 t o 30 J une 2009.

We will demonst r at e how t he I BA hist or y is compiled. The I BA comput at ion will be;

Cost AllowancesY/ e 30 J une 2004 £ £

Addit ion Not in use on last day so no WDA yet

650,000

Y/ e 30 J une 2005 I n indust r ial use on last day so WDA given WDA @ 4% (26,000) 26,000



Y/ e 30 J une 2008 Empt y on last day – pr eceding use was indust r ial so WDA given

WDA @ 4% (26,000) 26,000 Y/ e 30 J une 2009

Non-indust r ial use on last day so Not ional WDA Not ional WDA 4% (26,000) Nil

WDV at 1 J uly 2009 £ 520,000 ______

Allowances given £ 104,000 Not e t hat as t he building was specif ically being used f or a non-indust r ial pur pose on 30 J une 2009, no I BAs ar e available f or t his per iod. I nst ead t he r esidue of expendit ur e is r educed by a “not ional” WDA of £ 26,000 but “nil” in ent er ed int o t he claim column. Non-indust r ial use is dif f er ent f r om t he building being “empt y” which implies t hat no act ivit ies at all ar e being conduct ed in t he building. I f a building is empt y at t he end of t he per iod, I BAs will be given as nor mal if t he building was in indust r ial use in t he pr eceding per iod (as is t he case her e).


55

B6.14 Disposal of an industrial building

The amount of sale pr oceeds is t he key f act or when dealing wit h t he disposal of an indust r ial building. This is best shown by a f lowchar t .

s. 314 - s. 324

I f pr oceeds exceed cost , t her e is a profit. Wher e a building is sold at a pr of it wit hin it s “25 year t ax lif e”, the balancing charge on disposal will always be

equal to the allowances previously given. There is no exception to this rule. I BAs compensat e a t r ader f or t he f all in value of an indust r ial building. Ther ef or e if t he building is sold at a pr of it , t her e is no f all in value. The Revenue will t hen r eclaim t he allowances given because t her e has been no cost t o t he business; t hey have made a pr of it .

s. 318

s, 320

No balancing adjustment (allowance or charge) will arise if the building is

sold outside its “tax life”. The t ax lif e of a building is 25 years, st ar t ing f r om when it was f ir st br ought int o use. For planning pur poses, a balancing char ge can be avoided by selling t he building once t he t ax lif e has expir ed.

s. 314(4)

A pr of it on t he sale of a building could give r ise t o a char geable gain (r egar dless of whet her t he t ax lif e has expir ed). A gain can be def er r ed under t he “r oll-over r elief ” pr ovisions if a building is r eplaced wit h anot her . Wher e t he building is sold f or less t han cost , i.e. a loss has been made, t her e ar e t wo dif f er ent t r eat ment s.

Pr oceeds

Exceed cost Less t han cost

BC = Allowances given

100% indust r ial use

Par t non indust r ial use

Deduct pr oceeds f r om WDV b/ f

“Adj ust ed net cost ” pr inciple


I f t he pr oper t y had been used f or 100% indust r ial pur poses t hr oughout it s per iod of owner ship, we simply deduct the proceeds from the written down

value brought forward. This gives a balancing allowance or balancing charge in t he same way as non-pooled plant & machiner y (eg, an expensive car ). Not e t hat a balancing char ge could st ill ar ise wher e a cash loss has been made on t he sale of a building.

s. 318

I f , however , t her e was part industrial and part non-industrial use, we have t o comput e t he “adj ust ed net cost ”.

s. 319

Bef or e we move on and look at t he adj ust ed net cost r ules, a quick r eminder - as discussed in t he pr evious chapt er - t hat FA 2003 has int r oduced specif ic ant i-avoidance legislat ion t o deny businesses r elief f or balancing allowances ar ising wher e pr oceeds ar e low as a r esult of a t ax avoidance scheme.

B6.15 Adjusted net cost (ANC) s. 323

The net cost is t he loss on sale. I f we bought a pr oper t y f or £ 900,000 and sold it f or £ 750,000, we have a net cost of £ 150,000. The adj ust ed net cost (ANC) is t he indust r ial pr opor t ion of t his loss. For example, if t he building was used f or 50% of t he t ime f or indust r ial pur poses and 50% f or non-indust r ial pur poses, t he adj ust ed net cost is; £ 150,000 x 50% = £ 75,000 That is t he indust r ial pr opor t ion of t he net cost (ie t he loss t he t r ader has made whilst t he building was being used f or indust r ial pur poses). We t hen compar e t he adj ust ed net cost t o t he allowances given.

£ Adj ust ed net cost ANC Less: I BAs pr eviously given (I BAs) BA / (BC) BA / (BC)

The dif f er ence is a balancing char ge or balancing allowance, depending on t he level of allowances given. For example, if t he allowances given wer e, say, £ 70,000, t her e would have a balancing allowance of £ 5,000 because adj ust ed net cost is £ 75,000.

£ Adj ust ed net cost 75,000 less I BAs pr eviously given (70,000) Balancing Allowance £ 5,000


57

Ef f ect ively, t he t r ader has made a loss of £ 75,000 whilst using t he building f or indust r ial pur poses. The Revenue has given him £ 70,000 of I BAs t o compensat e him f or t he loss. The Revenue will give t he “balance of allowances” of £ 5,000 in t he year of sale.

I f I BAs pr eviously given wer e, say £ 85,000, a balancing char ge would ar ise;

£ Adj ust ed net cost 75,000 Less: I BAs pr eviously given (85,000) Balancing Char ge £ (10,000)

The t r ader made a loss of £ 75,000 whilst using t he building f or indust r ial pur poses. The Revenue gave £ 85,000 of I BAs t o compensat e him f or t he loss. This is t oo much, so t he Revenue will claw-back £ 10,000 in t he year of sale.

Example 3

Cont inuing Clar ke Kent above, calculat e t he balancing adj ust ment if t he f act or y is sold f or £ 800,000 on 1 December 2009.

Example 4

Assume t hat Clar ke Kent sold t he pr oper t y on 1 December 2009 f or £ 475,000. The pr oper t y was in indust r ial use f r om 1 J uly 2009 t o t he dat e of sale. Complet e t he st eps f or t he calculat ion as f ollows: a) Calculat e t he net cost b) Calculat e t he number of mont hs of indust r ial usage c) Calculat e t he number of mont hs of Tot al usage d) Calculat e t he ANC = I ndust r ial usage x net cost Tot al usage

e) Calculat e t he balancing adj ust ment f ) Est ablish whet her it is a balancing allowance or a balancing char ge


B6.16 The purchaser’s position s. 311

The pur chaser r eceives allowances based on t he f ollowing f or mula: Residue af t er sale x 12 = Annual WDA Remaining t ax lif e (mont hs) The pur chaser cannot claim 4% allowances. They must use t he f or mula above t o det er mine t heir annual wr it ing down allowance. The pur chaser is ent it led t o t he WDA if t he building is in indust r ial use on t he last day of t heir account ing per iod. By “Residue af t er sale” we mean t he wr it t en down value bef or e sale, minus any balancing allowance at sale or plus any balancing char ge at sale, ie

£ TWDV at st ar t of AP of sale X Less BA or Plus BC (X) Residue af t er sale X

Residue af t er sale can never exceed t he pr ice paid by t he new user . Remaining t ax lif e is simply t he unexpir ed pr opor t ion of t he t ax lif e. The t ax lif e of an indust r ial building is 25 year s (ie 300 mont hs). Remaining t ax lif e = 300 mont hs - mont hs of use t o dat e Example 5

Cont inuing Clar ke Kent above, calculat e t he allowances available t o t he pur chaser in each of t he t wo scenar ios (ie examples 3 & 4). Remember :

(a) (b) Sale pr ice £ 800,000 £ 475,000 WDV at 30 J une 2009 £ 520,000 £ 520,000 Balancing char ge/ (allowance) £ 104,000 (£ 43,656) Expir ed usage 64 mont hs 64 mont hs


59

B6.17 Buildings in Enterprise Zones s. 281

I f a commer cial building is const r uct ed in a designat ed Ent er pr ise Zone (EZ), init ial allowances ar e available on t he const r uct ion cost s at 100%. The init ial allowance is int ended t o encour age invest ment in ar eas wher e r egener at ion is r equir ed.

s.306

Not e t hat 100% init ial allowances ar e available f or “commercial” buildings in EZs. “Commer cial” in t his cont ext will include shops and showrooms et c as long as t hey ar e used f or t he pur poses of a t r ade. Offices will always qualif y f or 100% init ial allowances r egar dless of what t hey ar e used f or (except if t hey ar e used as a dwelling house!).

s. 281(b)

All or par t of t he init ial allowance may be disclaimed. Ther eaf t er , wr it ing down allowances ar e given on t he balance of expendit ur e at a r at e of 25% on a r educing balance basis.

s.306(2)

Allowances ar e given eit her against t r ading income (if t he per son having t he r elevant int er est is a t r ader ) or against Pr oper t y income (if t he per son having t he r elevant int er est let s t he building t o a t r ader ).

Allowances ar e only given if t he const r uct ion expendit ur e is incur r ed wit hin 10 years of t he zone being of f icially designat ed as an Ent er pr ise Zone.

s. 298- s. 299

Balancing allowances and char ges will apply as f or ot her indust r ial buildings if t he building in t he EZ is sold wit hin 25 years. I f 100% init ial allowances have been claimed, a sale wit hin 25 year s will inevit ably lead t o a balancing charge.

s. 314


Answer 1

Yes

No

Building used f or t he mechanical pr ocessing of cheques.

R

Plant hir e depot used f or r epair and maint enance of plant bet ween hir ings.

R

War ehouse st or ing bought -in goods f or onwar d sale t o t he public.

R

A spor t s pavilion owned by Bank Plc f or employee use.

R

A hot el wit h eight let t ing bedr ooms R

A building used f or t he mechanical pr ocessing of cheques is not an indust r ial building. I n t he case of Gir obank Plc v Clar k (1998) t he pr ocessing of cheques was deemed t o be a pr ocess, but pieces of paper car r ying inf or mat ion wer e not deemed t o be goods. A plant hir e depot used f or r epair and maint enance of plant bet ween hir ing is not an indust r ial building. I n t he case of Vibr oplant Lt d v Holland (1982), t he depot was not deemed t o be a f act or y and t he plant was not subj ect t o a pr ocess. A war ehouse st or ing bought in goods f or onwar d sale t o t he public is not an indust r ial building. I n Dale v J ohnson Br ot her s (1951), a r et ailer or wholesaler who st or es goods f or r esale cannot claim I BAs because he himself is t he pur chaser . A spor t s pavilion owned by a bank f or t he use of employees is an indust r ial building. S.280 CAA 2001 says t hat a building occupied by a per son car r ying on a t r ade and used as a spor t s pavilion f or t he welf ar e of employees is an indust r ial building - it does not mat t er t hat t he bank is not car r ying on a qualif ying t r ade. A hot el wit h 8 let t ing bedr ooms is not an indust r ial building. I n or der t o qualif y as an indust r ial building t he hot el must have at least 10 let t ing bedr ooms (S.279 CAA 2001).


61

Answer 2

£Const r uct ion (see Not e) 600,000Levelling and cut t ing 35,000Ar chit ect s’ f ees 15,000 650,000

Not e £ 650,000 x 25% = £ 162,500 Of f ices cost £ 160,000 so t hey qualif y as below 25%

Answer 3

The building was sold at a pr of it so a balancing char ge ar ises equal t o t he allowances given of £ 104,000. Answer 4

Net cost : £ (475,000 – 650,000) = £ 175,000

Tot al Use I ndust r ial Use

Non-I ndust r ial Use

1.8.0430.9.07 38 38 1.10.07 31.8.08 11 11 1.9.0830.6.09 10 10 1.7.091.12.09 5 5 64 54 10

ANC = £ 175,000 x 5464 = £ 147,656

Balancing adj ust ment = £ 147,656 – 104,000 = £ 43,656 This is a balancing allowance as t he business can claim allowances on £ 147,656 but has only claimed £ 104,000 so f ar .


Answer 5

(a) (b) Residue bef or e sale 520,000 520,000 BC/ (BA) 104,000 (43,656) Residue af t er sale 624,000 476,344

Limit ed t o pr ice paid £ 475,000 (a) Allowances f or pur chaser = 624,000 x 12 300 – 64 = £ 31,729 (b) Allowances f or pur chaser = 475,000 x 12 300 – 64 = £ 24,153


63

SUMMARY - INDUSTRIAL BUILDINGS ALLOWANCES I ndust r ial buildings ar e buildings used in a qualif ying t r ade. Qualif ying hot els wit h 10 let t ing bedr ooms, open f or 4 mont hs f r om Apr il t o Oct ober of f er ing nor mal hot el ser vices also qualif y f or allowances. Spor t s pavilions always qualif y no mat t er what t he t r ade is. Buildings in Ent er pr ise Zones qualif y f or 100% allowances. Qualif ying t r ades include manuf act ur ing, pr ocessing and st or age. Pr ocessing means t he subj ect ion of goods t o a pr ocess. St or age qualif ies if it is of r aw mat er ials, f inished goods or goods ar r iving f r om over seas. The st or age of r et ail goods pr ior t o sale does not qualif y. The allowances ar e given t o t he t axpayer wit h t he r elevant int er est in building. This is usually t he f r eeholder but could be t he lessee in r espect of enhancement expendit ur e. I f a long lease is gr ant ed (over 50 year s) a j oint elect ion can be made t o t r ansf er t he r elevant int er est t o t he lessee. The allowances ar e given on qualif ying expendit ur e which is t he const r uct ion cost . I t excludes land but pr epar ing/ cut t ing t he land and ar chit ect s f ees qualif y. Any non-indust r ial par t s such as of f ices, shops or showr ooms will also qualif y if t hey amount t o less t han 25% of t he const r uct ion cost . The allowance is 4% p.a. st r aight line on cost (t ax lif e of 25 year s) and is given pr ovided t he building is in indust r ial use on t he last dat e of t he account ing per iod. I f t he per iod is not 12 mont hs in lengt h, t he 4% WDA is t ime appor t ioned. I f t he building is in non-indust r ial use on t he last day a not ional allowance is given. Empt y per iods t ake on t he same f or m as t he immediat e pr eceding use. I f t he building is sold as a pr of it , t her e is a balancing char ge in t he year of sale. The balancing char ge will equal I BAs pr eviously given I f t he building is sold at a loss, t he ‘adj ust ed net cost ’ (or indust r ial pr opor t ion of t he loss) is compar ed t o t he allowances given and a BA or BC comput ed accor dingly.

Adj ust ed net cost = I ndust r ial usage

Tot al usage x net cost

The pur chaser of a used building does not get a 4% allowance, inst ead t heir allowances ar e:

Residue af t er sale Remaining t ax lif e x 12 = Annual WDA

The r esidue af t er sale is t he WDV of t he building including t he balancing adj ust ment at sale comput ed f or t he seller . I t is r est r ict ed t o pr ice paid.

B7: INTANGIBLE FIXED ASSETS

B7.1 Introduction

I FAs ar e r ecognised as income as t hey ar e debited / credited in determining

the company’s profit or loss. The r ules ar e similar t o t he loan r elat ionship r ules.

Par a 1 Sch 29

FA 2002

B7.2 Intangible fixed assets

The t er m “I nt angible Fixed Asset ” has t he same meaning as it has f or account ing pur poses. I n par t icular it includes intellectual property which means any patent, r egist er ed trademark, design or copyright et c. I t also includes goodwill, again as def ined f or account ing pur poses.

I FAs include f ungible asset s. A f ungible asset is def ined as an asset which can be dealt in wit hout ident if ying t he par t icular asset s involved. An example would be a milk quot a in t he dair y f ar ming indust r y. Fungible asset s of t he same kind (eg successive acquisit ions of milk quot as) held by t he same per son in t he same indust r y ar e t r eat ed as indist inguishable par t s of a single asset .

Cer t ain asset s ar e expr essly excluded f r om t he pr ovisions of Sch 29. Wher e an asset is excluded an opt ion or ot her r ight t o acquir e or dispose of such an asset is also excluded

Par a 72 Sch 29 FA 2002

Asset s ent ir ely excluded ar e r ight s over t angible asset s; oil licences; f inancial asset s; r ight s in companies, t r ust s et c; and asset s held f or non commer cial pur poses et c.

Par a 73-77 Sch 29 FA 2002

Asset s excluded except as r egar ds r oyalt ies ar e; asset s held f or a lif e assur ance business; asset s held f or any mut ual t r ade or business; f ilm and sound r ecor dings; and comput er sof t war e t r eat ed as par t of cost of r elat ed har dwar e.

Par a 78-81 Sch 29 FA 2002

Asset s excluded f r om t he pr ovisions of Sch 29 t o t he ext ent specif ied ar e; r esear ch and development expendit ur e; and capit al expendit ur e on comput er sof t war e.

Par a 82-83 Sch 29 FA 2002

B7.3 Trade and non-trade IFAs Par a 30-34 Sch 29

FA 2002

I t is impor t ant t o classif y I FAs accor ding t o whet her t hey r elat e t o a t r ade, a pr oper t y business, or ar e non-t r ade. Trading debits and credits f or m par t of DI as t hey ar e accr ued t o t he pr of it and loss account . Debit s and cr edit s r elat ing t o a pr oper t y business ar e t r eat ed as par t of t he expense/ income of t hat pr oper t y business.

Non-trade debits and credits are pooled. I f t he non-t r ade cr edit s exceed non-t r ade debit s t hen t her e is a gain char geable under DVI.

I f non-t r ade debit s exceed non-t r ade cr edit s t hen t her e is a non-trade loss on IFAs. Cer t ain r elief s ar e available f or t his loss.

B7.4 Relief for non-trade loss on IFAs Par a 35

Sch 29 FA 2002

A claim can be made t o set t he whole or part of t he loss against t he company’s total profits f or t hat per iod. Ther e is a two year time limit f or t his claim. A claim can be made t o use t he loss under t he group relief pr ovisions which we will look at lat er . To t he ext ent t hat t he loss has not been used in a cur r ent year claim or sur r ender ed as gr oup r elief it will be carried forward as a non-t r ade debit t o t he next account ing per iod.

B7.5 Impact on tax computations

Royalty payments ar e allowed under DI or DVI on an accruals basis.

Patent and copyright royalties ar e paid gr oss bet ween UK companies. Remember t hat all f igur es t hat appear in t he t ax comput at ion must be gr oss f igur es. Royalty receipts ar e t axed on an accruals basis under DI or DVI.

Goodwill (which was pr eviously par t of t he capit al gains t ax r egime) will now only give r ise t o income gains or losses. Goodwill has ceased to be a qualifying asset for capital gains tax rollover. However , a form of rollover relief is

available. The r ules apply t o goodwill bought or created after 1 April 2002.

For goodwill pur chased and ot her I FA asset s acquir ed or cr eat ed af t er 1 Apr il 2002 t he company is allowed a deduction for the amortisation or impairment

charged in t he account s. Alt er nat ively t hey can claim a straight line deduction of 4% on cost. I nt er nat ional Account ing St andar d No 38 (I AS 38) does not allow a company t o amor t ise goodwill. Goodwill will be st at ed in t he balance sheet at f air value and subj ect t o an impair ment r eview.

Par a 10 & 11 Sch 29

FA 2002

When a company f ir st adopt s I AS 38 it may be r equir ed t o incr ease t he car r ying value of goodwill. Schedule 29 ensur es t hat t he wr it e up is a t axable cr edit , limit ed t o t he amount of r elief alr eady given. Any impair ment f r om wr it t en up cost will be deduct ible.

Par a 116A - 116B, 116F

Sch 29 FA 2002

Realisat ions of asset s r esult in income gains or losses, r ollover r elief may be available.

65 I nt angible Fixed Asset s


A r ealisat ion is def ined as any t r ansact ion r esult ing in, in accor dance wit h gener ally accept ed account ing pr act ice, (i) t he asset ceasing t o be r ecognised in t he company' s balance sheet ; or

(ii) a r educt ion in t he account ing value of t he asset , usually wher e only par t

of t he asset is sold or ot her wise r ealised. “Tr ansact ion” is def ined as including any event giving r ise t o a gain r ecognised f or account ing pur poses.

Pr oceeds of r ealisat ion ar e t hose r ecgonised f or account s pur poses less incident al cost s of r ealisat ion. Wher e an asset has been wr it t en down f or t ax t he gain is t he dif f er ence bet ween t he pr oceeds and t he TWDV. I f no amount s have been wr it t en of f f or t ax t hen t he f ull cost may be br ought in. I n t he case of a par t r ealisat ion The amount deduct ed is adj ust ed pr o r at a t o t he account ing value at t r ibut able t o t he r ealisat ion and t he account ing value bef or e r ealisat ion.

B7.6 Rollover relief for IFAs Par a 37

Sch 29 FA 2002

I f an I FA is sold t hen any gain ar ising will be an income gain.

Illustration 1

A Lt d pur chased goodwill on 1 May 2005 f or £ 250,000 and sold it f or £ 300,000 on 31 December 2005. The company amor t ised t he goodwill at 10% per annum. I t s year end is 30 J une.

The amor t isat ion char ged f or t he 8-mont h per iod f or which t he company owned t he goodwill (1 May t o 31 December 2005) will be:

£ 250,000 x 10% x 8/ 12 = £ 16,667 The wr it t en down value of t he goodwill is: £ Cost 250,000 Less: amor t isat ion t o dat e (16,667) 233,333

The sale t akes place in t he account ing per iod ended 30 J une 2006 and t he income gain will be: £ Pr oceeds of sale 300,000 Less: WDV (233,333) I ncome gain 66,667 Wher e a company r einvest s t he pr oceeds of sale in ot her goodwill (or ot her I FA) it can claim r ollover r elief . The pr oceeds need t o be r einvest ed in t he per iod 12 months before to 36 months after t he sale of t he old I FA. To get full relief t he whole of the proceeds need to be reinvested.

Par as 39-41 Sch 29

FA 2002

Illustration 2

Cont inuing t he example of Company A Lt d. The company buys r eplacement goodwill f or £ 400,000. All pr oceeds have been r einvest ed so r ollover r elief will be available in f ull. The amount r olled over will be: £ Pr oceeds r einvest ed 300,000 Less: cost of old I FA (250,000) 50,000 Not e t hat we do not t ake account of t he amount s wr it t en of f t he cost in t his calculat ion. £ I ncome gain 66,667 Amount r olled over (50,000)

16,667 Following t he claim, t he company will st ill show a cr edit in it s P&L of £ 16,667 r epr esent ing a r ever sal of t he wr it e-of f . The cost of t he new goodwill going f or war d will be: £ Cost of new I FA 400,000 Less: income gain r olled over (50,000) 350,000 I f only part of the proceeds are reinvested, t he amount available f or rollover is t he amount by which the amount reinvested exceeds the cost of the old

asset.

Par a 41(3) Sch 29

FA 2002

Illustration 3

I f A Lt d above decides t o r einvest only £ 270,000, as t his is less t han t he pr oceeds r eceived, r elief will only be available f or :

£ Amount r einvest ed 270,000



Less: cost of old asset (250,000) 20,000 The gain f or t he year will be: £ I ncome gain 66,667 Amount r olled over (20,000)

46,667 The cost of t he new asset going f or war d will be: £ Cost of new I FA 270,000 Less: income gain r olled over (20,000) 250,000 Special r ules apply wher e t he asset sold was cr eat ed bef or e 1 Apr il 2002. I FAs t hat exist ed bef or e t his dat e st ay wit hin t he capit al gains t ax r egime however t hey do not stay within the capital gains tax rollover relief rules.

On disposal t he asset will give r ise t o a capit al gain, f r om 1 Apr il 2002 t his gain can only be r olled over under t he r ules set down in t he FA 2002. This is achieved by making cer t ain amendment s t o t he r ollover pr ovisions t hat we looked at above.

Par a 130 Sch 29

FA 2002

The net pr oceeds r eceived (i.e. pr oceeds less incident al cost of disposal) ar e compar ed t o cost . Cost is def ined as net pr oceeds less t he char geable gain as calculat ed f or capit al gains t ax in ot her wor ds we include indexat ion allowance wher e applicable. Illustration 4

X Lt d sells goodwill it has held since December 1990 f or £ 300,000 paying solicit or s f ees of £ 30,000 in r elat ion t o t he sale. The goodwill or iginally cost £ 55,000. I A is 20%. X Lt d is consider ing t he f ollowing invest ment s in a new I FA: a) £ 280,000 b) £ 220,000 The gain ar ising will be:

£ Pr oceeds 300,000 Less: expenses (30,000) Net pr oceeds 270,000 Less: Cost (55,000) 215,000 I A £ 55,000 x 20% (11,000) Char geable gain £ 204,000

Under opt ion a) t her e will be f ull r einvest ment as t he new asset cost s £ 280,000 which is mor e t han t he net pr oceeds f or t he old asset of £ 270,000. The gain t hat can be r olled over is £ 204,000 giving a base cost f or t he new asset of £ 280,000 - £ 204,000 = £ 76,000. Under opt ion b) t her e will be par t ial r einvest ment . The new asset cost £ 220,000 which is less t han t he net pr oceeds r eceived of £ 270,000. The gain t hat can be r olled over will be £ 220,000 - £ 66,000 = £ 154,000. This gives t he same r esult t o t hat which would have ar isen under t he CGT r ules wher eby net pr oceeds not r einvest ed r emain char geable. The base cost of t he new asset will be £ 220,000 - 154,000 = £ 66,000.

B7.7 Groups Par as 46-54 Sch 29

FA 2002

For I FA pur poses, gr oups ar e essent ially t he same as t hose def ined f or capital gains pur poses. We examine t his def init ion in a lat er chapt er . Tr ansf er s of I FAs wit hin a gr oup ar e tax neutral, pr ovided t hat t he asset is a char geable I FA bef or e and af t er t he t r ansf er . Rollover is allowed on a group wide basis pr ovided t hat t he company t hat buys t he new asset is wit hin t he same gr oup at t he t ime of pur chase and is not a dual r esident invest ment company. I n addit ion t he new asset must be bought f r om out side t he gr oup. Relief is also available wher e a company buys a cont r olling int er est in anot her company which holds I FAs. For t he pur poses of a r ollover claim t he pur chasing company is t r eat ed as buying t he under lying I FA at t he lower of :

Par a 57 Sch 29

FA 2002

• t ax wr it t en down value;

• cost of t he cont r olling int er est . The pur chasing company can make a r ollover claim pr ovided it and t he company wit h t he under lying I FA sign t he claim. As a r esult t he TWDV of t he under lying asset will be wr it t en down t o t he ext ent of t he claim.

B7.8 Companies leaving a group Par a 58 Sch 29

FA 2002

Wher e a company leaves a group within six years of an IFA transfer and st ill holds t he I FA, it is t r eat ed as having t he sold and purchased the IFA at

market value on the date of the transfer. The r esult ing debit or cr edit will be t r eat ed as arising immediately before the transferee leaves the group.

I nt angible Fixed Asset s 69


Wher e a degr ouping char ge ar ises t he company about t o leave t he gr oup t oget her wit h anot her gr oup member can jointly elect to treat the degrouping charge or any part of it as arising in that other group company. The gain will be t r eat ed as a non-t r ade cr edit ar ising in t hat ot her company immediat ely bef or e t he f ir st company leaves t he gr oup. Payment s wit hin t he gr oup in r elat ion t o r ollover or degr ouping char ges ar e not t axable so long as t hey do not exceed t he amount of t he r elief . Not e: I t would be advisable t o look at t hese sect ions of t his chapt er again once you have complet ed all of t he chapt er s dealing wit h gr oups of companies.

B7.9 Related Parties

Par a 92-99 Sch 29 FA 2002

Ther e ar e r ules r elat ing t o t r ansact ions wit h r elat ed par t ies. The def init ion of a r elat ed Par t y is similar t o t hat used f or t r ansf er pr icing. A r elat ed par t y can be a company, individual or ot her sor t of per son. Par t ies ar e r elat ed when: • bot h par t ies ar e companies and one cont r ols t he ot her or has a maj or

int er est in t he ot her ; • bot h par t ies ar e companies and anot her per son cont r ols bot h of t hem (t his

does not apply wher e bot h ar e cont r olled by a gover nment or an int er nat ional or ganisat ion);

• wher e t he company is a “close company”, a per son is r elat ed if t hey ar e a

par t icipat or of t he company, or a par t icipat or in anot her company t hat has cont r ol of , or a maj or int er est in t he company; or

• (f or account ing per iods beginning af t er 19 J une 2003) bot h par t ies ar e

companies and t hey ar e member s of t he same 75 per cent gr oup.

Tr ansact ion bet ween r elat ed par t ies must t ake place at mar ket value.

Par a 92

Royalt ies t o r elat ed par t ies ar e deduct ed on a paid basis if not paid wit hin 12 mont hs of t he paying company’s per iod of account .

Par a 94

Rollover r elief cannot be claimed on t r ansact ions wit h r elat ed par t ies.

Par a 93

Tr ansact ions wit h r elat ed par t ies cannot cr eat e new asset s f or t he pur poses of Sch 29 FA 2002. A pr e 1 Apr il 2002 I FA bought f r om a r elat ed par t y will st ay wit hin t he capit al gains t ax r ules.

Par a 118

B7.10 Commencement of the rules for IFAs

The legislat ion applies t o int angible f ixed asset s bought or cr eat ed f r om 1 Apr il 2002 onwar ds.

An asset bought or created partly before and partly after 1 Apr il 2002 is treated as two assets. The expendit ur e on t he pur chase or cr eat ion of t he asset is appor t ioned on a j ust and r easonable basis. I nt er nally gener at ed goodwill is t r eat ed as cr eat ed under t he old r ules if t he company car r ied on t he business bef or e 1 Apr il 2002. The t r ansit ional r ules r elat ing t o r ollover r elief on asset s t hat st ay wit hin t he capit al gains t ax r ules ar e set out above.



SUMMARY – INTANGIBLE FIXED ASSETS

Fr om 1 Apr il 2002 new r ules wer e int r oduced f or I nt angible Fixed Asset s (I FAs). Debit s and cr edit s in r elat ion t o I FAs ar e t axed/ r elieved in line wit h t he account ing t r eat ment . Amor t isat ion of an I FA is allowed or t he company can elect f or a 4% st r aight line wr it e of f . Royalt ies ar e br ought in on an accr uals basis f or t ax f ollowing t he account s. Debit s and cr edit s r elat ing t o I FAs ar e DI or DVI depending on whet her t hey r elat e t o t he t r ade. Non-t r ade debit s and cr edit s go t o a DVI pool. I f t her e is a net def icit t his can be set of f in t he cur r ent year against ot her income, gr oup r elieved or car r ied f or war d. Disposals of I FAs such as goodwill give r ise t o an income gain or loss however , a f or m of r ollover r elief is available. Tr ansf er s of I FAs in a CGT gr oup ar e t ax neut r al. A degr ouping char ge can ar ise f ollowing t he t r ansf er of an I FA. This degr ouping char ge can be t r ansf er r ed t o anot her company. Gr oup wide r ollover is possible f or I FAs. Tr ansact ions wit h r elat ed par t ies ar e t r eat ed as t aking place at mar ket value. Lat e paid r oyalt ies (mor e t han 12 mont hs f r om t he end of an account ing per iod) t o r elat ed par t ies will be deduct ible on a paid basis.

B8: RESEARCH AND DEVELOPMENT EXPENDITURE

This chapt er will out line t he r elief available f or expendit ur e on r esear ch and development , cover ing in par t icular : - t he 150% t ax r elief available t o small and medium sized companies; - t he t ax cr edit s available t o loss making small and medium sized companies; - t he 125% t ax r elief available t o lar ge companies.

B8.1 Introduction

This r elief was or iginally int r oduced f or small and medium sized companies by Finance Act 2000. Not e t hat t he r elief is not available t o t r ader s – only t o companies. The r elief has now been extended and improved by subsequent Finance Act s t o include r elief f or large companies and f or wor k subcontracted to small and medium companies Usef ul guidance can be f ound in t he legislat ion in t he Miscellaneous Non St at ut or y Mat er ial, Number I X.

B8.2 Definition of R&D

The legislat ion def ines r esear ch and development (R&D) as act ivit ies t hat f all t o be t r eat ed as R&D in accor dance wit h generally accepted accounting practice. Thus we need t o look at SSAP 13 (I AS 38) f or t he def init ion. This def init ion is t hen modif ied by guidelines and t he lat est of t hese wer e published in Mar ch 2004.

s.837A SI 2004/ 712 Misc I

SSAP 13 dist inguishes R&D act ivit y f r om non-r esear ch act ivit y by t he t est of whet her t her e is presence of an appreciable element of innovation. I f t he act ivit y depar t s f r om r out ine and br eaks new gr ound it is nor mally included; however , if it f ollows an est ablished pat t er n it is nor mally excluded.

The f ollowing act ivit ies ar e nor mally included wit hin t he def init ion of R&D:

(a) exper iment al, t heor et ical or ot her wor k aimed at t he discover y of new knowledge, or t he advancement of exist ing knowledge;

(b) sear ching f or applicat ions of t hat knowledge;

(c) f or mulat ion and design of possible applicat ions f or such wor k;

(d) t est ing in sear ch f or , or evaluat ion of , pr oduct , ser vice or pr ocess alt er nat ives;


(e) design, const r uct ion and t est ing of pr e-pr oduct ion pr ot ot ypes and models and development bat ches;

(f ) design of pr oduct s, pr ocesses, ser vices or syst ems involving new t echnology or subst ant ially impr oving t hose alr eady pr oduced or inst alled;

(g) const r uct ion and oper at ion of pr ot ot ypes and pilot plant s.

Wor k on t he per iodic updat ing or modif icat ion of a pr oduct is not R&D if it does not involve an appr eciable element of innovat ion and does not br eak new gr ound. A pr ogr amme of R&D may however r esult in incr ement al impr ovement s t o a pr oduct , ser vice or pr ocess.

B8.3 Small and medium sized companies

A company incur r ing qualif ying Resear ch and Development (R&D) expendit ur e will be able t o claim a deduction equal to 150% of the costs incur r ed in calculat ing it s PCTCT.

Par a 13 Sch 20

FA 2000

The usual ef f ect of t his is t hat t he further 50% of t he R&D expendit ur e needs t o be deducted in arriving at the adjusted profits for tax purposes. Illustration 1

Small Limit ed spends £ 65,000 on qualif ying R&D in it s account ing per iod ended 31 December 2006. I n calculat ing PCTCT f or t he year t o 31 December 2006 t he t ot al deduct ion f or R&D will be:

£ 65,000 x 150% = £97,500

I f t he £ 65,000 has alr eady been deduct ed in ar r iving at t he account ing pr of it , t his means t hat an addit ional deduct ion of

(£ 97,500 - 65,000) = £32,500 i.e. 50% of £ 65,000 should be put t hr ough as an adj ust ment in ar r iving at t he pr of it s f or t ax pur poses. To qualif y f or t he r elief t he company must spend £10,000 on qualif ying R&D.

Par a 1 Sch 20 FA 2000

This f igur e is f or a 12 month accounting period and will be pr opor t ionally r educed wher e t he account ing per iod is less t han 12 mont hs e.g. f or a six mont h per iod t he limit will be £ 5,000.

To qualify as a small or medium sized enterprise (SME) t he company must have:

(i) f ewer t han 250 employees; and Par a 1 Sch 20

FA 2000

(ii) eit her annual t ur nover of less t han 50m Eur os or an annual balance sheet t ot al of less t han 43m Eur os.

These limit s ar e in your Tax Tables.

B8.4 Qualifying R&D

Cer t ain condit ions have t o be met in r elat ion t o t he expendit ur e:

(i) it must be revenue not capital in nat ur e;

Par a 3 Sch 20

FA 2000

(ii) it must be related to a trade car r ied on or t o be car r ied on by t he company;

(iii) it must be incur r ed on: (a) staff costs; (b) software; (ba) relevant payments to the subjects of clinical trials;

(c) consumable or transformable materials; (d) subcontracted R & D costs; or (e) externally provided workers.

(iv) Any intellectual property cr eat ed as a r esult of t he expendit ur e must vest in the company;

(v) I t is not incurred in t he car r ying on of activities which ar e contracted out t o t he company by any per son (alt hough under FA 2002 t hese r ules have been ext ended in cer t ain cir cumst ances - we will look at t his lat er );

(vi) I t is not subsidised, (alt hough an SME is allowed a 25% enhanced deduct ion on ‘subsidised’ expendit ur e pr ovided it would be available t o a lar ge company in t he same cir cumst ances).

B8.5 Staff costs

St af f cost s compr ise: (i) all emoluments of what ever nat ur e paid out t o t he dir ect or s or employees

ot her t han benef it s in kind;

Par a 5 Sch 20

FA 2000

(ii) secondary class one NIC paid by t he company;

(iii) cont r ibut ions t o pension f unds paid by t he company f or t he benef it of dir ect or s and employees.

Only st af f ing cost s f or dir ect or s and employees directly and actively involved in R&D will qualif y. Wher e someone is partly engaged in R&D, t heir t ime is apportioned so t hat only st af f ing cost s incur r ed on R&D act ivit ies can be included. The cost of st af f who pr ovide support to R&D staff do not qualify, f or example secr et ar ies or administ r at ive st af f .

Resear ch and Development Expendit ur e 7 5


B8.6 Software

Qualif ying expendit ur e is t hat which is incur r ed on sof t war e t hat is employed dir ect ly in car r ying out t he R&D, f or example t o r ecor d r esult s. The cost of sof t war e used indir ect ly, f or example t hat used by t he human r esour ces depar t ment t o r ecor d t he act ivit ies of t he R&D st af f , would not qualif y. Wher e only par t of t he cost incur r ed r elat es dir ect ly t o R&D a pr opor t ion of t he cost will be allowable.

B8.7 Consumable or transformable items

Qualif ying expendit ur e is t hat which is incur r ed on r evenue it ems dir ect ly employed in R&D. This includes consumable st or es t oget her wit h wat er , f uel and power of any kind. Wher e only par t of t he cost incur r ed r elat es dir ect ly t o R&D a pr opor t ion of t he cost will be allowable.

B8.8 Relevant payments to subjects of clinical trails Par a 6A Sch 20 FA 2000

Relevant payment s mean payment s f or par t icipat ing in t he t r ials. A clinical t r ial is an invest igat ion in human subj ect s under t aken in connect ion wit h t he development of a healt h car e t r eat ment or pr oduct . For lar ge companies, expendit ur e on or af t er 1 Apr il 2006 qualif ies. The dat e f or SMEs will be announced by st at ut or y inst r ument but will not be ear lier t han 1 Apr il 2006.

B8.9 Sub-contracted R & D

Wher e t he SME subcont r act s R&D wor k t o a t hir d par t y, t he SME may claim r elief . The t r eat ment var ies depending on whet her t he t wo par t ies ar e connect ed.

Par a 9 Sch 20

FA 2000

Wher e t he payment is t o a connected company, which dr aws it s account s up under GAAP, t he whole of any payment up t o t he amount of t he connect ed company’s expendit ur e is allowable.

Par a 10 Sch 20

FA 2000

In any other case 65% of t he payment s made can be claimed. However a j oint irrevocable election can be made f or connected company treatment. The t ime limit f or t he elect ion is t wo year s f r om t he end of t he f ir st account ing per iod in which t he cont r act is ent er ed int o.

Par a 11 & 12 Sch 20

FA 2000

B8.10 Externally provided workers

Wher e a company makes a payment t o anot her per son f or t he pr ovision of wor ker s, sever al condit ions apply in order t o get r elief f or t he payment . An ext er nally pr ovided wor ker must :

Par a 8A Sch 20

FA 2000

(i) be an individual;

(ii) not be also a dir ect or or employee of t he company;

(iii) be obliged t o pr ovide ser vices t o t he company per sonally;

(iv) be under t he cont r ol of t he company. As wit h t he company’s own st af f , t he ext er nally pr ovided wor ker s must be directly and actively involved in R&D. Secr et ar ial and administ r at ive ser vices ar e specif ically excluded. Wher e a wor ker is par t ly engaged in R&D, t he expendit ur e must be appor t ioned.

I f t he ext er nally pr ovided wor ker s ar e not provided by a connected company

65% of t he payment made will be qualif ying expendit ur e. However , t he company and t he st af f pr ovider can jointly elect in writing for the connected company

rules to apply. The election is irrevocable and must be made wit hin two years f r om t he end of t he f ir st account ing per iod in which t he cont r act is ent er ed int o.

Par a 8E & 8D Sch 20

FA 2000

Wher e t he wor ker s ar e pr ovided by a connect ed company and t hat company dr aws up it s account s in accor dance wit h GAAP t hen t he whole of t he payment up t o t he st af f pr ovider ’s cost of t he wor ker s can be claimed.

Par a 8C Sch 20

FA 2000

B8.11 R&D Tax Credits

This r elief allows companies wit h t r ading losses t o “surrender” par t of t hat loss t o t he gover nment in r et ur n f or a t ax r ef und. A company wit h a t r ading loss t hat has incur r ed qualif ying R&D can sur r ender all or par t of t he loss as f ollows. Fir st ly t he surrenderable amount needs t o be calculat ed. This is t he lower of:

(i) t he unrelieved trading loss; and

(ii) 150% of the qualifying R&D expenditure.

Par a 15 Sch 20

FA 2000

For t hese pur poses an unr elieved t r ading loss means t he trading loss of t he per iod reduced by any actual and potential claims for relief for that loss in

the current period and any ot her act ual loss r elief claims made in r espect of t he loss. No account is t aken of losses brought forward or carried back to t his account ing per iod. Once t his loss has been sur r ender ed t he amount of credit given is the lower of:

(i) 16% of t he sur r ender able loss f or t he per iod; and

(ii) t he company’s PAYE and NIC bill f or t he per iod.

Par a 16 Sch 20 FA2000

77 Resear ch and Development Expendit ur e


Illustration 2

Medium Lt d has t he f ollowing r esult s: Tr ading loss £ 170,000 Qualif ying R&D £ 45,000 PAYE/ NI C bill £ 85,000 The sur r ender able loss is t he lower of : (i) £ 170,000 (ii) £ 45,000x 150% = £ 67,500 i.e. £ 67,500 The t ax cr edit given will be t he lower of (i) 16% x £ 67,500 = £ 10,800 (ii) £ 85,000 i.e. £10,800 This t ax cr edit of £ 10,800 will eit her be used t o r educe Medium Lt d ‘s t ax bill if it has ot her sour ces of income or will be r eceived as a t ax f r ee r ef und. The t r ading loss of t he company car r ied f or war d is now: £ 170,000 - £ 67,500 = £ 102,500

For expendit ur e of £ 45,000 t he company has r eceived a r ef und of £ 10,800 which equat es t o 24% (10,800/ 45,000) or 150% x 16% = 24%.

Illustration 3

Raf ael Lt d, a small company, spends £ 125,000 on qualif ying R&D. The company has a t r ading loss of £ 135,000 and has DI I I income of £ 40,000. The company’s PAYE/ NI C bill of £ 67,000. The sur r ender able loss is t he lower of : (i) £ 135,000 less t he £ 40,000 pot ent ial CY loss claim i.e. £ 95,000 (ii) £ 125,000 x 150% = £ 187,500

i.e. £ 95,000 The t ax cr edit given will be t he lower of (i) 16% x £ 95,000 = £ 15,200 (ii) £ 67,000 i.e. £15,200

79

B8.12 Large Companies Sch 12 FA 2002

Lar ge companies qualif y f or R&D r elief f or accounting periods ending on or

after 1 April 2002. Lar ge companies ar e t hose t hat do not qualif y as SMEs under t he r ules above. The r elief given t o lar ge companies is a 125% deduction in calculat ing PCTCT. The usual ef f ect of t his is t hat t he further 25% of t he R&D expendit ur e needs t o be deducted in arriving at the adjusted profits for tax purposes.

Par a 11 Sch 12

FA 2002

Illustration 4

Lar ge Limit ed spends £ 245,000 on R&D dur ing t he account ing per iod ended 31 Mar ch 2007. The deduct ion in calculat ing t he PCTCT will be:

£ 245,000 x 125% = £ 306,250 I f t he £ 245,000 has alr eady been deduct ed in ar r iving at t he account ing pr of it , t his means t hat an addit ional deduct ion of

(£ 306,250 - 245,000) = £61,250 i.e.25% of £ 245,000 should be put t hr ough as an adj ust ment in ar r iving at t he pr of it s f or t ax pur poses. The def init ion of r esear ch and development is t he same as t hat which is applied t o small and medium sized ent er pr ises. To qualif y f or t he r elief t he company has t o spend a minimum of £10,000 dur ing t he account ing per iod. This limit is again pr o r at ed f or account ing per iods of less t han t welve mont hs. A lar ge company can claim for expenditure on work contracted to it pr ovided it is cont r act ed by anot her lar ge company or any per son ot her wise t han in t he cour se of a t r ade char geable t o Schedule D Cases I or I I .

Par a 4 Sch 12

FA 2002

No r elief can be claimed wher e wor k is subcont r act ed t o a lar ge company by an SME as t he SME will claim r elief . Ther e is no requirement for the intellectual property cr eat ed by t he R&D to vest in t he company.

Resear ch and Development Expendit ur e


B8.13 Subcontracted R&D

Lar ge companies will be able t o claim relief for R&D subcontracted to others and on cont r ibut ions t o independent r esear ch and development so long as it is expendit ur e incur r ed in making payment s t o qualifying bodies being:

Par a 5 Sch 12

FA 2002

• Univer sit ies;

• Char it ies;

• Scient if ic r esear ch or ganisat ions;

• NHS bodies; and

• I ndividuals or par t ner ships. Relief of 125% can be claimed by an SME f or R&D subcont r act ed t o it so long as it s t ot al expendit ur e (it s own plus subcont r act ed) on R&D f or t he account ing per iod exceeds £ 10,000. This is r educed f or account ing per iods of less t han 12 mont hs.

Par a 7 Sch 20

FA 2000

The wor k has t o be subcont r act ed t o t he SME by a lar ge company or any ot her per son not t axable under Schedule D Cases I or I I . The SME can claim f or expendit ur e on wor k dir ect ly under t aken it self or f or expendit ur e wher e t he wor k is under t aken by ot her s on behalf of t he SME so long as t he payment s ar e t o qualif ying bodies as f or lar ge companies above or individuals/ par t ner ships.

B8.14 Vaccine Research

Sch 13 FA 2002

A similar r elief is available f r om 22 Apr il 2003 f or companies car r ying out r esear ch int o cer t ain vaccines and medicines (TB, Malar ia, HI V and AI DS). For large companies t he deduct ion is 150% wit h no ot her par t icular condit ions applying i.e. no £ 10,000 limit et c.

Par a 21 Sch 13

FA 2002

For SMEs t he r elief is a deduct ion of 150% of t he cost incur r ed if t hey do not qualif y f or R&D r elief and a further 50% (i.e. 200% in t ot al) deduct ion if t hey do so qualif y. The amount claimable can be included in a t ax cr edit claim by t he SME.

Par a 14 Sch 13

FA 2002

B8.15 Claims for Research and Development relief. Par t 9A t o 9C

Sch 18 FA 1998

For account ing per iods ending on or af t er 31st Mar ch 2006 all claims f or R&D t ax cr edit s and enhanced deduct ions will need t o be made wit hin t he company’s t ax r et ur n.

81

Par agr aphs 83A t o 83E of Sch 18 FA 1998 ar e amended t o include all R&D r elief claims, not j ust t ax cr edit claims. Similar r ules have been added f or lar ge company claims and vaccine r elief . The r ules r elat ing t o penalt ies in Par a 83F Sch 18 FA 1998 r emain specif ic t o t ax cr edit s. Claims f or enhanced deduct ions will be cover ed by t he nor mal penalt y r egime f or f r audulent or negligent r et ur ns. For account ing per iods ending af t er 31 Mar ch 2002 but bef or e 31 Mar ch 2006 all claims must be amended or wit hdr awn by 31 Mar ch 2008. Pr eviously t her e wer e only specif ic r ules r elat ing t o R&D t ax cr edit s but none r elat ing t o t he enhanced r elief which meant t hat t he six year t ime limit f r om t he end of t he account ing per iod applied.

Example 1

Lamp Lt d, a small company, spends £ 35,000 on R&D dur ing t he year t o 31 Mar ch 2007. Pr of it s bef or e R&D deduct ions ar e £ 155,000. You ar e r equir ed t o calculat e t he PCTCT

Example 2

Net Lt d, a small company, spends £ 150,000 on R&D. Dur ing t he year t he company makes a t r ading loss of £ 70,000 and had a PAYE/ NI C bill of £ 35,000. You ar e r equir ed t o calculat e t he amount of t ax cr edit t he company may claim.



Answer 1

£ Pr of it s 155,000 Less R&D 35,000 x 150% (52,500) PCTCT £102,500

Answer 2

The sur r ender able loss will be t he lower of :

£ Unr elieved loss 70,000 150% x 150,000 225,000 Ther ef or e 70,000 The t ax cr edit will be t he lower of 16% x 70,000 11,200 The NI C/ PAYE bill = 35,000

Ther ef or e t he t ax cr edit will be £11,200

83

SUMMARY – RESEARCH AND DEVELOPMENT EXPENDITURE

R&D r elief of 150% is available t o SMEs. The r elief r elat es t o r evenue expendit ur e on sof t war e and consumable it ems, r elevant payment s t o subj ect s of clinical t r ials, st af f cost s, sub-cont r act ed R&D cost s and ext er nally pr ovided wor ker s. I n t he case of payment s t o connect ed companies all t he cost s qualif y f or r elief . For subcont r act ed R&D and ext er nally pr ovided wor ker payment s t o unconnect ed companies, only 65% of t he cost can be claimed unless an elect ion is made f or connect ed par t y t r eat ment . SMEs wit h losses can sur r ender t hem t o t he Revenue and r eceive a t ax cr edit / r epayment . The sur r ender able amount is t he lower of :

Qualif ying R&D x 150% Unr elieved t r ading losses

The t ax cr edit will be t he lower of :

Sur r ender ed amount x 16% The company’s PAYE/ NI C bill

Lar ge companies can claim a t ax deduct ion of 125% f or qualif ying R&D. Similar r elief is available f or expendit ur e on vaccine r esear ch. Par as 9A, 9BA and 9C of Sch 18 FA 1998 set down t he r ules f or making claims.


B9: TAX LAW AND ACCOUNTING PRACTICE

This chapt er looks at t he int er act ion of t ax law and account ancy pr act ice cover ing in par t icular : - t he impor t ance of GAAP; - Her ber t Smit h V Honour ; - t he r ecognit ion of income.

B9.1 General principle

I n gener al t he t ax t r eat ment of a par t icular it em will f ollow t he account ing t r eat ment , i.e. income shown in t he P & L Account is t axable and expenses ar e deduct ible. This pr inciple applies unless t ax legislat ion or case law dict at es ot her wise. This pr inciple has been ar ound f or year s as t he st ar t ing point f or t he measur e of pr of it t axable under Schedule D Case I . However , r ecent legislat ive changes have act ually made t he account ing r ules apply f or t ax pur poses in many cases. I n Finance Act 1993 t he f or eign exchange gains and loss r ules f or t ax pur poses wer e aligned wit h t he account ing t r eat ment . Finance Act 1994 r equir ed t he r ecognit ion of gains and losses under t he f inancial inst r ument s r ules t o f ollow t he account ing t r eat ment . This was f ollowed in Finance Act 1996 which applies t he account ing t r eat ment t o all loan r elat ionships, namely her e t he t ax t r eat ment of int er est . The Gover nment went vir t ually t he whole way t owar ds aligning t ax and account ing in s.42 of t he Finance Act 1998 which r equir es all account s t o be pr epar ed using t he t r ue and f air basis. This ef f ect ively r emoved t he cash basis f or t he r ecognit ion of income f or all businesses and companies. Recent ly we have seen many changes in t he r ules t o deal wit h t he adopt ion of int er nat ional account ing st andar ds (I AS). Most not ably GAAP is now def ined as including int er nat ional account ing st andar ds. The t er minology used in st at ut e has been amended t o f ollow t hat used in I AS. For example, r ef er ences t o bad debt r elief have been r eplaced wit h r ef er ences t o impair ment losses.

B9.2 Accounting standards

As t he t ax t r eat ment , in many cases, is dict at ed by t he account ing t r eat ment , it is impor t ant t o ensur e t he pr oper adopt ion of accounting standards. The t ax t r eat ment should f ollow gener ally accept ed account ing pr inciples or GAAP as it is commonly shor t ened t o. For account ing per iods beginning on or af t er 1 J anuar y 2005 t he def init ion of GAAP is ext ended t o include adher ence wit h I nt er nat ional Account ing St andar ds (I AS) wher e r equir ed. The need t o f ollow GAAP has been developed bot h in legislat ion by s.42 Finance Act 1998 and in case law.

Tax Law and Account ing Pr act ice

85

I n t he case of Gallagher v Jones, a company ent er ed int o a f our year f inance lease wit h lease r ent als ar e payable over t his f our year per iod. The r ent act ually paid was £ 397 in year 1 and a pepper cor n r ent i.e. £ 1 p.a. f or t he r emainder of t he lease and t his was t he t r eat ment which was adopt ed in t he account s. However , under SSAP21 t he cor r ect account ing t r eat ment should r ecognise t he economic r ealit y of t he t r ansact ion. The asset is being leased f or a f our year per iod at an over all cost of £ 400, so t her ef or e t he cor r ect account ing t r eat ment is t o r ecognise t he cost evenly over t he per iod of t he lease as £ 100 per annum. The Revenue disput ed t he account ing t r eat ment and put f or war d t he view t hat t her e is no r ule in t ax law st at ing t hat expenses ar e deduct ible when t hey ar e paid. The company was, t hr ough t he account ing t r eat ment , giving it self an up-f r ont t ax deduct ion t o which t he Revenue obj ect ed. I t was held in t his case t hat t he t ax t r eat ment should f ollow GAAP. Consequent ly t he Revenue can successf ully r equest t hat pr oper account ing pr inciples ar e applied, at least in t he t ax comput at ions, even if t he it em is not mat er ial t o t he account s.

The decision in t he Gallagher v Jones case r einf or ced SP 3/ 91 which r equir es t he t ax t r eat ment of f inance leased asset s t o f ollow cor r ect account ing t r eat ment .

B9.3 Importance of GAAP

Gener ally accept ed account ing pr inciples ar e ver y impor t ant when it comes t o calculat ing t axable pr of it s. I f t he cor r ect account ing pr inciples have been f ollowed t he Revenue cannot disput e t he t r eat ment unless st at ut e or case law st at es ot her wise. For inst ance, st at ut e st at es t hat ent er t aining expenses ar e disallowed f or t ax pur poses. This par t icular pr inciple was est ablished par t icular ly in t he case of Johnston v Britannia Airways. Br it annia Air ways f ly a f leet of aer oplanes. Br it annia mat ched t he cost s of over hauling t he j et engines t o t he act ual f lying hour s t he f leet had f lown dur ing t he year . The Revenue disput ed t his pr ovision, basically saying it did not r elat e t o t he cost s act ually incur r ed, but t o cost s which may have been t heor et ically incur r ed. They want ed t he company t o f ollow t he accr uals met hod of account ing by br inging f or war d an accr ual f r om t he pr evious year , account ing f or t he expenses act ually incur r ed dur ing t he account ing per iod and accr uing f or expendit ur e commit t ed t o by t he end of t he year . However , in t he j udgement t o t his case it was held t hat what Br it annia was doing was per f ect ly accept able under gener ally accept ed account ing pr inciples. The Cour t did not f ollow t he ar gument put f or war d by t he Revenue t hat somet hing else might have been mor e accept able.


Ther ef or e, t he conclusion t hat we can dr aw f r om t his case is wher e t her e is a choice as to how we apply a particular standard, t he choice rests with the

tax paying company. We only need t o pr ove what we have done is accept able. I t is not f or t he Revenue t o ar gue t hat somet hing else might be mor e accept able.

Unf or t unat ely FRS 12 which deals specif ically wit h t he account ing f or pr ovisions, has effectively prohibited a “Britannia style” provision in the

future. Br it annia would now need t o show t hat t hey have a pr esent day obligat ion t hat is eit her cont r act ual or legal, bef or e t hey could pr ovide f or t he over haul cost s in t his way. This is examined in t he next chapt er .

B9.4 Herbert Smith v Honour (1999)

Her ber t Smit h is a solicit or s pr act ice. They opened up of f ice number one in cent r al London and soon expanded t heir oper at ions t o a second sit e. They expanded again and opened up a t hir d and a f our t h of f ice, all in cent r al London. I t was becoming logist ically dif f icult t o r un t he pr act ice f r om f our separ at e locat ions and consequent ly t hey made t he decision t o t ake out a lease on new lar ger pr emises, of f ice f ive and moved ever yt hing under t he same r oof . All t his happened back in December 1990, t his dat e being ver y impor t ant f or what was happening in t he economy at t he t ime. The leases on of f ices one, t wo, t hr ee and f our wer e t aken out by t he f ir m in t he lat e 1980s when land pr ices, par t icular ly in cent r al London, wer e ver y high and t her ef or e t hey had commit t ed t hemselves t o oner ous r ent al payment s. I n December 1990 when t hey moved int o sit e f ive, r ent al values on t hese pr oper t ies had f allen consider ably. As t heir landlor ds would not let t hem r elinquish t he leases, t he only opt ion t hat t hey had was t o sub-let t he pr emises unt il t he head leases expir ed. As a r esult of t his sub-let t ing, losses in excess of £ 5½ million would be cr eat ed and t he f ir m pr ovided f or t he f ull amount in t he 1990 account s. The Revenue sought t o disallow t his pr ovision. They quot ed SP 3/90 which basically says t hat we ar e not allowed t o ant icipat e losses f or t ax pur poses. Their ar gument was t hat t he f ir m should have accr ued f or t he r ent al losses over t he per iod t hat t he head leases expir ed. The f ir m disagr eed as t hey ar gued t hat what t hey had done was consist ent wit h t he concept of pr udence. SSAP 2 specif ically says t hat t he pr udence concept over r ides t he accr uals concept . Consequent ly when t he case came bef or e t he High Court t he J udge ruled in favour of the firm on t he basis t hat t hey could pr ove what t hey had done was accept able on account ing gr ounds. As a r esult t he Revenue wer e f or ced t o wit hdr aw SP 3/ 90.


87

B9.5 Review of the main accounting policies

The recognition of income

Cur r ent ly we f ollow t he pr udence and mat ching r ules, i.e. gener ally accept ed account ing pr inciples. However , a new f inancial r epor t ing st andar d (FRS) is t o be issued shor t ly and once t his is applicable, we must f ollow it , not only f or account ing pur poses, but also f or t ax pur poses. I f we f ail t o apply t his new FRS t he Revenue can ar gue successf ully, as given by t he Gallagher v J ones, case t hat we have not applied gener ally accept ed account ing pr inciples.

St ock St ock valuat ion is given under SSAP 9. This af f ect s t he pr of it f igur e, but of cour se, we have a choice as t o how we value st ock and pr ovided t hat what we do is accept able, i.e. we f ollow SSAP 9 t her e is not hing t he Revenue can do t o challenge t he f igur es.

Pr ovisions The t r eat ment of pr ovisions is given under FRS 12. This is cover ed in t he next chapt er . Many disput es wit h t he Revenue may cent r e on t he int er pr et at ion and applicat ion of account ing st andar ds, as we have seen f r om t he t hr ee cases r ef er r ed t o alr eady. Ther ef or e, t he Revenue ar e making incr easing use of account ant s, bot h in t heir invest igat ions t eam and as exper t wit nesses in t ax appeal hear ings.

B9.6 Materiality

The concept of materiality is not recognised by the Revenue. For t ax pur poses all t he f igur es in t he account s must be examined, not j ust t he mat er ial ones, as t he f ailur e t o apply gener ally accept ed account ing pr inciples is likely t o lead t o an adj ust ment being r equir ed. For inst ance, let us say t hat we r eceived a let t er f r om t he Revenue asking us t o conf ir m whet her a par t icular pr ovision meet s t he r equir ement s of FRS 12. When we open up t he audit f ile we r ealise t hat we did not make any comment s dur ing t he audit on t his par t icular pr ovision as it is immat er ial t o t he account s. Unless we can put f or war d suf f icient evidence t o show t hat we have applied FRS12 cor r ect ly t he Revenue have ever y r ight t o ask f or an adj ust ment t o be made in t he t ax comput at ion.


B9.7 GAAP and the FRSSE

The Revenue will accept accounts prepared under the Financial Reporting

Standards for Small Enterprises (FRSSE) and cannot insist t hat a non-FRSSE st andar d is applied in a par t icular sit uat ion as t he account s as submit t ed f or t hat size of or ganisat ion have f ollowed t he cor r ect account ing t r eat ment and t her ef or e it cannot be challenged. A company may choose not t o adopt FRSSE, in ot her wor ds t o adopt t he f ull ar r ay of st andar ds. The Revenue’s view on t his is t hat if a company chooses t o apply one par t icular st andar d which is not applicable t o t he FRSSE, t hey must apply all of t he ot her st andar ds and must do so in f ull. This view is yet t o be challenged.

B9.8 Capital and revenue

The Revenue believe t hat t he accounting treatment cannot change the nature

of an item, be it capital or revenue. This view is expr essed in t heir bi-mont hly publicat ion Tax Bulletin, issue 39. I s t his cont r ar y t o t he pr inciple est ablished in t he Her ber t Smit h case? S.72 ICTA 1988 disallows capital expenditure specifically.

S. 74(f), disallows expenditure which provides an enduring benefit to the

business. This has been subj ect t o plent y of int er pr et at ion bef or e t he Cour t s. S. 74(g) disallows the costs of improvement to business premises.

Consequent ly, t he Revenue can r ely on separ at e st at ut or y r ules so one can legit imat ely say t hat t his is not cont r ar y t o t he Her ber t Smit h pr inciple which only r equir es t he account ing t r eat ment t o be f ollowed if t ax st at ut e or case law is silent on t he mat t er .

B9.9 Income recognition

The cr it ical ar ea f or t ax pur poses is t he r ecognit ion of income. Ther e is cur r ent ly no account ing st andar d dealing wit h t he r ecognit ion of income f or account ing or indeed t her ef or e t ax pur poses. However , wher e t he Revenue can show t hat GAAP have not been f ollowed in r ecognising income in t he account s, t hey can successf ully r equest t he appr opr iat e adj ust ment . This was given in t he decision in t he Gardner Mountain case. I n t his par t icular case, insur ance commission agent s sold policies and wer e ent it led t o an amount of commission which was paid t o t hem at t he t ime t he policy was sold. However , if t he policyholder cashed t he policy in wit hin t he f ir st t wo year s some of t hat commission may have t o be r ef unded back t o t he insur ance company. The insur ance company, Gar dner Mount ain, advised all of t heir agent s t o account f or t he commissions income t o t he Revenue as f ollows:


89

• 50% in Year 1 • 25% in Year 2 • 25% in Year 3 The ar gument being t hat at t he t ime t he commission is act ually paid t o t hem t her e is a r isk some of it will have t o be r ef unded and t her ef or e it would be wr ong t o r ecognise all of it f or t ax pur poses up f r ont . However , t he Revenue successf ully ar gued t hat t his t r eat ment did not accor d wit h t he under lying economic r ealit y of t he t r ansact ion. For t ax pur poses, t he Revenue wer e of t he view t hat all of t he commission should be br ought int o char ge in t he account ing per iod in which it is r eceived, as it is t his account ing per iod in which t he wor k has been done t o sell t he policy. I n t he second and t hir d year s t he Revenue would accept an expense of any commissions which t he agent subsequent ly has t o r ef und. I n some sit uat ions, a pr ovision might be accept able, but of cour se nowadays we would need t o f ollow FRS 12.

B9.10 Moving towards IAS

As st at ed above, f or account ing per iods beginning on or af t er 1 J anuar y 2005, compliance wit h GAAP includes compliance wit h I nt er nat ional Account ing St andar ds (I AS). The main dif f er ence bet ween t he GAAP and I AS is t he t endency t owar ds f air value account ing. I AS concent r at e mor e on t he balance sheet and r ecognising movement s in t he opening and closing balance sheet wit hin t he pr of it and loss account . I AS pr ovide f or r ecognit ion of ant icipat ed pr of it s. Accr uals and pr udence ar e st ill t he basis f or account ing however t her e is gr eat er use of f air value account ing. Wher e t her e is a conf lict bet ween pr udence and f air value, f air value will pr evail. I n amending t he legislat ion, in par t icular t hat r elat ing t o loan r elat ionships and der ivat ives, t o deal wit h I AS t he Revenue have lef t t hemselves t he r ight t o issue r egulat ions r equir ing t hat amount s r ecognised under GAAP ar e not br ought in f or t ax and vice ver sa giving specif ic r ules on how t hese amount s will be dealt wit h f or t ax. We have seen an example of t hese r ules in t he chapt er on loan r elat ionships. For account ing per iods beginning on or af t er 1 J anuar y 2005, wher e in a gr oup of companies one company uses I AS and anot her UK GAAP, t hen if t her e ar e t r ansact ions bet ween t he t wo and a t ax advant age would ar ise as a r esult of t he dif f er ent account ing policies, t hey ar e bot h t o be t r eat ed as using UK GAAP. A gr oup f or t hese pur poses is as def ined f or capit al gains t ax.

s.51 FA2004


SUMMARY – TAX LAW AND ACCOUNTING PRACTICE

The Revenue is looking mor e and mor e t owar ds Account ing St andar ds t o det er mine t he t ax t r eat ment of income and expendit ur e. GAAP is ver y impor t ant . I f t he cor r ect account ing t r eat ment has been f ollowed t he Revenue cannot disput e t he t r eat ment unless st at ut e or case law st at es ot her wise. Following t he Her ber t Smit h case, which looked at t he pr ovision f or losses on a lease, t he Revenue had t o wit hdr aw SP 3/ 90 which pr ohibit ed ant icipat ion of losses. Ther e is cur r ent ly no account ing st andar d dealing wit h t he r ecognit ion of income. However if t he Revenue can show t hat GAAP has not been f ollowed t hey can r equest t he appr opr iat e adj ust ment as t hey did in t he Gar dner Mount ain case. The inclusion of I AS in GAAP will r esult in a move t owar ds f air value account ing and r ecognising movement s in balance sheet values. The Revenue have t he r ight t o issue r egulat ions r equir ing amount s r ecognised f or GAAP t o be adj ust ed in t he t ax comput at ions.

C: Taxation of Limited Companies

C1: COMPUTATION OF CORPORATION TAX

This chapt er will explain how a company calculat es it s cor por at ion t ax liabilit y once PCTCT is known. I n par t icular it will explain how t he level of a company’s pr of it s af f ect s t he r at e of t ax t hat is applied.

C1.1 Rates of tax

Companies pay Cor por at ion Tax f or a chargeable accounting period or CAP. The r ules f or det er mining t he CAPs of a company wer e cover ed in t he f ir st chapt er .

Cor por at ion t ax is calculat ed based on r at es of t ax set by t he Chancellor of t he

Exchequer f or each f inancial year . A f inancial year f or companies r uns f r om 1 Apr il t o 31 Mar ch and is denot ed by t he year in which it begins. For example, financial year 2006 (FY 2006) runs from 1 April 2006 to 31 March 2007.

The r at es of t ax applicable in t he last f ew f inancial year s ar e as f ollows and ar e

given in your t ax t ables:

Financial Year 2006 2002 to

2005

Full r at e 30% 30% Small companies’ r at e 19% 19% St ar t ing r at e N/ A 0% Pr of it limit f or st ar t ing r at e N/ A £ 10,000 Pr of it limit f or st ar t ing r at e mar ginal r elief N/ A £ 50,000 Pr of it limit f or small companies’ r at e £ 300,000 £ 300,000 Pr of it limit f or small companies’ mar ginal r at e £ 1,500,000 £ 1,500,000

Mar ginal r elief f r act ion - small companies’ r at e 11

400 11

400

Mar ginal r elief f r act ion – st ar t ing r at e N/ A 19400

Ther e has been a signif icant change in t he cor por at ion t ax r at es wit h ef f ect f r om FY 2006 as t he 0% “st ar t ing r at e” has been abolished. We will r et ur n t o t his lat er .


Companies pay tax on t heir pr of it s char geable t o cor por at ion t ax (PCTCT). However , t he rate of tax is determined by a company’s “notional profit” (NP). For example, if a company has not ional pr of it of £ 2m, it will be a “lar ge” company and will pay cor por at ion t ax on t he whole of it s PCTCT at t he f ull r at e of 30%. A company wit h not ional pr of it of , say, £ 100,000 will be a “small” company and it s PCTCT would be f ully char ged at t he small companies r at e of 19%. Companies whose not ional pr of it is bet ween t he limit s ar e known as “mar ginal” companies and will r eceive “mar ginal r elief ”. We will look at mar ginal r elief lat er in t his chapt er . Diagr ammat ically, t he r at es of cor por at ion t ax as t hey apply f or FY 2006 can be shown as f ollows:

“Pr of it s”

For FY 2002 t o FY 2005 t her e was an addit ional mar ginal calculat ion f or pr of it s bet ween £ 50,000 and £ 10,000.

C1.2 Notional profit

The not ional pr of it is obt ained by t aking PCTCT and adding t o it dividends r eceived, gr ossed up at a r at e of 100/ 90. This gr oss dividend f igur e is known as franked investment income and is commonly shor t ened t o FII.

30%

“Mar ginal r elief ”

19%

£ 300,000

£ 1,500,000

Comput at ion of Cor por at ion Tax

93

This gives us t he not ional pr of it and it is t his f igur e which we compar e wit h t he limit s in t he t ax t ables t o det er mine t he r at e of t ax applicable t o t he par t icular company.

PCTCT X

FII = Dividends received x 100

90 X

Notional profit X

Remember t hat UK dividends r eceived by a UK company ar e not char ged t o cor por at ion t ax. We only consider UK dividends received in or der t o det er mine t he rate at which t he company will pay cor por at ion t ax. Fur t her mor e we only consider UK dividends r eceived f r om non-group companies. We will look at t he def init ion of non-gr oup companies lat er .

Illustration 1

Two separ at e companies, A Lt d and B Lt d make up account s f or t he 12 mont hs t o 31 Mar ch 2007. Their PCTCTs f or t he per iod ar e: A Lt d £ 200,000 B Lt d £ 2,000,000

Bot h companies r eceive UK dividends of £ 1,800.

To comput e each company’s CT liabilit y f or t he year t he f ollowing met hod should be used: 1) Calculat e t he notional profit f igur e; 2) Consider t he limits t o det er mine which rate is t o be applied t o t he

PCTCT; 3) Apply t he CT rate to the PCTCT.

A Lt d B Lt d £ £

PCTCT 200,000 2,000,000FI I £ 1,800 x 100/ 90 2,000 2,000“ Not ional Pr of it ” 202,000 2,002,000

Rat e t o be applied 19% 30%

£ 200,000 x 19% £ 38,000£ 2m x 30% £ 600,000


Remember t hat t he dividends ar e not t axable income in t he hands of a company, but t hey ar e included t o decide what rate of t ax will be payable on t he t axable pr of it s (PCTCT).

Example 1

Consider t he f ollowing companies wit h a year end of 31 Mar ch 2007:

X Lt d £

Y Lt d £

PCTCT 1,400,000 280,000 Dividends r eceived 100,000 16,200

Calculat e t he cor por at ion t ax liabilit y f or each company.

C1.3 Marginal relief

Mar ginal r elief applies wher e a company’s notional profit is between upper and lower profit limits of £ 300,000 and £ 1.5m. s.13

I n comput ing t he cor por at ion t ax liabilit y, PCTCT is initially taxed at the full

rate of 30% wher e pr of it s ar e bet ween t he lower and t he upper limit s.

Marginal relief is then deducted.

Mar ginal r elief is given by t he f or mula:

Fraction x (Upper Limit – Notional Profit) x PCTCT

Notional Profit

I n FY 2006 t he f r act ion is 11

400 and t he mar ginal r elief calculat ed is deduct ed

f r om t he init ial calculat ion of cor por at ion t ax at 30% t o give t he act ual t ax payable.

Illustration 2

A company has t he f ollowing r esult s f or t he year t o 31 Mar ch 2007:

£ PCTCT 500,000 FI I 80,000 Not ional Pr of it £ 580,000


95

The not ional pr of it is bet ween t he £ 300,000 and £ 1,500,000 limit s and mar ginal r elief will apply. The t ax calculat ion will be:

£ £ 500,000 x 30% 150,000 Less: mar ginal r elief 11

400 x (1,500,000 – 580,000) x 500000580000

(21,810)

Gr oss Cor por at ion Tax (GCT) £128,190 Example 2

G Lt d has f ollowing f or r esult s t he year ended 31 Mar ch 2007: £ Schedule DI 250,000 Schedule A 60,000 Capit al gain 180,000 Dividends r eceived 18,000

Calculat e t he Gr oss Cor por at ion Tax payable.

C1.4 Abolition of the starting rate

Since FY 2002, pr of it s of £ 10,000 or less have been char ged at t he “st ar t ing r at e” of 0%. For FY 2006 t he starting rate of tax does not apply. Pr of it s of £ 10,000 or less ar e now char ged at t he small companies r at e of 19%. Wher e account ing per iods st r addle 1 Apr il 2006 (e.g. year ended 31 December 2006), par t of t he pr of it s ar e char ged at t he FY 2005 r at es and par t ar e t axed at t he FY 2006 r at es. We t her ef or e need t o time apportion PCTCT and notional

profits in or der t o calculat e cor por at ion t ax.

Illustration 3

A company has PCTCT of £ 8,000 and FI I of £ 1,500 f or t he year ended 30 Sept ember 2006. This year end st r addles FY 2005 and FY 2006.


Ther ef or e we appor t ion PCTCT, t he limit s and FI I as f ollows: FY 2005 FY 2006 6/ 12 6/ 12 £ £ PCTCT 4,000 4,000 FI I 750 750 Not ional pr of it s 4,750 4,750 Pr of it limit f or st ar t ing r at e 5,000 N/ A Rat e of t ax 0% 19% Gr oss Cor por at ion Tax £ 4,000 x 0% / £ 4,000 x 19% £ 0 £ 760 Tot al £760

We could have r eached t he same answer by consider ing t he company’s average rate of tax. The company will pay t ax at 0% f or t he f ir st six mont hs and 19% f or t he second six mont hs. The aver age r at e of t ax is: 6/ 12 x 0% 0% 6/ 12 x 19% 9.5% Aver age r at e 9.5% I f we apply 9.5 % t o pr of it s we get £ 8,000 x 9.5 % = £ 760 Using t he aver age r at e is quicker .

Example 3

A company wit h a 31 December 2006 year -end has PCTCT of £ 4,000 and dividends r eceived of £ 450. Calculat e t he Cor por at ion t ax payable.

C1.5 Abolition of starting rate marginal relief

Bef or e FY 2006, mar ginal r elief also applied t o not ional pr of it s bet ween £ 10,000 and £ 50,000. The marginal relief fraction was 19/400. The mar ginal r elief calculat ed was deduct ed f r om t he init ial calculat ion of cor por at ion t ax at 19% t o give t he act ual t ax payable.


97

Profits

Once again wher e a company has an account ing per iod t hat st r addles 1 Apr il 2006, we apportion the profits and see if st ar t ing r at e mar ginal r elief would apply f or t he per iod f alling wit hin FY 2005. This will apply if not ional pr of it s f or t he account ing per iod ar e less than £50,000.

Illustration 4

A company has PCTCT of £ 36,000 and FI I of £ 4,000 in it s year ended 30 J une 2006. This year end st r addles t wo f inancial year s, FY 2005 and FY 2006. The company’s pr of it s and FI I t her ef or e need t o be appor t ioned t o t he t wo per iods:

FY 2005 9/ 12

FY 2006 3/ 12

£ £ PCTCT 27,000 9,000 FI I 3,000 1,000 Not ional pr of it 30,000 10,000

£ 1,500,000

£ 300,000

£ 50,000

£ 10,000

30%


19%


0%


We need t o consider t he st ar t ing r at e as t he f ir st 9 mont hs’ char geable pr of it s f all int o FY 2005. The second 3 mont hs of t he account ing per iod f all wit hin FY 2006. As t he st ar t ing r at e has been abolished t hey will be t axed at 19%. The st ar t ing r at e limit should be t ime appor t ioned f or t he 9 mont h per iod: Pr of it limit f or st ar t ing r at e £ 10,000 x 9/ 12 = £ 7,500 Pr of it limit f or st ar t ing r at e mar ginal r elief £ 50,000 x 9/ 12 = £ 37,500

The company’s not ional pr of it in FY 2005 is bet ween t hese limit s and t her ef or e st ar t ing r at e mar ginal r elief applies. The t ax is t her ef or e calculat ed as f ollows:

FY 2005 £

FY 2006 £

Cor por at ion t ax: £ 27,000 x 19% 5,130

£ 9,000 x 19% 1,710 Mar ginal r elief : 19/ 400 x £ (37,500 - 30,000) x 27,000

30,000

(321)

N/ A £ 4,809 £ 1,710 Tot al £6,519


99

Answer 1

X Lt d £

Y Lt d £

PCTCT 1,400,000 280,000

FI I (dividends x 10090 )

111,111 18,000

Not ional pr of it £ 1,511,111 £ 298,000

> 1.5m limit

< £ 300k limit

Tax r at e

30% 19%

Cor por at ion Tax (PCTCT x r at e)

£ 1,400,000 x 30% £420,000 £ 280,000 x 19% £53,200

Answer 2

G Lt d £

Schedule DI 250,000 Schedule A 60,000 Capit al gain 180,000 PCTCT 490,000

FI I (10090 )

20,000

£ 510,000 Cor por at ion t ax:

Bet ween limit s

£

£ 490,000 x 30% 147,000 Less mar ginal r elief :

11

400 x (1,500,000 – 510,000) x 490000510000

(26,157)

GCT £120,843


Answer 3

FY 2005

3/ 12 FY 2006

9/ 12 £ £ PCTCT 1,000 3,000 FI I (£ 450 x 100/ 90 = £ 500) 125 375 Not ional pr of it 1,125 3,375

The company has not ional pr of it s below £ 2,500 (£ 10,000 x 3/ 12), t hus t he st ar t ing r at e applies f or FY 2005. Pr of it s ar e t axed at 19% in f or FY 2006.

Pr of it limit f or st ar t ing r at e 2,500 N/ A Rat e of t ax 0% 19% Gr oss Cor por at ion Tax £ 1,000 x 0% / £ 3,000 x 19% £ 0 £ 570 Tot al £570

Alt er nat ive answer The aver age r at e of t ax is:

% 3/ 12 x 0% 0 9/ 12 x 19% 14.25% Aver age r at e 14.25% CT: £ 4,000 x 14.25% £ 570


101

SUMMARY – COMPUTATION OF CORPORATION TAX

Companies pay t ax based on t he level of t heir not ional pr of it s. Not ional Pr of it s = PCTCT + FI I (UK dividends r eceived x 100/ 90) “Mar ginal r elief ” applies t o companies whose not ional pr of it s ar e bet ween t he r elevant limit s. The f or mula f or mar ginal r elief is

Fr act ion x (Upper Limit – Not ional Pr of it ) x PCTCT Not ional Pr of it

The upper limit will be eit her £ 1,500,000 or £ 50,000 depending on which limit s t he pr of it s ar e bet ween.

The mar ginal r elief amount is deduct ed f r om t he init ial calculat ion of cor por at ion t ax at eit her t he f ull r at e or t he small companies r at e t o give t he act ual t ax payable. The 0% “st ar t ing r at e” has been abolished f or FY 2006. Ther ef or e, wher e account ing per iods st r addle 1 Apr il 2006 and not ional pr of it s ar e less t han £ 50,000, we must appor t ion t hese pr of it s bet ween FY 2005 and FY 2006 t o see if t he st ar t ing r at e / st ar t ing r at e mar ginal r elief applies.

C2: ASSOCIATED COMPANIES

This chapt er looks at t he impact of associat ed companies when consider ing what r at e of cor por at ion t ax a company should pay.

C2.1 Definition

Companies ar e associated wit h each ot her if one company controls another

company, or two companies ar e controlled by the same person or per sons.

The definition of person in t he Taxes Act is ver y wide. I t includes, f or inst ance, a company, an individual, or individuals, trustees of a t r ust , or partners in a par t ner ship. For inst ance if I CI plc has t wo subsidiar ies, bot h of t hem ‘cont r olled by’ I CI , all 3 companies ar e associat ed. Control means more than 50% of any of t he f ollowing: s.416

(i) Vot ing power ; or

(ii) Or dinar y shar e capit al (not f ixed r at e pr ef er ence shar es); or

(iii) Ent it lement t o dist r ibut able pr of it s; or

(iv) Ent it lement t o asset s on a winding up.

Example 1

Which of t he f ollowing companies ar e associat ed wit h Mouse Limit ed, a company

owned ent ir ely by Mickey?

a) Rat Limit ed, a company in which Mickey owns 50% of t he or dinar y shar es.

b) Cheese Limit ed, a company wholly owned by Mouse Limit ed.

c) Mole Limit ed, a company in which Mickey owns 40% of t he shar es which ent it le him t o 60% of t he dist r ibut able pr of it s.

d) Tr ap Limit ed, a company in which Mouse Limit ed owns 10% of t he shar es but has 55% of t he vot ing power .

C2.2 Implications

The exist ence of associat ed companies means t hat :

• When computing FI I (Fr anked I nvest ment I ncome) we ignore any dividends received from associated companies.

• The corporation tax limits, t hat is t he £ 1.5 million, £ 300,000, ar e divided equally among all of the associated companies. Remember f or FY 2005 we may need t o divide t he £ 50,000 and £ 10,00 limit s t hat applied.

Associat ed Companies

103

Ther ef or e in t he last example, we would ignor e any dividends r eceived by Mouse Lt d f r om Cheese Lt d and Tr ap Lt d in comput ing not ional pr of it f or Mouse Lt d and when we comput e Mouse Lt d’s cor por at ion t ax liabilit y, we would have t o divide t he limit s by f our as t her e ar e f our associat ed companies (Mouse Lt d plus it s t hr ee associat es).

Not e t hat it is t hese r evised limit s t hat ar e used in any mar ginal r elief calculat ion.

Illustration 1

I ain Lt d has t he f ollowing income f or t he year ended 31 Mar ch 2007

PCTCT £ 120,000 Dividends f r om non-associat ed companies £ 18,000 Dividends f r om associat ed companies £ 45,000

We will assume t hat it has:

(a) one associat ed company (b) t wo associat ed companies (c) t welve associat ed companies and will show how t he cor por at ion t ax char ge is calculat ed in each case. To comput e t he CT liabilit y:

St ep One: Consider t he small company limit s How many associat ed companies ar e t her e? Remember t o include I ain Lt d it self ! (a) (b) (c) £ 300,000 & £ 1,500,000 divided by

(a) 2

£ 150,000 &

£ 750,000

(b) 3

£ 100,000 &

£ 500,000

(c) 13

£ 23,077 &

£ 115,385


St ep Two: Calculat e t he “not ional pr of it s” I gnor e dividends f r om associat es PCTCT 120,000

120,000

120,000

FI I £ 18,000 x 100/ 90 20,000 20,000 20,000 Not ional pr of it s 140,000 140,000 140,000

St ep Thr ee: Decide which t ax r at e applies:

19%

Mar ginal

30% St ep Four : Comput e t he liabilit y:

a) £ 120,000 x 19% £22,800

b) £ 120,000 x 30% 36,000 Less: 11 x (£ 500,000 – 140,000) x 120,000 400 140,000

( 8,486)

£27,514

c) £ 120,000 x 30%

£36,000

Example 2

Plant Lt d and Flower Lt d each have 2 associat ed companies. Their pr of it s in t he year ended 31 Mar ch 2007 ar e as f ollows:

Plant Lt d £

Flower Lt d £

PCTCT 450,000 120,000 FI I 60,000 30,000

Calculat e t he Gr oss Cor por at ion Tax liabilit y in each company. C2.3 Associates s.417

When det er mining whet her companies ar e associat ed, t he holdings of an individual must be added t o holdings of his associat es. These include t he individual and his spouse, plus also his br ot her s and sist er s, childr en and r emot er issue, i.e. gr andchildr en et c.

I ndividuals ar e also associat ed wit h par ent s and r emot er f or bear , i.e.

gr andpar ent s et c. and any business par t ner s t r ading in par t ner ship. This does not ext end t o individuals who ar e dir ect or s in t he same company. We also appor t ion t he r ight s and power s of t r ust ees, wher e t he set t lor is t he individual


105

or an associat e of t hat individual. The set t lor is t he per son who act ually put s t he money int o t he t r ust .

Example 3

Sam invit es t he f ollowing people r ound t o dinner :

a) His br ot her

b) His br ot her ’s wif e

c) His godson

d) His ex-wif e

e) His business par t ner

f ) His gr andmot her

g) His bank manager . Who is associat ed wit h Sam?

C2.4 Other rules

Companies ar e associated for a whole accounting period. Ther ef or e we include companies t hat j oin or leave t he gr oup dur ing t he year , even t hough t hey ar e only associat ed f or par t of t he per iod.

s.13(5)

We also include all worldwide companies. Alt hough only UK companies ar e subj ect t o cor por at ion t ax, exist ence of wor ldwide subsidiar ies or holding companies will dilut e t he upper and lower limit s.

Dormant companies are excluded. A dor mant company is basically one t hat is not doing anyt hing. I n J owet t v O’Neill v Br ennan Const r uct ion Lt d, a company simply holding f unds in a bank deposit account and r eceiving int er est income, was not an act ive company and count ed as dor mant f or associat ed company pur poses. Pr ior t o t his decision, t he Revenue believed t hat a company was only dor mant if it had no income. Fr om t his decision, t he company is dormant provided it has no

activity.

s.513(3)

C2.5 Holding companies

Pur e holding companies will be t r eat ed as dor mant pr ovided t hat all of t he f ollowing apply:

SP5/ 94

• I t has no asset s ot her t han shar es in 51% subsidiar ies.

• I t is not ent it led t o any deduct ions f or char ges or management expenses in r espect of any out goings.

• I t has no income or gains ot her t han dividends which it has dist r ibut ed in f ull t o it s member s.


C2.6 Concession

The Revenue will t r eat t he def init ion of a r elat ive as including only a spouse or minor child so long as t her e is no “subst ant ial commer cial int er dependence” bet ween t he t wo companies. Ther e is no clear def init ion of what is “subst ant ial commer cial int er dependence”. The Revenue will look at all t he f act s. The Revenue have indicat ed t hat it means r eliance on each ot her . This is not necessar ily a f inancial t est and can r elat e t o f act or s t hat cannot be measur ed numer ically such as shar ed dir ect or s or f acilit ies.

ESC C9

C2.7 Sub-subsidiaries

Sub-subsidiar ies, i.e. wher e one company cont r ols anot her , which in t ur n cont r ols anot her , ar e also included as associated companies. The def init ion is a ver y wide one. Ther ef or e if one company cont r ols anot her , and t hat cont r ols anot her , we do not need to multiply the holdings downwards t o wor k out whet her one company owns mor e t han 50% of anot her . I n ot her wor ds, you do not need t o use your calculat or in det er mining whet her companies ar e associat ed.

Example 4

Consider t he f ollowing gr oup st r uct ur e:

How many companies ar e associat ed wit h A Lt d f or it s account ing per iod t o 31 December 2007?

Mr A

A Lt d D Lt d

B Lt d

(Dor mant ) C Lt d

(acquir ed

dur ing t he AP)

F Lt d

E Lt d

51%

51% 45%

60%

60%

80%


107

Answer 1

(b), (c) and (d) Not e t hat t he cont r ol condit ion is mor e t han 50% hence in (a) Rat Limit ed is not associat ed wit h Mouse Lt d. For t he ot her s we t ake t he highest per cent age of vot ing power , shar es, pr of it s or asset s t o det er mine whet her t he cont r ol condit ion is sat isf ied. Ther ef or e Mouse Lt d has 3 associat ed companies and t her e ar e 4 associat ed companies in t ot al.

Answer 2

Plant Lt d £

Flower Lt d £

PCTCT 450,000 120,000 FI I 60,000 30,000 £ 510,000 £ 150,000 Adj ust ed pr of it limit s (Each company has 2 associat es)

£ 1,500,000/ 3 = £ 500,000 >500k Bet ween limit s £ 300,000/ 3 = £ 100,000

Cor por at ion t ax: £ £ £ 450,000 x 30% 135,000

£ 120,000 x 30%

36,000

Less mar ginal r elief :

11

400 (£ 500,000 – 150,000) x 120000150000

_______

(7,700)

£135,000 £28,300


Answer 3

(a), (e) and (f) only Answer 4

A Lt d has 3 associates: D Lt d, E Lt d and F Lt d


109

SUMMARY – ASSOCIATED COMPANIES

The pr of it s limit s ar e r educed f or associat ed companies. Dividends r eceived f r om associat ed companies ar e ignor ed in det er mining FI I . Associat ed companies ar e companies under common cont r ol (i.e. >50%). Common cont r ol can be by anot her company or an individual. Dor mant companies ar e excluded. Over seas companies ar e included. Companies which become associat es or cease t o be associat es dur ing t he account ing per iod count as associat es f or t he whole account ing per iod. When looking at sub-subsidiar ies t her e is no need t o mult iply t hr ough t o f ind an ef f ect ive int er est – t he sub-subsidiar ies will be associat ed wit h t he t op company in t he gr oup pr ovided t her e is cont r ol (i.e. > 50%) at each level.

C3: SHORT ACCOUNTING PERIODS

This chapt er demonst r at es how t o calculat e t he t ax liabilit y of a company t hat has an account ing per iod of less t han 12 mont hs

C3.1 Apportioning the limits

The cor por at ion t ax limit s apply t o a t welve mont h per iod. Ther ef or e, when t he

char geable account ing per iod is less t han 12 mont hs long, t he limit s must be time

apportioned.

Illustration 1

Duncan Lt d changed it s year end f r om 31 Mar ch t o 31 December . Wit h t his in mind, it makes up it s account s f or t he 9 mont hs t o 31 December 2006. To det er mine t he amount of t ax payable it is necessar y t o know t he small companies limit s. These need t o be adjusted for the fact that there are only 9 month accounts pr epar ed. The limit s become:

£ 300,000 x 9/ 12 £ 225,000 £ 1.5m x 9/ 12 £ 1,125,000

The limit included in t he mar ginal r elief calculat ion should be t he r evised limit :

Fr act ion x £ (1,125,000 – Not ional pr of it ) x PCTCT Not ional Pr of it Assume t hat Duncan Lt d’s r esult s f or t he 9 mont hs ended 31 December 2006 ar e as f ollows:

£ PCTCT 200,000 FI I 50,000 Not ional pr of it s 250,000

As not ional pr of it s ar e bet ween t he limit s, mar ginal r elief applies:

GCT: £ £ 200,000 x 30% 60,000 Less mar ginal r elief 11

400 x (1,125,000 – 250,000) x 200000250000

(19,250)

Gr oss cor por at ion t ax £ 40,750

Shor t Account ing Per iods

111

Example 1

What will t he limit s be f or an 8 mont h char geable account ing per iod?

Upper Limit

Lower Limit

Example 2

Geor ge Limit ed and Zippy Limit ed make up account s f or t he 8 mont hs ended 30

November 2006 which show t he f ollowing r esult s:

Geor ge Lt d £

Zippy Lt d £

PCTCT 1,300,000 198,000 Dividends r eceived 45,000 7,200

Calculat e t he gr oss cor por at ion t ax f or each company.

C3.2 Short APs and associates

I f a company had a shor t account ing per iod t oget her wit h associat ed companies,

t he met hodology r emains t he same i.e. ascer t ain t he amended limit s and calculat e t he t ax accor dingly.

Illustration 2

Ashdown Lt d has 3 subsidiar ies. I t dr aws account s f or a 6 mont h per iod ended 30 Sept ember 2006. The limit s become:

£ 300,000 x 612 x

14

£ 37,500

£ 1,500,000 x 612 x

14

£ 187,500

The r esult s f or t he 6 mont hs ended 30 Sept ember 2006 ar e:

PCTCT 160,000 FI I 30,000 Not ional pr of it s 190,000

As not ional pr of it s exceed t he upper limit , Ashdown Lt d is t r eat ed as a “Lar ge” company and will pay cor por at ion t ax at t he f ull r at e: i.e.

£ 160,000 x 30% = £ 48,000


Example 3

Par asol Lt d dr aws up account s f or t he per iod 1 Apr il 2006 t o 30 November 2006, showing PCTCT of £ 22,000 and FI I of £ 12,000. Par asol Lt d has one associat ed company. Calculat e t he gr oss cor por at ion t ax liabilit y.

Example 4

Ar cher Limit ed dr aws up account s f or t he per iod 1 J anuar y 2006 t o 30

Sept ember 2006 showing PCTCT of £ 56,000 and dividends r eceived f r om non-associat ed companies of £ 4,000. Ar cher Limit ed has f our associat ed companies.

You ar e r equir ed t o calculat e t he gr oss cor por at ion t ax liabilit y.


113

Answer 1

Upper limit (£ 1,500,000 x 812 )

£1,000,000

Lower limit (£ 300,000 x 812 )

£200,000

Answer 2

Geor ge Lt d £

Zippy Lt d £

PCTCT 1,300,000 198,000


50,000 8,000

Not ional pr of it

£ 1,350,000 £ 206,000

Relevant limit s: UL 1,000,000 1,000,000 LL 200,000 200,000 Over upper limit Bet ween limit s Cor por at ion Tax: £ £ £ 1,300,000 x 30% 390,000 £ 198,000 x 30%

59,400

Mar ginal r elief :

11

400 (1,000,000 – 206,000) x

198,000/ 206,000

(20,987)

_______ _______ £390,000 £38,413


Answer 3

£ PCTCT 22,000 FI I 12,000 £ 34,000 Pr of it Limit s (2 associat es and an 8 mont h CAP)

15000002 x

812

500,000

3000002 x

812

100,000

Small companies r at e applies: £ 22,000 x 19% £4,180

Answer 4

£ PCTCT 56,000


4,444

Not ional Pr of it £ 60,444 Pr of it Limit s (5 associat es and a 9 mont h CAP)

Upper limit : 1500000

5 x 912

225,000

Lower limit : 300000

5 x 912

45,000

Bet ween limit s so mar ginal r elief

Cor por at ion t ax £ 56,000 x 30%

£ 16,800

Less: Mar ginal r elief 11

400 x (225,000 – 60,444) x 5600060444

(4,192)

GCT £12,608

Not e: Alt hough t he account ing per iod st r addled 1 Apr il 2006 no addit ional calculat ions wer e r equir ed - st ar t ing r at e mar ginal r elief was not in point as t he company has 4 associat es.


115

SUMMARY – SHORT ACCOUNTING PERIODS

Wher e a company makes up it s account s f or less t han 12 mont hs, it is necessar y t o adj ust t he cor por at ion t ax limit s on a pr o-r at a basis. Limit s x n 12 wher e n = number of mont hs in t he shor t account ing per iod. These adj ust ed limit s ar e also used in t he mar ginal r elief calculat ions.

C4: LONG PERIODS OF ACCOUNT

This chapt er demonst r at es how t o calculat e t he t ax liabilit y of a company t hat dr aws up account s f or a per iod mor e t han 12 mont hs long.

C4.1 Introduction

A char geable account ing per iod (CAP) f or cor por at ion t ax cannot exceed 12 months. However , under company law, account s can be dr awn up f or per iods as long as 18 mont hs. The per iod f or which account s ar e made up is known as t he per iod of account (POA).

s.12

Wher e a per iod of account exceeds 12 months, it must be split into two

separ at e CAPs f or t ax pur poses. The f ir st will be t he first 12 months, because a CAP cannot exceed 12 mont hs. The second will be t he balance of the period, because a CAP always ends when a per iod of account ends.

Example 1

Longt on Limit ed makes up a set of account s f or t he 16 mont hs ended 31 J uly

2006. What ar e t he char geable account ing per iods her e? C4.2 Splitting the profits

Once we have wor ked out t he account ing per iods, we then split the company’s

income between the two separate CAPs, as t he account s will have been dr awn up showing pr of it s f or t he ent ir e per iod of account .

Tr ading pr of it is adj ust ed f or t he ent ir e per iod f or disallowed it ems, such as

ent er t aining and depr eciat ion. The adj ust ed r esult is t hen t ime appor t ioned t o t he t wo per iods.

As f ar as capital allowances ar e concer ned, we have t o pr epar e separate

computations f or each CAP t aking account of addit ions and disposals in each separ at e CAP. We claim a separ at e wr it ing down allowance f or each of t he t wo CAPs, r emember ing t hat t he writing down allowance is time apportioned f or t he second CAP. First year allowances however do not need to be time

apportioned.

Long Per iods of Account

117

Illustration 1

Longt on Limit ed pr epar es account s f or t he 16 mont hs ended 31 J uly 2006. The adj ust ed pr of it bef or e capit al allowances f or t he per iod is £ 480,000. You ar e also given t he f ollowing inf or mat ion in r espect of capit al allowances:

Plant pool b/ f 1.4.05 £ 30,000 Addit ions: 1.1.06 £ 8,000 1.6.06 £ 6,000 Disposals: 1.7.06 £ (3,000)

Longt on Limit ed is a medium sized company and is eligible f or 40% f ir st year allowances. The Schedule DI pr of it f or each CAP is as f ollows: 12m t o 31.3.06

£ 4m t o 31.7.06

£ Adj ust ed pr of it bef or e capit al allowances

£ 480,000 x 1216 ,

416

360,000 120,000

Less capit al allowances (below) (10,700) (4,425)Schedule D Case I pr of it s £ 349,300 £ 115,575 FYAs Gener al Pool ClaimY/ e 31.3.06: Pool at 1.4.05 30,000 Addit ion: Machine (1.1.06) 8,000 FYA @ 40% (3,200) 3,200WDA @ 25% _____ (7,500) 7,500 4,800 22,500 £ 10,700

Tr ansf er t o pool 4,800 TWDV c/ f 27,300 4 m/ e 31.7.06 Addit ion: Machine (1.6.06) 6,000 FYA @ 40% (2,400) 2,400Disposal: Machine (1.7.06) _____ (3,000) 3,600 24,300

WDA @ 25% x 412

(2,025) 2,025

22,275 £ 4,425Tr ansf er t o pool 3,600 TWDV c/ f 25,875 Not e how WDAs have been appor t ioned in t he second CAP but FYAs have not .


C4.3 Splitting other income and charges

Schedules A, DIII, and DVI ar e split on a time apportionment basis as t he

accr uals basis of account ing applies t o t hese sour ces of income. Management expenses f or an invest ment company ar e split on an accr uals basis. Chargeable gains ar e split bet ween t he t wo separ at e account ing per iods based

on t he date of disposal of t he asset . This is t he dat e of a binding cont r act of sale, which f or pr oper t y is t he dat e of exchange of cont r act s.

Charges on income, ar e split bet ween t he per iods based on t he date t hat t he

amount was act ually paid.

Franked investment income, is split bet ween t he account ing periods based on the date of receipt of t he dividend.

We must be car ef ul wit h t he t ime appor t ionment of Schedule A, DI I I or DVI

income wher e t he sour ce is acquir ed par t way t hr ough t he account ing per iod. I n t his case, we must t ime appor t ion t he income over t he per iod in which it ar ose, r at her t han f or t he ent ir e account ing per iod.

Af t er all t he income and char ges have been allocat ed t o t he r elevant CAP, t wo separ at e CT comput at ions ar e pr epar ed f or t he t wo separ at e per iods. As we shall see lat er , t hese t wo separ at e CT liabilit ies ar e paid at dif f er ent t imes so t her e is never any point in adding t hem t oget her . I t is also possible f or a company t o pay t ax at dif f er ent r at es f or t he t wo per iods. For example, a company could pay t ax at t he small companies r at e in t he f ir st (12 mont h) CAP, but t hen pay t ax at t he f ull r at e in t he ot her (shor t ) CAP if , f or example, a lar ge capit al gain f ell int o t his lat t er per iod.

Illustration 2

Longt on Limit ed (f r om I llust r at ion 1) also r eceived and paid t he f ollowing:

I nt er est income (bank account opened in 1991) £ 8,000 Schedule A r ent s (pr oper t y acquir ed 1.1.06) £ 14,000 Capit al gains (asset sold 30.5.06) £ 10,000 Annual gif t aid donat ion (paid 1 J uly each year ) £ 1,000 pa


119

We split t hese amount s bet ween t he char geable account ing per iods f or t he 16 mont hs t o 31 J uly 2006 as f ollows: 12m t o 31.3.06

£ 4m t o 31.7.06

£

Schedule DI I I (1216 ,

416 )

6,000 2,000

Schedule A

1.1.06 – 31.3.06 (37 )

6,000

1.4.06 – 31.7.06 (47 )

8,000

Char geable gain 10,000 Char ge on income (paid basis) (1,000) (1,000)

Not e. The Schedule A sour ce commenced on 1.1.2006. The r ent s of £ 14,000 t her ef or e ar ise over a 7 mont h per iod. Thr ee mont hs of r ent s ar e accr ued in t he f ir st CAP and f our mont hs ar e accr ued in t he second CAP. Example 2

I f we also assume t hat Longt on Limit ed r eceived FI I of £ 10,000 on 1 J anuar y 2006, t he cor por at ion t ax comput at ions f or t he 2 per iods can now be shown as f ollows:

Longt on Limit ed 12m t o 31.3.06

£ 4m t o 31.7.06

£ Schedule DI 349,300 115,575 Schedule A 6,000 8,000 Schedule DI I I 6,000 2,000 Char geable gain - 10,000 Char ges on income (1,000) (1,000) PCTCT 360,300 134,575 FI I 10,000 - Not ional pr of it 370,300 134,575

Assuming Longt on Limit ed had one wholly owned subsidiar y which was sold on 1 J anuar y 2006 calculat e t he gr oss cor por at ion t ax liabilit y f or each char geable account ing per iod.


Example 3

Smit h Lt d makes up it s account s f or t he 18 mont hs t o 30 J une 2006. I t owns 60% of t he shar es of Hague Lt d. I t has t he f ollowing income and expendit ur e:

Adj ust ed pr of it bef or e CAs £ 240,000 Rent al income £ 12,000 pa, incr easing t o £ 15,000 pa f r om 1 J anuar y 2006 £ 19,500 Bank int er est (accr uing evenly) £ 3,600 Gain on disposal 14 May 2006 £ 110,000 Dividend r eceived 14 Sept ember 2005 £ 9,000 Gif t Aid donat ions: 1 May 2005 £ 20,000 1 May 2006 £ 24,000 The TWDV of t he capit al allowances pool was £ 80,000 on 1 J anuar y 2005. Dur ing t he year t hey had t he f ollowing t r ansact ions: 1 May 2005 Bought P&M £ 20,000 1 J uly 2005 Bought new car £ 16,000 (MD pr ivat e use 20%) 1 Febr uar y 2006 Sold P&M £ 8,000 pr oceeds 1 Mar ch 2006 Bought P&M £ 12,000 Smit h Lt d is a medium sized company You ar e r equir ed t o calculat e t he cor por at ion t ax liabilit y f or each char geable account ing per iod.


121

Answer 1

CAP 1: 1.4.05 to 31.3.06

CAP 2: 1.4.06 to 31.7.06

The per iod of account begins on 1 Apr il 2005 and so t her ef or e, t he f ir st CAP will r un t hr ough t o 31 Mar ch 2006. The second char geable account ing per iod will st ar t immediat ely af t er war ds on 1 Apr il 2006 and will r un t hr ough t o t he end of t he per iod of account on 31 J uly. 2006.

Answer 2

12m t o 31.3.06 £

4m t o 31.7.06 £

PCTCT 360,300 134,575 FI I 10,000 _______ Not ional Pr of it 370,300 134,575

Pr of it Limit s: 12m t o 31.3.06 - one associat e 1500000

2

£ 750,000

3000002

£ 150,000

4m t o 31.7.06 – no associat es

1,500,000 x 412

£ 500,000

300,000 x 412

£ 100,000

Cor por at ion Tax: £ £

£ 360,300 x 30% 108,090 £ 134,575 x 30% 40,373

Mar ginal Relief :

11400 x (750,000 – 370,300) x

360300370300

(10,160)

11400 x (500,000 – 134,575)

(10,049)

GCT £97,930 £30,324


Answer 3

Comput at ion of cor por at ion t ax liabilit y:

12 mont hs t o 31.12.05

£

6 mont hs t o 30.6.06

£ Adj ust ed pr of it (12:6)

160,000 80,000

CAs (W1) ( 31,000) (14,300) Schedule DI 129,000 65,700

Schedule A 12,000 7,500

DI I I (12:6) 2,400 1,200

Gain 110,000 ________ _______ 143,400 184,400

Less: char ges ( 20,000) (24,000)

PCTCT 123,400 160,400

CT (W2) £ 123,400 x 19%

23,446

£ 160,400 x 30%

48,120

Less: 11

400 x (375,000 – 160,400)

(5,902)

42,218


123

(W1) CAs

FYA Gener al Pool

£

Car > £ 12,000 £

Tot al allowances

£ 12 m t o 31 December 2005 TWDV b/ f 80,000 Addit ion – car (no FYAs) 16,000

WDA 25% Maximum £ 3,000

(20,000) ( 3,000)

20,000 3,000

60,000 13,000 FYA pur chases 1.5.2005 20,000 FYA 40% (8,000)

12,000

______ 8,000 31,000

TWDV c/ f 72,000 13,000 6m t o 30 J une 2006 Disposal (8,000) 64,000 WDA 6/ 12 x 25% Maximum £ 3,000 x 6/ 12

(8,000) _____

(1,500)

8,000 1,500

56,000 11,500 FYA pur chases 1.3.2006 12,000 FYA 40% ( 4,800)

7,200

____ 4,800 14,300

TWDV c/ f 63,200 11,500

(W2) Tax r at es £ £ PCTCT 123,400 160,400

FI I £ 9,000 x 100/ 90 10,000 ______ _______ Pr of it s 133,400 160,400 Limit s – one associat e

150,000/ 750,000

Limit s - 6 mont h account ing per iod

75,000/ 375,000

Tax r at e: 19% Mar ginal r elief


SUMMARY – LONG PERIODS OF ACCOUNT

For a company wit h a per iod of account t hat exceeds 12 mont hs, t he per iod of account must be split int o t wo char geable account ing per iods (CAPs) – t he f ir st CAP will be t he f ir st 12 mont hs and t he second CAP will be t he balance (n mont hs). A separ at e t ax comput at ion must be per f or med f or each CAP. The adj ust ment of pr of it s, bef or e capit al allowances, is done f or t he per iod of account as a whole. The income and gains ar e t hen split bet ween t he t wo CAPs as f ollows:

Adj ust ed pr of it Time appor t ionment

Capit al allowances Two comput at ions r equir ed – one f or each CAP Scale down WDA by n/ 12 in shor t CAP but not FYA

Sch A, DI I I and DVI Accr uals basis

Gains When r ealised Char ges When paid

Dividends r eceived When r eceived

Don’t f or get t o t ime appor t ion t he limit s by n/ 12 when calculat ing cor por at ion t ax f or t he second CAP which will be less t han 12 mont hs long.

C5: CORPORATION TAX SELF ASSESSMENT (CTSA)

This chapt er examines t he Cor por at ion Tax Self Assessment (CTSA) pr ocedur es, including: - f iling r equir ement s; - enquir ies; - claims; - r ecor d keeping.

C5.1 Introduction

Cor por at ion t ax self assessment applies t o all char geable account ing per iods

ending on or af t er 1 J uly 1999. The r egime deals wit h all of t he administ r at ion ar eas of cor por at ion t ax which includes t he payment of t ax.

Corporation tax f or smaller companies is due 9 months and 1 day after the

end of the chargeable accounting period. Lar ger companies ar e r equir ed t o pay t ax under t he quar t er ly inst alment syst em.

The r egime also deals wit h t he f iling of tax returns (CT600) which give det ails

of t he income a company has ear ned, t oget her wit h t he calculat ion of t he cor por at ion t ax liabilit y.

The submission of t he t ax calculat ion is compulsor y f or companies, unlike

individuals who can shif t t he r esponsibilit y f or calculat ing t he t ax t o t he I nland Revenue pr ovided t hey f ile t he r et ur n by an ear lier dat e. This f acilit y is not available t o companies.

Ther e is a statutory liability for a company to notify chargeability to

corporation tax.

s.55 FA 2004

Wher e a company has not r eceived a not ice t o f ile a t ax r et ur n (CT603) it must give not ice t o t he Revenue wit hin 12 mont hs of t he end of t he account ing per iod t hat it is char geable t o t ax.

Par a 2(1) Sch 18

FA 1998

When a company submit s it s form CT600, it will also send in a set of accounts t oget her wit h any ot her det ailed analysis and comput at ions necessar y t o show t hat t he r et ur n is complet e and cor r ect and answer s all of t he Revenue Of f icer ’s most obvious quest ions.

Nor mally a CT600 is due f or submission t o t he Revenue 12 mont hs f r om t he end

of t he char geable account ing per iod. For example if t he char geable account ing per iod ends 31 December 2006, t he CT600 must be f iled by 31 December 2007.


However , a lat er f iling dat e may be appr opr iat e as a company will always have a minimum of 3 mont hs f r om t he r eceipt of t he f iling not ice. I f t his dat e is lat er t han t he 12 mont h dat e, t hen t his dat e becomes t he new f iling dat e.

Illustration 1

A company makes it s account s f or t he 12 mont hs t o 30 J une 2007. I t r eceives it s CT 600 f or t his per iod on 30 Apr il 2008. The nor mal f iling dat e would be 30 J une 2007 + 12m = 30 J une 2008. Not ice r eceived 30 Apr il 2008 and 3 mont hs af t er t hat is 31 J uly 2008. The f iling dat e is t her ef or e 31 J uly 2008 as t his is lat er t han t he nor mal f iling dat e.

C5.2 Long periods of account

Wher e t he company makes up it s account s f or mor e t han 12 mont hs, it is r equir ed t o split it int o t wo account ing per iods f or t he pur poses of calculat ing t he t ax payable. However , f or f iling pur poses, t her e is a single f iling dat e t hat will be 12 mont hs f r om t he end of t he per iod of account .

Two r et ur ns will be submit t ed – one f or each CAP – but t he due dat e f or f iling t hese r et ur ns is t he same. Illustration 2

A small company dr aws account s f or a 15 mont h per iod ending on 31 Mar ch 2007.

The per iod of account must be divided int o t wo char geable account ing per iods f or t he pur poses of calculat ing cor por at ion t ax:

CAP No. 1: 12 m/ e 31 December 2006 CAP No. 2: 3 m/ e 31 Mar ch 2007

The due dat es f or t he payment of cor por at ion t ax and f or t he f iling of t he f or m CT600 ar e:

CAP No. 1 y/ e 31.12.06

CAP No. 2 y/ e 31.3.07

Tax due 1.10.07 1.1.08 CT600 due 31.3.08 31.3.08

Two f or ms CT600 will be submit t ed on 31 Mar ch 2008, t oget her wit h f inancial st at ement s and cor por at ion t ax comput at ions cover ing bot h char geable account ing per iods.

Cor por at ion Tax Self Assessment (CTSA)

127

Example 1

Complet e t he f iling dat e in t he f ollowing:

CAP ends Not ice issued Filing dat e a) 31.3.07 12.11.07 b) 31.5.07 24.3.08

C5.3 Duty to notify chargeability s.55 FA 2004

Companies have an obligat ion t o not if y t he Revenue when t heir f ir st account ing per iod begins or when t hey come back wit hin t he char ge t o t ax. They will also have t o pr ovide cer t ain pr escr ibed inf or mat ion.

The company must give written notice within three months of the start of the

accounting period. The notice must state when the accounting period began.

s.55(2) FA 2004

The det ailed inf or mat ion t o be given in t he not ice is as f ollows:

(a) The company’s name and r egist r at ion number ;

(b) The addr ess of t he company’s r egist er ed of f ice;

(c) The addr ess of t he company’s pr incipal place of business;

(d) The nat ur e of t he business being car r ied on by t he company;

(e) The dat e t o which t he company int ends t o pr epar e account s; and

(f ) The f ull names and addr esses of t he dir ect or s of t he company.

(g) I n t he case of a business f or mer ly car r ied on by ot her s:

t he name and addr ess of t hat f or mer business; and

t he name and addr ess of t he per son f r om whom t he business was acquir ed.

(h) I n t he case of a company which is in a gr oup r elief gr oup:

t he name of t he par ent company and t he addr ess of it s r egist er ed of f ice.

(i) I n t he case of a company which, has been obliged t o comply wit h t he r equir ement s of t he I ncome Tax (Pay as You Ear n) Regulat ions 2003:

t he dat e on which t hat obligat ion f ir st ar ose.

The r ules do not apply to unincorporated associations or partnerships. s.55(5) FA 2004

No failure t o give not ice will ar ise wher e t he company has a reasonable excuse, so long as it gives not ice wit hin a r easonable t ime once t he excuse has passed.

s.55(4) FA 2004

SI 2004/ 2502 Reg 2


C5.4 Para 3 Schedule 18 Notice (CT603)

The Revenue will issue a not ice t o t he company r equir ing it t o f ile a cor por at ion t ax r et ur n. Unt il t his not ice is issued, t he company does not have any obligat ion t o f ile a r et ur n. The not ice will st at e t he per iod t o which it r elat es. Par a 5 r ef er s t o t his as t he “specif ied per iod”.

Par a 5 Sch 18 FA 1998

(i) I f an account ing per iod ended dur ing (or at t he end) of t he specif ied

per iod, a r et ur n is r equir ed f or t hat account ing per iod. I f t her e is mor e t han one such account ing per iod, separ at e r et ur ns ar e made f or each.

(ii) I f (i) above does not apply but an account ing per iod began dur ing t he

specif ied per iod, a r et ur n is r equir ed f or t hat par t of t he specif ied per iod bef or e t he account ing per iod began.

(iii) I f t he company was out side t he char ge t o t ax f or t he whole of t he

specif ied per iod, a t ax r et ur n is r equir ed f or t he whole per iod.

I f none of t he above apply no t ax r et ur n is r equir ed f or t he specif ied per iod.

C5.5 The self assessment

The r et ur n must include a self assessment of t he amount of t ax payable in r espect of t hat per iod based on t he inf or mat ion cont ained in t he r et ur n.

Par a 7 Sch 18

FA 1998

The t ax due is calculat ed as f ollows: Par a 8

Sch 18 FA 1998

(i) Take t he PCTCT of t he company and apply t he r at e of t ax applicable t o t he company.

(ii) Then give ef f ect t o any r elief s against cor por at ion t ax:

• Mar ginal r elief • CVS r elief • DTR • ACT

(iii) Add any amount s char geable or assessable as if t hey wer e cor por at ion t ax: • s.419 penalt y t ax • s.747(4)(a) appor t ionment in r elat ion t o a CFC

(iv) Deduct amount s t o be set against t he over all t ax bill: • I ncome Tax


129

Not e: Under CTSA it is t he company’s r esponsibilit y t o ensur e t hat s.419 and s.747(4)(a) t ax is included in t he t ot al amount of t ax payable. Pr eviously separ at e assessment s wer e r aised by t he Revenue in r espect of t hese t axes. Similar ly it is t he company’s r esponsibilit y t o ensur e t hat all necessar y t r ansf er pr icing adj ust ment s ar e made in ar r iving at PCTCT.

C5.6 Processing of the returns

A f or m CT600 is submit t ed t o t he Revenue, and is pr ocessed by t he cor por at ion t ax pr ocessing depar t ment . As par t of t he pr ocessing pr ocedur e t he Revenue will have 9 mont hs f r om t he act ual dat e of f iling t he r et ur n t o cor r ect any obvious er r or s in it . This would include, f or inst ance, wher e a list of f igur es had been added incor r ect ly or t he wr ong r at e of t ax has been t aken.

Par a 16 Sch 18

FA 1998

These er r or s will be ident if ied when t he Revenue t ype t he f igur es f r om t he

r et ur n int o t heir comput er syst em, and f ind t hat t her e ar e dif f er ences bet ween t he t wo. I n t his case, t he pr ocessor will wr it e t o t he company and ask f or t he appr opr iat e amendment s t o be made.

The company has 12 months from the due filing date, (not t he act ual f iling dat e) to make any amendments to the return. This could be, f or inst ance, r evising a loss r elief claim, amending a capit al allowances claim, or any ot her amendment s.

Par a 15 Sch 18

FA 1998

Once t he r et ur n has been pr ocessed, it may t hen go t o a Revenue Of f icer , who might give it a mor e det ailed r eview. I f t he Of f icer looks at t he r et ur n and t he accompanying account s, and he sees t her e is inf or mat ion t hat he would like t o ask quest ions about , he has 12 months from the due filing date to start an

enquiry. I t is ver y impor t ant t hat t he Revenue st ick t o t hese enquir y deadlines, because once t hey have passed t his deadline t her e is ver y lit t le t hey can do if t hey disagr ee wit h somet hing on t he r et ur n.

Par a 24 Sch 18

FA 1998

I f t he char geable account ing per iod ends on 31 December 2006, t he CT600 must

be f iled by 31 December 2007 and any enquir y must commence by 31 December 2008.

For an enquir y t o commence, t he company must r eceive t he not ice of enquir y. The commencement dat e is not t he dat e st at ed on t he enquir y not ice but t he dat e t hat t he company must r easonably be expect ed t o r eceive it . Ther ef or e allowing f or f ir st class post , t his could t ake 3 days or second class post 6 days, so t he Revenue t r y t o make sur e t hey post it well bef or e t he deadline.

I f , however , t he return is filed late, t he Revenue will have a minimum of 12

months to start their enquiries and t he enquir y deadline will move t o t he end of t he next quar t er day. This also applies t o any amendment s r elat ing t o t hat r et ur n which ar e f iled af t er t he nor mal f iling dat e. The Revenue will have ext r a t ime t o st ar t an enquir y in r espect of t hose amendment s only.


The quar t er days do not coincide wit h t he usual quar t er days of t he year . They ar e 31 J anuar y, 30 Apr il, 31 J uly and 31 Oct ober . These ar e t he same quar t er days which apply t o income t ax self assessment .

Illustration 3

Lazy Lt d dr ew account s f or t he 12 mont hs ending 31 May 2006. A not ice t o deliver a r et ur n was r eceived by t he company on 15 J uly 2005, but t he company’s CT600 is not submit t ed t o t he Tax Of f ice unt il 14 August 2007. The r et ur n should have been f iled by 31 May 2007 – t her ef or e it is lat e. This ext ends t he deadline by which t he Of f icer can commence an enquir y int o t he r et ur n. The deadline f or commencing an enquir y is t he end of t he calendar quar t er f ollowing t he anniver sar y of t he r et ur n, i.e.

14 August 2007 + 12 mont hs = 14 August 2008 14 August 2008 is in t he q/ e 31 Oct ober 2008

The Of f icer has unt il 31 Oct ober 2008 t o st ar t an enquir y int o t he r et ur n.

Example 2

Consider t he f ollowing:

(a) (b) CAP ends 31.3.07 31.5.06 CT600 f iled 31.1.08 30.6.07

What ar e t he dat es by which t he Revenue may cor r ect obvious er r or s and t he dat es by which t he Revenue may open an enquir y?

C5.7 Enquiries

CTSA enquir ies t ake place t o ensur e t hat companies submit cor por at ion t ax

r et ur ns which ar e bot h complet e and cor r ect . An enquir y can st ar t f or a number of r easons. The enquir y could be “random” - gener at ed by t he Revenue’s comput er . The r et ur n could be subj ect t o a “selected” enquir y wher e t he Of f icer has ident if ied somet hing on t he r et ur n which he is not happy about , or wishes t o ask f ur t her quest ions about .

Ther e could also be “routine” enquir ies. This will apply par t icular ly t o ver y lar ge

companies, wher e simply because of t he amount of pr of it s and t ax involved, t he r et ur n will be subj ect t o an enquir y vir t ually ever y year .


131

Select ed and r out ine enquir ies can be avoided by t he company making complet e and t hor ough disclosur e on t he r et ur n of ever yt hing t he Revenue may want t o ask about . I n par t icular , f ull analysis should be given of all cont ent ious expendit ur e headings, such as legal and pr of essional f ees, r epair s expendit ur e and ent er t aining (split bet ween allowable st af f ent er t aining and ot her disallowed ent er t aining). I f t his inf or mat ion is not supplied on t he r et ur n, t he Revenue will have t o st ar t an enquir y t o f ind t he br eak down of t he f igur es.

I t is also a good idea t o per f or m an analyt ical r eview of t he pr of it and loss

account , as t hough you wer e a Revenue Of f icer . The r et ur n and suppor t ing schedules should at t empt t o explain dif f er ences of income and expendit ur e heads f r om one year t o t he next . I f t her e is a legit imat e r eason f or an incr ease in adver t ising expendit ur e why not explain it , r at her t han t he Of f icer r aising an enquir y?

C5.8 Determinations Par a 36 Sch 18

FA 1998

Det er minat ions ar e issued by t he I nland Revenue wher e a company f ails t o f ile a CT600. This allows t he Revenue t o t ake pr oceedings against t he company t o obt ain t he cor por at ion t ax demanded on t he det er minat ion.

The det er minat ion is t r eat ed like a self assessment , but t he company cannot

appeal against it . I t can only be super seded by an act ual self assessment . Ther ef or e, if t he det er minat ion is on t he high side, t he company should submit it s pr oper cor por at ion t ax comput at ions and CT600 as soon as it possibly can, in or der t o halt t he Revenue f r om t aking pr oceedings f or t he ent ir e amount of t ax demanded.

C5.9 Discovery assessments Par a 41 Sch 18

FA 1998

Legislat ion exist s f or dealing wit h “discover y” assessment s f or companies. “Discover y” assessment s can be made wher e t ax has been lost due t o t he fraudulent or negligent conduct of a company, or wher e t he Revenue has not been pr ovided wit h sufficient information t o enable t hem t o make a cor r ect assessment of t he company’s pr of it s. The legislat ion cont ains guidelines on what is consider ed t o be “pr oviding inf or mat ion”. I nf or mat ion is “pr ovided” t o t he Revenue if it is cont ained in eit her t he r et ur n, t he account s or document s suppor t ing or accompanying t he r et ur n or account s, or in claims made by t he company.

Par a 44 Sch 18

FA 1998

For inst ance, assume a company owns a pr oper t y in Por t ugal and f ails t o disclose t he r ent al income on t he r et ur n. I f t he Revenue subsequent ly discover t his, t hey will be able t o r aise an addit ional assessment t o collect t he t ax. The t ax on t he discover y assessment is due on t he nor mal due dat es f or cor por at ion t ax and int er est r uns on any amount s paid lat e.


No “discover y” assessment will be made t o collect f ur t her t ax due if an er r or or mist ake is made wit hin t he r et ur n, but t he or iginal r et ur n was agr eed by t he Of f icer based on t he “prevailing practice” at t he t ime t he f igur es wer e agr eed.

Par a 45 Sch 18

FA 1998

C5.10 Error or mistake relief Par a 51 Sch 18

FA 1998

A company can claim er r or or mist ake r elief , if t hey believe t hey have over -paid cor por at ion t ax due t o an er r or or mist ake in a pr evious r et ur n. However , no r elief is available if t he r et ur n is made in accor dance wit h pr act ice t hen pr evailing.

For inst ance a r ecent change in an account ing st andar d might change t he t ax t r eat ment of a par t icular it em. I f under a pr evious st andar d t he it em was t r eat ed dif f er ent ly in t he pr evious t ax comput at ion, t hen no er r or or mist ake claim can be made, as t he pr evious r et ur n was made in accor dance wit h pr act ice pr evailing at t hat t ime.

Changes in case law can also br ing t o light an er r or or mist ake claim. The Revenue

will of t en give t heir opinion as t o whet her an er r or or mist ake claim will be accept ed in a par t icular leading case.

I n t he case of Herbert Smith, a f ir m of solicit or s successf ully ar gued t hat t he

pr ovision f or sublet t ing losses on t heir pr emises wer e allowable in t he year t hat t hey signed t he leases. The Revenue have accept ed t hat an er r or or mist ake claim can be made in r espect of pr evious cases as t hey did not believe t her e was a pr ecedent set in t he past wit h r egar ds t o sublet t ing losses.

However , in t he case of Jenners, t he depar t ment st or e successf ully ar gued t hat t heir r epair s pr ovision, as r equir ed under t he t er ms of t heir lease, should be allowed f or t ax pur poses and was not prevent ed because s 74(1)(d) r equir ed t he money t o be expended. However , t he Revenue’s view is t hat a mist ake claim will not be allowed in r espect of t he J enner s case, as t hey believe t hat pr act ice pr evailing in t he past was t hat gener al r epair s pr ovisions should be disallowed, and t his was widely document ed in many t ax and account ing t ext books.

C5.11 Claims

Claims must be made on the tax return. Examples of claims include losses, gr oup r elief and capit al allowances. The claims t hemselves must be made on t he CT600 and must be quant if ied in amount . Claims may be amended in t he nor mal t ime limit , which is 12 mont hs f ollowing t he nor mal f iling dat e.

Par a 54 Sch 18

FA 1998

The general time limit for claims is six years unless otherwise specified in t he Taxes Act . Supplement ar y claims can be made in t he case of er r or s in claims.


133

The Revenue, on issuing an amended self assessment or a discover y assessment can incr ease t he t ime limit f or making or wit hdr awing claims. The t ime limit will be ext ended t o one year af t er t he end of t he account ing per iod in which t he assessment is issued or one year af t er t he enquir y int o t he r et ur n was closed. Wher e t he assessment ar ises due t o an enquir y, t his ext ension does not apply if t he claim is ir r evocable or t her e has been f r audulent or negligent conduct .

C5.12 Group relief

Clear inst r uct ions on gr oup r elief claims ar e set down in Par as 66 t o 77 of Sch 18 FA 1998. The claim has t o be made on t he claimant company’s tax return.

Par a 67 Sch 18

FA 1998

I t must specify the amount claimed, t he name of the surrendering company, whet her any of t he companies ar e not r esident in t he UK dur ing t he account ing per iod of t he sur r ender ing company t o which t he sur r ender r elat es and t he accounting period of t he claimant t o which t he claim r elat es.

Par a 68 Sch 18

FA 1998

A claim can be made f or less t han t he amount available. The claim will be ineffective if made for more than the amount available. Wher e t her e is mor e t han one claim and t he t ot al exceeds t he amount available, t he Revenue can det er mine which claims ar e inef f ect ive.

Par a 69 Sch 18

FA 1998

A claim r equir es t he written consent of the surrendering company f or a gr oup r elief claim and t he wr it t en consent of each member of a consor t ium in t he case of a consor t ium r elief claim.

Par a 70 Sch 18

FA 1998

Claims will be ineffective unless they are accompanied by the written consent.

To be ef f ect ive t he wr it t en consent must specif y:

• The name of t he sur r ender ing company;

• The name of t he claimant ;

• The amount ;

• The account ing per iod of t he sur r ender ing company t o which t he claim r elat es;

• The t ax dist r ict r ef er ences of t he sur r ender ing and claimant company.

Par a 71 Sch 18

FA 1998

Not ices of consent can be wit hdr awn and r eplaced by anot her not ice, they

cannot be amended. The not ice of wit hdr awal has t o have t he wr it t en consent of t he claimant t o t he wit hdr awal unless it ar ises due t o a r educt ion in t he amount available f or r elief . The claimant must amend it s t ax r et ur n f or t he per iod of t he claim t o r ef lect t he wit hdr awal.

Par a 73 Sch 18

FA 1998


The sur r ender ing company must amend it s t ax r et ur n if t he not ice of consent is given af t er it has f iled t he r et ur n. I f , as a r esult a r educt ion ar ises in a f ut ur e account ing per iod in r espect of losses car r ied f or war d, t hat r et ur n must also be amended. A claimant company can only withdraw a claim for group relief by amending

its tax return. I t cannot amend t he claim. I t can only be wit hdr awn and r eplaced. The time limit f or making and wit hdr awing gr oup r elief claims is whichever is t he latest of t he f ollowing dat es:

Par a 74 Sch 18

FA 1998

• Fir st anniver sar y of t he f iling dat e of t he claimant ;

• 30 days af t er complet ion of an enquir y int o t he r et ur n;

• 30 days af t er t he issue of an amended self assessment f ollowing t he complet ion of an enquir y;

• 30 days af t er t he set t lement of an appeal against such an amendment ;

• such lat er t ime as t he Revenue allow.

Wher e t he amount available f or sur r ender is r educed, t he sur r ender ing company has 30 days t o wit hdr aw and r e-issue t he consent t o sur r ender , sending copies t o t he Revenue and each claimant company.

Par a 75 Sch 18

FA 1998

I f t he sur r ender ing company f ails t o do so, t he Revenue can give not ice t o t he sur r ender ing company as t o how t he r educed gr oup r elief will be sur r ender ed sending a copy of t he not ice t o each claimant company. The sur r ender ing company has 30 days in which t o appeal in wr it ing against any such not ice issued by t he Revenue. The claimant company on r eceipt of t he new sur r ender or Revenue not ice must amend t heir t ax r et ur n. Wher e t he wit hdr awal of consent (or a new consent ) r esult s in a company becoming char geable t o t ax, and t hat t ax r emains unpaid af t er six mont hs af t er t he t ime limit f or claims by t hat company, t he Revenue can issue an assessment in t he name of t hat company or any company t hat has obt ained gr oup r elief as a r esult of t he sur r ender . The Revenue have t wo year s t o issue t he assessment . The assessment cannot be mor e t han t he lower of t he t ax unpaid or t he t ax saved by t he ot her company r eceiving group r elief . The company so assessed is ent it led t o r ecover t he amount plus int er est on unpaid t ax under s.87 TMA 1970 f r om t he company t hat f ailed t o pay t he t ax. The Revenue can issue an assessment t o r ecover any excessive gr oup r elief claimed. This does not af f ect t heir abilit y t o issue a discover y assessment .

Par a 76 Sch 18

FA 1998


135

C5.13 Claims in respect of overseas losses of non resident companies Par a 77A

Sch18 FA 1998

The company must st at e t he Eur opean Economic Ar ea (EEA) amount and t he r elief being claimed – see lat er in your cor por at ion t ax st udies f or how t his is calculat ed. Ref er ences t o t he sur r ender ing companies account ing per iod will be t o t he deemed account ing per iod as def ined by Sch 18A I CTA 1988. I n t he case of over seas losses of a non r esident company t he consent t o sur r ender is t o be given t o t he of f icer t o whom t he claimant company makes it s r et ur n by t he claimant company not t he sur r ender ing company. I f t he sur r ender ing company is not wit hin t he char ge t o I ncome or Cor por at ion Tax t he consent does not have t o cont ain det ails of it s t ax r ef er ence number . Any wit hdr awal of consent t o sur r ender and any new sur r ender ar e t o be given t o t he of f icer of t he boar d of t he claimant company by t he claimant company. Any not ice cont aining dir ect ions by an of f icer of HMRC is t o be given t o t he claimant company. Any appeal under Par a 75 Sch 18 FA 1988 can be br ought by t he claimant company. A not ice t o pr oduce document s f or t he pur poses of an enquir y under Par a 27 Sch 18 FA 1998 will be given t o t he claimant company.

C5.14 Simplified arrangements for group relief SI 1999/ 2975

Under t he simplif ied ar r angement s, t he gr oup makes an applicat ion t o t he t ax of f ice t hat deals wit h t he authorised company ident if ying all t he companies t o be cover ed by t he ar r angement s by giving t ax r ef er ences and t he names of t ax of f ices f or each one and suf f icient det ail on each one t o ver if y t hat t hey ar e a gr oup company. The applicat ion is made by t he aut hor ised company and signed by all the other companies (the authorising companies), st at ing t hat t hey will be bound by t he ar r angement s. The applicat ion must include an example of t he gr oup r elief schedule t hat t he aut hor ised company will use in t he f ut ur e. Once t he applicat ion is submit t ed, t he aut hor ised company cannot implement t he ar r angement s f or three months unless t he Revenue give t heir consent at an ear lier dat e. The Revenue can, wit hin t he t hr ee mont hs, accept t he applicat ion but exclude cer t ain companies if t hey t hink t hey have not complied wit h all t heir obligat ions t o f ile r et ur ns and pay t ax.


The Revenue can r ef use t he applicat ion wit hin t hr ee mont hs if t hey t hink one or mor e companies is not a gr oup company or t hey have not complied wit h t heir obligat ions t o f ile r et ur ns and pay t ax. The applicat ion can also be r ef used if it is not t he case t hat all or subst ant ially all t he companies’ t ax r et ur ns ar e dealt wit h in t he same t ax of f ice or t he specimen gr oup r elief schedule is not adequat e. At any t ime t he Revenue can exclude companies which it believes ar e not gr oup companies or have not complied wit h t heir obligat ions. Under t he ar r angement s, t he claim for group relief is made by the authorised

company and does not have to include a consent to surrender if t he aut hor ised company gives aut hor it y t o t he claim being made. This aut hor it y has t o be included in t he t ax r et ur n of t he aut hor ising company f or which t he claim is made and be signed by t he aut hor ised per son. The aut hor ised company must f r om t ime t o t ime pr ovide a group relief schedule t o t he Revenue cont aining suf f icient inf or mat ion f or t he making of r et ur ns f or it self and t he aut hor ising companies as r egar ds making and wit hdr awing gr oup r elief claims. The st at ement must cont ain t he same det ails as list ed above concer ning t he det ails of t he claim and t he amount sur r ender ed. I t must also include det ails showing t he ef f ect on each company’s self assessment and det ails of any of t he company’s t ax r et ur ns t hat ar e under enquir y. I f suf f icient det ail is not shown in t he st at ement it is inef f ect ive. An aut hor ising company r emains liable f or any er r or s in claims or t ax r et ur ns. Bot h t he aut hor ised company and t he Revenue can give not ice in wr it ing at any t ime t o t he ot her t er minat ing t he ar r angement s f r om t he dat e of t he not ice. The aut hor ised company can at any t ime give not ice in wr it ing excluding an aut hor ising company f r om t he ar r angement s f r om t he dat e of t he not ice.

C5.15 Capital allowances claims

Claims must be made in t he t ax r et ur n. They must specif y t he amount claimed which must be quant if ied.

Par a 79 Sch 18

FA 1998

Claims can be amended or wit hdr awn only by amending t he t ax r et ur n. The t ime limit f or making, amending or wit hdr awing claims is t he lat er of :

• Fir st anniver sar y of t he f iling dat e f or t he t ax r et ur n

Par a 82 Sch 18

FA 1998

• 30 days af t er an enquir y int o t he r et ur n is complet ed

• I f t he r et ur n is amended by t he Revenue f ollowing an enquir y, 30 days af t er t he not ice of amendment is issued.


137

• I f an appeal is br ought against such an amendment 30 days af t er t he appeal is f inally det er mined.

• Such lat er t ime as t he Revenue allow. The time limit otherwise applying t o amendment of a company’s t ax r et ur n does not apply to an amendment to the extent it relates to capital allowances.

Ref er ences t o an enquir y int o t he r et ur n above do not include an enquir y r est r ict ed t o a pr evious amendment making or wit hdr awing or amending a capit al allowances claim. Wher e a claim r esult s in a r est r ict ion t o capit al allowances available f or anot her account ing per iod f or which t he r et ur n has been deliver ed, t he company has 30 days within which to make amendments to the other tax return. I f it f ails t o do so t he Revenue may, by not ice in wr it ing, amend t he r et ur n t o make it consist ent wit h t he amount available by way of capit al allowances. The company can br ing an appeal against such a not ice by t he Revenue wit hin 30 days of t he not ice being issued. The t ime limit s ot her wise applicable t o amending a r et ur n do not pr event t hese amendment s.

Par a 83 Sch 18

FA 1998

C5.16 Claims not made in the return Sch 1A TMA 1970

Claims have t o be made t o t he Boar d in such form as the Revenue may

determine. The f or m will pr ovide f or a declaration that all information is

correctly stated t o t he best belief of t he per son making t he claim. Claims may r equir e:

• A st at ement of t he amount of t ax r equir ed t o be dischar ged or r epaid.

• Such inf or mat ion r easonably r equir ed t o det er mine if t he claim is cor r ect .

• Deliver y of account s and document s r easonably r equir ed. Schedule 18 also cont ains r equir ement s r elat ing t o t he keeping of r ecor ds, amendment of r et ur ns (9 mont hs Revenue, 12 mont hs t he company), power s t o enquir e int o a r et ur n, power t o call f or document s but wit h r ight of appeal. I f a claim is made out side a r et ur n, wit hin t he t ime limit s f or amending t he r et ur n, it is t r eat ed as an amendment t o t he r et ur n. We nor mally see claims out side r et ur ns wher e t her e is a six year t ime limit f or t he r et ur n.

C5.17 Duty to keep and preserve records Par a 21&22 Sch 18

FA 1998

The company must keep such r ecor ds r equir ed t o allow it t o f ile a correct and complete return and t o pr eser ve t hose r ecor ds f or six years f r om t he end of t he per iod f or which t he company may be r equir ed t o deliver a t ax r et ur n.


Wher e t he company is r equir ed t o deliver a t ax r et ur n bef or e t he end of t hat six year per iod t he r ecor ds have t o be kept unt il t he lat er of :

(i) t he dat e an enquir y int o t he r et ur n is complet ed

(ii) if t her e is no enquir y, t he dat e t he Revenue can no longer enquir e int o t he r et ur n.

I f t he company is r equir ed by not ice t o deliver a r et ur n out side t hat six year per iod and it st ill has t hose r ecor ds t hen t o t he lat er of t he same above dat es. The r ecor ds t hat must be kept ar e

(i) all r eceipt s and expenses ar ising in t he cour se of t he t r ade and det ails of t he mat t er s t o which t hey r elat e;

(ii) all sales and pur chases of goods f or a company dealing in goods;

(iii) all suppor t ing document s must also be kept .

C5.18 Conclusiveness of amounts in the return Par a 88 Sch 18

FA 1998

The t ax payable by a company making a r et ur n and t he t ax liabilit y of anot her company f or any account ing per iod will be t r eat ed as no longer alterable on t he later of t he complet ion of :

(i) 12 mont hs f r om t he f iling dat e

(ii) 30 days af t er t he complet ion of an enquir y int o t he r et ur n

(iii) 30 days af t er amendment t o t he r et ur n f ollowing an enquir y

(iv) 30 days af t er t he det er minat ion of an appeal against an assessment f ollowing an amendment of t he self assessment by t he Revenue.

Wher e amendment s have been made t o t he r et ur n out side 12 mont hs f r om t he f iling dat e, amount s af f ect ed by t he amendment will no longer be alt er able on t he lat er of t he end of t he per iod int o which not ice of enquir y in t he r et ur n may be given as a r esult of t he amendment , t he end of t he per iod int o which an appeal can be made f ollowing an amendment t o t he r et ur n or t he det er minat ion of an appeal against such an amendment .


139

Answer 1

a) 31.3.08

For t he CAP ending 31 Mar ch 2007, t he r et ur n must be f iled by 31 Mar ch 2008. The not ice was issued bef or e t he st ar t of t he 3 mont hs leading up t o t he f iling dat e and t her ef or e t he nor mal due f iling dat e is r elevant .

b) 24.6.08

For t he CAP ending 31 May 2007, t he not ice was issued wit hin t he 3 mont hs leading up t o t he nor mal f iling dat e of 31 May 2008. Ther ef or e, as t he company will always have a minimum of 3 mont hs f r om t he r eceipt of t he not ice, t he due f iling dat e is 24 J une 2008.

Answer 2

(a) (b) Cor r ect ion of obvious er r or s 31.10.08 31.3.08

Enquir y deadline 31.3.09 31.7.08

I n (a) t he r et ur n is f iled on t ime. Ther ef or e, t he Revenue has 9 mont hs f r om t he act ual f iling dat e t o cor r ect any obvious er r or s. That is 31 Oct ober 2008. The enquir y deadline r uns exact ly one year f r om t he due f iling dat e, which is 31 Mar ch 2009. I n (b) t he r et ur n is f iled a mont h lat e, t he Revenue will have 9 mont hs f r om t he act ual f iling dat e t o cor r ect any obvious er r or s, which t akes us t o t he 31 Mar ch 2008 and, will have one year f r om t he next quar t er dat e t o st ar t an enquir y. The next quar t er dat e is 31 J uly 2007, add 12 mont hs, t hat t akes us t o 31 J uly 2008.


SUMMARY – CORPORATION TAX SELF ASSESSMENT (CTSA)

Companies ar e r equir ed t o f ile t heir r et ur n and st at ut or y account s 12 mont hs af t er t he end of t he account ing per iod (or 3 mont hs af t er t he not ice t o submit a r et ur n has been issued, if lat er ). Wher e t he company has a long per iod of account , t her e ar e t wo char geable account ing per iods and t wo r et ur ns, but bot h r et ur ns ar e due on t he same dat e. Companies have t o self assess t he amount of t ax due. Ther e is a st at ut or y obligat ion t o not if y char geabilit y wher e a company f ir st comes wit hin t he char ge t o t ax or comes back int o t he char ge. Cer t ain pr escr ibed inf or mat ion must also be pr ovided. The Revenue have t he r ight t o r aise discover y assessment s if t ax has been lost due t o t he f r audulent or negligent conduct of t he company or t he Revenue have not been pr ovided wit h suf f icient inf or mat ion t o allow t hem t o make a cor r ect assessment of t he company’s pr of it s. Companies can make er r or or mist ake claims if t hey t hink t hey have over paid t ax on an ear lier r et ur n. However , no r elief is available if t he r et ur n was made in accor dance wit h pr act ice t hen pr evailing. Schedule 18 FA 1998 lays down clear guidelines on how claims ar e t o be made and amended. Ther e is a simplif ied pr ocedur e available f or gr oup r elief claims. Companies must keep r ecor ds t o suppor t t heir t ax r et ur ns.

C6: PAYMENT OF CORPORATION TAX

This chapt er looks at t he payment of cor por at ion t ax cover ing in par t icular : - t he due dat e f or payment of a company’s cor por at ion t ax liabilit y; - payment by inst alment s; - gr oup payment ar r angement s; - gr oup t ax sur r ender s.

C6.1 Introduction

Ther e ar e t wo t ypes of company f or payment pur poses; t hose who pay t ax at t he f ull r at e and t hose who do not .

Small companies (including mar ginal r elief companies) ar e r equir ed t o pay all of

t heir cor por at ion t ax 9 months and 1 day af t er t he end of t he char geable account ing per iod.

For example, wher e a char geable account ing per iod ends on 31 December 2006, t he due and payable dat e f or cor por at ion t ax is 1 Oct ober 2007.

Large companies ar e r equir ed t o pay their tax by quarterly instalments.

Lar ge companies ar e def ined as t hose who have not ional pr of it s (PCTCT + FI I ) in excess of £ 1,500,000. This f igur e is adj ust ed f or shor t account ing per iods and associat ed companies.

I n summar y, companies t hat pay t ax at t he f ull 30% r at e pay t ax by inst alment s. All ot her companies pay t ax 9 mont hs and one day af t er t he char geable account ing per iod.

C6.2 Payment of tax by instalments SI

1998/ 3175

Companies who paid corporation tax at the full rate in the previous

accounting period will have an obligat ion t o pay t ax by inst alment s.

The first year that a company is large, there is no need to pay tax by

instalments, unless profits exceed £10 million.

Reg 3 STI 1998/ 3175

The £ 10 million is divided among all the associated companies, and is reduced for accounting periods which are less than 12 months long. However , t he number of associat ed companies is ar r ived at by looking at t he associat ed companies at t he end of t he immediately preceding account ing per iod. Full r at e companies whose CT liability is below £10,000, are exempt f r om quar t er ly payment s. These could be companies t hat pay t ax at 30%, but ar e par t of a ver y lar ge gr oup, so t heir individual liabilit y is r elat ively small.

Reg 3 STI 1998/ 3175


The inst alment payment s ar e due as f ollows: Reg 5

STI 1998/ 3175

(i) The first payment is due 6 months plus 13 days from the star t of t he account ing per iod;

(ii) Subsequent payment s ar e due 3 months after t he pr evious inst alment ;

(iii) Final payment is due 3 months plus 14 days from the end of t he char geable account ing per iod.

All t ax due by inst alment s must be paid by t he due dat e f or t he f inal payment , ot her wise int er est will r un. Illustration 1

Assume we have a char geable account ing per iod f or t he year ending 31 Mar ch

2007.

The f ir st inst alment will be due 6 mont hs plus 13 days f r om t he st ar t of t his account ing per iod, i.e. 14 Oct ober 2006.

The next inst alment is due 3 mont hs lat er , i.e. 14 J anuar y 2007. The f ollowing inst alment is due 3 mont hs af t er t he pr evious, i.e. 14 Apr il 2007. The f ollowing inst alment is due 3 mont hs af t er t he pr evious, i.e. 14 J uly 2007. As t his is t he f inal inst alment , it cannot be lat er t han 3 mont hs and 14 days f r om t he end of t he account ing per iod, i.e. 14 J uly 2006. For a t welve mont h account ing per iod t he f inal inst alment will f all 3 mont hs and 14 days af t er t he end of t he account ing per iod. Example 1

Assume we have a char geable account ing per iod f or t he year ending on 31 J uly 2007. What ar e t he inst alment dat es?

C6.3 Amount due by instalments

The amount of each inst alment is based on t he cor por at ion t ax liabilit y of t he current year, even t hough t he company at t he t ime of making t he f ir st inst alment is only half way t hr ough t he account ing per iod.

The syst em was init ially phased in, such t hat in t he f ir st 3 year s of CTSA not all of t he t ax was due by inst alment s but since J uly 2002, lar ge companies have been paying 100% of t heir cor por at ion t ax by inst alment s.

Payment of Cor por at ion Tax

143

Each inst alment is calculat ed using t he f or mula:

Reg 5(5) STI 1998/ 3175

3

N x estimated corporation tax liability

wher e N is t he number of mont hs in t he account ing per iod.

The f ir st t hing we must do is t o ident if y how many instalments t her e will

act ually be, using t he 3N f or mula. For a 12 mont h account ing per iod, t he

inst alment s will be 312 t hs,

312 t hs,

312 t hs and

312 t hs, of t he t ax due by

inst alment s. This gives a t ot al of f our inst alment s, which ar e due. For a 10 mont h account ing per iod, f or example, t he inst alment s will be as f ollows,

310 t hs,

310 t hs,

310 t hs (which gives us

910 t hs) and t he f inal inst alment will be j ust

110 t h. I f we pay anot her

310 t hs we will act ually have paid t oo much. This once

again gives us f our inst alment s.

For an 8 mont h account ing per iod t he inst alment s due will be 38 t hs,

38 t hs and

28

t hs, which gives only t hr ee inst alment s. For a 5 mont h per iod t he inst alment s due

will be 35 t hs and

25 t hs, which only gives t wo inst alment s.

Once we have est ablished how many inst alment s ar e due we then need to

consider the amounts. The impor t ant t hing is t o look at when t he account ing per iod ends.

Illustration 2

Assume we have a char geable account ing per iod f or t he year ending 31 Mar ch

2007, wit h pr of it s of £ 2 million. This gives us a cor por at ion t ax liabilit y at 30% of £ 600,000.

Each inst alment amount will be £ 600,000 x 312 = £ 150,000.

The f ir st inst alment will be due f or payment on t he 14 Oct ober 2006. The next 3 inst alment s will each be £ 150,000 due on 14 J anuar y, 14 Apr il and 14 J uly 2007. Example 2

Consider a char geable account ing year ended 31 J uly 2007, wit h pr of it s of £ 1.75 million. Show t he amount of t ax due on each of t he appr opr iat e dat es.


Illustration 3

Consider an 8 mont h account ing per iod ended 31 December 2006 and a t ax liabilit y of £ 800,000. Our f ir st st ep is t o wor k out how many inst alment s t her e

act ually ar e. Her e t his will be 38 t hs,

38 t hs and

28 t hs, which is t he 3 inst alment s.

The f ir st inst alment is due 6 mont hs plus 13 days f r om t he st ar t of t he account ing per iod, which t akes us t o 14 November 2006. The next inst alment is due 3 mont hs lat er , which is 14 Febr uar y 2007. The f inal inst alment cannot be later than 3 months plus 14 days f r om t he end of t he account ing per iod, which is 14 Apr il 2007. I f we wer e t o use t he t hr ee mont hs r ule we would go t o 14 May 2007. This is not allowed so t he f inal inst alment f alls on 14 Apr il 2007. Summar y of Payment s:

I nst alment Due Wor king £ 1 14.11.06 £ 800,000 x 3/ 8 300,000 2 14.2.07 as above 300,000 3 14.4.07 £ 800,000 x 2/ 8 200,000 £ 800,000

Example 3

Consider a 6 mont h account ing per iod ending on 30 J une 2007, wit h a t ax liabilit y due of £ 100,000.

Calculat e t he amount s and due dat es of t he t ax payable.

C6.4 Group payment arrangements

Wher e one or mor e companies in a 51% group (par ent wit h 51% subsidiar ies and t heir 51% subsidiar ies) ar e liable t o pay t ax by inst alment s, t hey may nominat e a company t o deal wit h t he gr oup payment ar r angement s f or t he gr oup. They complet e a gr oup payment ar r angement s document list ing all t he companies who ar e t o par t icipat e and submit it t o t he Revenue t wo mont hs bef or e t he f ir st inst alment payment is due by any gr oup member .

s.36 FA 1998

& Revenue Manuals

“Group” is def ined in sect ion 36 FA 1998 as a company and all it s 51 per cent subsidiar ies, and t heir 51 per cent subsidiar ies, and so on.

s.36(4) FA 1998

The applicat ion must st at e t he st ar t and end dat es of t he f ir st per iod t o which t he ar r angement s ar e t o apply. The ar r angement s will t hen apply aut omat ically t o subsequent per iods of account unless and unt il t he companies not if y t hat t hey t hat wish t o t er minat e it or t he Revenue t er minat e it . The Revenue will t er minat e t he ar r angement s if :


145

• any of t he par t icipat ing companies f ails t o meet it s obligat ions t o pay cor por at ion t ax and f ile it s company t ax r et ur n f or any account ing per iod;

• t he nominat ed company br eaks any of it s obligat ions under t he ar r angement ;

• t hey have r eason t o believe t hat any member of t he gr oup of companies (including t hose not cover ed by t he same or any gr oup payment ar r angement ) may become liable t o t ax under Sect ions 767A or 767AA I CTA (change in company owner ship wit h CT r emaining unpaid).

Nor mally t he Revenue will only t er minat e t he ar r angement s in cases wher e t her e has been a ser ious f ailur e or br each or a pat t er n of non-compliance, not f or minor mat t er s. I f a gr oup has an ar r angement t er minat ed, it will not be ent it led t o r egist er a new ar r angement f or t he next Per iod of Account .

The nominat ed company under t akes t o pay t he cor por at ion t ax liabilit ies of t he par t icipat ing companies f or account ing per iods f alling wit hin t he per iods of account cover ed by t he ar r angement s (t he r elevant account ing per iods). I t is up t o t he nominat ed company t o det er mine how much t o pay and when t o make payment s. Payment r equest s or r eminder s will not be issued. “Liabilit ies” means cor por at ion t ax and any liabilit ies under Sect ion 419 and Sect ion 747 I CTA (loans t o par t icipat or s in close companies, and cont r olled f or eign companies).

The ar r angement s apply f or a “per iod of account ” which is nor mally t he account ing per iod of each of t he par t icipat ing companies. Gener ally, t he par t icipat ing companies should all have account ing per iods which ar e ident ical t o t he per iod of account . However , t he ar r angement document also allows a company in a gr oup t o t ake par t in a gr oup payment ar r angement if it s account ing per iods dif f er f r om t he per iod of account under some cir cumst ances. The liabilit ies f or an account ing per iod of such a company can be included in an ar r angement f or a per iod of account if • t he account ing per iod st ar t s wit hin t he per iod of account , and ends on t he

same day as t he nominat ed company’s account s; or • t he account ing per iod st ar t s on or af t er , but ends bef or e t he end of

t he per iod of account , and is f ollowed by anot her (shor t ) account ing per iod ending on t he same day as t he per iod of account .

This will allow newly-f or med and newly-acquir ed companies t o be included wit hin a gr oup payment ar r angement .


I t is possible t o set up separ at e gr oup payment ar r angement s f or dif f er ent sub-set s of t he gr oup. But no one company can par t icipat e in mor e t han one gr oup payment ar r angement in r espect of any one of it s account ing per iods. The par t icipat ing companies can change over t ime as companies j oin and leave t he gr oup. The nominat ed company must r emove f r om t he gr oup payment ar r angement any par t icipat ing company, ot her t han t he nominat ed company, which ceases t o be a member of t he gr oup, or which does not have an account ing per iod which ends on t he same day as t he per iod of account . The r evenue can r emove a company f r om t he ar r angement if it t ur ns out never t o have been a member of t he gr oup, or if t he nominat ed company f ails t o f ulf il it s obligat ion t o do so. For ever y per iod of account cover ed by a gr oup payment ar r angement , t her e is a “Closing Date”. This is t he dat e at which t he nominat ed company’s liabilit ies ar e f ixed, and af t er which it must say how t he payment s it has made ar e t o be allocat ed t o t he individual par t icipat ing companies. The closing dat e is t he lat er of • whichever f iling dat e is t he lat est , out of all t he f iling dat es of t he

par t icipat ing companies f or r et ur ns f or r elevant account ing per iods, and

• t he day when t he Revenue r eceive t he last of t hose r et ur ns (or make a det er minat ion of t ax in t he absence of a r et ur n).

The amount payable by t he nominat ed company in r espect of each r elevant account ing per iod of t he par t icipat ing companies will not be af f ect ed by changes in t heir liabilit y occur r ing af t er t he closing dat e. Ther ef or e adj ust ment s made t o t he liabilit y of an individual par t icipat ing company (f or example, in r espect of int er est or penalt ies, or as a r esult of an enquir y int o t he company’s r et ur n) will be t he r esponsibilit y of t he individual par t icipat ing company, not t he nominat ed company. The nominat ed company can claim a r epayment . This might be t he case wher e, f or example, t he f or ecast of pr of it s at gr oup level has f allen as a r esult of t he unexpect ed loss of business t o a new compet it or , or wher e a par t icular ly pr of it able company has been sold out of t he gr oup dur ing t he r elevant account ing per iod. No st eps will be t aken bef or e t he closing dat e, t o r ecover liabilit ies f r om t he par t icipat ing companies f or r elevant account ing per iods. The Revenue st ill have t he r ight t o r ecover out st anding liabilit ies f r om t he individual par t icipat ing companies, but only after t he closing dat e.


147

Af t er t he closing dat e, t he Revenue will send a not ice of t heir calculat ion of t he amount t he nominat ed company should have paid under t he ar r angement , and any balance out st anding or over paid. This calculat ion will be f inal and conclusive, and binding on t he nominat ed company. The nominat ed company t hen wit hin 30 days ir r evocably specif ies in wr it ing how payment s made under t he agr eement should be appor t ioned amongst t he par t icipat ing companies. Payment s t o be appor t ioned will be net of any r epayment s made, and of any ot her appor t ionment s alr eady made (f or example t o a depar t ing company). I f t he nominat ed company f ails t o make t he appor t ionment t he Revenue will make an appor t ionment inst ead in accor dance wit h t he liabilit ies of t he par t icipat ing companies as shown on t heir r et ur ns, t o t he ext ent t hat t he aggr egat e amount paid is enough t o cover t hose liabilit ies giving not ice in wr it ing t o t he nominat ed company of t he appor t ionment . The nominat ed company has t he r ight t o amend t his appor t ionment if it does so wit hin 30 days f r om t he dat e of t he not ice. The Revenue can r eappor t ion payment s among t he par t icipat ing companies if t he liabilit ies of one or mor e of t hem r emain out st anding af t er t he nominat ed company’s appor t ionment . The nominat ed company cannot amend such a r eappor t ionment . This will only be done if t he nominat ed company’s appor t ionment leaves an under payment on t he account of a par t icipat ing company and t he Revenue cannot r ecover t he shor t f all f r om t hat company. Payment s made by t he nominat ed company on behalf of t he par t icipat ing companies ar e deemed t o have been made by t hose companies in t he amount s f inally appor t ioned t o t hem, and on t he dat es t hey wer e made by t he nominat ed company. Payment s will be deemed t o be appor t ioned (t o t he ext ent t hey have not been r epaid) t o t he par t icipat ing companies in t he f ollowing or der :

1. t o t hose which have not incur r ed a lat e-f iling penalt y, or have only incur r ed a f ixed-r at e penalt y;

2. t o t hose which have incur r ed a t ax-r elat ed penalt y at t he lower r at e of 10%;

3. t o t hose which have incur r ed a t ax-r elat ed penalt y at t he higher r at e of 20%, eit her by f ailing t o f ile a r et ur n, or by f iling it mor e t han t wo year s af t er t he end of t he per iod f or which it is r equir ed.

This ensur es t hat a company t hat has f iled it s r et ur n lat e, and is t her ef or e liable t o a t ax-r elat ed penalt y, cannot have t he amount of t hat penalt y r educed as a r esult of t he nominat ed company’s appor t ionment .


C6.5 Group tax surrenders s.102 FA 1989

This sect ion r elat es t o gr oups which have not ent er ed int o gr oup payment ar r angement s. A company t hat is due a r ef und can sur r ender it t o a f ellow gr oup company. A gr oup her e is as f or gr oup r elief . The companies must have t he same account ing per iod and have been member s of t he gr oup t hr oughout t he per iod f r om t he st ar t of t he account ing per iod t o t he day t he not ice is given. The companies have t o give j oint not ice in wr it ing of t he sur r ender , st at ing t he name and t ax r ef er ence of bot h companies and t he t ype and amount of t he r ef und sur r ender . The sur r ender can apply t o t he whole or par t of a r ef und. The r ecipient company is t r eat ed as having paid t he amount sur r ender ed on t he lat er of t he dat e it was paid or t he due dat e of payment . The sur r ender ing company is t r eat ed as r eceiving a r ef und on t he same day. For inst alment payment s t he t ax is t r eat ed as being paid t he lat er of t he dat e it was paid by t he sur r ender ing company and t he due dat e f or t he f ir st inst alment . I nt er est paid by t he sur r ender ing company is t r eat ed as if it had been paid by t he r ecipient company. Payment s bet ween t he companies in r espect of t he sur r ender ar e ignor ed f or t ax and will not be t r eat ed as dist r ibut ions.


149

Answer 1

14 Febr uar y 2007 14 May 2007 14 August 2007 14 November 2007

Answer 2

Tot al t ax due: £ 1,750,000 x 30% = £ 525,000 Each inst alment will be

£ 525,000 x 312 t hs = £ 131,250

Due on 14.2.07 £ 131,250

14.5.07 £ 131,250 14.8.07 £ 131,250

14.11.07 £ 131,250

Answer 3

How many inst alment s? 2 of 36 t hs each

I nst alment

Due £

1 14.7.07 £ 100,000 x 3/ 6 50,000

2 14.10.07 as above 50,000

________

Tot al £100,000


SUMMARY – PAYMENT OF CORPORATION TAX

Companies paying t ax at t he f ull r at e of 30% ar e r equir ed t o pay t heir cor por at ion t ax by inst alment s. Companies who do not pay t ax at t he f ull r at e ar e not r equir ed t o pay by inst alment s. I nst ead any t ax is due 9 mont hs and one day af t er t he end of t he account ing per iod. Wher e t he t ax due is under £ 10,000, no inst alment s will be r equir ed. A company is not r equir ed t o pay in inst alment s f or t he f ir st year it becomes lar ge pr oviding t he pr of it s ar e less t han £ 10 million (t welve mont h limit ). For companies who do pay at t he f ull r at e t he r equir ed inst alment s ar e due on t he 14 t h of mont hs 7,10, 13, and 16 count ing f r om t he st ar t of t he AP. I f t he t ax is not paid on t he due dat e, int er est will be char ged f r om t he due dat e t o t he dat e bef or e it is paid. Wher e t her e is a 51 % gr oup t he gr oup can apply f or t he nominat ed company t o make all payment s of t ax f or t he gr oup and allocat e t he payment s af t er t he closing dat e. I f t he gr oup payment ar r angement s ar e not used amount s of t ax over paid can be sur r ender ed wit hin a gr oup r elief gr oup.

C7: INTEREST ON LATE PAID TAX

This chapt er looks at int er est and in par t icular it cover s: - int er est on lat e paid t ax and r epayment s; - t he ef f ect of amount s car r ied back.

C7.1 Introduction

I nt er est r uns from the due date of payment to the day before the actual date of payment of t he t ax wher e cor por at ion t ax is paid lat e.

s.97A TMA 1970

s.826 I CTA 1988

This applies t o all payment s of cor por at ion t ax – whet her t he company pays by inst alment s or not . So small companies, who ar e r equir ed t o pay t heir t ax 9 mont hs and 1 day af t er t he end of t he account ing per iod, will also be char ged int er est wher e t hey pay t hat t ax lat e.

Pr oblems ar e exper ienced par t icular ly by lar ger companies, as tax due by

instalments is based on the tax liability of the current year, yet t he payment s ar e made dur ing t he year . A company will t her ef or e have t he pr oblem of estimating its tax bill, which could well change dur ing t he year , so what t hey pay may not r ef lect t heir act ual liabilit y. I f t hey do not pay enough, int er est will r un. I f t hey pay t oo much, t hey will get r epayment int er est , but at a lower r at e.

Illustration 1

Guesswor k Limit ed est imat es it s pr of it s f or t he year ended 31 May 2007 t o be £ 2 million when it makes it s f ir st inst alment of cor por at ion t ax.

As t his is a 12 mont h CAP each inst alment will be 3/ 12 x 100% = 25%. The amount of t ax due on 14.12.06 will t her ef or e be:

£ 2,000,000 x 30% = £ 600,000 x 25% = £ 150,000

At t he beginning of Mar ch t he company wins a maj or new cont r act which is likely

t o incr ease t he company' s pr edict ed pr of it f or t he year t o £ 2.2 million. For it s second inst alment due on 14.3.07 t he company would be advised t o make a payment as f ollows:-

£ 2,200,000 x 30% = £ 660,000 x 50% = £ 330,000 Less t ax paid on 14.12.06 (150,000)

£180,000


By t he end of t he account ing per iod t he dr af t account s r eveal a t axable pr of it of £ 2.25 million. The company should t her ef or e pay t ax as f ollows on 14.6.07 in r espect of it s t hir d inst alment :

£ 2,250,000 x 30% = £ 675,000 x 75% = £ 506,250 Less t ax paid so f ar (330,000)

£176,250

By t he end of August t he company has been audit ed and t he pr of it or iginally ant icipat ed has been r educed t o £ 2.15 million. The company should t her ef or e pay t ax as f ollows on 14.9.07 in r espect of it s f our t h inst alment :

£ 2,150,000 x 30% = £ 645,000 x 100% = £ 645,000 Less t ax paid so f ar (506,250)

£138,750

The company pr epar es it s f inal cor por at ion t ax comput at ions by t he end of Febr uar y 2008, which show a f inal t axable pr of it of £ 2,190,000.

The company t her ef or e pays t ax as f ollows on 1.3.08:

£ 2,190,000 x 30% = £ 657,000 Less t ax paid by inst alment s (645,000)

£ 12,000 I t is nor mal f or a company t o keep revising its estimated corporation tax

liability in t his way.

Payment s Summar y:

Paid £

Cumulat ive £

Due £

Cumulat ive £

Under paid/ (over paid)

14.12.06 150,000 150,000 164,250 164,250 14,250

14.3.07 180,000 330,000 164,250 328,500 (1,500)

14.6.07 176,250 506,250 164,250 492,750 (13,500)

14.9.07 138,750 645,000 164,250 657,000 12,000

1.3.08 12,000 657,000 ______

657,000 657,000 The Revenue will issue an int er est st at ement once t he r et ur n has been submit t ed and t he f inal liabilit y has been calculat ed.

I nt er est on Lat e Paid Tax

153

I nt er est Summar y:

14.12.06 t o 13.3.07 I nt er est charged on £ 14,250 under paid

14.3.07 t o 13.6.07 I nt er est credit on £ 1,500 over paid

14.6.07 t o 13.9.07 I nt er est credit on £ 13,500 over paid

14.9.07 t o 29.2.08 I nt er est charged on £ 12,000 under paid

Assuming a r at e of int er est on under paid t ax of 7% and a r at e of int er est on over paid t ax of 5% t he int er est posit ion can be calculat ed as f ollows:

£

£ 14,250 x 7% x 90

365 = 245.96

£ (1,500) x 5% x 92

365 (18.90)

£ (13,500) x 5% x 92

365 (170.14)

£ 12,000 x 7% x 169366

387.87

I nt er est due t o t he Revenue £444.79

The Revenue will r aise an interest demand which must be settled within 30

days. I f it is set t led lat e t her e will be int er est char ged on t he int er est .

The Revenue have conf ir med t hat t hey will accept payment s of cor por at ion t ax at any t ime so if t he company calculat es and pays it s cor por at ion t ax ear lier t his will st op t he int er est r unning. Any int er est r eceived will be t axed under Schedule DI I I . Any int er est paid by t he company will be t r eat ed as int er est paid on a non-t r ading loan and can be deduct ed f r om DI I I income.

s.100 FA 1996

C7.2 Effect of carry backs

Wher e losses ar e car r ied back under s.393A(1) and r esult in a r epayment of t ax, t hen f or calculat ing t he int er est on t his r epayment it is treated as tax repaid for the accounting period of the loss unless the repayment arises in respect

of an accounting period that falls wholly within the twelve months prior t o t he one in which t he loss ar ose.


I f t he car r y back r educes an amount of unpaid t ax, interest will cease to run

from the due date of the period in which the loss was made f or t he amount of t ax unpaid t hat t he car r y back negat es. Apar t f r om t his it is ignor ed in calculat ing t he int er est on unpaid t ax except f or an account ing per iod f alling wholly wit hin t he 12 mont hs bef or e t he one in which t he loss ar ose. For car r y back of non-trade deficits on loan r elat ionships t he calculat ion of int er est on under paid or over paid cor por at ion t ax is not af f ect ed except t hat in t he case of under payment s the amount met by the carry back is treated as

paid on the due date for the accounting period in which the deficit arose. Ot her wise it is t r eat ed as a r epayment of cor por at ion t ax f or t he account ing per iod in which t he def icit ar ose.

I nt er est on Lat e Paid Tax

155

SUMMARY – INTEREST ON LATE PAID TAX

I nt er est r uns on t ax paid lat e f r om t he due dat e t o t he day bef or e payment . I nt er est will be paid on over paid t ax f r om t he due dat e/ dat e paid t o t he day bef or e t he r epayment . Tax r epaid as a r esult of a loss car r y back is t r eat ed as t ax r epaid f or t he year giving r ise t o t he loss unless t he account ing per iod of t he car r y back f alls wholly wit hin t he t welve mont hs bef or e t hat of t he loss. Tax r epaid as a r esult of a DI I I def icit car r y back is t r eat ed as a r epayment of cor por at ion t ax f or t he year in which t he def icit ar ose.

C8: CTSA PENALTY REGIME

This chapt er examines t he Cor por at ion Tax Self Assessment (CTSA) pr ocedur es r elat ing t o penalt ies.

C8.1 Introduction

The CTSA penalt y r egime has been int r oduced t o ensur e compliance wit h t he var ious CTSA administ r at ive r equir ement s. The penalt y r egime aims t o penalise var ious misdemeanour s. These include late filing of r et ur ns, failure to notify char geabilit y, record-keeping f ailur es and fraudulent or negligent r et ur ns.

C8.2 Late filing of returns

All companies ar e required to file their return within 12 months of the end of

the period of account (POA) which is t he company' s f inancial r epor t ing per iod i.e. t he per iod f or which t he company has made up it s set of account s. I n most sit uat ions t he per iod of account and t he char geable account ing per iod will be t he same.

Ther e ar e t wo t ypes of penalt ies f or t he lat e f iling of a r et ur n; a flat rate penalty and a tax geared penalty. A flat rate penalt y of £100 will be levied aut omat ically by t he Revenue (subj ect t o a 7 day period of grace) wher e t he r et ur n is up to three months late. The £ 100 penalt y st ands r egar dless of t he level of pr of it s.

Par a 17 Sch 18

FA 1998 and

ESCB46

The penalt y it self incr eases t o £200 wher e t he r et ur n is more than 3 months

late. These penalt ies ar e incr eased t o £500 and £1,000 if t his is t he company's third consecutive offence. As f or t he tax geared penalt ies, a 10% penalt y will ar ise if t he r et ur n is filed more than 18 months af t er t he end of t he char geable account ing per iod. The 10% will be t aken on any cor por at ion t ax owing at t hat 18 mont h point . This penalt y doubles t o 20% wher e t he r et ur n is filed more than 24 months af t er t he char geable account ing per iod but t his is based on t he tax owing at the 18

month point.

Par a 18 Sch 18

FA 1998

Remember t hat t he end of t he period of account is t he t r igger in r espect of t he flat rate penalties as t hese ar e based on t he filing date but t he end of t he chargeable accounting period t r igger s t he tax geared penalt ies.

CTSA Penalt y Regime

157

Illustration 1

Har r is Limit ed makes up account s f or t he 16 mont hs ended 31 August 2006. This is a long POA f or t ax pur poses and must be split int o t wo separ at e CAPs - one f or t he f ir st 12 mont hs and t hen t he balance of t he per iod. The company will have 2 CAPs, 2 payment dat es and 1 f iling dat e which we can r emember by calling t his t he “2-2-1” r ule. The CAPs ar e t he 12 m/ e 30 Apr il 2006 and t he 4 m/ e 31 August 2006. This leads t o t wo separ at e payment dat es: t he liabilit y in r espect of t he 12 m/ e 30 Apr il 2006 is due on 1 Febr uar y 2007 and t he liabilit y in r espect of t he 4 mont h per iod is due on 1 J une 2007. This is on t he assumpt ion t hat t he company is a small company and not liable under t he CTSA inst alment r egime. Ther e is only one f iling dat e because t his is t r igger ed by t he POA. Bot h r et ur ns ar e due wit hin 12 mont hs of t he end of t he POA so t he due dat e f or t he f iling of bot h t he r et ur ns is 31 August 2007. Ther e will be penalt ies if Har r is Lt d f ails t o comply wit h CTSA r equir ement s. The £ 100 penalt y will be t r igger ed if eit her of t he r et ur ns is f iled mor e t han 7 days af t er 31 August 2007. This applies per r et ur n, so t wo r et ur ns f iled lat e means £ 200. Each penalt y it self incr eases t o £ 200 if eit her of t he r et ur ns ar e f iled af t er 30 November 2007, in ot her wor ds ar e over 3 mont hs lat e. Not e: The Revenue allows a 7 day per iod of gr ace f or f iling t he r et ur n, however t his is by concession. The penalt y of 10% of t he t ax out st anding is t r igger ed if eit her of t he r et ur ns ar e f iled mor e t han 18 mont hs af t er t he end of t he r elevant CAP:

y/ e 30.4.05 + 18m = 31.10.07 4m/ e 31.8.05 + 18m = 29.2.08

The penalt y of 20% of t ax out st anding is t r igger ed if eit her t he r et ur ns ar e f iled mor e t han 24 mont hs af t er t he end of t he r elevant CAP and will be char geable on any t ax out st anding at t he 18 mont h point - not t he 24 mont h point .

y/ e 30.4.06 + 24m = 30.4.08 4m/ e 31.8.06 + 24m = 31.8.08


C8.3 Failure to notify chargeability

For account ing per iods beginning on or af t er 22 J uly 2004 a penalt y will ar ise f or companies f ailing t o not if y char geabilit y wit hin t hr ee mont hs of t he st ar t of t heir f ir st account ing per iod or of t hem coming back wit hin t he char ge t o t ax.

The penalty will be £300 for initial failure with a potential penalty of £60 a

day for continued failure once the initial penalty has been levied.

s.98 TMA 1970

A penalty of £3,000 can be char ged if incor r ect inf or mat ion is pr ovided fraudulently or negligently.

s.98 TMA 1970

C8.4 Record keeping failures

Companies ar e r equir ed t o keep certain records f or at least 6 years by t he end of t he char geable account ing per iod. These ar e t he same as t he Companies Act r equir ement s and will include:

Par a 21 Sch 18

FA 1998

(i) r ecor ds of r eceipt s and expenses, and t he mat t er s t o which t hey r elat e;

(ii) det ails of all sales and pur chases made in t he cour se of t r ade, wher e t he t r ade involves dealing in goods; and

(iii) suppor t ing document s, such as account s, books, voucher s, cont r act s, deeds et c.

The penalt y f or f ailing t o keep t hese r ecor ds is £3,000 per chargeable

accounting period.

Par a 23 Sch 18

FA 1998

C8.5 Fraudulent or negligent returns

Negligent f or t hese pur poses includes any innocent er r or t hat t he company f ails t o cor r ect wit hout “unr easonable delay”. The penalt y also ext ends t o f r audulent or negligent claims made on t he r et ur n or amendment s t o it .

Par a 20 Sch 18

FA 1998

The penalt y is up to 100% of the tax avoided as a r esult of t he negligence or f r aud on t he r et ur n, i.e. t he dif f er ence bet ween t he t ax t hat should be payable and t he t ax t hat act ually was paid based on t hat r et ur n. This penalt y is subj ect t o mit igat ion based on t he size of t he of f ence, t he degr ee of co-oper at ion and volunt ar y disclosur e of t he er r or giving r ise t o t he under -declar at ion of t ax.

CTSA Penalt y Regime

159

C8.6 Not producing documents

A company f ailing t o pr oduce document s f or t he pur pose of an enquir y is liable: (i) £ 50 penalt y (ii) Wher e t her e is cont inuing f ailur e af t er t he above penalt y f ur t her

penalt ies of £ 30 a day if t he penalt y is imposed by a Revenue Of f icer £ 150 a day if it is imposed by t he Commissioner s.

Par a 29 Sch 18

FA 1998

C8.7 Multiple penalties

Wher e t he company r eceives mor e t han one penalt y t hat is det er mined by t he t ax payable f or t he account ing per iod, t he second and subsequent penalt ies ar e r educed so t hat t hey do not exceed t he maximum of such penalt ies.

s. 90 Sch 18

FA 1998

C8.8 Failure to pay by instalments

I f a company deliber at ely and r ecklessly f ails t o pay it s inst alment s or makes a claim f or r epayment of inst alment s, t her e is a penalt y of t wice t he amount of int er est char ged on t he t ax unpaid.

Par a 13 SI

1999/ 3175


SUMMARY – CTSA PENALTY REGIME

Penalt ies will apply wher e a r et ur n is lat e. The f lat r at e penalt ies ar e: £ 100 up t o 3 mont hs lat e; £ 200 mor e t han 3 mont hs lat e; Tax gear ed penalt ies ar e char ged if t he r et ur n is f iled mor e t han 18 mont hs af t er t he end of t he CAP. The penalt ies ar e:

10% of t ax unpaid at 18 mont hs if r et ur n > 18 mont hs af t er CAP 20% of t ax unpaid at 18 mont hs if r et ur n > 24 mont hs af t er CAP

An init ial penalt y of £ 300 will be char ged wher e a company f ails t o not if y char geabilit y in accor dance wit h s.55 FA 2004. An addit ional penalt y of £ 60 a day can be char ged. A £ 3,000 penalt y can be char ged wher e incor r ect inf or mat ion is pr ovided negligent ly or f r audulent ly in r elat ion t o not if icat ion of char geabilit y. Penalt ies will also be applied wher e t her e has been a f ailur e t o keep r ecor ds or t he r et ur n is incor r ect due t o f r audulent or negligent conduct .

C9: INCOME FROM PROPERTY

This chapt er will consider t he t axat ion of income f r om pr oper t y in par t icular : - r ules r elat ing t o Schedule A; - r ever se pr emiums; - r ent f act or ing; - r eal est at e invest ment t r ust s.

C9.1 Introduction

I ncome f r om UK situated property is t axed on companies under Schedule A.

I ncome f r om overseas property is t axed under Schedule D Case V.

Income from all property is t r eat ed as a single sour ce of business income. A single sour ce means t hat all pr of it s and losses are pooled together. Wher e t he pool cr eat es a pr of it , we t ax it under Schedule A; wher e t he pool cr eat es a loss, we r elieve it under t he Schedule A loss r elief r ules.

We br ing t he income int o char ge t o t ax using account ing pr inciples as applied f or Schedule D Case I , ie t he basis of t axat ion will be an accr uals basis f or t he r ecognit ion of income.

Example 1

Rent on Limit ed acquir es an invest ment pr oper t y on 1 J uly 2006 and let s it out immediat ely on an annual r ent of £ 24,000, payable on t he f ir st day of each mont h in advance.

How much r ent al income will be t axable in Rent on Limit ed’s account ing per iod f or t he year ended 31 Mar ch 2007?

C9.2 Expenses

As r ent al income is t r eat ed as business income, deduct ion of expenses f ollows t he nor mal r ules. Relief is given f or expenses which have been incur r ed wholly

and exclusively for the purposes of the rental business. This is t he same as deduct ion f or t r ading expenses as given by Sect ion 74 I CTA 1988.

The det ailed r ules on allowable expenses ar e cover ed wit hin t he I ncome Tax cour se.


Common deduct ible expenses include:

(i) Maint enance and r epair s but not impr ovement s - r edecor at ion would t her ef or e qualif y but not anyt hing t o act ually impr ove t he f abr ic of t he building. For inst ance, a complet e r ef ur bishment when t he pr oper t y is f ir st pur chased would not be an allowable deduct ion against r ent al income. I f a window get s br oken and a new pane is f it t ed, t hat is deduct ible as a maint enance or r epair cost .

(ii) I nsur ance

(iii) Management and agent s f ees

(iv) Rent collect ion cost s

(v) Adver t ising f or t enant s

(vi) 10% wear and t ear allowance - t his is only available f or f ur nished pr oper t y and is calculat ed as 10% x (r ent s less council t ax and wat er r at es).

Example 2

Comlet Limit ed let s a f ur nished pr oper t y on commer cial t er ms. The r ent al income char ged f or t he per iod t o 31 December 2006 was £ 20,000 r ising t o £ 22,000 f or t he per iod t o 31 December 2007.

Expenses r elat ing t o let t ing included: £ Wat er r at es 1,000 I nsur ance 500 Gr ound r ent 700

Agent ’s f ees amount ed t o 15% of r ent al income. I n November 2006 t he t enant accident ally damaged t he ceiling in t he living r oom. Comlet Limit ed t ook t he oppor t unit y t o r ef ur bish t he whole r oom at a t ot al cost of £ 4,000. The cost r elat ing t o r ect if ying t he damage amount ed t o only £ 500. Comlet Limit ed makes up account s f or t he year ended 31 Mar ch 2007. What is t he Schedule A income?

C9.3 Loan interest

For companies, interest on a loan taken out to purchase a rental property is not an allowable expense in ar r iving at t he income t axed under Schedule A. I nst ead t he loan int er est is t r eat ed as a non-t r ading loan r elat ionship debit under t he loan r elat ionship r ules. These ar e cover ed in a lat er chapt er .

C9.4 Schedule A losses

The r elief f or Schedule A losses is cover ed lat er in t he chapt er ent it led Relief f or Ot her Losses.

C9.5 Reverse premiums

A r ever se pr emium ar ises when a per son r eceives a payment to enter into a

lease. For many year s t he t ax t r eat ment of r ever se pr emiums was uncer t ain and of t en depended on t he f act s of t he case. Rever se pr emiums ar e revenue receipts. Wher e t hey ar e r eceived in connect ion wit h land used f or t he pur pose of a t r ade t hey will be a t r ading r eceipt , ot her wise t hey will be char geable t o Schedule A.

Par a 22 Sch 6

FA 1999

Gener ally t he pr emium will be t axed over t he lif e of t he lease. However t his r ule will not apply if t he lease is bet ween connect ed per sons and not on ar m’s lengt h t er ms in which case t he pr emium will be br ought in as a r evenue r eceipt in t he per iod t hat t he lease is ent er ed int o.

Par a 3 Sch 6

FA 1999

Under Sch 6 t he f ollowing are not cover ed by t he r ules:

• r eceipt s t aken account of f or capit al allowances;

Par a 5-7 Sch 6

FA 1999

• t r ansact ions r elat ing t o a PPR;

• t r ansact ions caught by t he sale and lease back r ules. A Revenue I nt er pr et at ion t ells us t hat t he aim of Sch 6 is t o t ax payment s or ot her benef it s which ar e inducement s t o ent er leases.

RI Dec 1999

The most common f or m of commercial inducements include:

• Rent f r ee per iods;

• Cont r ibut ion t o t enant cost s;

• Assumpt ion of t he t enant ’s liabilit ies;

• Wr it ing of f sums owed.

Sch 6 only char ges t hose inducement s t hat involve t he laying out of money not amount s f or gone or def er r ed. The f ollowing will not be taxed:

• Rent f r ee per iods;

• Replacing a lease when mar ket condit ions have changed so as t o r educe t he r ent ;

• Replacing an exist ing lease t o r emove clauses made oner ous by mar ket condit ions.

The Revenue have given guidance in r elat ion t o f it t ing out cost s. I f t he landlor d pays t he t enant ’s f it t ing out cost s t hen t his will be caught . However if t he t enant ef f ect ively r epays t he landlor d in t he f or m of higher r ent s t hen t his will not be caught .

I ncome f r om Pr oper t y 163


The Revenue give t he example of complet ion cost of a building. A t enant want s a special t ype of r oof and agr ees t o be r esponsible f or t he inst allat ion. Reimbur sement by t he landlor d of t he cost of inst alling t he r oof will not be t axable ir r espect ive of whet her t he landlor d r eimbur ses t he cost of a nor mal r oof or a specialist r oof as t o complet e t he building t her e must be a r oof .

C9.6 Real Estate Investment Trusts (REIT) s.103 FA 2006

For account ing per iods beginning on or af t er 1 J anuar y 2007 cer t ain qualif ying companies may, by giving not ice t o HMRC, be t r eat ed as a Real Est at e I nvest ment Tr ust (REI T).

A company which is a REI T will be exempt f r om cor por at ion t ax and capit al gains on it s exempt business.

par a 119 FA 2006

I n summar y, t o qualif y t he company must be a UK r esident company list ed on a r ecognised st ock exchange t hat is r ent ing out at least t hr ee pr oper t ies. The company must dist r ibut e at least 90% of it s pr of it s bef or e t he f iling dat e f or it s t ax r et ur n. Ther e ar e r ules r est r ict ing t he t ype of shar e capit al and t he maximum shar eholding allowed by any one shar eholder .

par a 107 FA 2006

When a REI T makes a dist r ibut ion it will not be t r eat ed as a dividend. I nst ead t he shar eholder s will be t r eat ed as r eceiving income f r om pr oper t y. Wher e t he shar eholder is a company t his will be t r eat ed as Schedule A income.

Answer 1

The r ent al income accr ues f or t he per iod 1 J uly 2006 t o 31 Mar ch 2007, which is a per iod of nine mont hs.

£ 24,000 x 9/ 12 = £18,000 Answer 2

Y/ e 31.3.07 £

Rent al income accr ued:

£ (20,000 x 912 ) + (22,000 x

312 )

20,500

Expenses: Agent ’s f ees: £ 20,500 x 15% (3,075) Redecor at ion Nil Wat er r at es (1,000) I nsur ance (500) Gr ound r ent (700) Wear and t ear : 10% x (20,500 – 1,000) (1,950) Schedule A income £13,275

165I ncome f r om Pr oper t y


SUMMARY – INCOME FROM PROPERTY

Schedule A income is t axed on an accr uals basis. Relief is given f or expenses incur r ed wholly and exclusively f or t he Schedule A business. I nt er est on loans t aken out t o buy pr oper t ies is never a Schedule A expense f or companies, it is inst ead r elieved under t he loan r elat ionship r ules. Rever se pr emiums ar e t axed as a r evenue r eceipt . The r ules only r elat e t o t he laying out of cash. Fr om 1.1.07 companies can, by giving not ice, t o be t r eat ed as a REI T. A REI T is exempt f r om cor por at ion t ax and capit al gains t ax. Shar eholder s r eceiving dist r ibut ions will be t r eat ed as r eceiving pr oper t y income.

C10: LOAN RELATIONSHIPS

This chapt er looks at loan r elat ionships cover ing in par t icular : - t he meaning of loan r elat ionship; - t r ade v non t r ade; - r elief f or non t r ade def icit s; - connect ed par t ies; - bad debt r elief ; - special r ules f or gr oups.

C10.1 Definition s.81 FA 1996

A loan r elat ionship is any transaction involving t he borrowing or lending of

money. For a loan r elat ionship t o exist t her e must be a t r ansact ion f or t he lending of money.

This will include interest received on bank accounts, int er est r eceived on loan stock or debent ur es or even int er est paid t o t he company by t he gover nment on a t ax r epayment . The loan r elat ionship r ules also cover interest paid by a company – f or example; int er est on a bank overdraft, debent ur e int er est paid t o loan st ockholder s or interest on a loan t aken out by t he company t o buy a new building or t o pur chase t r ading st ock.

We can conclude f r om t he above t hat what we need is a money debt t hat has ar isen f r om t he lending of money. Thus if a company was t o sell some shar es but did not immediat ely r eceive t he cash, we do not necessar ily have a money debt . Ther e is a debt - however , it ar ises f r om t he selling of t he shar es and not f r om t he lending of money. Money debt s include non-sterling cur r ency.

s. 81(1) FA 1996

s.81(6)

FA 1996

Wher e an inst r ument is dr awn up t o evidence t he money debt , t her e will be a t r ansact ion f or t he lending of money.

s. 81(3) FA 1996

Debt s ar ising in r elat ion t o shar es in t he company (f or example, non-payment of dividends) do not give r ise t o loan r elat ionships.

s. 81(4) FA 1996


Example 1

Which of t he f ollowing const it ut e a loan r elat ionship?

a) Debent ur es in a company

b) Gover nment gilt s

c) Bank deposit account

d) Bank over dr af t

e) Debt or s ledger

f ) Loan t o an employee

C10.2 Debits and credits s.84 –s.85 FA 1996

Debit s and cr edit s on loan r elat ionships f ollow t he account ing t r eat ment , i.e. t he pr of it and loss account def init ion, in t hat debits are expenses and credits are income. The r ule int r oduced in Finance Act 1996 is t hat t he amounts put

through the profit and loss account or income st at ement in accor dance wit h UK gener ally accept ed account ing pr act ice or int er nat ional account ing st andar ds, ar e t he amount s t hat ar e t ax deduct ible (if expenses) or t hat ar e t axable (if income). This includes amount s r ecognised:

• in t he company’s st at ement of r ecognised gains and losses or st at ement of changes in equit y, or

• in any ot her st at ement of it ems br ought int o account in comput ing t he company’s pr of it s and losses f or t hat per iod.

The amount s put t hr ough t he pr of it and loss account and ot her st at ement s f or account ing pur poses ar e int er est receivable and int er est payable. I t includes pr ior year adj ust ment s but not t he cor r ect ions of f undament al er r or s. I n t he case of a f undament al er r or t he company should amend t he r et ur n f or t he ear lier per iod. I t is not j ust int er est t hat comes wit hin t he loan r elat ionship r ules. All debits

and credits in relation to the debt liability ar e t axed under t he r ules.

Example 2

Which of t he f ollowing ar e eligible f or t ax r elief under t he loan r elat ionship r ules?

a) I nt er est payable

b) Ear ly r edempt ion penalt ies

c) Bank ar r angement f ees

d) Amount s wr it t en of f loans (bad debt s)

e) Loss on disposal of loan st ock

Loan Relat ionships

169

C10.3 Trading v non-trading s.82 FA 1996

A company can be eit her a debt or or a cr edit or in t er ms of a loan r elat ionship. I n eit her case t he t ax t r eat ment is det er mined by looking at whet her t he loan r elat ionship is trade or non-trade. Looking at t he posit ion wher e t he company is t he bor r ower , we ask “why did t he company bor r ow t he money”?

A trading purpose is def ined as a loan t aken out f or t he pur poses of t he t r ade. Gener ally speaking, t his is wher e t he funds are used to generate income which is taxed under Schedule DI. An example could be a loan t o buy st ock used in t he t r ade.

The loan equally may have been ent er ed int o f or a non-trading purpose. This is

wher e t he funds are used to generate income which is not taxed under DI. A good example of t his could be a loan t aken out t o buy unit s in a unit t r ust , which gener at es invest ment income r at her t han t r ading income.

Example 3

Classif y t he f ollowing loans bet ween t r ading and non-t r ading:

a) Loan t o buy a f act or y

b) Loan t o buy r ent al pr emises

c) Loan t o buy shar es on t he st ock mar ket

d) Loan t o buy shar es in a t r ading subsidiar y company

e) Funds lent t o a subsidiar y f or t he pur pose of it s t r ade. When we look at loans wher e t he company is t he cr edit or , we def ine t r ade and non-t r ade slight ly dif f er ent ly. This t ime we ask was t he lending of t he money done as an int egr al par t of t he company’s t r ade? Her e t he answer will only be “yes” in t he case of banks and f inancial inst it ut ions.

C10.4 Tax treatment

This can best be summar ised by a f lowchar t :


C10.5 DIII loss relief

The r ules f or r elief f or Schedule D Case I I I def icit s (or “DI I I losses”) ar e ver y similar t o t he r ules r elat ing t o Schedule D Case I losses, which will be cover ed in a lat er chapt er .

s. 83(2) FA 1996

Illustration 1

Assume a company t akes out a loan of £ 100,000 t o buy a por t f olio of quot ed shar es. I nt er est payable on t he loan is £ 10,000 per annum.

This is quit e clear ly a non-t r ade loan as t he income gener at ed by t he quot ed shar es will be dividend income which is not t axed under Schedule DI . Assume t he company has a bank deposit account which ear ns int er est of £ 6,000 per annum. This int er est is t axable under Schedule DI I I . I nt er est payable on non-t r ading loans is deduct ed f r om DI I I income as f ollows;

Schedule DI I I cr edit s 6,000 Schedule DI I I debit s (10,000) DI I I loss £ (4,000)

DI I I income DI I I loss or def icit

Tr ading

DI expense DI income

Cr edit Debit

Non t r ading

Debit Cr edit

Pool

NET

DEBI T NET

CREDI T

Pur pose of t he loan?

Loan Relat ionships

171

The next st ep t o consider is what t he company can do wit h t his DI I I loss? 1. Relief is allowed in t he current year against other income bef or e char ges

including capit al gains. This is given in pr ior it y t o Schedule D Case I cur r ent year loss r elief . Ther ef or e if a company makes DI I I and DI losses in t he same year , and makes t wo separ at e cur r ent year claims, t he DI I I loss claim will be r elieved f ir st ; or

s.83(2)(a) FA 1996

2. Ther e is a car r y back pr ovision, wher eby t he Schedule DI I I loss can be

carried back one year and set against DIII income in t he pr evious account ing per iod. This is DI I I as r educed by any char ges on income or ot her losses, in t he pr evious year ’s comput at ion. This is t he only claim which is det er mined by a set f or mula and is not ent ir ely open t o t he company t o decide; or

s.83(2)(c) FA1996

3. DI I I def icit s ar e available f or group relief by allowing t he loss t o be t r ansf er r ed t o a f ellow 75% gr oup company. These r ules will be cover ed in det ail in a lat er chapt er ; or

s.403

I CTA 1988

4. Carry forward t he DI I I loss, and set it against future non-trading profits.

This is basically any income and gains in t he f ut ur e year , except DI .

s.83(3A) FA1996

I t should be appr eciat ed t hat all of t hese claims ar e independent and we can

make a cur r ent year claim bef or e we car r y back or a gr oup r elief claim whenever we want t o, et c.

What we gener ally must r emember is t he two key rules f or r elieving losses:

(i) set t hem of f against t he income subj ect t o t ax at t he highest marginal

rate; and (ii) t r y t o r elieve t hem earlier rather than later.

I n t he claim, we must specify the amount that we wish to relieve and

t her ef or e, it does gives us f lexibilit y t o use par t of t he loss in say, t he cur r ent year , and par t of it by say gr oup r elief , if t hat is what we want t o do.

To t he ext ent t hat t he DI I I def icit is not used by gr oup r elief , cur r ent year claim or car r y back it will go f or war d t o be used against non-t r ading pr of it of t he succeeding account ing per iod. The company will have two years to make a claim

not to have the deficit set off against non-trading profit in t he succeeding account ing per iod.

Par a 4 Sch 8

FA 1996


Example 4

Which of t he f ollowing is not available t o r elieve a Schedule D Case I I I def icit ?

a) Set of f against gener al income in t he cur r ent year

b) Set of f against gener al income in t he pr eceding 12 mont hs

c) Gr oup r elief

d) Car r y f or war d against non-t r ading pr of it s in f ut ur e per iods

C10.6 Connected parties s.87 & 87A

FA 1996

Wher e t he par t ies ar e connect ed, t he only accounting basis t hat can be used is t he amortised cost basis.

C10.7 Late interest Par a 2 Sch 9 FA 1996

Wher e t he par t ies t o a loan r elat ionship ar e connected and t he int er est is not paid within 12 months of the end of the accounting period, a debit f or t hat int er est will not be allowed unt il it has been paid if t he cr edit or is not wit hin t he char ge t o cor por at ion t ax in r espect of t he loan - f or example wher e t he cr edit or is t he over seas par ent of t he debt or . Example 5

When is int er est deduct ible on a paid basis?

a) I f t he int er est r emains unpaid 12 mont hs af t er t he year end; or

b) Wher e t he bor r ower and lender ar e connect ed; or

c) Wher e t he lender is not char geable t o cor por at ion t ax; or

d) Wher e all of t he above apply.

C10.8 Bad debt relief – impairment losses

Bad debt s ar e r ecor ded in a company’s account s as “impair ment losses”. Tax r elief is obt ained f or such impair ment losses simply by t he t ax t r eat ment f ollowing t he account ing t r eat ment . Wher e companies ar e connect ed at any t ime in an account ing per iod, t he cr edit or company cannot br ing in debit s r elat ing t o amount s wr it t en of f a loan r elat ionship. The ar e t wo except ions t o t his r ule f or connect ed par t y loans:

i. When t her e is a f or giveness of debt f or equit y and no connect ion exist ed bef or e t he equit y was issued. I n which case a debit is allowed in t he account ing per iod of t he issue only and only in r elat ion t o t he debt equit y swap.

ii. When t he cr edit or is in insolvent liquidat ion

Loan Relat ionships

173

A connect ion bet ween companies may cease whilst a debt is st ill in exist ence f or example if t he debt or company is sold out of t he gr oup.

C10.10 Impairment losses and consortium relief

Wher e t her e is a consor t ium t he companies will not always be connect ed f or t he pur poses of loan r elat ionships.

Par a 5A Sch 9

FA 1996

As a r esult r elief f or impair ment losses will be available t o consor t ium member s.

I f r elief has been allowed f or impair ment losses t o a consor t ium member or gr oup member via a link company, t hen t her e will be a r est r ict ion on t he consor t ium r elief t hat can be claimed. The amount of consor t ium r elief t hat can be claimed is r educed by t he debit s alr eady allowed in ear lier account ing per iods f or impair ment against t he loan.

Illustration 2

M Lt d holds 30% of CC Lt d. M Lt d has made a loan of £ 1,000,000 t o CC Lt d. CC Lt d has been exper iencing pr oblems f or many year s and t o dat e £ 250,000 of t he loan has been wr it t en of f . I n t he per iod t o 31 Mar ch 2007, M Lt d makes a consor t ium r elief claim f or losses of £ 300,000 f r om CC Lt d. The losses under t he consor t ium claim will be r educed t o £ 50,000 t o t ake account of t he bad debt r elief pr eviously given.

C10.11 Loans for an unallowable purpose

No debit s will be allowed unless t he loan is f or an allowable pur pose. Two classes of unallowable pur pose ar e set out in t he legislat ion:

(i) t he loan is in r elat ion t o any par t of t he company’s activities which are not

within the charge to corporation tax; or

(ii) t he main pur pose of t he loan is tax avoidance.

Tax avoidance is def ined as secur ing a t ax advant age. This is a ver y wide def init ion as set down by s.703 I CTA 1988.

C10.9 Impairment and cessation of connection Par a 6c Sch 9 FA 1996

The cr edit or company cannot br ing in any debit s t hat r elat e t o ear lier wr it e-downs in t he account s t hat wer e not r elieved because of Par a 6 Sch 9 FA 1996.

Par a 6c Sch 9 FA 1996

A company does not have t oo br ing a cr edit int o account f or r ever sal of an impair ment loss t hat has been disallowed because t he companies ar e connect ed.

Par a 6 (3A) Sch 9

FA 1996


C10.12 Money debts etc not arising from the lending of money s.100 FA 1996

Wher e t her e is a money debt which ar ises f r om a t r ansact ion which is not f or t he lending of money and t he money debt is one:

i. on which int er est is payable t o or by t he company; or

ii. in r elat ion t o which exchange gains or losses ar ise t o t he company; or

iii. in r espect of which a payment would f all t o be br ought int o account

f or t he pur poses of cor por at ion t ax as a r eceipt of a t r ade, Schedule A business or over seas pr oper t y business and in r elat ion t o which an impair ment loss (or r ever sal) ar ises t o t he company; or

iv. wher e a discount ar ises

there is deemed to be a loan relationship, but t he only debit s or cr edit s t o be br ought in ar e t hose r elat ing t o t he mat t er s st at ed above.

S.100 also pr ovides t hat int er est payable/ r eceivable under t he Taxes Act ar e t o be t r eat ed as non t r ading debit s or cr edit s. As a r esult of t he amendment s t o s.100 we will now see pr ovisions against t r ade debt or s being r elieved under t he loan r elat ionship r ules. Remember t hat under I AS no gener al pr ovisions will be allowed - all pr ovisions will be specif ic.

Loan Relat ionships

175

Answer 1

All but the debtors ledger (e) – t his is not a loan r elat ionship as it has not ar isen t hr ough t he lending of money but t hr ough t he company selling goods or pr oviding ser vices t o a cust omer .

Answer 2

All items are tax deductible as t hey ar e all amount s put t hr ough t he account s r elat ing t o a loan.

Answer 3

(a) The loan t aken out t o buy t he f act or y is a trading loan, pr oviding t he f act or y is used by t he company f or t he pur pose of it s t r ade.

(b) The loan t aken out t o buy r ent ed pr emises gener at es Schedule A income,

t her ef or e, as t his is not DI , it is a non-trading loan.

(c) The loan t aken out t o buy shar es on t he st ock mar ket pr oduces dividend income, again t his is not DI , so is a non-trading loan.

(d) Equally t he loan t aken out t o buy shar es in t he t r ading subsidiar y, is also a

non-trading loan because, again t hese shar es will gener at e dividend income. I t doesn’t mat t er what t he subsidiar y act ually does, what is impor t ant is t hat we ar e buying shar es and shar es do not gener at e t r ading income (unless t he company is a shar e dealing company).

(e) The loan t aken out t o lend money t o a subsidiar y f or t he pur poses of it s

t r ade is again a non-trading loan, because t he loan is not t aken out t o f und t he t r ade of t he lending company. This of cour se is on t he assumpt ion t hat t he lending company is not a bank.

Answer 4

The answer is (b)

The set of f is against DI I I income (not gener al income) of t he pr eceding 12 mont hs.

Answer 5

The answer is (d)


SUMMARY – LOAN RELATIONSHIPS

A loan r elat ionship ar ises when t her e is t he lending of money. I nt er est payable on t r ading loans is deduct ed f r om DI income. I nt er est payable on non t r ading loans (e.g. int er est on a loan t o buy an invest ment pr oper t y) is deduct ed f r om DI I I income. I nt er est r eceivable will be t r eat ed as DI I I in most cases. DI I I debit s and cr edit s ar e pooled if t he DI I I debit s exceed t he DI I I cr edit s t hen loss r elief is available f or t he r esult ing def icit . A DI I I def icit can be set of f against ot her income in t he cur r ent year , gr oup r elieved, car r ied back or car r ied f or war d. Special r ules apply f or connect ed par t ies. They must use t he amor t ised cost basis of account ing. Bad debt r elief will not usually be available and int er est unpaid mor e t han t welve mont hs af t er t he year end will not be allowed a deduct ion if t he r ecipient is not char geable t o UK t ax. I mpair ment of t r ade debt or s has been br ought wit hin t he loan r elat ionship r ules as have all money debt s wit h discount s. Ther e ar e ant i-avoidance r ules t o deal wit h loans f or unallowable pur poses.

C11: RELIEF FOR TRADING LOSSES

This chapt er examines t he r elief available t o a company when it makes a t r ading loss in par t icular : - t he availabilit y of r elief f or t r ading losses in t he cur r ent and ear lier account ing

per iods; - t he ef f ect of car r ying f or war d t he t r ading loss t o a lat er per iod.

C11.1 Introduction

A company makes a loss when it s income is less t han it s expenses. The loss per t he account s is adj ust ed f or t he nor mal t ax deduct ions, such as disallowed expendit ur e (e.g. ent er t aining, depr eciat ion) and can be incr eased by claiming capit al allowances. A company may not wish t o claim all of t he capit al allowances in or der t o r educe t he amount of loss.

Wher e t he adj ust ed Schedule D Case I f igur e is a loss, t he Schedule D Case I

assessment in t he cor por at ion t ax comput at ion will be nil. The loss it self is r elieved by making a number of separ at e claims.

C11.2 Relief for trading losses

Ther e ar e a number of opt ions available:

(i) Set against t ot al pr of it s bef or e char ges in t he cur r ent account ing per iod.

s.393A(1)(a) I CTA 1988

(ii) Carry back and set against total profits before non-trade charges in

t he pr eceding 12 months.

s.393A(1)(b) I CTA 1988

(iii) Carry forward and set against next available future profits from the

same trade.

s.393(1)

I CTA 1988

(iv) Surrender t he loss to a fellow 75% owned group company. This t ype of

r elief is known as gr oup r elief . These r ules will be cover ed in a lat er chapt er .

s.402 I CTA 1988

C11.3 Current year relief

The loss is set against t ot al profits before charges of t he cur r ent year . The claim must be f or t he lower of t he available loss or t he available pr of it . I n ot her wor ds, no par t ial claims ar e allowed, t he claim must eit her use all of t he loss, or eliminat e all of t he available pr of it s.

s. 393A(1)(a)


Illustration 1

Lossingt on Lt d has t he f ollowing r esult s f or t he year t o 31 Mar ch 2007: £ Tr ading loss (70,000) Char geable gains 15,000 Schedule A 21,000 Char ge on income (3,000) The cur r ent year claim under s.393A(1)(a) will be as f ollows:

12m t o 31.3.07

£ Schedule DI Nil Schedule A 21,000 Char geable gains 15,000 Tot al pr of it s 36,000 s.393A(1)(a) Cur r ent year loss (36,000) - Char ge on income Unr elieved PCTCT -

As t he loss is of f set bef or e t he deduct ion f or char ges on income, t he char ge her e is unr elieved. The unr elieved t r ading loss of £ 34,000 will be car r ied f or war d against f ut ur e pr of it s f r om t he same t r ade. This is summar ised in a loss memor andum as f ollows:

Loss memor andum £ Loss (y/ e 31.3.07) 70,000 Cur r ent year claim s.393A(1)(a) (36,000) Unr elieved loss t o car r y f or war d £ 34,000

C11.4 Unrelieved charges

Unr elieved trade charges may be car r ied f or war d and set against f ut ur e pr of it s of t he same t r ade i.e. t hey ar e added to the s.393(1) loss car r y f or war d. However , f ollowing t he int r oduct ion of t he IFA r ules wit h ef f ect f r om 1 Apr il 2002, t r ade char ges became ver y r ar e, and, looking f or war d, t r ade char ges no longer exist . Ther ef or e, it makes sense t o ignor e t hem f or t he r est of t his session.

Relief f or Tr ading Losses

179

Non-trade charges, such as Gif t Aid payment s, ar e lost if t her e is no pr of it in t he cur r ent year t o set t hem against . They cannot be car r ied f or war d.

C11.5 Carry back of losses

The claim t o carry back a loss under s.393A(1)(b) may only be made once a

current year claim has been made, under s.393A(1)(a) – i.e. (a) bef or e (b). s. 393A(1)(b)

The loss car r ied back is set against pr of it s in t he previous 12 months, bef or e any non-t r ade char ges. As wit h t he cur r ent year claim, t he car r y back claim must be f or t he lower of t he available loss or t he available pr of it . Illustration 2

Assume in t he last illust r at ion t hat Lossingt on Limit ed had t he f ollowing income in t he pr evious 12 mont h account ing per iod, t he year ended 31 Mar ch 2006: £

Schedule D Case I 10,000 Schedule A 21,000 Gif t Aid payment (1,000)

As a cur r ent year claim t o use t he loss in t he year ended 31 Mar ch 2007 has alr eady been made, we can now car r y t he loss back t o t he year ended 31 Mar ch 2006. The car r y back claim under s.393A(1)(b) will be 12m t o 31.3.06

£

Schedule D Case I 10,000 Schedule A 21,000 Tot al 31,000 Cur r ent year loss (nil as t here is no loss in t his year ) -

_____ 31,000 s.393A(1)b Losses car r ied back (31,000) Nil Non-t r ade char ges (Gif t Aid) Unr elieved PCTCT Nil


This f ur t her use of t he loss can again be shown in t he loss memor andum as f ollows:

Loss Memo: £ Tot al loss 70,000 Cur r ent year claim (f r om I llust r at ion 1) (36,000) 34,000 Car r y back claim s.393A(1)(b) (31,000) Loss t o car r y f or war d £ 3,000

I f a company wishes t o make a claim under s. 393(A) t o use it s losses in t he cur r ent year / pr eceding year , it must notify the Revenue within two years of t he end of t he account ing per iod in which t he loss was made. I n t his example a claim must be made no lat er t han 31 Mar ch 2009. The Revenue may ext end t his t ime limit at t heir discr et ion.

C11.6 Losses carried forward

The losses ar e set against t he f ir st available f ut ur e pr of it s f r om t he same t r ade under s.393(1) i.e. against DI income only.

s. 393(1)

No claim is r equir ed as t he r elief is given automatically. The r elief is compulsor y

- if we have a loss br ought f or war d, it will aut omat ically be set against t he next available f ut ur e pr of it s f r om t he same t r ade.

Illustration 3

I n t he Lossingt on Limit ed illust r at ion t her e is an unr elieved loss of £ 3,000. Assume t he company has t he f ollowing r esult s in t he year ended 31 Mar ch 2008: Schedule D Case I £ 15,000 Schedule A £ 21,000 The r elief available under s.393(1) will be as f ollows:

£ Schedule D Case I 15,000 s.393(1) loss br ought f or war d (3,000) 12,000 Schedule A 21,000 PCTCT £ 33,000

Finally her e let ’s show t he comput at ions of PCTCT f or all t hr ee year s her e in columns next t o each ot her , as you would pr obably set it out like t his in an examinat ion quest ion:


181

Year ended 31 Mar ch 2006

£ 2007

£ 2008

£ Schedule D Case I 10,000 nil 15,000 Less losses b/ f wd - - (3,000) 10,000 nil 12,000 Schedule A 21,000 21,000 21,000 Char geable gains - 15,000 - 31,000 36,000 33,000 Less cur r ent year loss ______ (36,000) _____ 31,000 nil 33,000 Less car r ied back loss (31,000) _____ _____ nil nil 33,000 Less non t r ade char ges Lost Lost - PCTCT nil nil 33,000

Example 1

X plc has t he f ollowing r esult s: Y/ e 31.3.06

£ Y/ e 31.3.07

£ Y/ e 31.3.08

£ Schedule DI pr of it 100,000 nil 14,000 Tr ading loss (150,000) Schedule DI I I 10,000 12,000 5,000 Char geable gain 12,000 - - Non t r ade char ge (500) (500) (500) You ar e r equir ed t o:

(a) Show how t he t r ading loss will be r elieved assuming r elief is r equir ed as ear ly as possible

(b) List any amount s t o be car r ied f or war d, indicat ing t he r elief available

(c) Calculat e t he r epayment of t ax due t o X plc as a r esult of t he loss r elief .

C11.7 Carry back complications

Remember t hat t he car r y back of a loss is f or a f ull 12 mont h per iod. I f t he

pr evious account ing per iod is less t han 12 mont hs, you can car r y back t o t he per iod bef or e t hat one by applying time apportionment to the profits before

charges of the previous period.


Example 2

Losst er Limit ed has t he f ollowing r esult s in r ecent year s:

Y/ e 30.9.05

£

6m/ e 31.3.06

£

Y/ e 31.3.07

£

Y/ e 31.3.08

£ Schedule D Case I 26,000 12,000 nil 6,000 Tr ading loss (50,000) Schedule A 10,000 5,000 10,000 10,000 Non-t r ade char ges (1,000) (1,000) (1,000) (1,000)

(a) What will t he S. 393A(1)(a) claim be?

(b) What will t he S. 393A(1)(b) claim be?

(c) How much loss will be r elieved under S. 393(1)?


183

Answer 1

(a) X plc Year ended 31 Mar ch 2006

£ 2007

£ 2008

£ Schedule D Case I 100,000 nil 14,000 Less losses b/ f wd - - (14,000) 100,000 nil nil Schedule DI I I 10,000 12,000 5,000 Char geable gains 12,000 - - 122,000 12,000 5,000 Less cur r ent year loss ______ (12,000) _____ 122,000 nil 5,000 Less car r ied back loss (122,000) _____ _____ nil nil 5,000 Less non t r ade char ges Lost Lost (500) PCTCT Nil Nil 4,500 (b) Loss Memo: £ Loss y/ e 31.3.07 150,000 Used cur r ent year 31.3.07 (12,000) Used pr evious year 31.3.06 (122,000) Available t o car r y f or war d 16,000 Used f ollowing year 31.3.08 (14,000) Loss available t o c/ f wd 2,000

(c) Tax r epayment y/ e 31 Mar ch 2006 Or iginal comput at ion: £ DI pr of it 100,000DI I I 10,000Gain 12,000 122,000Less: non t r ade char ge (500)PCTCT 121,500 GCT @ 19% £ 23,085

The whole of t he t ax of £ 23,085 will be r epaid as PCTCT is r educed t o nil af t er t he car r y back of losses.


Answer 2

(a) Cur r ent Year Claim

Y/ e 31.3.07 £

Schedule D Case I Nil Schedule A 10,000 Tot al Pr of it s 10,000 s.393A(1)(a) current year loss (10,000)

Nil Non-t r ade char ges Unr elieved PCTCT Nil

Loss Memo:

£ Tot al loss 50,000 Cur r ent year claim (10,000)

£ 40,000

The unr elieved non t r ade char ges will be lost .

(b) Losses Car r ied Back

Y/ e 30.9.05

£ 6m/ e 31.3.06

£ Schedule D Case I 26,000 12,000 Schedule A 10,000 5,000 36,000 17,000 s.393A(1)(b) loss brought back (18,000)* (17,000)

18,000 Nil Non-t r ade char ges (1,000) Unr elieved PCTCT £ 17,000 Nil

* The t ime appor t ioned car r y back is calculat ed on pr of it s bef or e char ges

i.e. £ 36,000 x 612 = £ 18,000.


185

(c) Loss Car r ied For war d

Y/ e 31.3.08

£ Schedule D Case I 6,000 Losses brought forward (5,000)

1,000 Schedule A 10,000 11,000 Non-t r ade char ges (1,000) PCTCT £10,000

Loss memo: £ Tot al loss 50,000 Cur r ent year (10,000) Car r ied back t o 6m/ e 31.3.06 (17,000) t o 12m/ e 30.9.05

£ 36,000 x 612 (18,000)

Car r ied f or war d 5,000 Of f set in y/ e 31.3.08 (5,000) Car r ied f or war d Nil


SUMMARY – RELIEF FOR TRADING LOSSES

When a company makes a t r ading loss it can r elieve it against t he pr of it s of : (i) t he same account ing per iod, t hen (ii) t he pr evious 12 mont hs, and any unused loss is t hen aut omat ically (iii) c/ f wd against f ut ur e t r ading pr of it s only. A car r y back claim can only be made af t er a cur r ent year claim has been made. Bot h claims ar e all-or -not hing – par t ial claims ar e not per mit t ed. The t ime limit f or t hese claims is t wo year s f r om t he end of t he loss making account ing per iod. Car e needs t o be t aken if t her e is a shor t account ing per iod, as t he car r y back must be against 12 mont hs wor t h of pr of it s, if t he loss is lar ge enough.

When a loss is car r ied back it will gener at e a r epayment of CT paid f or t he ear lier account ing per iod.

C12: RELIEF FOR OTHER LOSSES

This chapt er examines t he r elief available t o a company when it makes ot her losses, cover ing in par t icular : - Schedule A losses; - Management expenses; - Capit al losses; - Ter minal loss r elief ; - Schedule DI I I losses; - Schedule DVI losses on I FAs.

C12.1 Other losses

Ot her losses include:

(i) Schedule A losses, on pr oper t y income;

(ii) Excess management expenses, f or companies wit h invest ment business;

(iii) Capit al losses.

(iv) Schedule D Case I I I losses, being def icit s on non t r ading loan r elat ionships;

(v) DVI losses on I FAs C12.2 Schedule A losses

A company may r ent out a number of dif f er ent pr oper t ies, some may make a

pr of it , some a loss. All of t he results of each property are pooled together int o a Schedule A pool, ver y similar t o t he r ules f or pooling debit s and cr edit s f or loan r elat ionships.

Wher e t he pool pr oduces a net pr of it , t his is simply t axed under Schedule A as

income. Wher e t he pool pr oduces a net loss, r elief will be available.

I nit ially Schedule A losses must be set against other profits in the current

accounting period. No claim is r equir ed as t he r elief is aut omat ic. The set of f is compulsor y and when we make a Schedule A loss, we simply include a negat ive f igur e in t he cor por at ion t ax comput at ion.

s.392A I CTA 1988

The r elief is given in priority t o any DI losses of t hat year . The excess

Schedule A loss, i.e. t he amount of t he Schedule A loss t hat exceeds pr of it s t he cur r ent year , will be available for group relief by sur r ender ing it t o f ellow 75% gr oup companies. A claim is r equir ed under S. 402 I CTA 1988.


I f gr oup r elief does not r elieve t he r est of t he loss or is not available, t he loss is automatically carried forward and t r eat ed as a Schedule A loss of t he next per iod and t hus it is possible t o set it against ot her pr of it s in t hat f ut ur e per iod.

Losses on over seas pr oper t ies (Schedule DV Losses) ar e pooled t oget her wit h pr of it s on over seas pr oper t ies. Any r esult ing loss is t hen car r ied f or war d and set against Schedule DV pr of it s of f ut ur e account ing per iods. Ther e is no “mixing and mat ching” of DV losses wit h Schedule A pr of it s. Remember t hat a Schedule A loss is aut omat ically set against cur r ent year income (which could include income t axed under DV).

s.392B

C12.3 Management expenses

Management expenses ar e set against investment income and gains in t he

current account ing period. This r elief , like t hat f or Schedule A losses, is aut omat ic and compulsor y.

To t he ext ent t hat t he management expenses exceed cur r ent year income and

gains, t hey ar e “excess”. Like Schedule A, t hey may be group relieved or , f ailing t hat , t hey ar e carried forward against future income and gains of any descr ipt ion.

C12.4 Capital losses

Capital losses may only be carried forward against future capital gains.

Ther e is no cur r ent year r elief against income, t her e is no car r y back and no gr oup r elief . However , gr oup companies can make not ional t r ansf er s t o ensur e gains and losses in dif f er ent gr oup companies ar e set of f against each ot her . This is cover ed in mor e det ail in a lat er chapt er .

C12.5 Terminal loss relief s.393A(7)

When a company ceases t o t r ade, and it makes a loss in t he f inal per iod, it is not possible t o car r y t he loss f or war d, as t her e will be no f ut ur e pr of it s (and no f ut ur e t r ade). I n t his sit uat ion, t he loss of t he f inal 12 mont hs of t r ade can be car r ied back against t he pr of it s of t he pr evious 3 year s. This ef f ect ively ext ends t he claim under s393A(1) beyond t he nor mal 12 mont h car r y back. Losses ar e r elieved f ir st against any pr of it s of t he f inal per iod (bef or e char ges), t hen ar e car r ied back f or a maximum of 36 mont hs against lat er per iods bef or e t hose of ear lier per iods.

Relief f or Ot her Losses

189

C12.6 Schedule DIII losses s.83 FA 1996

I nt er est paid and int er est r eceived on non-t r ading loan r elat ionships is pooled t oget her t o give a Schedule DI I I cr edit (“pr of it ”) or a Schedule DI I I def icit (“loss”). The possible claims a company can make t o use a DI I I loss ar e:

(i) Set against any pr of it s of t he same account ing per iod; or

(ii) Set against DI I I pr of it s of t he pr evious 12 mont hs; or

(iii) Sur r ender t o a company in t he same gr oup (“gr oup r elief ”). DI I I losses ar e ver y f lexible – i.e., t he company can car r y back t he loss wit hout f ir st having t o use t he loss in t he cur r ent year . DI I I losses ar e used in pr ior it y t o DI t r ading losses and Schedule A losses:

£ I ncome f or per iod X Less DI I I def icit (X) Less Schedule A loss (X) Less t r ading losses (X) PCTCT X

To t he ext ent t hat a DI I I def icit has not been used by gr oup r elief , a cur r ent year claim or a car r y back claim, it will go f or war d t o t he succeeding account ing per iod t o be set against non DI income and gains. I f t he company does not want t his aut omat ic set of f in t he next account ing per iod t hen t hey have t wo year s t o make a claim so t hat all or par t of t he def icit car r ied f or war d is not so set of f .

s.83(3A) Par a 4 Sch 8

FA 1996

C12.7 The carry back of a DIII deficit

The car r y back claim is an all or not hing claim as it has t o be made f or t he lower of :

Par a 3 Sch 8

FA 1996

(i) t he DI I I def icit available f or car r y back and

(ii) t he pr of it s available t o set it of f against . The DI I I def icit available t o car r y back is t he def icit of t he cur r ent year t o t he ext ent t hat it has not been r elieved by a cur r ent year or gr oup r elief claim.

C12.8 DVI losses on IFAs Par a 35 Sch 29 FA 2002

Wher e a company incur s a non-t r ading loss on I FAs, it has t wo year s f r om t he end of t he account ing per iod of t he loss t o make a claim t o set t he whole or par t of t he loss against t ot al pr of it s of t hat per iod. Alt er nat ively excess DVI losses can be gr oup r elieved.


Ot her wise t he loss is car r ied f or war d and t r eat ed as a non-t r ading debit ar ising in t he next account ing per iod.

C12.9 Losses summary

DI trading losses DIII deficits

Schedule A losses/

Management

Expenses/DVI losses on

non trade IFAs

CURRENT

YEAR

Pr of it s bef or e Char ges

Pr of it s bef or e Char ges

(in pr ior it y t o bot h DI and Sch A losses)

Pr of it s bef or e

Char ges (compulsor y of f set f or Sch A and management

expenses)

CARRY

BACK

12 mont hs – against pr of it s bef or e non-

t r ade char ges (must do cur r ent year claim f ir st )

12 mont hs – against DI I I only

(no need t o cur r ent year claim f ir st )

N/ A

CARRY

FORWARD

Fut ur e pr of it s of same t r ade (aut omat ic)

Any f ut ur e pr of it s except DI

(can claim f or t his not t o occur )

Any pr of it s

GROUP

RELIEF Whole loss Whole def icit

Excess amount only (i.e. must use in CY

bef or e gr oup r elieve)

Relief f or Ot her Losses

191

SUMMARY – RELIEF FOR OTHER LOSSES

Schedule A losses must be set -of f against any pr of it s of t he cur r ent per iod. I f excess losses r emain t hese can be car r ied f or war d against f ut ur e pr of it s. Excess Schedule A losses can be also be gr oup r elieved. Management expenses f or an invest ment company must be set -of f against any pr of it s of t he cur r ent per iod. I f excess management expenses r emain t hese can be car r ied f or war d against f ut ur e pr of it s. Excess management expenses can be also be gr oup r elieved. Capit al losses can only be used t o r elieve capit al gains of t he same or lat er account ing per iods. Wher e t he company ceases t o t r ade, t he t r ading loss of t he last 12 mont hs can be car r ied back against pr of it s bef or e non t r ade char ges of t he last 36 mont hs r at her t han t he nor mal 12 mont hs. Schedule DI I I losses can also be of f set against any pr of it s in t he per iod, alt hough a 12 mont h car r y back against DI I I income is also possible. They can also be gr oup r elieved. These claims can be done in any or der and ar e ver y f lexible. Unused DI I I losses ar e aut omat ically car r ied f or war d against f ut ur e non t r ading income and gains unless t he company elect s f or t hem not t o be of f set in t his way. DVI losses on I FAs can be used in t he cur r ent per iod against ot her income, gr oup r elieved (if excess) or car r ied f or war d.

C13: CORPORATE CAPITAL GAINS

This chapt er explains how companies pay cor por at ion t ax on capit al gains cover ing in par t icular : - how we calculat e t he gain char geable; - what r elief is available against a capit al gain.

C13.1 Introduction

A company pays corporation tax on capital gains ar ising on t he disposal of char geable asset s. Most capit al asset s ar e char geable wit h a number of minor except ions, e.g. car s. The def init ion of a car does not ext end t o vans and ot her commer cial vehicles which may give r ise t o char geable gains wher e t hey ar e sold at a pr of it .

Individuals pay capital gains tax (CGT) on disposals, wher eas companies pay cor por at ion t ax. The r ules f or comput ing gains f or companies ar e ver y similar t o t he r ules t hat apply t o individuals. However , companies cont inue t o claim indexat ion allowance beyond 5 Apr il 1998 when it was f r ozen f or individuals. Companies ar e not eligible f or t aper r elief , nor ar e t hey ent it led t o an annual exempt ion.

C13.2 Computation of gains

The pr of or ma f or comput ing gains f or a company is shown below. We st ar t wit h sale pr oceeds f r om which we can deduct any incident al cost s such as solicit or ’s or sur veyor ’s f ees, et c.

We deduct t he cost of t he asset s which will also include any enhancement expendit ur e and ot her incident al cost s of acquisit ion. That gives us t he unindexed gain. We t hen deduct indexat ion allowance, which is an allowance f or inf lat ion, t o give t he indexed gain, which is t he gain we subj ect t o cor por at ion t ax.

£

Pr oceeds X

Less: cost (X)

Unindexed gain X

I ndexat ion allowance (X)

I ndexed gain X

Cor por at e Capit al Gains

193

Illustration 1

Viscount Limit ed sold a f act or y f or £ 1,200,000 on 30 Sept ember 2006. Solicit or s f ees amount ed t o £ 2,000. The f act or y had been pur chased in May 1992 at a cost of £ 350,000. The capit al gain will be comput ed as f ollows:

£

Pr oceeds 1,200,000 Less incident al selling cost s (2,000) 1,198,000 Cost (350,000) Unindexed gain 848,000

I ndexat ion (£ 350,000 at , say, 50%) (175,000) I ndexed gain £ 673,000

C13.3 Indexation allowance

The indexat ion f act or is calculat ed by t aking t he movement in t he Retail Price Index (RPI ) between the date of acquisition of the asset and the date of

sale. Wher e t her e is enhancement expendit ur e, we also look at t he movement in t he Ret ail Pr ice I ndex bet ween t he dat e t he enhancement expendit ur e was incur r ed and t he dat e of disposal.

The RPI s ar e given in t he t ax t ables accompanying t his cour se.

The indexat ion f act or is comput ed using t he f or mula:

RPI at sale – RPI at acquisition

RPI at acquisition

The r esult of t his is r ounded t o t hr ee decimal places or can be expr essed as a per cent age.

Illustration 2

I n t he pr evious illust r at ion, Viscount Limit ed, we assumed t he indexat ion f act or was 50%. The cor r ect indexat ion f act or f or May 1992 t o Sept ember 2006 is:

197.0 – 139.3 139.3 = 0.414213926 = 0.414 (or 41.4%) The cor r ect gain is t her ef or e: £ Unindexed gain 848,000 I ndexat ion (£ 350,000 x 41.4%) (144,900) I ndexed gain £ 703,100


Example 1

Cr est a Limit ed pur chased a war ehouse in May 1989 f or £ 425,000 and incur r ed

solicit or ’s and sur veyor ’s f ees on t his pur chase amount ing t o £ 2,000. St amp Dut y Land Tax was char ged at 3% on t he pur chase pr ice and t his was payable by Cr est a Limit ed. The war ehouse is sold in J anuar y 2007 f or £ 1.5 million and solicit or ’s f ees of £ 3,000 wer e incur r ed. You ar e r equir ed t o calculat e t he indexed capit al gain assuming t he RPI in J anuar y 2007 is 198.6.

13.4 Enhancement expenditure

Enhancement expenditure is added to the “base cost”, or allowable cost , of t he asset . I t may need t o be indexed separ at ely if t he enhancement occur s in a mont h ot her t han t he mont h of acquisit ion of t he asset .

Illustration 3

Assume in t he Viscount Limit ed illust r at ion t hat t he f act or y was ext ended in Oct ober 1996 at a cost of £ 200,000. For simplicit y we will ignor e t he incident al selling cost s now.

£ Pr oceeds (Sept 2006) 1,200,000Cost (May 1992) (350,000)Enhancement (Oct 1996) (200,000)Unindexed gain 650,000

I ndexat ion on cost May 1992 t o Sept 2006 197.0 – 139.3 139.3 = 41.4% x £ 350,000

(144,900)

I ndexat ion on enhancement Oct 1996 t o Sept 2006 197.0 – 153.8 153.8 = 28.1% x £ 200,000

(56,200)_______

I ndexed gain 448,900

C13.5 Capital losses

Capital losses ar e comput ed in t he same way as capit al gains, except t hat indexat ion cannot cr eat e or incr ease a capit al loss, it can only reduce a gain to zero.


195

Illustration 4

Assume in I llust r at ion 2 t hat t he asset was act ually sold f or j ust £ 400,000. £

Pr oceeds 400,000 Cost (350,000) Unindexed gain 50,000

I ndexat ion allowance: 41.4% x £ 350,000 = £ 144,900 r est r ict ed t o

(50,000)

I ndexed gain nil

Illustration 5

Assume now t hat t he asset was act ually sold f or j ust £ 250,000. £

Pr oceeds 250,000 Cost (350,000) Allowable loss £(100,000)

No indexat ion is claimable as it cannot incr ease t his loss.

The capit al loss may be ut ilised against capit al gains in t he same year , or car r ied f or war d against f ut ur e char geable gains. The r elief f or capit al losses is dealt wit h lat er .

C13.6 Restriction on capital losses for companies S8 (2A)TCGA 1992

For disposals on or af t er 5 December 2005, ant i avoidance measur es have been int r oduced t o pr event companies using capit al losses t hat have ar isen f r om ar r angement s t he main pur pose or one of t he main pur poses of which is t o secur e a t ax advant age.

“Tax advant age” means r elief or incr eased r elief f r om cor por at ion t ax, r epayment or incr eased r epayment of cor por at ion t ax, t he avoidance or r educt ion of a char ge t o cor por at ion t ax or an assessment t o cor por at ion t ax, or t he avoidance of a possible assessment t o cor por at ion t ax.

S184D TCGA 1992

I n t he guidance not es issued by HMRC t he f ollowing example of ar r angement s is given.

Y plc is t he pr incipal company of a pr oper t y gr oup t hat includes a subsidiar y company X Lt d. X Lt d owns a pr oper t y in t he cent r e of London wit h a base cost of £ 1bn. The pr oper t y was pr eviously acquir ed f r om a f ellow group company at no gain/ no loss when t he mar ket value of t he pr oper t y st ood at £ 900m. X Lt d issues shar es t o an unconnect ed par t y, B Lt d, t o t he ext ent t hat B Lt d holds 30% of t he issued shar e capit al of X Lt d and so X Lt d is no longer a member of t he Y plc gr oup.


These new shar es have ver y r est r ict ed r ight s compar ed t o t hose alr eady in issue. The pr esence of only ver y r est r ict ed r ight s at t ached t o t he new shar es indicat es t hat Y plc has no int ent ion of making any mat er ial disposal of it s economic int er est in t he pr oper t y. I n t he absence of t he new legislat ion t he f act t hat X Lt d is no longer par t of t he gr oup headed by Y plc t r igger s t he degr ouping pr ovisions, and a capit al loss is r ealised, r ef lect ing t he pr evious f all in pr oper t y value of £ 100m. I n t his example it is clear t hat Y plc has t aken advant age of t he st at e of t he pr oper t y mar ket in or der t o r ealise a loss f or t ax pur poses even t hough t her e has been no genuine disposal, eit her of t he asset whose value was r educed, or of t he company t hat owns it . A loss has ar isen t o a company dir ect ly in consequence of ar r angement s, t he main pur pose of which is t o secur e a t ax advant age. New sect ion 8(2A) pr ovides t hat t he loss ar ises in disqualif ying cir cumst ances and is not t her ef or e an allowable loss. I f , however , in t he above example B Lt d genuinely wished t o ent er int o a j oint vent ur e involving t he pr oper t y, t hen a dif f er ent out come can be expect ed. I t would have subscr ibed f or shar es t hat had r ight s compar able t o t hose in issue, so t hat it acquir ed a cor r esponding shar e of t he economic value of X Lt d. I n t hose cir cumst ances, secur ing a t ax advant age is unlikely t o have been a main pur pose of t he t r ansact ion.

C13.7 Avoidance involving capital losses

For disposals on or af t er 5 December 2005 HMRC can issue a not ice t o a company denying loss r elief if ar r angement s have been ent er ed int o t o conver t income t o capit al or secur e a deduct ion t hat would not ot her wise be available

S184G&H TCGA 1992

I n bot h cases denial of t he loss only occur s on t he issue of a not ice by HMRC, t he company is not under any obligat ion t o self assess.

The not ice must (a) specif y t he ar r angement s, (b) specif y t he account ing per iod in which t he r elevant gain accr ues, and (c) inf or m t he r elevant company of t he ef f ect of t his sect ion. I f r elevant gains accr ue in mor e t han one account ing per iod, a single not ice under t his sect ion may specif y all t he account ing per iods concer ned. Not ices may be issued bef or e or af t er t he company has f iled it s CT600. I f t he r et ur n has been made a not ice can only be issued once an enquir y has been opened. A not ice can also be issued under t he discover y r ules.


197

Following t he issue of a not ice a company has 90 days t o consider t he impact on it s r et ur n. I n t he case of an enquir y no closur e not ice can be issued unt il t he 90 days expir es. A r et ur n will be incor r ect if it is not amended wit hin t he 90 days. A clear ance pr ocedur e is available f or t r ansact ions which may be caught by t hese r ules.

C13.8 Assets purchased before 31 March 1982

Capit al gains and losses can be comput ed by compar ing t he calculat ion based on cost wit h t he calculat ion based on t he value of t he asset on 31 Mar ch 1982.

Consequent ly, if t he value of t he asset has r isen f r om t he t ime of pur chase t o Mar ch 1982, it will be advant ageous t o use t he Mar ch 1982 value. We will pr epar e two calculations; one based on cost and one based on the

March 1982 value. Wher e t his pr oduces two gains, we take the lower gain. I f t his gives us two losses or any ot her r esult , we t ake t he lower loss. Wher e we pr oduce one gain and one loss, t he answer will be zero.

I ndexat ion allowance r uns f r om Mar ch 1982 and is based on t he higher of t he cost or Mar ch 1982 value in bot h calculat ions.

I f t he company has submit t ed a “global r ebasing elect ion”, t he cost calculat ion need not be per f or med, as t he elect ion means t hat t he company will only use Mar ch 1982 values in t he comput at ions.

Illustration 6

Vent ur a Limit ed pur chased a f act or y in J une 1970 f or £ 80,000. I t was wor t h £ 190,000 on 31.3.82. The f act or y is sold in Sept ember 2006 f or £ 500,000 when you should assume t he RPI f act or was 197.0.

Cost £

Mar ch 1982 £

Pr oceeds 500,000 500,000 Cost / Mar ch 1982 value (80,000) (190,000) Unindexed gain 420,000 310,000 I ndexat ion Mar ch 1982 t o Sept ember 2006 On higher of cost or Mar ch 1982 value 197.0 – 79.44 79.44 = 148.0% x £ 190,000

(281,200)

(281,200)

I ndexed gain £138,800 £28,800

As t he t wo columns bot h pr oduce gains, t he lower is t aken i.e. £ 28,800


Illustration 7

Assume now t hat inst ead t he asset was sold f or £ 400,000.

Cost £

Mar ch 1982 £

Pr oceeds 400,000 400,000 Cost (80,000) (190,000) Unindexed gain 320,000 210,000 I ndexat ion: £ 190,000 x 148.0% (281,200) (210,000)* I ndexed gain £38,800 nil

* The indexat ion is r est r ict ed so as not t o pr oduce a loss.

The lower amount is t aken i.e. nil.

C13.9 Rollover relief

Wher e a company sells one qualif ying asset and pur chases anot her qualif ying asset , wit hin a specif ied per iod, t he gain on t he sale of asset 1 can be deducted f r om t he base cost of asset 2 upon t he company making an elect ion. This will ensur e t hat t he company does not pay cor por at ion t ax on t he sale of t he f ir st asset .

These r ules only apply when t he company is selling asset s used f or t he pur poses of a t r ade. The Gover nment is keen t o encour age companies t o r einvest in t heir t r ading act ivit ies wit hout having t o pay cor por at ion t ax on gains along t he way.

Eligible asset s include:

(i) Land and buildings (used in t he t r ade)

(ii) Goodwill bought or cr eat ed pr ior t o Apr il 2002

(iii) Fixed plant and machiner y - “Fixed” means bolt ed t o t he f loor or building.

Goodwill bought or cr eat ed af t er 1 Apr il 2002, is not wit hin t he CGT r ules as explained in t he chapt er on I FAs. The specified period dur ing which asset 2 must be pur chased, is one year

before the disposal of asset 1 to three years afterwards.

Fur t her det ails r egar ding r ollover r elief can be f ound in he next chapt er .

C13.10 Disposal of substantial shareholding

Disposals by a company of “subst ant ial shar eholdings” in ot her companies ar e exempt f r om t ax. Consequent ly gains ar e not t axable and losses ar e not allowable when dealing wit h disposals of subst ant ial shar eholdings.


199

The r ules apply t o shar eholdings in bot h UK r esident and non-r esident companies. A subst ant ial shar eholding is def ined as 10% or more of a company’s or dinar y shar e capit al. The or dinar y shar es held must also give ent it lement t o at least 10% of t he company’s dist r ibut able pr of it s and 10% of asset s on a winding up. For t hese pur poses t he holdings of ot her gr oup member s ar e t aken int o account . To qualif y

(i) A subst ant ial shar eholding must have been held f or at least 12 months in a per iod beginning not lat er t han t wo year s bef or e t he sale t akes place.

(ii) t he invest ing company must eit her be a sole t r ading company or t he member of a t r ading gr oup. For t hese pur poses t he def init ion of t r ading company is t he same as t hat used f or t aper r elief .

(iii) t he shar es must be in a qualif ying company which is a def ined as a t r ading company or a member of a t r ading gr oup.

Condit ions (ii) and (iii) must apply in t he lat est 12 mont h per iod in which t he subst ant ial shar eholding t est has been sat isf ied and ending wit h t he t ime of t he disposal AND immediat ely f ollowing t he disposal. These r ules ar e cover ed in mor e det ail in a lat er chapt er .

Answer 1

£ £

Pr oceeds 1,500,000 I ncident al cost s (3,000) Net sale pr oceeds 1,497,000 Cost 425,000 I ncident al cost s 2,000 St amp dut y land t ax (£ 425,000 x 3%) 12,750 Tot al cost (439,750) Unindexed gain 1,057,250 I ndexat ion May 1989 t o J anuar y 2007 198.6 – 115 115 = 72.7% x £ 439,750

(319,698) I ndexed gain £737,552


SUMMARY – CORPORATE CAPITAL GAINS

I ndexat ion allowance did not cease f or companies on 6 Apr il 1998. Companies do not get t aper r elief or an annual exempt ion. Ther e ar e r est r ict ions on losses ar ising f r om ar r angement s, t he main pur pose of which or one of t he main pur poses of which is t o secur e a t ax advant age. Rollover r elief is available when qualif ying asset s ar e disposed of and t he pr oceeds ar e r einvest ed in ot her qualif ying asset s. Goodwill bought or cr eat ed af t er 1 Apr il 2002 is not an eligible asset f or r ollover r elief f or companies. Fr om 1 Apr il 2002, gains on t he disposal of subst ant ial shar eholdings will be exempt . Subst ant ial is def ined as 10% or mor e. A 10% holding must have been held f or at 12 mont hs in t he pr eceding t wo year s. The company making t he sale and t he company whose shar es ar e being sold must bot h be t r ading companies.

C14: ROLLOVER RELIEF

I n t his chapt er you will look at t he gener al pr inciples of r ollover r elief including: - how t he r elief oper at es; - pr oceeds not f ully r einvest ed; - condit ions f or t he r elief ; - qualif ying asset s; - t ime limit s.

C14.1 Introduction

You will somet imes see r ollover r elief r ef er r ed t o as “r eplacement of business asset s” r elief , f or t he simple r eason t hat t he legislat ion gives a company r elief when he sells a business asset and replaces it with another.

s. 152

Illustration 1

A company is using a building f or t he pur poses of it s t r ade. I t sells t he building f or £ 200,000 making a capit al gain – bef or e any r elief s – of £ 80,000. The r eason t he company has sold t he old asset , is because it wishes t o r eplace it wit h a new one. The company may be expanding and needs lar ger pr emises.

The company r eplaces t he old of f ice building wit h a new of f ice building cost ing £ 250,000. Wher e a company disposes of a business asset and r einvest s t he pr oceeds in buying anot her business asset , t he company can make a claim t o def er t he gain it has made. I n t his example, t he company sells it s old asset f or £ 200,000 and r einvest s t he whole of it s pr oceeds in buying a new asset f or £ 250,000. The company has t her ef or e not r et ained any of t he sale pr oceeds.

As all proceeds are reinvested, full rollover relief is given as below. s. 152(1)

£ Pr oceeds 200,000 Cost (100,000) I ndexat ion (say) (20,000) Gain 80,000 Roll over r elief (80,000) Gain Nil

Rollover r elief is a def er r al r elief as it pushes t he capit al gains back t o a lat er per iod in t ime. The way r ollover r elief wor ks, is t hat t he amount of t he gain deferred – in t his inst ance £ 80,000 – is rolled over and reduces the base cost of the new asset purchased.

s. 152(1)(b)


New building: £ Cost 250,000Rolled over gain (80,000)Base cost of new asset £ 170,000

Ther ef or e when t he company comes t o sell t he second building, because it s base cost has been r educed by £ 80,000, t he capit al gain on t he sale of t hat building will be uplif t ed by £ 80,000. Ther ef or e t he capital gain of £ 80,000 on t he sale of building number 1, has been deferred until the sale of building number 2. The advant age of making a r ollover r elief claim, is t hat t he company can elect t o pay t ax on t his £ 80,000 sever al year s lat er , t her ef or e obt aining a cash f low advant age.

C14.2 Proceeds not fully reinvested s.153

Illustration 2

Assume a company sells a business asset f or £ 200,000 r ealising a capit al gain of £ 80,000. The company uses t he money t o buy a r eplacement asset which cost s £ 180,000. You will see t her ef or e, t hat t he company has not f ully r einvest ed it s pr oceeds of sale.

Cash r et ained = £ 200,000 – 180,000 = £ 20,000

Wher e t he company does not spend all of t he sale pr oceeds, t he amount of cash retained (£ 20,000) is immediately chargeable t o capit al gains t ax. This amount is t he gain bef or e t aper r elief . This means t hat having made a capit al gain of £ 80,000, t he company is immediat ely char ged on £ 20,000. The balance – her e being £ 60,000 – is the rollover relief t hat t he company can claim.

£ Pr oceeds 200,000 Cost (100,000) I ndexat ion (20,000) Gain 80,000 Roll over r elief (60,000) Gain (£ 200,000 – 180,000)

£ 20,000

The £ 60,000 will be r olled over and r educes t he base cost of t he new asset .

£ Cost 180,000 Rolled over gain (60,000) Base cost of new asset £ 120,000

Rollover Relief

203

Illustration 3

Assume a company sells a business asset f or £ 200,000, r ealising a capit al gain of £ 80,000. The company uses par t of t he sale pr oceeds t o buy a r eplacement asset . The new building is consider ably smaller and cost s £ 110,000. Wher e a company has not f ully r einvest ed his pr oceeds of sale, we must ident if y t he amount of cash r et ained.

Cash r et ained = £ 200,000 – 110,000 = £ 90,000

However it is not possible f or t he Revenue t o char ge t he company on a gain of £ 90,000, as t he act ual gain is only £ 80,000. Ther ef or e t he whole of t his gain of £ 80,000 will be immediat ely char ged t o t ax, and no r ollover r elief will be available. The base cost of t he new asset will r emain at £ 110,000. This demonst r at es t hat when t he cash retained by the company exceeds the

capital gain, t he whole of t he gain is char geable and no rollover relief can be claimed.

£ Pr oceeds 200,000 Cost (100,000) I ndexat ion (20,000) Gain 80,000 Roll over r elief Nil Gain 80,000 Base cost of new asset £ 110,000

C14.3 Conditions for the relief

Rollover r elief can only be claimed by company if it sells an asset and r einvest s t he pr oceeds in a r eplacement asset . Rollover r elief can also be claimed by persons carrying on a trade. I ndividuals t r ading as sole t r ader s or wit hin a par t ner ship can claim r ollover r elief .

s. 152(1)

The old asset – i.e. t he asset being sold – must be used for the purposes of a business car r ied on by t he company. Rollover r elief is also available wher e an individual owns an asset , but t he asset is used by his per sonal company. (i.e. wher e t he individual owns at least 5% of t he vot ing shar es). The new asset – i.e. t he asset being acquir ed – must be immediately taken into

use for the purposes of the trade. I t is not possible f or a company t o buy an asset , and use it f or non-t r ading pur poses if r ollover r elief is t o be claimed.

ESC D24

I f an individual is car r ying on t wo t r ades at t he same t ime, t hese two trades are regarded as one single trade f or r ollover r elief pur poses. Ther ef or e if an individual makes a capit al gain on an asset used in t r ade “A”, he can claim r ollover r elief by buying a business asset and using it f or t he pur poses of t r ade “B”.

s. 152(8)


C14.4 Qualifying assets

Rollover r elief is only available t o a company who makes a disposal of a “qualif ying asset ”, and who r einvest s all or par t of t he pr oceeds in anot her “qualif ying asset ”. The legislat ion cont ains a list of qualif ying asset s at s.155 TCGA 1992.

s. 155

The most common t ype of qualif ying asset s is land and buildings used f or t he pur poses of a t r ade. These will t ypically include shops, of f ices, f act or ies, war ehouses et c. Fixed plant and machinery ar e qualif ying asset s f or r ollover r elief . Not e t he wor d “f ixed”. Fixed means immovable, so asset s such as t r act or s or combine har vest er s used by a f ar mer , or vehicles used by t r ader s, will not be eligible f or r ollover r elief . Ships, air cr af t and hover cr af t ar e qualif ying asset s as ar e sat ellit es, space st at ions and spacecr af t . Milk, pot at o and f ish quot as will also qualif y f or r ollover r elief , as will ewe and cow suckler pr emiums. The qualif ying asset s you ar e most likely t o see in pr act ice ar e t he t op t wo in t he list – land and buildings or f ixed plant and machiner y. I t is impor t ant t o not e t hat t he old and the new assets do not need to fall

within the same category. I f a company makes a gain on t he sale of a building, it will obt ain r ollover r elief if it pur chases eit her anot her building, or any of t he ot her qualif ying asset s. Ther ef or e a company t hat sells a milk quot a and r einvest s t he pr oceeds in space t r avel, will obt ain r ollover r elief . One asset you will not f ind on t he list of qualif ying asset s is shares. I f an company eit her buys or sells shares, it will not be able to claim rollover

relief. Shar es can never be used f or t he pur poses of a t r ade. A shar e is simply an invest ment in a company, and is not used f or any specif ic pur pose.

C14.5 Statutory time limits

Rollover r elief is only available if t he new asset is acquir ed wit hin a cer t ain per iod of t ime. The new asset must be acquired wit hin a f our year t ime window, r unning from 12 months before the sale of the old asset, to 36 months

afterwards. These t ime limit s can be ext ended at t he discr et ion of t he Revenue.

s. 152(3)

Rollover relief must be claimed by t he company wit hin a cer t ain t ime limit . That t ime limit is six years from the end of the company’s accounting period. For example, us assume a company sells t he old asset in it s year ended 31 December 2007. A r ollover r elief claim should t her ef or e be made no lat er t han 31 December 2013.

s. 43(1) TMA 1970

Provisional claims f or r ollover r elief will be allowed. Ther ef or e if t he above company sells an asset in 2006, but has not bought t he new asset by 31

s. 153A

Rollover Relief

205

December 2007, but is int ending t o buy t he asset bef or e t he t hr ee year r einvest ment per iod has expir ed, t he Revenue will allow t he company t o def er t he capit al gain, even t hough pr oper comput at ions cannot be pr epar ed. Rollover r elief is not aut omat ic, and if a company does not wish t o def er a capit al gain, it will simply not make a r ollover r elief claim. This may be t he case if t he gain is cover ed by losses.

Example 1

Which of the below assets are qualifying assets for rollover relief purposes?

(a) Fr eehold of f ice (b) Lease on a f act or y (c) Tr act or (d) Shar es in a per sonal company (e) Paint ing

Example 2

X Lt d bought a shop in May 1994 f or £ 180,000. I t sold it in May 2006 f or £ 250,000. I n J une 2005 X Lt d had bought a hover cr af t f or use in it s t r ade f or £ 230,000. I t sold t he hover cr af t in Mar ch 2007 f or £ 240,000. X Lt d has a 31 Mar ch year end. Assuming all claims are made calculate X Ltd’s chargeable gains in the year

ended 31 March 2007.

Ignore indexation.


Answer 1

Qualif ying Asset ? Yes No a) Fr eehold of f ice X b) Lease on f act or y X c) Tr act or X (Not f ixed) d) Shar es in Per sonal Co. X e) Paint ing X (Not used in t r ade)

Answer 2

May 2006 Gain on shop £ Pr oceeds 250,000 Less: Cost (180,000) Gain 70,000 Rollover r elief (50,000) Gain 20,000 (250,000-230,000) Hover cr af t £ Cost 230,000 Rolled over gain (50,000) Base cost of new asset 180,000

Mar ch 2007 Gain on Hover cr af t £

Pr oceeds 240,000 Less: base cost (above) (180,000) Gain 60,000 Add: Gain on shop 20,000 Char geable gains £ 80,000

Rollover Relief

207

SUMMARY – ROLLOVER RELIEF

Rollover r elief applies when a company sells one business asset and r eplaces it wit h anot her . I f all t he pr oceeds f r om t he sale of t he old asset ar e r einvest ed in t he new asset , t he gain on t he old asset is not char ged but inst ead is deduct ed f r om t he base cost of t he new asset . Ther e will t her ef or e be a bigger gain in t he f ut ur e when t he new asset is sold. I f pr oceeds ar e not f ully r einvest ed a gain equal t o t he cash r et ained must be lef t char geable. Rollover r elief is available t o companies and per sons car r ying on a t r ade. The old and t he new asset must bot h be used in t he t r ade. Qualif ying asset s include:

Land and buildings Goodwill (f or individuals only) Fixed plant and machiner y Ships/ air cr af t / hover cr af t Sat ellit e/ space st at ions/ space cr af t Milk/ pot at o/ f ish quot as

Shar es ar e not a qualif ying asset f or r ollover r elief . The new asset must be acquir ed 12 mont hs bef or e t o 36 mont hs af t er t he sale of t he old asset . A claim must be made f or r ollover r elief by six year s f r om t he end of t he account ing per iod. Pr ovisional claims can be made.

C15: SHARES AND SECURITIES: MATCHING RULES

I n t his chapt er you will cover t he r ules t hat apply when a company sells shar es including: - t he mat ching r ules; - t he FA 1985 pool; - t he 1982 holding.

C15.1 Introduction

Bef or e we examine t he special r ules f or shar es, let us spend a f ew moment s discussing why we need t hem in t he f ir st place. Consider a company who has been buying shar es in a quot ed company called XYZ Plc f or a number of year s. The shar e pur chases have been as f ollows:

Date Shar es Cost

December 1975 1,000 £ 1,000 J une 1986 3,000 £ 6,000 Sept ember 1990 2,000 £ 8,000 December 1999 4,000 £ 20,000 Tot al 10,000 £ 35,000

The company cur r ent ly has 10,000 shar es, which have been acquired in four

tranches bet ween 1975 and 1999 and t he t ot al cost of t he t axpayer ’s shar eholding is £ 35,000. I n August 2006, t he company sells 6,500 of t he XYZ Plc shar es f or t ot al pr oceeds of £ 39,000. I n or der t o calculat e t he char geable gain ar ising on t he sale of t hese 6,500 shar es, we need to identify exactly which shares the company has sold. Unt il we know exact ly which shar es have been sold, we cannot ident if y t he base cost of t he shar es, and we cannot t her ef ore wor k out t he indexat ion allowance. The share “matching” rules det er mine t he exact or der in which shar es ar e deemed t o have been sold. The “mat ching” r ules we ar e about t o st udy, apply for companies only. Ther e ar e slight ly dif f er ent mat ching r ules f or disposals of shar es by individuals. Also not e t hat t he “mat ching” r ules only apply to

shares in the same class in the same company. We should never mix up dif f er ent t ypes of shar es in dif f er ent companies.

I R 218 Tax Bullet in

No. 52 (Apr il 2001)

Shar es and Secur it ies: Mat ching Rules 209

C15.2 The share matching rules

Ther e ar e 6 mat ching r ules, and we shall cover t hem in t heir or der of pr ior it y:

(1) I f a company disposes of shar es, it is first deemed t o have sold any shar es

acquir ed on t he same day.

(2) Wher e t he company owns at least 2% of t he issued shar e capit al of anot her company, it is deemed t o have disposed of shar es acquir ed in t he previous month (lat est f ir st ), t hen shar es acquir ed in t he following month (ear liest f ir st ). This r ule will not be seen ver y of t en.

(3) Wher e (2) does not apply, t he company is deemed t o have sold any shar es it

acquir ed in t he previous 9 days. Even if t his acquisit ion was in t he pr evious mont h, no indexation allowance is available t o r educe t he gain.

(4) Next t he disposal will be mat ched wit h shar e acquisit ions bet ween 1 April

1982 and 10 days before the sale. Shar es bought in t his per iod, ar e pooled t oget her and f or m one asset f or gains pur poses. Shar es acquir ed bet ween t hese dat es, ar e held in what we call t he “Finance Act 1985 pool”.

(5) Next t he company is deemed t o have sold shar es which it bought bet ween

April 1965 and April 1982. Shar es bought bet ween t hese t wo dat es ar e pooled t oget her in what we call t he “1982 pool” or t he “1982 holding”.

(6) Finally t he company is deemed t o have sold shar es acquir ed before 6 April

1965. These r ules apply ver y r ar ely and will not be cover ed on t his cour se. Illustration 1

Tolley Lt d has acquir ed shar es in Glaxo Smit hKline plc as f ollows:

Dat e Shar es Cost £

1 December 1992 6,000 6,000 1 J uly 2000 4,000 8,000

25 Febr uar y 2007 2,000 5,000 12,000 19,000 On 1 Mar ch 2007, Tolley Lt d sold 7,000 of t he shar es f or gr oss pr oceeds of £ 21,000. To calculat e t he capit al gain, we must f ir st ident if y which shar es have been sold, by applying t he shar e mat ching r ules. Tolley Lt d sold t he shar es on 1 Mar ch 2007. Our f ir st quest ion is “did t he company buy any shar es on t he same day” – i.e. did it buy any shar es on 1 Mar ch 2007? I f it did, t hese shar es will be sold in pr ior it y t o any ot her s.

210 Pr inciples of Business Taxat ion ‘Finance Act 2006’

The answer t o t his quest ion is “no”. We t her ef or e move t o t he second mat ching r ule. 12,000 shar es is clear ly not mor e t han 2% of t he shar es of a maj or plc, so r ule (2) can be ignor ed. This will ver y of t en be t he case. We next ask our selves whet her Tolley Lt d bought any shar es in t he 9 days

before t he dat e of disposal – i.e. bet ween 20 February and 28 February 2007. The answer t o t his quest ion is “yes” - Tolley Lt d did buy some shar es in t his per iod – it bought 2,000 shar es on 25 Febr uar y 2007. We t her ef or e have a “mat ch”. What we ar e saying her e, is t hat of t he 7,000 shar es sold on 1 Mar ch 2007, t he first ones t o be sold wer e t hose bought on 25 Febr uar y 2007. We now move down t o mat ching r ule number (4). The next mat ch, is wit h any shar es acquir ed bet ween 1 April 1982 and 19 February 2007.

Tolley Lt d has bought t wo lot s of shar es in t his per iod – 6,000 shar es in December 1992 and 4,000 shar es in J uly 2000. These ar e “pooled” t oget her t o f or m one single bunch of shar es. These shar es f or m t he “FA 1985 pool”. On 1 Mar ch 2007 Tolley lt d s deemed t o have sold 5,000 of t he 10,000 shar es in t his “pool”. This can be summar ised as below:

Dat e FA 1985 pool Pr ior 9 days

1 December 1992 6,000 1 J uly 2000 4,000

25 Febr uar y 2007 _____ 2,000 10,000 2,000

Sale 1 Mar ch 2007 (5,000) (2,000) 2nd “mat ch” 1st “mat ch” Once we have a “mat ch”, t he next st ep is t o calculat e t he r esult ing char geable gain. I n t his quest ion, we have 2 matches, which means we will need t o pr epar e 2 capital gains computations.

At f ir st sight t his seems a ver y complicat ed exer cise, but you will quickly become f amiliar wit h t he pr ocess once you have done a f ew pr act ice quest ions.

Let us now calculat e Tolley Lt d’s capit al gain on t he sale of t he 7,000 Glaxo Smit hKline Plc shar es on 1 Mar ch 2007.


The f ir st mat ch is wit h 2,000 shar es, bought on 25 Febr uar y 2007:

£ Disposal 1: Pr oceeds

£ 21,000 x 20007000

6,000

Less: cost (25.2.07) (5,000) Gain £ 1,000

Not e t hat even t hough t he shar es wer e bought in Febr uar y and sold in Mar ch, as t he “9 day” r ule applies, no indexation is available. The second mat ch is wit h 5,000 in t he FA 1985 pool.

£ Disposal 2: Pr oceeds

£ 21,000 x 50007000

15,000

Less: cost ? Less; indexat ion ?

Gain X To ascer t ain t he cost of t he shar es sold (and t he indexat ion allowance), we need t o put t oget her t he “FA 1985 pool”.

C15.3 Share pooling

Shar es acquir ed in t his per iod ar e grouped together in “the Finance Act 1985

pool”. This is so called because t he shar e pooling r ules wer e or iginally int r oduced in t he 1985 Finance Act .

I f we ar e calculat ing gains on shar es acquir ed af t er Apr il 1982, we under t ake a pr ocess known as “shar e pooling”. Shar es acquir ed since Apr il 1982 ar e treated as one single asset f or capit al gains pur poses. The FA 1985 pool cont ains shar es bought since Apr il 1982 and in t he illust r at ion of Tolley Lt d (above) will look like t his:

We will use t he f ollowing RPI s: December 1992 139.2 J uly 2000 170.5 Mar ch 2007 186.4


Shar es Cost I ndexed cost £ £ December 1992 - buy 6,000 6,000 6,000I ndexed r ise: Dec 1992 t o J uly 2000 170.5-139.2

139.2 x £ 6,000

1,349

7,349 J uly 2000 - buy 4,000 8,000 8,000 10,000 14,000 15,349I ndexed r ise: J uly 2000 t o Mar ch 2007 186.4-170.5

170.5 X £ 15,349 _____10,000

_____ 14,000

1,43116,780

Mar ch 2007 – sell (5,000) (7,000) (8,390)Balance 5,000 £ 7,000 £ 8,390

Let us f ir st look at t he number of shar es in t he pool. I n December 1992, Tolley Lt d bought 6,000 shar es. I t bought a f ur t her 4,000 shar es in J uly 2000. The t ot al number of shar es in t he “1985 pool” is t her ef or e 10,000.

I n Mar ch 2007, Tolley Lt d sold 5,000 shar es out of t he 1985 pool. This means t hat af t er t he sale, t he balance of shar es in t he pool will be 5,000.

The second column shows t he acquisit ion cost of t he shar es. The 6,000 shar es bought in December 1992 cost £ 6,000. The 4,000 shar es bought in J uly 2000 cost £ 8,000. The base cost of t he 10,000 shar es in t he pool is t her ef or e £ 14,000.

5,000 shar es – i.e. exact ly half t he number of shar es in t he pool – have been sold. I f t he cost of 10,000 shar es is £ 14,000, t hen t he cost of 5,000 shar es is exact ly half of t his – i.e. £ 7,000. Having removed half of the shares from the

pool, we also take out half of the base cost. This leaves 5,000 shar es r emaining in t he pool wit h a base cost of £ 7,000.

We have now ident if ied t he base cost of t he 5,000 shar es being sold. Tr y not t o lose sight of what you ar e doing. The obj ect ive is t o calculat e t he capit al gain on t he sale of t hese 5,000 shar es. To calculat e t he capit al gain, we need the base cost. The base cost is t her ef or e £ 7,000, and t his will be r ef lect ed in t he capit al gains comput at ion.

The f inal f igur e we need t o complet e t he comput at ion, is t he indexation

allowance. We deal wit h indexat ion allowance in t he “1985 pool” in a special way, by having a separate column in which we calculat e t he indexat ion. We call t his column “indexed cost ”. Rat her t han dealing wit h indexat ion at t he end – i.e. wit hin t he capit al gains comput at ion – when we ar e const r uct ing t he 1985 pool, we accrue indexation as we go along.


What we ent er int o t he “indexed cost ” column, is t he cost of t he shar es plus accrued indexation. This means t hat when we have f inished const r uct ing t he 1985 pool, we will have all of t he number s – i.e. t he pr oceeds, t he cost and t he indexat ion allowance – t o enable us t o calculat e t he capit al gain.

As t he “indexed cost ” column is made up of cost plus indexat ion allowance, any f igur es t hat go int o t he middle column – i.e., t he “cost ” column - must also go int o t he “indexed cost ” column.

You will see t hat in December 1992 t he shar es have a base cost of £ 6,000 and an indexed cost of £ 6,000. The next st ep is t o accr ue some indexat ion. Indexation is calculated between “operative events”. An “oper at ive event ” is any event that either increases or decreases the base cost of t he shar es.

The next oper at ive event af t er December 1992 is t he pur chase of shar es in J uly 2000. We comput e t he indexat ion allowance bet ween t hese t wo dat es. The “indexed r ise” bet ween December 1992 and J uly 2000 is £ 1,349.

Ther ef or e, at J uly 2000, t he indexed cost of t he shar es is t he cost plus t he accr ued indexat ion, being £ 7,349.

When calculat ing t he indexat ion allowance f or shar es in t he “1985 pool”, t her e is no need to round the indexation factor t o t hr ee decimal places. This is t he one and only time when we do not round the indexation factor.

Tolley Lt d bought 4,000 shar es f or £ 8,000 in J uly 2000. This cost of £ 8,000 will also go int o t he indexed cost column, giving a t ot al indexed cost of £ 15,349.

The next st ep is t o wor k out indexat ion bet ween J uly 2000 and t he next oper at ive event . The next event in t he 1985 pool is t he sale of shar es in Mar ch 2007. I ndexat ion will t her ef or e be accr ued bet ween J uly 2000 and Mar ch 2007.

This indexat ion f act or is t hen mult iplied by £ 15,349 – i.e. t he indexed cost of t he shar es as at J uly 2000. The accr ued indexat ion bet ween t hese point s is £ 1,431, giving a t ot al indexed cost of t he shar es of £ 16,780. This f igur e is simply t he act ual cost of £ 14,000, plus £ 2,780 of accr ued indexat ion. Tolley Lt d sold half of t he 1985 pool shar es, so we have r emoved half of t he base cost f r om t he 1985 pool. We must similar ly remove half of the indexed

cost from the pool. The indexed cost t o be r emoved f r om t he pool is t her ef or e £ 8,390. This t ells us t hat af t er selling t he shar es in Mar ch 2007, Tolley Lt d is lef t wit h 5,000 shar es, wit h a base cost of £ 7,000 and an indexed base cost of £ 8,390. The f igur e we have j ust r emoved f r om t he pool – i.e. t he £ 8,390 – is t he cost , plus t he accr ued indexat ion, of t he 5,000 shar es sold in Mar ch 2007. This f igur e will t hen be r ef lect ed in t he capit al gains comput at ion.


C15.4 Calculating the gain on the 1985 pool shares

Having const r uct ed t he 1985 pool, t he next st ep is t o wor k out t he char geable gain. I f we look back at t he pool, you will see t hat in Mar ch 2007, Tolley Lt d sold 5,000 shar es, t hey have a base cost of £ 7,000, and an indexed cost of £ 8,390. This f igur e is simply cost plus accr ued indexat ion. Ther ef or e t he indexation allowance, is the indexed cost minus the actual cost, being £ 1,309.

Pr oceeds £

£ 21,000 x 50007000

15,000

Less: cost (7,000) Less: indexat ion (8,390 – 7,000) (1,390) Gain on 1985 pool shar es £ 6,610

A slight ly quicker way t o calculat e t his char geable gain is by deduct ing t he indexed cost f r om t he sale pr oceeds. As you will see, t his gives t he same gain – i.e. £ 6,610. This is a per f ect ly accept able shor t cut , but r emember t hat indexation cannot create a capital loss, so you will have t o be careful if

indexed cost exceeds sale proceeds.

£ Pr oceeds 15,000 I ndexed cost (cost plus indexat ion) (8,390) Gain on 1985 pool shar es £ 6,610

The t ot al gain on t he sale of t he 7,000 shar es in Mar ch 2007 is t her ef or e:

£ Gain 1: Shar es bought 25.2.07 1,000 Gain 2: Shar es f r om 1985 pool 6,610 Char geable gains 7,610

C15.5 Shares bought before 1 April 1982

Shar es bought between April 1965 and April 1982 f or m t he “1982 holding”. As is t he case f or t he 1985 pool, shar es acquir ed bet ween 1965 and 1982 ar e pooled t oget her t o f or m one single asset . The main dif f er ence bet ween t he 1982 holding and t he 1985 pool, is t hat in t he 1982 holding we do not accrue

indexation within the pool. I ndexat ion allowance is dealt wit h at t he end in t he capit al gains comput at ion. The r eason we do t his, is because indexat ion allowance only came int o ef f ect f r om Mar ch 1982.


The ot her issue t o consider in r elat ion t o t he 1982 holding, is Mar ch 1982 r ebasing. Whenever an asset is acquir ed bef or e Mar ch 1982, we need t o compute an alternative gain using the value of the asset in March 1982. This pr inciple applies in t he same way when t he asset in quest ion is shar es.

Illustration 2

Halsbur y Lt d has been buying shar es in a quot ed company, Chancer y plc. Halsbur y Lt d has acquir ed t he shar es in var ious st ages since 1975 as f ollows:

Date Shar es Cost

£ 2.9.75 12,000 6,000 1.4.78 8,000 8,000

21.12.90 6,000 12,000 12.3.92 3,000 9,000 28.7.00 1,000 5,000

Tot al 30,000 £ 40,000

The shar es wer e wor t h £ 1.50 each in Mar ch 1982. The shar es r epr esent a 0.1% holding. Halsbur y Lt d sold 15,000 shar es in November 2006 f or £ 90,000. To calculat e t he capit al gain in November 2006, we f ir st consider t he mat ching r ules: Same day? X Pr evious 9 days? X 1985 Pool? X 10,000 shar es bought bet ween 1982 and 2004 1982 Pool? X 5,000 of t he 20,000 shar es bought bef or e 1982 15,000

We will pr epar e t wo CGT comput at ions, one f or each “mat ch”.

Assume t he f ollowing RPI s;

Mar ch 1982 79.44December 1990 129.9Mar ch 1992 136.7J uly 2000 170.5November 2006 185.6


1982 Gain 1 – 10,000 shar es in FA 1985 pool;

The 1985 pool is const r uct ed as f ollows:

Shar es Cost I ndexed cost £ £ December 1990 6,000 12,000 12,000 I ndexed r ise 136.7-129.9

129.9 x £ 12,000 628

12,628

Mar ch 1992 3,000 9,000 9,000 9,000 21,000 21,628 I ndexed r ise 170.5-136.7

136.7 x £ 21,628

5,348

26,976 J uly 2000 1,000 5,000 5,000 10,000 26,000 31,976 I ndexed r ise 185.6-170.5

170.5 x £ 31,976 2,832

34,808 Sale (Nov 2006) (10,000) (26,000) (34,808) Nil Nil Nil

Gain:

Pr oceeds £

£ 90,000 x 1000015000

60,000

Less: cost (26,000) Less: indexat ion (34,808 – 26,000) (8,808) Gain on 1985 pool shar es £ 25,192

1982 Gain 1 – 5,000 shar es in 1982 pool; 12,000 shar es wer e bought in Sept ember 1975 f or £ 6,000. 8,000 shar es wer e bought in Apr il 1978 f or £ 8,000. We t her ef or e have 20,000 shar es wit h a combined cost of £ 14,000. 5,000 of t hese 20,000 shar es ar e being sold in November 2006. The balance of shar es in t he 1982 holding, is t her ef or e 15,000.

One-quarter of the shares in the pool have been sold. Ther ef or e we must remove one-quarter of the base cost – i.e. £ 3,500 – leaving t he r emaining shar es in t he pool wit h a combined cost of £ 10,500.


As t he shar es wer e held as at 31 Mar ch 1982, we ar e int er est ed in t heir 1982 mar ket value. The shar es wer e wor t h £ 1.50 each in Mar ch 1982. The 20,000 shar es in t he pool wer e t her ef or e wor t h £ 30,000 in Mar ch 1982. The essent ial pr inciple of Mar ch 1982 r ebasing, is t hat we pr et end t hat t hese 20,000 shar es had been bought in 1982 f or £ 30,000. Shares Cost 1982 Value

£ £ Sept ember 1975 12,000 6,000 Apr il 1978 8,000 8,000 20,000 14,000 30,000 Sale (Nov 2006) = 5,000 shar es (5,000) (3,500) (7,500) Remaining 15,000 10,500 22,500 As we have r emoved one-quar t er of t he shar es and one-quar t er of t he cost f r om t he pool, we must also remove the same proportion of March 1982 value. The Mar ch 1982 value of t he 5,000 shar es being sold is £ 7,500, and t his is r emoved f r om t he 1982 holding. Finally we calculat e t he gain on t he sale of 5,000 shar es in t he 1982 holding. As is always t he case f or asset s acquir ed bef or e Mar ch 1982, we will pr epar e t wo comput at ions, one using cost t he ot her using 1982 mar ket value.

Disposal 2; Cost

£ 82MV

£ Pr oceeds

£ 90,000 x 500015000

30,000

30,000

Less: cost (3,500) Less: 1982 value ______ (7,500) 26,500 22,500 Less: indexat ion 185.6-79.44

79.44 (1.336) x £ 7,500

(10,020)

(10,020)

Gain on 1982 pool shar es £ 16,480 £ 12,480 Take lower gain £ 12,480

Summar y of Gains: £ 10.000 shar es 1985 pool 25,1925,000 shar es 1982 holding 12,48015,000 ______

Tot al gains £ 37,672


C15.6 The “substantial shareholding” exemption

Fr om 1 Apr il 2002, disposals by companies of “subst ant ial shar eholdings” in ot her companies ar e exempt from corporation tax, so no gain / loss needs t o be calculat ed.

A “subst ant ial” shar eholding is 10% or more of t he or dinar y shar e capit al.

To qualif y f or t he exempt ion, t he subst ant ial shar eholding must have been held f or at least 12 months in t he t wo year s up t o t he dat e of t he disposal.

Ther ef or e, when consider ing t he shar e mat ching / shar e pooling r ules above, first check whether the selling company are holding at least 10% of t he shar es of t he company in which t hey have invest ed. I f so, t her e is no r equir ement t o calculat e t he gain.

I n pr act ice, wher e companies ar e holding shar es in quot ed plc’s as an invest ment t o gener at e dividend income, t he shar eholding will invar iably be a ver y small per cent age so t he shar e mat ching / pooling r ules will apply.


Example 1

Pool-I t Lt d acquir ed shar es in XYZ plc on t he f ollowing dat es:

Date Shar es Cost £

1.11.87 1,000 10,000 2.3.90 2,000 30,000 1.1.98 3,000 60,000

Pool-I t Lt d sold 1,500 shar es in November 2006 f or £ 45,000.

Assume t he f ollowing RPI s;

November 1987 103.4Mar ch 1990 121.4J anuar y 1998 159.5November 2006 185.6

Calculate the chargeable gain.

Example 2

Nexis Lt d had t he f ollowing shar e t r ansact ions in TAX plc.

Dat e Shar es Event Cost Pr oceeds

£ £ 12.5.74 2,000 Buy 6,000 13.6.75 3,000 Buy 9,000 14.7.76 5,000 Buy 10,000

25.9.2006 1,000 Buy 6,500 28.9.2006 3,000 Sell £ 18,000

The shar es wer e wor t h £ 2 each at Mar ch 1982.

Assume t he f ollowing RPI s:

Mar ch 1982 79.44Sept ember 2006 185.2

Calculate Nexis Ltd’s chargeable gain.


Answer 1

Mat ch wit h shar es in FA 1985 pool:

Shar es Cost I ndexed Cost (Cost + I A)

£ £ November 1987 - buy 1,000 10,000 10,000I ndexed r ise 121.4-103.4

103.4 x 10,000 1,741

11,741

Mar ch 1990 - buy 2,000 30,000 30,000 3,000 40,000 41,741I ndexed r ise 159.5-121.4

121.4 x 41,741 13,10054,841

J anuar y 1998 - buy 3,000 60,000 60,000 6,000 100,000 114,841I ndexed r ise 185.6-159.5

159.5 x 114,841 18,792

133,633

Sale November 2006 - sell (1,500) (25,000) (33,408)Remaining 4,500 £ 75,000 £ 100,225 £Gain: Pr oceeds 45,000 Less: cost (25,000) Less: indexat ion (33,408 – 25,000) (8,408) Gain £ 11,592


Answer 2

1982 Holding 25.9.2006 12 May 1974 2,000 13 J une 1975 3,000 14 J uly 1976 5,000 25 Sept ember 2006 _____ 1,000 10,000 1,000 Sell (28.9.06) (2,000) (1,000) Remaining 8,000 Nil

Disposal 1 – 1,000 shar es acquir ed 25.9.06 (pr evious 9 days)

Pr oceeds

£

18,000 x 10003000

6,000

Less: cost (25.9.06) (6,500) Loss (500)

Disposal 2 – 2,000 shar es f r om 1982 holding 1982 Holding:

Shar es

Cost

82 MV

May 1974 2,000 6,000 J une 1975 3,000 9,000 J uly 1976 5,000 10,000 10,000 25,000 20,000 Sale (28.9.06) (2,000) (5,000) (4,000) Remaining 8,000 20,000 16,000

Cost 82MV Pr oceeds £ £

£ 18,000 x 20003000

12,000

12,000

Less: cost (5,000) Less: 1982 value (4,000) Less: indexat ion

185.2-79.44

79.44 (1.331) x £ 5,000

(6,655)

(6,655)

I ndexed gain £ 345 £ 1,345 Take lower gain £ 345

Summar y of Gains: £ 1,000 shar es Pr evious 9 days (500) 2,000 shar es 1982 holding 345 3,000 ____

Net loss £ (155)


SUMMARY – SHARES AND SECURITIES: MATCHING RULES

When shar es t hat have been bought in t r anches over t ime ar e sold, we use mat ching r ules t o ident if y which shar es ar e being sold. The mat ching r ules f or companies ar e:

1st Shar es acquir ed on same day 2nd Shar es acquir ed in pr evious 9 days 3r d Shar es acquir ed bet ween 1 Apr il 1982 and 10 days bef or e disposal (“FA

1985 pool”) 4t h Shar es acquir ed bet ween 6 Apr il 1965 and 31 Mar ch 1982 (“1982 pool”) 5t h Shar es acquir ed bef or e 6 Apr il 1965

Ther e is a dif f er ent r ule (2) wher e t he selling company holds 2% or mor e of t he shar es, and shar es have been bought in t he mont h bef or e or t he mont h af t er t he disposal. Once t he disposals have been mat ched wit h t he acquisit ions, a gain is calculat ed f or each mat ch. The “1985 pool” gr oups t oget her shar es bought af t er Apr il 1982 and t r eat s t hem as a single asset . The pool wor king has t hr ee columns being t he number of shar es, t he cost and t he indexed cost . Each acquisit ion is ent er ed int o t he pool and we index bet ween oper at ive event s (being acquisit ions and disposals) as we go along wit hout r ounding t he indexat ion f act or . Finally, t he appr opr iat e pr opor t ions of t he pooled cost and indexed cost ar e used in calculat ing t he gain based on t he number of shar es sold t hat wer e mat ched wit h t his pool. The “1982 holding” or “1982 pool” gr oups t oget her shar es bought bef or e Apr il 1982 and t r eat s t hem as a single asset . The pool wor king has t hr ee columns being t he number of shar es, t he cost and t he 1982 value. The appr opr iat e pr opor t ions of t he pooled cost and 1982 value ar e used in calculat ing t he gain, based on t he number of shar es sold t hat wer e mat ched wit h t his pool. I ndexat ion can be calculat ed in one st ep based on t he higher of t he cost / MV82 of t he shar es being sold. Disposals of subst ant ial shar eholdings ar e exempt f r om t ax. “Subst ant ial” means 10% or mor e of t he shar e capit al.

C16: SUBSTANTIAL SHAREHOLDING EXEMPTION

I n t his chapt er you will look at t he exempt ion t hat applies t o subst ant ial shar eholdings held by companies in mor e det ail, including: - t he def init ion of “subst ant ial” f or t hese pur poses; - t he 12 mont h per iod dur ing which t he holding must have been subst ant ial; - t he condit ions f or t he invest ing company; - t he condit ions f or t he invest ee company; - t he int er act ion of t hese r ules wit h ot her ar eas including t he gr oup r ules.

C16.1 Introduction

Gains ar ising on disposals of qualif ying shar eholdings are exempt and losses are not allowable.

Ot her EU count r ies oper at e similar syst ems – Aust r ia, Belgium, Denmar k, Ger many, Luxembour g, t he Net her lands, Por t ugal and Spain cur r ent ly exempt gains on all or some classes of subst ant ial shar eholding.

C16.2 Outline of the relief Sch 7AC TCGA 1992

Gains ar e not char geable and losses ar e not allowable wher e:

(i) an invest ing company;

(ii) which has held a subst ant ial shar eholding in an invest ee company (r ef er r ed t o by Sch 7AC TCGA 1992 as ‘t he company invest ed in’) t hr oughout a 12-mont h per iod;

(iii) disposes of any shar es in t he invest ee company.

Ther e is no r equir ement f or t he pr oceeds f r om t he sale of t his shar eholding t o be used in any par t icular way.

C16.3 The substantial shareholding requirement

The exempt ion is dependent on t he invest ing company having held a subst ant ial shar eholding in t he invest ee company t hr oughout a 12-mont h per iod beginning no mor e t han t wo year s pr ior t o t he disposal.

Par a 7 Sch 7AC

TCGA 1992

The invest ing company must hold at least 10% of t he or dinar y shar e capit al of t he invest ee company and must also be benef icially ent it led t o at least 10% of :

Par a 8 Sch 7AC

TCGA 1992

(i) t he pr of it s available f or dist r ibut ion t o equit y holder s; and (ii) t he asset s available f or dist r ibut ion t o equit y holder s on a winding up.


The def init ion of ‘equit y holder ’ and t he det er minat ion of pr of it s or asset s available f or dist r ibut ion br oadly f ollow t he appr oach in Sch 18 I CTA 1988. The pur pose of t he t ime limit r ef er r ed t o above is t o allow subsequent disposals out of what was once a subst ant ial shar eholding t o cont inue t o qualif y f or exempt ion f or a f ur t her 12 mont hs, not wit hst anding t he f act t hat t he 10% t hr eshold may have ceased t o be sat isf ied. Illustration 1

Vaughan Lt d has owned 15% of Key Tr ading Lt d since 1998. On 1 J une 2006, Vaughan Lt d sold a 10% st ake in t he company at a pr of it . The gain on t his disposal clear ly qualif ies f or t he subst ant ial shar eholding exempt ion. However , some mont hs lat er , t he dir ect or s of Vaughan Lt d ar e consider ing t he possibilit y of selling t he r emaining 5% shar eholding.

Even t hough t he shar es in Key Tr ading Lt d no longer const it ut e a subst ant ial shar eholding, t he exempt ion is st ill available f or disposals in t he 12 mont hs f ollowing 1 J une 2006. Thus, if t he second sale is also expect ed t o r ealise a gain, it will be sensible f or Vaughan Lt d t o ef f ect t he disposal on or bef or e 1 J une 2007. However , if t he value of Key Tr ading Lt d has r ecent ly declined such t hat a shar e sale would now cr yst allise a loss, t he company should wait unt il af t er 1 J une 2007 so t hat t he loss will be allowable. I f a gr oup’s shar eholding in t he invest ee company is split bet ween var ious gr oup member s, t he shar es can be aggr egat ed in or der t o det er mine whet her t he subst ant ial shar eholding r equir ement is sat isf ied. For t he pur poses of t hese r ules, a gr oup compr ises a pr incipal company and it s 51% subsidiar ies – not e t hat t he s.170 TCGA 1992 def init ion of a gr oup is used, t he only dif f er ence being t he subst it ut ion of ‘51%’ f or ‘75%’.

Par a 9 Sch 7AC TCGA 1992

Par a 26 Sch 7AC TCGA 1992

Illustration 2

St ewar t Lt d

Gough Lt d

Giles Lt d

60%

7%

5%

Subst ant ial Shar eholding Exempt ion

225

I n t his diagr am, Gough Lt d does have a subst ant ial shar eholding in St ewar t Lt d (5% + 7% = 12%). Because Gough Lt d cont r ols Giles Lt d t he shar es in Giles Lt d ar e t r eat ed as t hough t hey ar e held by Gough Lt d. Not e t hat t her e is no need t o wor k out an indir ect int er est .

C16.4 Liquidations

When a company goes int o liquidat ion, it loses benef icial owner ship of it s asset s as a r esult of t hose asset s being vest ed in t he liquidat or . However , t he r ules pr ot ect an invest ing company f r om t his out come as f ar as t he subst ant ial shar eholding r ules ar e concer ned so t hat it can cont inue t o sat isf y t he necessar y condit ions f or exempt ion.

Par a 16 Sch 7AC

TCGA 1992

C16.5 Conditions for the investing company

Par a 18

Sch 7AC TCGA 1992

The invest ing company must be eit her :

(i) a ‘sole t r ading company’; or

(ii) a member of a ‘t r ading gr oup’

beginning wit h t he st ar t of t he lat est 12-mont h per iod in r elat ion t o which it passed t he subst ant ial shar eholding t est and ending wit h t he t ime of t he disposal. I t must also be a sole t r ading company or a member of a t r ading gr oup immediat ely af t er t he disposal. A sole t r ading company means any t r ading company which is not a member of a gr oup. ‘Tr ading company’ and ‘t r ading gr oup’ ar e def ined in much t he same way as t hey ar e f or business asset t aper r elief pur poses. Illustration 3

Poult er Lt d acquir ed 2,500 or dinar y shar es in Rose Lt d on 30 Apr il 2001. This

r epr esent ed a 25% st ake.

On 30 Apr il 2006 Poult er Lt d sold 2,000 of t hese shar es and 11 mont hs lat er on 31 Mar ch 2007 t he r emaining 500 wer e disposed of .

I n r espect of t he sale on 30 Apr il 2006, Poult er Lt d must be a t r ading company or a member of a t r ading gr oup f or 12 mont hs f r om 1 May 2005 unt il 30 Apr il 2006.

However , f or t he sale on 31 Mar ch 2007, t he qualif ying per iod r uns f or 23 mont hs f r om 1 May 2005 unt il 31 Mar ch 2007.


C16.6 Conditions for the investee company Par a 19 Sch 7AC

TCGA 1992

The invest ee company must have been a t r ading company or t he holding company of a t r ading gr oup t hr oughout t he per iod r ef er r ed t o in I llust r at ion 3.

I t must also be a t r ading company or t he holding company of a t r ading gr oup immediat ely af t er t he disposal.

However , wher e t he invest ee company ceases t o t r ade on being put int o liquidat ion or f ollowing an int r a-gr oup t r ansf er of it s t r ade (so t hat it would no longer sat isf y t he t est above), a special r ule means any gain accr uing t o t he invest ing company on a disposal of shar es in t he invest ee company t o cont inue t o be exempt f or a f ur t her t wo-year per iod. This is of t en called t he second subsidiar y exempt ion.

Par a 3 Sch 7AC

TCGA 1992

C16.7 Holdover relief

Wher e a gif t of shar es is made t o a company and holdover r elief is claimed under s.165 TCGA 1992, it is not possible f or t he company subsequent ly t o dispose of t hose shar es wit h t he benef it of t he subst ant ial shar eholding exempt ion. An amount equal t o t he held over gain will st ill be char geable.

Par a 37 Sch 7AC

TCGA 1992

C16.8 Investments in non-UK resident companies

The subst ant ial shar eholding exempt ion is not r est r ict ed t o disposals of shar es in UK-based companies. Gains ar ising on t he sale of non-UK r esident subsidiar ies and ot her invest ment s ar e also cover ed.

C16.9 Intra-group transfers

The subst ant ial shar eholding exempt ion does not apply t o s.171 t r ansf er s wit hin a capit al gains t ax gr oup. Ef f ect ively t he s.171 pr ovisions over r ide t he subst ant ial shar eholding r ules wher e shar es in t r ading companies ar e t r ansf er r ed bet ween gr oup companies.

Par a 6 Sch 7AC

TCGA 1992

When an invest ing company acquir es shar es under a s.171 t r ansf er and subsequent ly disposes of t hose shar es t o an unr elat ed company, t he holding per iod is ext ended t o include t he per iod f or which t he t r ansf er or held t hose shar es (and any per iod f or which t he t r ansf er or was t r eat ed as holding t hose shar es as a r esult of t he same pr ovisions).

Par a 10 Sch 7AC

TCGA 1992

C16.10 Degrouping charge

Wher e a degr ouping char ge ar ises under s.179 TCGA 1992 in r elat ion t o a holding of shar es t hat , at t he t ime of t he company leaves t he gr oup, would qualif y f or t he subst ant ial shar eholding exempt ion on an act ual disposal of t he shar es, t he subst ant ial shar eholding r ules ef f ect ively over r ide t he s.179 pr ovisions.

Par a 38 Sch 7AC

TCGA 1992

Subst ant ial Shar eholding Exempt ion

227

SUMMARY – SUBSTANTIAL SHAREHOLDINGS EXEMPTION

Fr om 1 Apr il 2002 gains on shar es held by companies ar e exempt f r om cor por at ion t ax pr ovided t hat at least a 10% st ake has been held f or 12 out of t he last 24 mont hs of owner ship. Bot h companies must be t r ading companies (or member s of a t r ading gr oup) as def ined f or t aper r elief pur poses t hr oughout t he 12 mont h holding per iod AND immediat ely af t er t he disposal. Losses on t he sale of a “subst ant ial shar eholding” ar e not allowable and negligible value claims made on or af t er 1 Apr il 2002 cannot be backdat ed t o t r igger a loss. Subst ant ial shar eholdings ar e t r ansf er r ed wit hin a capit al gains gr oup on a no gain/ no loss basis. Owner ship per iods of all gr oup companies ar e aggr egat ed t o det er mine whet her t he condit ions have been sat isf ied. Wher e a company leaves a gr oup t aking a “subst ant ial shar eholding” wit h it a degr ouping char ge under s.179 will not ar ise. The base cost of t he shar es will become t he mar ket value at t he t ime of leaving t he gr oup.

C17: THE PRINCIPLES OF GROUP RELIEF

This session will consider t he r elief t hat is available t o a gr oup of companies wher e one of t hem makes a t r ading loss. I n par t icular it will look at : - how a gr oup is const it ut ed; - t he r at es at which a loss can be r elieved; - how a company will decide wher e t he loss should be r elieved bear ing in mind t he

amount of t ax saved; - t he t iming of t he r elief .

C17.1 Introduction

Gr oup r elief allows losses t o be t r ansf er r ed t o pr of it making companies in t he

same 75% group. Illustration 1

Under t he gr oup r elief pr ovisions, we can sur r ender t he loss of £ 60,000 f r om B t o A r educing A' s t axable pr of it and it s cor por at ion t ax liabilit y.

The maximum claim is t he lower of t he available loss or the available profit.

Illustration 2

A Lt d £ 100,000

B Lt d (£ 60,000)

75%

A Lt d (£ 100,000)

B Lt d £ 60,000

75%

The Pr inciples of Gr oup Relief

229

The gr oup r elief claim her e will be a maximum of £ 60,000. A Lt d will have t he r emaining loss of £ 40,000 which it may be able t o set of f in t he cur r ent year , car r y back, or car r y f or war d. Losses t hat ar e unut ilised can only be car r ied f or war d in t he company t hat or iginally sust ained t hem.

C17.2 The 75% definition s.413 Sch 18 I CTA 1988

For group relief t o apply, one company must own at least 75% of the other. For example if A Limit ed owns 75% of B Limit ed, t hat means t hat losses can f low f r om A t o B or f r om B t o A. Not e t hat t he pr ovisions only apply to company ownership, t her ef or e, if Mr A owned 75% of B Limit ed, losses could not f low bet ween Mr A and B Limit ed, as Mr A pays I ncome Tax and B Limit ed pays Cor por at ion Tax.

Gr oup r elief also applies between two companies t hat ar e each owned to t he

ext ent of 75% by the same parent company.

Losses can flow bet ween t he par ent and t he t wo subsidiar ies in either direction and losses can also f low bet ween t he t wo subsidiar ies.

I f t he t wo subsidiar ies ar e owned by Mr P inst ead of Par ent Lt d, losses could not

f low eit her bet ween Mr P and t he t wo companies, or indeed bet ween t he t wo subsidiar ies. Cor por at e owner ship must apply f or gr oup r elief of losses.

The 75% test applies t o all t hr ee of t he f ollowing: (i) Ther e must be 75% ownership of ordinary share capital of t he

company; and (ii) Those shar es must ent it le t he shar eholder s t o at least 75% of t he

available distributable profits; and (iii) Those shar es must ent it le t he shar eholder t o at least 75% of t he

company’s assets on a winding up.

These t hr ee t oget her f or m t he def init ion of “equitable ownership”.

Par ent Lt d

Sub 1 Lt d Sub 2 Lt d

75% 75%


Illustration 3

Par ent Co

I n t he above scenar io, Par ent Co and A Lt d ar e in a 75% gr oup.

However t o det er mine whet her Par ent Co and B Lt d ar e in t he same gr oup r elief gr oup, we mult iply 80% and 90% t o give 72%. This is less t han 75% so a gr oup is not f or med. I f B Lt d has a loss, it cannot sur r ender it t o Par ent Co. or vice ver sa. B Lt d and A Lt d ar e in a 75% so t r ading losses can be sur r ender ed bet ween t hem. Cont r ast t his wit h t he r elat ionship bet ween Par ent Co and C Lt d and D Lt d. I n t his inst ance t he 3 companies ar e in a gr oup r elief gr oup as Par ent Co’s ef f ect ive int er est in D Lt d is 81% (i.e. 90% x 90%). The gr oup r elief gr oups ar e t her ef or e: Par ent Co + A Lt d + C Lt d + D Lt d and A Lt d + B Lt d I t can be seen, t her ef or e, t hat a company can par t icipat e in mor e t han one gr oup r elief gr oup. Not e t hat all 5 companies ar e associat ed wit h each ot her so t he cor por at ion t ax limit s f or each of t he companies ar e divided by 5.

C17.3 Available amounts

The sur r ender ing company (i.e. t he loss making company) may sur r ender : s.403 I CTA 1988

(i) t r ading losses

(ii) DI I I losses The t ot al amount of t hese losses may be sur r ender ed bef or e t he sur r ender ing company is r equir ed t o consider any loss of f set in it s own comput at ion.

Fur t her mor e t he sur r ender ing company may also sur r ender

(iii) excess management expenses

(iv) excess Schedule A losses

80% 90%

A Lt d C Lt d

B Lt d D Lt d

90% 90%


231

(v) excess DVI losses on non t r ade I FAs

(vi) excess char ges (t r ade and non-t r ade) The amount of “excess” available f or gr oup r elief is f ound by compar ing gr oss income bef or e any loss set of f s t o char ges, management expenses, Schedule A losses and DVI losses on I FAs as appr opr iat e.

The sur r ender ing company sur r ender s t o t he claimant company (i.e. t he pr of it

making company) who must set the losses against profits chargeable to

corporation tax.

The claimant company must set t he losses against pr of it s char geable t o cor por at ion t ax in t he same account ing per iod. The claimant company must use the losses in its current accounting period – any losses claimed under gr oup r elief cannot be car r ied back, car r ied f or war d or given t o anot her gr oup member .

The of f set against PCTCT will be made af t er char ges and any cur r ent year or br ought f or war d losses. However t he of f set is made bef or e losses br ought back f r om a f ut ur e per iod i.e. losses car r ied back do not displace gr oup r elief alr eady claimed.

Illustration 4

Two 75% gr oup companies have t he f ollowing r esult s:

Claimt on Lt d £

Sur r t on Lt d £

Schedule D Case I (6,000) (80,000) Schedule D Case I I I 20,000 (4,000) Schedule A - 10,000 Char ges on income (1,000) -

The available loss of Sur r t on Lt d is as f ollows:

Sur r t on Lt d

£

Schedule D Case I (80,000)

Schedule D Case I I I (4,000)

Available loss (84,000)


The available pr of it of Claimt on Lt d is as f ollows:

Claimt on Lt d

£ Sur r t on Lt d

£

Schedule D Case I Nil (80,000)

Schedule D Case I I I 20,000 (4,000)

Cur r ent Year Loss (6,000)

14,000

Char ges on income (1,000) ______

13,000 (84,000)

Gr oup r elief f r om Sur r t on Lt d – lower of PCTCT or loss available

(13,000) 13,000

(71,000)

Cur r ent year claim in Sur r t on (if made) 10,000

_______

Remaining loss £ (61,000)

C17.4 Effective use of losses

When using losses, it is impor t ant t o obt ain r elief at t he highest mar ginal r at es

of t ax and secondly t o use t he losses up sooner r at her t han lat er . Fr om a t iming per spect ive our pr ef er ence would be f or claims in t he f ollowing

or der :

(i) current year and t hen carry back;

(ii) group relief;

(iii) carry forward. However , t he pr imar y obj ect ive f or t he companies is t o save t he maximum t ax possible on a gr oup wide basis. To appr eciat e how t his is done, we must consider t he ef f ect ive marginal rates of t ax of all of t he companies in t he gr oup.

C17.5 Marginal rates of tax

We have var ious mar ginal r at es of t ax, depending on t he level of t he company’s

not ional pr of it .


233

By “mar ginal” r at e we mean t he r at e of cor por at ion t ax ef f ect ively payable on t he f inal £ 1 of a company’s PCTCT.

Tax r at es: FY 2006 FY 2002 t o 2005 £ 0 - £ 10,000 19% 0%

£ 10,001 - £ 50,000 19% 23.75% £ 50,001 - £ 300,000 19% 19%

£ 300,001 - £ 1,500,000 32.75% 32.75% > £ 1,500,000 30% 30%

The limits would obviously be divided amongst the number of associates in the

group.

The mar ginal r at es of 23.75% and 32.75% ar e calculat ed as f ollows:

23.75% r at e:

£ £ 50,000 x 19% 9,500 (10,000) x 0% - 40,000 9,500 9500

40000 = 23.75%

32.75% r at e:

£ £ 1,500,000 X 30% 450,000 (300,000) X 19% (57,000) 1,200,000 393,000 393000

1200000 = 32.75%

Illustration 5

Hill Lt d owns 100% of t he shar es of Collis Lt d. As t he companies ar e associat ed, t he cor por at ion t ax limit s (FY 2005) will be as f ollows:

£ St ar t ing r at e limit 5,000 Lower r at e limit 25,000 Small companies limit 150,000 Upper limit 750,000

Assuming Hill Lt d has PCTCT of £ 1m it will be a “lar ge” company and will pay cor por at ion t ax at t he f ull r at e of 30%, i.e.

£ 1,000,000 x 30% = £ 300,000


Anot her way t o ar r ive at t his CT liabilit y is t o consider t he mar ginal t ax r at es which apply wit hin each of t he 5 t ax bands:

£ Fir st £ 5,000 @ 0% - Next £ 20,000 @ 23.75% 4,750 Next £ 125,000 @ 19% 23,750 Next £ 600,000 @ 32.75% 196,500 Remaining £ 250,000 @ 30% 75,000 Tot al t ax on PCTCT of £ 1m £ 300,000

Diagr amat ically t hese mar ginal r at es can be illust r at ed as below:

£ 1,500,000

£ 300,000 £ 50,000 £ 10,000 Pr of it s

Pr of it s Divided by number of

associat es as appr opr iat e

This diagr am illust r at es t hat if a company had pr of it s bet ween t he upper limit and t he small companies limit s (i.e. bet ween £ 300,000 and £ 1,500,000 in t his example), and it wer e given an extra £1 of income it would pay cor por at ion t ax at a r at e of 32.75% on t hat “mar ginal” £ 1. This 32.75% r at e is an ef f ect ive marginal r at e and should not be used when calculat ing MCT liabilit ies. Ther ef or e when making gr oup r elief claims, we will t r y t o eliminat e pr of it s t axed at t he highest mar ginal r at e, i.e. 32.75%.

30%

32.75%

19%

23.75%

0%


235

To achieve t his we need t o specify t he amount of gr oup r elief r equir ed in or der t o br ing t he pr of it down t o t he exact level of t he small companies limit . This ensur es t hat all of t he loss will be r elieved at an ef f ect ive r at e of 32.75%. As gr oup r elief claims can be specif ied, t his is ver y easy t o do. We would t hen st ar t er oding pr of it s t axed at 30%, t hen pr of it s t axed at 23.75%, again specif ying t he claim t o r educe t he pr of it down t o t he st ar t ing r at e lower limit and no f ur t her . Next we er ode pr of it s t axed at 19%, we should avoid eliminat ing pr of it t hat is t axed at 0%

Illustration 6

X Lt d is a par ent company wit h t wo wholly-owned subsidiar ies Y Lt d and Z Lt d.

The r esult s in t he year ending 31 Mar ch 2007 ar e as f ollows:

X Lt d £

Y Lt d £

Z Lt d £

Schedule D Case I 600,000 (40,000) (20,000) Schedule D Case I I I 50,000 121,000 10,000

I n or der t o calculat e t he opt imum loss r elief we need t o car r y out t he f ollowing st eps. Fir st we build up t he cor por at ion t ax comput at ions so t hat we can wor k out what r at es of t ax t he pr of it s ar e being char ged at .

X Lt d £

Y Lt d £

Z Lt d £

Schedule D Case I 600,000 Nil Nil Schedule D Case I I I 50,000 121,000 10,000 Pr of it 650,000 121,000 10,000 Next we need t o calculat e t he upper and lower limit s:

Limit s £ 300000

3 = £ 100,000 £ 10000

3 = £ 3,333

£ 1.5m

3 = £ 500,000 £ 50000

3 = £ 16,667

We can see t hat X is paying t ax at 30%, Y is paying t ax at 32.75% on t he t op par t of it s pr of it s and Z is paying t ax at 23.75%. We want t o save t ax at t he highest mar ginal r at e.


Y has a loss of £ 40,000. The opt imum claim will be t o use £ 21,000 of loss t o r educe Y’s pr of it s down t o t he lower limit and t hen t o use t he balance of t he loss in X by way of gr oup r elief . Z has a loss of £ 20,000 and t he best place t o use t his loss will again be in X by way of gr oup r elief . Ther ef or e, in Y, as we cannot specif y t he amount t o of f set under a cur r ent year claim (it is an all or not hing claim), t he gr oup r elief claim of £ 19,000 must be made f ir st bef or e submit t ing an all-or -not hing cur r ent year claim under s.393A(1)(a) f or t he balance, being £ 21,000. X Lt d

£ Y Lt d

£ Z Lt d

£ Schedule D Case I 600,000 Nil Nil Schedule D Case I I I 50,000 121,000 10,000 Pr of it 650,000 121,000 10,000 Cur r ent year claim (21,000) Gr oup r elief : Y Lt d (19,000) Z Lt d (20,000) ______ _____ PCTCT £611,000 100,000 10,000

Example 1

Consider t he f ollowing:

Fog Lt d £

Mist Lt d £

Schedule D Case I 80,000 10,000 Schedule A - (100,000) Char ges on income (5,000) -

What is t he maximum loss t hat can be sur r ender ed f r om Mist Lt d t o Fog Lt d?

Example 2

Consider t he gr oup below: Mr Woot t en Haywar d Lt d 100% 76% 24% Seaf or d Lt d Br ight on Lt d

80% 51%

Hove Lt d East bour ne Lt d 100% Wor t hing Lt d 60% Hast ings Lt d


237

You ar e r equir ed t o:

(1) I dent if y t he companies which ar e associat ed wit h Seaf or d Lt d f or cor por at ion t ax pur poses.

(2) I dent if y t he gr oups which exist f or gr oup r elief pur poses.

Example 3

Houllier Lt d has t wo wholly owned subsidiar ies Owen Lt d and Heskey Lt d, and 60% of t he shar es in Ger r ar d Lt d. The r esult s f or t he year ended 31 Mar ch 2006 ar e as f ollows:

Houllier Lt d

£ Owen Lt d

£ Heskey Lt d

£ Ger r ar d Lt d

£

Schedule DI 100,000 40,000 nil 90,000 Tr ading loss (60,000) Schedule DI I I 10,000 4,000 6,000 2,000 Char geable gain 20,000 - - 4,000

You ar e r equir ed t o calculat e t he cor por at ion t ax liabilit y f or each company, assuming t he loss r elief is t aken in t he most ef f icient way.


Answer 1

Fog Lt d £

Mist Lt d £

Schedule D Case I 80,000 10,000 Schedule A (10,000) Char ge on income (5,000) ___ Pr of it 75,000 Nil Group relief (75,000) PCTCT Nil

The excess Schedule A loss is £ 90,000 of which £ 75,000 can be sur r ender ed. The r emaining £ 15,000 will be car r ied f or war d.

Answer 2

(1) Associat ed companies:

Seaf or d Lt d Hove Lt d Limit s f or cor por at ion East bour ne Lt d t ax ar e t her ef or e Wor t hing Lt d divided by 6 Hast ings Lt d Br ight on Lt d

Seaf or d Lt d is associat ed wit h Br ight on Lt d as t hey ar e cont r olled by t he same

per son – i.e. Mr Woot t en.

To det er mine whet her Seaf or d Lt d and Hast ings Lt d ar e associat ed, we do not mult iply t he ef f ect ive int er est s – it is suf f icient t hat each company in t he chain is cont r olled by it s par ent .

(2) Gr oup r elief gr oup:

Ther e is only one gr oup f or gr oup r elief pur poses, i.e.

Seaf or d Lt d + Hove Lt d + Wor t hing Lt d. Seaf or d Lt d and Br ight on Lt d ar e not in t he same gr oup as t hey ar e not under t he 75% cont r ol of t he same company.


239

Answer 3

Small companies limit s – 4 company gr oup £ 10,000 x ¼ £ 2,500 £ 50,000 x ¼ £ 12,500 £ 300,000 x ¼ £ 75,000 £ 1.5m x ¼ £ 375,000

Houllier Lt d

£ Owen Lt d

£ Heskey Lt d

£ Ger r ar d Lt d

£ Schedule DI 100,000 40,000 - 90,000 Schedule DI I I 10,000 4,000 6,000 2,000 Char geable gain 20,000 _____ _____ 4,000 PCTCT bef or e loss r elief 130,000 44,000 6,000 96,000 Tax r at e pr ior t o r elief

Mar ginal 19% Small mar ginal

Mar ginal

Cur r ent year (3,500) Gr oup r elief (55,000) (1,500) _____ n/ a PCTCT af t er gr oup r elief 75,000 42,500 2,500 96,000 CT @ 19% 14,250 8,075 - CT @ 30% 28,800 11/ 400 x (375,000 – 96,000)

_____

_____

___ ( 7,673) _____

CT payable 14,250 8,075 - 21,127 Not es: 1 Ger r ar d Lt d is not a 75 % subsidiar y and so cannot par t icipat e in t he gr oup

r elief claim (it is however an associat e)

2 Houllier Lt d’s pr of it s ar e in t he highest mar ginal band – i.e. 32.75%. Ther ef or e we f ir st use suf f icient losses t o br ing Houllier Lt d’s pr of it s down t o t he small companies limit of £ 75,000.

3 Heskey’s Lt d’s pr of it s ar e in t he lower mar ginal band – i.e. 23.75%. Ther ef or e we have used suf f icient losses t o br ing Heskey Lt d’s pr of it s down t o t he st ar t ing r at e limit of £ 2,500.

4 I t would have been equally cor r ect t o allocat e t he £ 1,500 balance of losses t o Houllier Lt d inst ead of Owen Lt d, as it saves 19% t ax in bot h cases, and in f act would save administ r at ive wor k as a signat or y f or each company has t o sign a gr oup r elief claim.

5 The or der of claims will be as f ollows: £ Loss in Heskey Lt d 60,000 Less: gr oup r elief in Houllier Lt d (55,000) Less: gr oup r elief t o Owen Lt d (1,500) Balance 3,500 Less: s.393(A)(1)(a) cur r ent year Claim in Heskey Lt d

(3,500)

Loss r emaining Nil


SUMMARY – THE PRINCIPLES OF GROUP RELIEF

When a company makes a t r ading loss it can sur r ender it t o anot her member of t he same 75% gr oup. The maximum amount t hat can be sur r ender ed is t he lower of : (i) t he loss of t he sur r ender ing company, and (ii) t he PCTCT of t he claimant company Ther e is no r equir ement f or t he sur r ender ing company t o use t he loss against it s own income bef or e sur r ender but it may do if it so chooses. Schedule DI I I def icit s may also be gr oup r elieved in t he same way. Excess Schedule A losses, excess char ges (t r ade or non t r ade), excess management expenses and excess DVI losses on non t r ade I FAs can also be included in a gr oup r elief claim. The loss is allocat ed t o r elieve income t axed at t he highest (mar ginal) r at es. The mar ginal r at es ar e: £ 0 - £ 10,000 0% £ 10,001 - £ 50,000 23.75% £ 50,001 - £ 300,000 19% £ 300,001 - £ 1,500,000 32.75% over £ 1.5m 30%

C18: GROUP CAPITAL GAINS

This chapt er cover s t he def init ion of a gains gr oup and looks at how it dif f er s f r om a losses gr oup. Once we have est ablished t he gr oup we will t hen consider : - t he ef f ect of t r ansf er r ing asset s bet ween gr oup companies; - t he loss r elief which is available; - t he availabilit y of r ollover r elief in a gains gr oup; - t he t r ansf er of asset s t o st ock wit hin a gr oup.

C18.1 Definition

Companies ar e in t he same capit al gains gr oup when one company owns at least 75% of t he or dinar y shar es of anot her company or t wo companies ar e 75% owned by t he same par ent .

s. 170 TCGA 1992

This 75% def init ion is similar t o t he r ules f or gr oup r elief but , f or gr oup gains pur poses, we only need 75% of the ordinary shares and not 75% of dist r ibut able pr of it s nor 75% of asset s on a winding-up.

The gr oup gains r egime also has slight ly dif f er ent r ules f or sub-subsidiar ies.

For gr oup gains, t he dir ect r elat ionship must be at least 75% but the indirect relationship need only be above 50%. We r ef er t o t his as t he ef f ect ive 51% subsidiar y t est .

s. 170(3) TCGA 1992

I n addit ion, f or gr oup gains a company can only be a member of one gr oup. s. 170(6)

TCGA 1992


Illustration 1

Consider t he f ollowing st r uct ur e:

Group relief group:

For gr oup loss r elief we need a 75% direct and indirect relationship. Ther ef or e, f or gr oup r elief we can t r ansf er losses bet ween A and B, bet ween B and C, bet ween C and D and bet ween D and E.

The indir ect r elat ionship bet ween A and C is 56.25%. For gr oup r elief we need at least 75%; no losses can f low bet ween A and C nor bet ween A and any ot her companies f ur t her down t he gr oup.

Group gains group:

When consider ing a capit al gains gr oup we must look at t he A gr oup as A is t he ult imat e holding company. Thus we call A t he pr incipal company. A owns 56.25% of C and, consequent ly, C can be included in A' s gains gr oup. However , A only owns 42% of D (75% of 56.25%), and t her ef or e as t his is below 50%, D is not par t of A' s gr oup. Consequent ly, t he A capit al gains gr oup compr ises companies A, B and C.

A Lt d

B Lt d

C Lt d

E Lt d

D Lt d

75%

75%

75%

75%

Gr oup Capit al Gains

243

We cannot link C and D f or t he gr oup gains pur poses - t he r eason f or t his is t hat a company which is a 75 % subsidiar y of anot her company cannot be a pr incipal company unless it f ails t he ef f ect ive subsidiar y t est . I n ot her wor ds a company cannot be a member of mor e t han one gr oup f or gr oup gains pur poses. As C is a member of A' s gains gr oup, it cannot f or m a sub-gr oup wit h D. This r ule does not apply t o gr oup r elief so f or gr oup r elief we can link C and D, but f or gr oup gains we cannot .

However , D can be a pr incipal company and f or m it s own gr oup and, consequent ly, we can link D and E t oget her f or gr oup gains pur poses as D becomes a new holding company. So, f or gr oup gains, we have t wo gr oups, t he A gr oup compr ising A, B and C, and t he D gr oup compr ising D and E.

Transfers of assets:

C and D ar e clear ly connect ed companies and consequent ly any t r ansf er s bet ween t hese companies will be at mar ket value.

Transfers of assets wit hin t he same capital gains group however will all t ake place at no gain no loss - we shall st udy t his in mor e det ail shor t ly.

s. 171 TCGA 1992

Example 1

Consider t he f ollowing st r uct ur e:

I dent if y which companies ar e in A’s gr oup r elief gr oup and capit al gains gr oup.

A Lt d

B Lt d

C Lt d

E Lt d

D Lt d

90%

90%

90%

90%


C18.2 Intra group transfers of assets s.171

TCGA 1992

Transfers bet ween members of t he same group ar e t r eat ed as no gain no loss

transfers. This r ule applies aut omat ically and is compulsor y. This is t he same r ule t hat applies t o t r ansf er s of asset s bet ween a mar r ied couple.

The r ules apply wher e: a) t he t r ansf er r ing company is UK r esident at t he t ime of t he disposal or t he

asset is a char geable asset in r elat ion t o t he company immediat ely bef or e t hat t ime and

b) t he t r ansf er ee company is eit her UK r esident at t he t ime of t he disposal or t he asset is a char geable asset in r elat ion t o t hat company immediat ely af t er t hat t ime.

Illustration 2

Beckham Limit ed owns 100% of Posh Limit ed. I n Sept ember 1992 Beckham Limit ed pur chased a pr oper t y at a cost of £ 500,000. I n J anuar y 2007, Beckham Limit ed decided t o t r ansf er t his pr oper t y t o Posh Limit ed. The t r ansf er will t ake place at no gain no loss. We have a cost of £ 500,000, indexat ion of say £ 250,000 t her ef or e, our pr oceeds ar e deemed t o be £ 750,000 in or der t o give us no gain no loss.

£ Pr oceeds 750,000 Cost (500,000) I ndexat ion at , say 50% (250,000) nil

I n ot her wor ds t he pr oceeds ar e cost plus indexat ion t o t he dat e of t r ansf er . Consequent ly, Posh Limit ed will have a base cost of t his par t icular pr oper t y of £ 750,000 which it will index in a f ut ur e disposal calculat ion f r om J anuar y 2007, t he dat e of t he int r a-gr oup t r ansf er .

Example 2

Thompson Lt d has one wholly owned subsidiar y, Mur phy Lt d. Mur phy bought a pr oper t y f or £ 180,000 in J uly 1987. I n December 1998 it t r ansf er r ed t he pr oper t y t o Thompson Lt d when it s mar ket value was £ 250,000. Thompson Lt d sold t he pr oper t y in August 2007 f or £ 380,000. You ar e r equir ed t o calculat e t he gain char geable on Thompson Lt d in it s account s f or t he 12 mont hs t o 31 December 2007.


245

Assume (f or illust r at ion pur poses) t he f ollowing indexed r ises: J uly 1987 – December 1998: 0.641 December 1998 -August 2007: 0.186

C18.3 Notional transfers s.171A TCGA 1992

A not ional t r ansf er is wher e we pretend t hat an asset or par t of it has been

transferred within the group prior to it being sold.

This is t o utilise capital losses and also t o ensur e gains are taxed at the

lowest marginal rate possible.

Illustration 3

Bush Limit ed owns 100% of Blair Limit ed. They have income in t he year ended 31

Mar ch 2007 of £ 500,000 and £ 75,000 r espect ively. Blair Limit ed has capit al losses br ought f or war d of £ 90,000.

I n t he year ended 31 Mar ch 2007, Bush Limit ed sold a pr oper t y and r ealised a capit al gain of £ 150,000. What we must do is ascer t ain in which company it would be bet t er f or t he gain t o ar ise. As t her e ar e t wo companies in t he gr oup, t he cor por at ion t ax lower and upper limit s must be divided by t wo giving us £ 150,000 and £ 750,000 r espect ively. The mar ginal r at es of t ax ar e 19% below £ 150,000, 32.75% bet ween t he limit s and 30% above £ 750,000.

As Bush has ot her pr of it s of £ 500,000, if we wer e t o add t he gain t o Bush' s pr of it s, t he gain would be t axed in f ull at t he mar ginal 32.75% r at e of t ax. The ext r a t ax would be:

£150,000 x 32.75% = £49,125

I f however we wer e t o do a not ional t r ansf er , t r ansf er r ing t he pr oper t y f r om Bush Limit ed t o Blair Limit ed (by elect ing on t he CT600), we might f ind we get a bet t er r esult . Blair Limit ed has ot her income of £ 75,000. We would ut ilise Blair Limit ed' s capit al losses br ought f or war d of £ 90,000 r educing t he t axable capit al gain t o £ 60,000. The gain will all be t axed at 19% so t he ext r a t ax t his t ime would be:

£(150,000 – 90,000) x 19% = £11,400

So ef f ect ing t he t r ansf er will save t he gr oup cor por at ion t ax of :

£ 49,125 - £ 11,400 = £ 37,725

Clear ly t his would be wor t hwhile.


C18.4 Making a notional transfer claim

s.171A TCGA 1992

The claim t o t r eat an asset or any par t of it as being t r ansf er r ed t o a f ellow gr oup company immediat ely bef or e it s sale can only be made if t he no gain no loss t r ansf er r ule would apply bet ween t he t wo companies who make t he elect ion. I t has t o be a joint election made in writing within two years of t he end of t he account ing per iod of t he company who sells t he asset .

s. 171A(4) TCGA 1992

Any incident al cost incur r ed by t he company making t he act ual disposal will be deemed t o be incident al cost of t he ot her company.

s. 171A(2) TCGA 1992

Any payment s made bet ween t he companies in r elat ion t o t he not ional t r ansf er will be ignor ed t o t he ext ent t hey do not exceed t he char geable gain or allowable loss t hat ar ises on t he company making t he deemed disposal.

s. 171A(5) TCGA 1992

Example 3

Calf Limit ed is a wholly owned subsidiar y of Bull Limit ed. Bull Limit ed does not

have any ot her subsidiar ies. Dur ing t he year ended 31 Mar ch 2007, t he pr edict ed pr of it s of each company ar e £ 100,000 and £ 700,000 r espect ively. Calf Limit ed has capit al losses br ought f or war d of £ 30,000 and in Febr uar y 2007 Bull Limit ed sold a pr oper t y r ealising a capit al gain of £ 100,000. Assuming t hat t hey ar e going t o make t he most benef icial elect ions, calculat e t he minimum cor por at ion t ax payable on t his gain.

C18.5 Group wide rollover relief

A capital gains group is treated as one unit for rollover relief purposes. Assume t hat A and B ar e par t of t he same capit al gains gr oup and t hat A has sold an asset f or £ 900,000 which has r ealised a capit al gain of £ 350,000.

s. 175 & s. 152 TCGA 1992

Remember ing t he nor mal r ules of r ollover , pr ovided t hat within one year prior

to the sale and three years after, A r einvest s all of t he £ 900,000 pr oceeds, t he capit al gain can be r olled over and deduct ed f r om t he base cost of a r eplacement asset . Assume B invest ed £ 1 million int o a new asset . This will enable t he gain in A t o be r olled over against t he base cost of t he asset pur chased by B under t he gr oup wide r ollover pr ovisions. This gives a base cost of t he r eplacement asset in B of £ 650,000.

The r ules on gr oup r ollover apply t o all companies so long as t hey ar e r esident in t he UK or car r ying on a t r ade in t he UK t hr ough a per manent est ablishment .


247

The r ules apply wher e a company which is a member of a gr oup disposes of an asset used in it s t r ade at a t ime when it is a member of t he gr oup, anot her company acquir es an asset at a t ime when it is a member of t he same gr oup and a j oint claim is made by t he companies. Thus t her e is no r equir ement f or t he companies t o be member s of t he gr oup at t he same t ime. However t he company making t he disposal must be UK r esident , or t he asset must be char geable at t he t ime of t he disposal and t he company acquir ing t he asset must be UK r esident , or t he asset must be a char geable UK asset at t he t ime it is bought . The disposal and acquisit ion of asset s by non-t r ading companies in t he gr oup can qualif y f or r ollover r elief so long as t hey ar e used in t he t r ade of ot her companies in t he gr oup. Rollover r elief cannot be claimed f or t he acquisit ion of asset s f r om gr oup companies wher e no gain no loss r ules apply.

C18.6 Transfers within a group: trading stock s.173 TCGA 1992

Special r ules apply wher e an asset held as capit al is t r ansf er r ed t o anot her member of a capit al gains gr oup which will hold t he asset as st ock and vice ver sa. Wher e an asset held as capital is t r ansf er r ed by company A to company B in t he same gains gr oup who will hold t he asset as trading stock, t he transfer will

take place under the no gain/ no loss rules. Once B r eceives t he asset , it will be immediat ely taken to trading stock at its market value.

Illustration 4

Cap Lt d, a t r ading company, t r ansf er s a pr oper t y t o Hat Lt d, a pr oper t y-dealing company. The companies ar e in t he same gains gr oup. Cap Lt d had bought t he pr oper t y many year s ago f or £ 550,000. The indexat ion f act or up t o t he dat e of t r ansf er is 0.225. The mar ket value of t he pr oper t y at t he t ime of t he t r ansf er was £ 740,000 Fir st ly, t he pr oper t y will go f r om Cap Lt d t o Hat Lt d at no gain no loss. The deemed disposal pr oceeds f or Cap Lt d will be:

£ Cost 550,000 I A 0.225 x 550,000 123,750 673,750 This will also be t he base cost of t he pr oper t y f or Hat Lt d. The asset will t hen be t aken t o st ock in Hat Lt d at it s mar ket value of £ 740,000 and so a gain will ar ise in Hat Lt d as f ollows:


Deemed pr oceeds 740,000 I ndexed cost (673,750) 66,250 I f Hat Lt d now sells t he pr oper t y f r om st ock at it s mar ket value t her e will be no t r ading pr of it . Hat Lt d, a pr oper t y-dealing company, has t her ef or e ended up wit h a capit al gain. The company nor mally has DI income or losses f r om pr oper t y sales. Hat Lt d can make use of t he elect ion in s.161 TCGA 1992 - t his elect ion allows a t r ader who is appr opr iat ing a capit al asset t o st ock t o elect for the asset to be taken to stock at its indexed cost. The elect ion has t o be made within two

years of t he end of t he account ing per iod in which t he asset is t aken t o st ock. I f Hat Lt d makes t his elect ion, at t he t ime of t he t r ansf er f r om Cap Lt d t he building will be t aken t o st ock at a value of £ 673,750 and t her e will be no capit al gain. On a f ut ur e sale of t he pr oper t y at mar ket value, a DI pr of it of £ 66,250 will ar ise. This elect ion will be especially usef ul wher e t he pr oper t y-dealing company has t r ading losses br ought f or war d or t he t r ansf er r ed asset is st anding at a capit al loss. I f an asset is t r ansf er r ed by a company t hat holds it as t r ading stock, to a company t hat will hold t he asset as a capital asset , t hen t he company t hat holds t he asset as t r ading st ock is t r eat ed as making a disposal from trading stock at mar ket value pr ior t o t he t r ansf er .

Illustration 5

Paper Lt d and Tr ay Lt d ar e t wo companies in a gains gr oup. Paper Lt d is a pr oper t y dealing company, Tr ay Lt d is a t r ading company. Paper Lt d has a pr oper t y which it bought f or £ 370,000. The mar ket value of t he pr oper t y is £ 400,000. I t is t o be t r ansf er r ed t o Tr ay Lt d. Paper Lt d will be t r eat ed as t aking t he pr oper t y out of t r ading st ock at it s mar ket value and so will make a DI pr of it of £ 400,000 - £ 370,000 = £ 30,000. Tr ay Lt d will r eceive t he pr oper t y at it s mar ket value of £ 400,000. I ndexat ion allowance will begin t o r un f r om t he dat e t he pr oper t y is t r ansf er r ed.


249

Answer 1

Group relief group:

Clear ly f or gr oup r elief we can t r ansf er losses bet ween A and B and bet ween B and C. A indir ect ly owns 81% of C (90% of 90%). Consequent ly, losses can also be t r ansf er r ed bet ween A and C. A indir ect ly owns 72.9% of D (90% of 81%). This is below 75% and consequent ly losses cannot f low bet ween A and D. Ther ef or e t he gr oup r elief gr oup r elevant t o A includes companies A, B and C.

Group gains group:

For gr oup gains A indir ect ly owns 81% of C, 72.9% of D and 65.61% of E (90% of 72.9%). So, going all t he way down t he chain, we f ind t hat A' s indir ect r elat ionship in E is above 50% so consequent ly all of t he companies ar e in A' s gains gr oup. Ther ef or e t he gr oup gains gr oup r elevant t o A includes companies A, B, C, D

and E.

Answer 2

Tr ansf er f r om Mur phy Lt d t o Thompson Lt d in December 1998: £ Cost t o Mur phy Lt d 180,000 I A f r om J uly 1987 - December 1998 0.641 x £ 180,000 115,380 Cost t o Thompson Lt d 295,380 Disposal by Thompson Lt d in August 2007: Pr oceeds 380,000 Less: cost December 1998 (295,380)

84,620 Less: I A Dec 1998 - August 2007

0.186 x £ 295,380 (54,941)

Gain y/ e 31.12.2007 29,679


Answer 3

The upper and lower limit s ar e £ 750,000 and £ 150,000 r espect ively.

Bull Lt d has ot her income of £ 700,000. I f t he gain was t axed in Bull Lt d it would incr ease cor por at ion t ax liabilit y by:

£ (50,000 x 32.75%) + £ (50,000 x 30%) = £ 31,375

Calf Lt d has ot her income of £ 100,000.

I f we not ionally t r ansf er t he asset t o Calf Lt d t o t r igger t he gain in Calf Lt d, t he posit ion would be impr oved as Calf has some capacit y in t he 19% band and also has capit al losses br ought f or war d.

£ Gain 100,000 Capit al losses b/ f (30,000) 70,000

The cor por at ion t ax liabilit y would be:

(£ 50,000 x 19% + £ 20,000 x 32.75%) = £16,050

Elect ing f or t he not ional t r ansf er has t her ef or e saved t ax of £ 15,325 f or t he gr oup.


251

SUMMARY – GROUP CAPITAL GAINS

A gains gr oup r equir es a 75% r elat ionship bet ween companies. However , unlike gr oup r elief gr oups it is possible t o include sub-subsidiar ies of 75% subsidiar ies, pr oviding t he ef f ect ive holding is mor e t han 50%. Asset s t r ansf er r ed bet ween member s of a gains gr oup aut omat ically move on a no gain no loss basis, i.e. t he new company inher it s t he indexed cost of t he old one. Companies can elect t o t r eat asset s as if t hey wer e t r ansf er r ed int r a gr oup pr ior t o sale. Gains gr oups can claim r ollover r elief on a gr oup wide basis. I f a f ixed asset held by one gr oup member is t r ansf er r ed t o anot her who will t ake it t o st ock t hen a gain will ar ise on t he t r ansf er ee when t he asset is appr opr iat ed t o st ock. An elect ion is however available t o allow t he asset t o be appr opr iat ed t o st ock at indexed cost .

C19: CLOSE COMPANY DEFINITION

This chapt er looks at t he f ollowing ar eas: - t he def init ion of a close company;

- t he def init ion of associat e; - except ions t o being a close company.

St at ut or y r ef er ences in t his chapt er ar e t o I CTA 1988 unless st at ed ot her wise.

C19.1 Introduction

A close company is a company which is resident in the UK and is controlled by either

s. 414

• five or fewer participators (shar eholder s); or • any number of directors who are also shareholders. Consequent ly, in t he UK, most private companies are close.

C19.2 Directors

I n t his cont ext a dir ect or is anyone who act s as a dir ect or by what ever name called (e.g. Chair man). I n addit ion, we include any manager of t he company, who, wit h t heir associat es, owns 20% or mor e of t he vot ing shar es of t he company.

C19.3 Associates

When determining the level of ownership by one particular shareholder we must also include shares owned by his or her associates. The r ules f or associat es ar e ver y similar t o t hose which apply in det er mining whet her companies ar e associat ed wit h each ot her .

s. 417

Close Company Def init ion

253

For close company pur poses associat es include: • t he individual’s immediate family,

Remoter forebear

Parents

Brothers + Spouse

and Sisters

Children

Remoter issue

• business partners (but not co-dir ect or s)

• trustees of trusts set up by t he individual or any of his immediat e f amily

• nominees (a nominee is simply an individual who owns shar es on behalf of someone else).

Example 1

J ulie invit es t he f ollowing people r ound t o dinner . Which of t hem ar e associat ed wit h her ?

Yes No Her sist er Her sist er ’s husband Her cousin Her uncle Her business par t ner Her gr andmot her Her invest ment adviser


Example 2

Reynolds Limit ed is owned as f ollows: Tim Reynolds J udit h Reynolds Alison Reynolds (Tim’s wif e) (Tim’s daught er )

Reynolds Limit ed

I s Reynolds Limit ed a close company?

Example 3

East ender s Limit ed is owned as f ollows:

* = Dir ect or I s East ender s Limit ed a close company? Does your answer change if Gar y Hobbs is appoint ed a dir ect or ?

Example 4

Tr ot t er s I ndependent Tr ader s Limit ed is owned as f ollows:

Der ek Tr ot t er 20% Rodney Tr ot t er (Der ek’s br ot her ) 7% Alber t Tr ot t er (Der ek’s uncle) 5% Boycee 10% Mar lene (Boycee’s wif e) 3% Tr igger 6% Cassandr a (Rodney’s gir lf r iend) 4% Ot her s (1% each) 45% 100%

I s t he company close?

* Phil Mit chell 11% * Pauline Fowler 11% * Dor ot hy Cot t on 11% * Pat Evans 11% * Ter r y Raymond 6% Gar y Hobbs 5% Ot her s – owing less t han 5% 45% 100%

40% 40%

20%


255

Example 5

Bill and Ben ar e br ot her s Bill Ben Flower Lt d Pot Lt d Ar e t he companies close?

Ar e t he companies associat ed f or t he pur pose of det er mining t he r at es of t ax payable?

C19.4 Exceptions s.414(1)

Cer t ain companies will not be close companies. These ar e:

1) non r esident companies;

2) r egist er ed f r iendly or indust r ial societ ies building societ ies and lif e assur ance companies;

3) companies cont r olled on or behalf of t he cr own;

4) companies cont r olled by open companies;

5) quot ed companies wit h subst ant ial public int er est .

C19.5 Quoted companies with substantial public interest s.415

The except ion applies t o a company t hat is quot ed on t he st ock exchange and has had dealing in it s shar es in t he last t welve mont hs. I n addit ion t he public must hold at least 35% of t he vot es and t he pr incipal member s must hold less t han 85%. The public is def ined as including:

• Any non close company

• Open pension f unds

• Shar es held by per sons ot her t han pr incipal member s Dir ect or s, t heir associat es and companies t hey cont r ol, can never be included as member s of t he public. The pr incipal member s ar e t he f ive biggest shar eholder s who hold at least 5% of t he vot ing power in t he company. Wher e t her e is a t ie t o be t he f if t h biggest shar eholder t hen we include 6 or what ever higher number of pr incipal member s is necessar y.

s.415(6)

100% 100%


Example 6

Cuent ame plc is a company list ed on t he st ock exchange wit h dealings in t he last t welve mont hs t he shar es ar e held as f ollows: Mer cedes Alcant ar a 24 Ant onio Alcant ar a (Mer cedes’s husband) 10 I nes Alcant ar a (Mer cedes’s daught er ) 4 Eugenio (f amily pr iest ) 3 Don Pablo (Ant onio’s boss) 7 Nieves Fer nando 2 Bar r io Lt d (open company) 25 J ubilacion (open pension f und) 13 Ot her s all less t han 3% 12 100 Mer cedes, Don Pablo and Nieves ar e dir ect or s of t he company. I s t he company close?


257

Answer 1

Yes No Her sist er X Her sist er ’s husband X

Her cousin X

Her uncle X

Her business par t ner X Her gr andmot her X Her invest ment adviser X

Answer 2

Reynolds Limit ed is a close company as over half of t he shar es (in t his case all of t he shar es) ar e owned by 5 or f ewer par t icipat or s.

Answer 3

The 5 “lar gest ” shar eholder s ar e:

Phil 11% Pauline 11% Dot 11% Pat 11% Ter r y 6% 50%

This is not cont r ol by f ive or f ewer shar eholder s (not mor e t han 50%) so t he company is not close. I f Gar y is appoint ed as a dir ect or , t hen 55% of t he shar es ar e owned by t he dir ect or s. This is cont r ol by any number of dir ect or shar eholder s so t he company would become close.

Answer 4

The t op 5 shar eholder s in t he company ar e as f ollows:

Der ek (including Rodney) 27% Boycee (including Mar lene) 13% Tr igger 6% Alber t 5% Cassandr a 4% 55%

This is cont r ol so t he company is close.


Answer 5

Each of t he companies is a close company because t hey ar e each cont r olled by j ust one per son. Bill and Ben ar e br ot her s and t hey each wholly own t heir own companies. Under s.416(6) ICTA 1988 we must appor t ion holdings bet ween associat es. Ther ef or e we should appor t ion Ben’s holding in Pot t o Bill. That means t hat Bill cont r ols bot h Flower and Pot . We should also appor t ion Bill’s holding in Flower t o Ben, which also means t hat Ben cont r ols bot h Flower and Pot . That would mean, t her ef or e, in t he absence of any special r ules t hat t hose t wo companies would be associat ed wit h each ot her even t hough Bill and Ben’s companies may have not hing t o do wit h each ot her ; t hey would simply be associat ed because t hey ar e cont r olled by f ellow f amily member s.

However , ESC C9 which deals wit h associat es f or small companies r at e pur poses, will ignor e t he appor t ionment r ules pr ovided t her e is not subst ant ial commer cial int er dependence bet ween t he t wo companies. Put t ing t his int o t he cont ext of an example, assume t hat Flower Limit ed makes f ur nit ur e and Pot Limit ed sells f ur nit ur e. I f Pot Limit ed only sold f ur nit ur e pr oduced by Flower Limit ed, and Flower Limit ed only supplies f ur nit ur e t o Pot Limit ed, t her e would be commer cial int er -dependence. Pot is t ot ally dependent upon Flower f or it s supplies, and Flower is t ot ally dependent on Pot f or it s mar ket . I f , however , Flower only sold f ur nit ur e t o Pot but Pot bought f ur nit ur e f r om loads of dif f er ent supplier s, and was not dependent upon Flower , t hen t her e may not be commer cial int er -dependence. I t is not a st r aight f or war d t est as t he companies do not need t o be dependant on each ot her in t he same way or t o t he same ext ent . Ult imat ely it will depend on all t he f act s. The Revenue will not j ust conf ine t hemselves t o consider at ion of t r ading t r ansact ions, t hey will also look at t he administ r at ion and dir ect or ship of t he companies t he pr emises used and ot her ar r angement s ent er ed int o such as int er company loans.


259

Answer 6

I s t he company cont r olled by t he dir ect or s Mer cedes 38 Don Pablo 7 Nieves 2 47% No I s t he company cont r olled by f ive or f ewer shar eholder s Bar r io Lt d 25 Mer cedes 38 63% Yes I s t he company cont r olled by an open company? No as Bar r io Lt d only holds 25% I s t he company wit hin t he quot ed company except ion? The public hold Bar r io Lt d 25 J ubilacion 13 Eugenio 3 Ot her s 12 53% The pr incipal member s hold Bar r io Lt d 25 J ubilación 13 Mer cedes 38 Don Pablo 7 83% Conclusion: it is not a close company Not e: I n calculat ing Mer cedes’ shar eholding we include t he shar es of her husband and daught er f or all t est s. Nieves cannot be a member of t he public as she is a dir ect or even t hough she is not a pr incipal member . Eugenio is not a pr incipal member as he holds less t han 5%, however , he is a member of t he public.


SUMMARY – CLOSE COMPANY DEFINITION

A close company is a company t hat is r esident in t he UK and cont r olled by eit her 5 or f ewer par t icipat or s or any number of par t icipat or dir ect or s. I n looking at a per son’s shar eholding we consider shar es held by t heir associat es. For close company pur poses associat e includes: Spouse, par ent s and r emot er f or bear s, childr en and r emot er issue and siblings. Ther e ar e except ions which include; - r egist er ed indust r ial societ ies, f r iendly societ ies, building societ ies and lif e

assur ance companies - companies cont r olled on behalf of t he cr own - companies cont r olled by open companies - quot ed companies wit h subst ant ial public int er est . The quot ed company except ion only applies if t he company is quot ed on t he st ock exchange wit h dealings in it s shar es in t he last t welve mont hs. I n addit ion t he pr incipal member s must hold less t hen 85% of t he vot es and t he public at least 35%. Dir ect or s and t heir associat es can never be member s of t he public. Non-close companies and open pension f unds can be member s of t he public even if t hey ar e pr incipal member s.

C20a: CLOSE COMPANY IMPLICATIONS – PART 1

This chapt er looks at t he f ollowing ar eas: - t he impact of being a close company on t he company and it s shar eholder s; - t he impact of a company making a loan t o one of it s shar eholder s.


C20a.1 Introduction

Close company r ules exist t o pr event shar eholder s and dir ect or s of close companies f r om using t hose companies as an ext ension t o t heir own pr ivat e banking f acilit ies wit hout paying any t ax! Rules exist wit h r egar d t o: • loans to participators and • benefits provided to participators.

C20a.2 Loans to participators

J ack is bot h a dir ect or and shar eholder of Vine Limit ed. Wit hin t he company’s books J ack is likely t o have a cur r ent account , wher e amount s he is ent it led t o f r om t he company ar e cr edit ed and amount s he t akes out ar e debit ed.

s. 419

J ack is ent it led t o a salar y, af t er t ax, of £ 80,000. The company will debit salar y cost s and cr edit J ack’s cur r ent account . The salar y it self is t axed as ear nings using t he PAYE syst em.

J ack is also ent it led t o dividends f r om t he company of £ 50,000. The company will debit dividends and cr edit J ack’s cur r ent account . The dividends t hemselves will be t axed on J ack at t he usual dividend r at es and higher r at e t ax may be due.

We can see t hat J ack is ent it led t o wit hdr aw a t ot al of £ 130,000 f r om t he company. Assume t hat J ack act ually t akes out £ 150,000. J ack has bor r owed an ext r a £ 20,000 f r om t he company by way of a “loan t o a par t icipat or ”. I t is t his loan t hat t he close company r ules seek t o t ax under t he pr ovisions of s.419 I CTA 1988.

C20a.3 S.419 tax

Close companies which ar e not liable t o pay t heir cor por at ion t ax by inst alment s will be r equir ed t o pay s.419 tax on their normal due date, i.e. 9 months and

1 day f ollowing t he end of t he char geable account ing per iod.

s. 419(3)

The tax is calculated as 25% of the loan and is payable by t he company.


The amount of the loan is t aken as t he lower of the amount outstanding on

• the last day of the chargeable accounting period or

• the normal due date.

For lar ger close companies s. 419 t ax is added t o t he amount of t ax due by inst alment s which adds a hor r endous complicat ion t o t he inst alment s syst em!

Example 1

J ack bor r owed £ 20,000 f r om Vine Limit ed (a small close company) on 30 Sept ember 2005. He will r epay it as f ollows:

30.9.06 Repaid £ 10,000 30.9.07 Repaid £ 5,000 30.9.08 Repaid £ 5,000

Vine Limit ed has a 31 December account ing dat e. How much t ax is due under s.419 and when is it due?

C20a.4 Repayment of s.419 tax

Wher e t he loan is eit her r epaid by t he par t icipat or or waived by t he company (in ot her wor ds wr it t en of f , wit h t he par t icipat or being r eleased f r om any f ur t her r epayment s), t ax pr eviously paid under sect ion 419 will be r ef unded back t o t he company. The refund is made by reducing the company’s tax liability for the

chargeable accounting period in which the loan is repaid or waived. As most close companies ar e small, t his will nor mally be nine mont hs and one day f r om t he end of t he account ing per iod in which t he r epayment or r elease of t he loan is made.

s. 419(4)

Example 2

I n t he pr evious example, Vine Limit ed paid s.419 t ax of £ 2,500 on 1.10.05 in r espect of a loan out st anding of £ 10,000.

The loan is r epaid as f ollows: 30.9.07 £ 5,000 30.9.08 £ 5,000

How much s.419 t ax will be r ef unded t o Vine Limit ed and when?

Close Company I mplicat ions – Par t 1

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C20a.5 Implications for the participator

I f a company waives a loan t o a par t icipat or t he company will r eceive a r epayment of t he s.419 t ax. The individual has r eceived r eal money f r om t he company. The participator t her ef or e will be treated as receiving a dividend

equal to the amount of the loan waived.

s. 421(1)

The dat e of r eceipt of t he dividend will be t he dat e of t he loan waiver . An individual will pay higher r at e t ax via self assessment if he is a higher r at e t axpayer .

Illustration 1

Heppel Limit ed, a small close company, advanced £ 15,000 t o Fr ed, who is a dir ect or and shar eholder , on 31 December 2005. On 31 December 2006 Fr ed r epaid £ 5,000 and Heppel Limit ed waived a f ur t her £ 9,000. Heppel Limit ed has a 31 Mar ch year end.

I mplicat ions f or Heppel Limit ed:

The loan is advanced on 31 December 2005, which is in t he company’s account ing per iod ended 31 Mar ch 2006. S.419 t ax is due nine mont hs and one day lat er , on 1 J anuar y 2007:

25% x £ 15,000 = £ 3,750

This t ax is r ef unded when t he loan is eit her waived or r epaid. A t ot al of £ 14,000 is r eleased f r om t he loan on 31 December 2007, which is dur ing t he company’s year ended 31 Mar ch 2008. Any r ef und is made nine mont hs and one day lat er , on 1 J anuar y 2009:

25% x £ 14,000 = £ 3,500 I mplicat ions f or Fr ed:

Fr ed is deemed t o r eceive a dividend of £ 9,000 on 31 December 2007, which is in t ax year 2007/ 08. Assuming t hat Fr ed is a higher r at e t axpayer , he will be t axed on t hat dividend. The dividend it self is gr ossed up f or t he t ax cr edit of 10%.

£

£ 9,000 x 10090

10,000

Tax at 32.5% 3,250 Tax cr edit : £ 10,000 x 10% (1,000) Higher r at e t ax due on 31 J anuar y 2009 2,250

A simpler way of calculat ing t his higher r at e t ax would be t o t ake t he net dividend of £ 9,000 and mult iply it by 25% which leads us t o t he same f igur e of £ 2,250.


Answer 1

Loan advanced 30.9.05 which is dur ing t he company’s year end 31.12.05 Amount out st anding: At end of CAP i.e. at 31.12.05 = £ 20,000 At due dat e of payment f or CT i.e. at 1.10.06 = £ 10,000 So t he s.419 t ax due on 1.10.06 is: £10,000 x 25% = £2,500

Answer 2

Fir st r epayment on 30.9.07 is dur ing t he company’s year ended 31.12.07 Ref und made on 1.10.08 is: £5,000 x 25% = £1,250

Second r epayment on 30.9.08 is dur ing t he company’s year ended 31.12.08 Ref und made on 1.10.09 is: £5,000 x 25% = £1,250


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SUMMARY – CLOSE COMPANY IMPLICATIONS (1)

Wher e a close company makes a loan t o a shar eholder it is f ir st necessar y t o see if it is exempt . I f not , t her e will be a s.419 char ge on t he company equal t o 25% of t he amount of t he loan. This will be payable wit h t he CT liabilit y f or t he per iod, unless t he loan has been r epaid bef or e t he t ax is due. Wher e t he t ax is payable, it can be r eclaimed by t he company if t he loan is r epaid. I f t he loan is wr it t en of f , t he company can r eclaim t he t ax but t he r ecipient will become liable t o income t ax as t hough t he loan wr it t en of f was a dividend.

C20b: CLOSE COMPANY IMPLICATIONS – PART 2

This chapt er looks at : - t he impact of close companies pr oviding benef it s t o shar eholder s who ar e not

employees; - t he consequences of being a close invest ment holding company.


C20b.1 Loans excluded from s.419 Charge s. 420

Loans made in the ordinary course of business of the company ar e excluded f r om t he s.419 char ge. Under t his exclusion t he close company must be a bank or similar moneylender .

I n Br ennan v Deanby I nvest ment Company Limit ed t he company made a ser ies of loans t o it s Chair man and one ot her loan t o an independent per son. I t was held in t his case t hat , alt hough t he Chair man was paying commer cial int er est t o t he company on t he loans, s.419 st ill applied because t he making of a number of dif f er ent loans t o t he same connect ed per son did not const it ut e t he business of a moneylender and t he company t her ef or e lost it s appeal. Ther e is also an exclusion f or t he supply of goods or ser vices in t he or dinar y cour se of t he t r ade unless t he cr edit per iod is longer t han nor mal.

s.420(1)

Ther e is also an exclusion f or loans of no mor e t han £ 15,000 made t o a f ull-t ime dir ect or or employee who is ent it led t o no mor e t han 5% of t he company’s asset s on a winding-up. When calculat ing t his 5%, we must also t ake account of holdings owned by his associat es.

s.420(2)

But if t he bor r ower acquir es a 5% holding at a t ime when t he whole or par t of t he loan r emains out st anding, t hen he will be t r eat ed as r eceiving a loan at t hat t ime.

s.420(2)

Illustration 1

Gr een Lt d a close company wit h a December year end makes a loan of £ 12,000 t o J im who is a f ull t ime wor king dir ect or and holds 3% of t he shar e capit al on 1 Oct ober 2006. On t he 1 J anuar y 2007 J im r epays £ 5000 of t he loan. On t he 31 Mar ch 2007 J im incr eases his shar eholding t o 6%. At t he t ime of t he loan it is cover ed by t he except ion as it is f or less t han £ 15,000, and t o a f ull-t ime wor king dir ect or who does not hold a mat er ial int er est in t he company. No s.419 t ax is payable. The r epayment of £ 5,000 has no implicat ions f or s.419.


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On 31 Mar ch 2007 J im acquir ed f ur t her shar es and now holds mor e t han 5%. Thus Gr een Lt d is t r eat ed as having made a loan on 31 Mar ch 2007 equal t o t he loan out st anding which is £ 12,000 - £ 5,000 = £ 7,000. S.419 t ax is payable in r espect of t he account ing per iod ended 31 December 2007. I f t he company is not lar ge it will be due on 1 Oct ober 2008.

C20b.2 Beneficial loan interest s. 418

Wher e a company makes a loan to a participator, and eit her charges no

interest, or char ges int er est below the official rate, a benefit in kind is levied on the participator. Wher e t he par t icipat or is an employee or dir ect or t his will need t o be r epor t ed on his P11D and will be t axed under t he ear nings r ules.

Illustration 2

Campbell Limit ed, a close company, lends £ 10,000 t o Ted who is a shar eholder and employee in t he company. The loan is advanced on 1 Oct ober 2005 and Ted r epays it t o Campbell Limit ed on 30 Sept ember 2006. Assuming t hat t he benef icial int er est r at e is 7.25%, Ted’s benef it in kind will be as f ollows. For t he t ax year 2004/ 05, we look at t he per iod 1 Oct ober 2005 t o t he 5 Apr il 2006 which is 187 days and t her ef or e t he benef it will be:

£ 10,000 x 7.25% x 187365 = £ 371

For t he next t ax year 2006/ 2007, we look at t he per iod 6 Apr il 2006 t o t he 30 Sept ember 2006, t hat is a per iod of 178 days, and t her ef or e t he benef it will be:

£ 10,000 x 7.25% x 178365 = £ 354

These f igur es will need t o be r epor t ed on Ted’s P11Ds f or t hose separ at e t ax year s.

C20b.3 Benefits to participators s. 418

Wher e a shar eholder is an employee or dir ect or of a close company, any benef it s he r eceives ar e t axed under t he ear nings r ules. Ther ef or e, in t he absence of any special r ules, wher e shar eholder s are not dir ect or s or employees, t hey would not pay any t ax on benef it s t hey r eceive. This is t he r eason f or S.418 which will

treat those benefits as net dividends paid to those shareholders. The net dividend is calculat ed using t he nor mal benef it r ules f or ear nings. S.418 applies t o any expense incur r ed by t he company in connect ion wit h t he pr ovision of living or ot her accommodat ion, ent er t ainment , domest ic or ot her ser vices or ot her benef it s or f acilit ies of what ever nat ur e.


S.418 does not include:

1) Benef it s t o employees which ar e t axed under t he ear nings r ules;

2) Living accommodat ion if it is wit hin t he except ions wit hin t he ear nings r ules;

3) Pensions, annuit ies or lump sums paid t o t he childr en, spouse or dependant s of an employee on t he employee’s deat h or r et ir ement .

Illustration 3

J oan r eceives a company car f r om Mor ley Limit ed, a close company. The car has a list pr ice of £ 21,000, and CO2 emissions of 188g/ km. She is a shar eholder in t he company but not an employee or a dir ect or . I n t ax year 2006/ 07, she will be t r eat ed as r eceiving a net dividend calculat ed using t he benef it in kind r ules.

£ Car Benef it [185 – 140]/ 5 = 9 + 15 = 24% £ 21,000 x 24% = £ 5,040 Deemed gr oss dividend

£ 5,040 x 10090

5,600

Tax at 32.5% 1,820 Tax cr edit : £ 5,600 x 10% (560) Higher r at e t ax due 1,260

That gives us a net dividend of £ 5,040 which we gr oss up at 100/ 90 t o £ 5,600.

The t ax will be added t o J oan’s t ax liabilit y f or 2006/ 07 and t he t ax must be paid by 31 J anuar y 2008.

C20b.4 Close investment holding companies

All close companies ar e Close I nvest ment Holding Companies (CI HCs) unless t hey exist wholly or mainly f or one of t he per mit t ed pur poses which basically ar e t o be a t r ading company or a member of a t r ading gr oup or t o make invest ment s in land.

s.13A

Wher e t he company is a CI HC, it cannot use the small and marginal company

rates of tax. I nst ead such companies will always be taxed at the full rate of cor por at ion t ax (cur r ent ly 30%), r egar dless of t he level of it s pr of it s.

C20b.5 Jointly held property

Fr om 6 Apr il 2004 wher e shar es in a close company ar e held j oint ly by a husband and wif e any income from the shares will be taxed according to actual

ownership. Pr eviously t he income was t axed 50:50 unless an elect ion was made f or t axat ion accor ding t o act ual owner ship.


269

C20b.6 Summary

Wher e a benefit is paid to an employee or director, as f ar as t he r ecipient is concer ned, t he benef it is t axed in t he usual way under t he ear nings r ules and r epor t ed on form P11D. As f ar as t he company is concer ned, t he cost of pr oviding t hat benef it is t ax deduct ible in t he usual way.

As f ar as a non-wor king par t icipat or r ecipient is concer ned, t he individual will be treated as receiving a dividend on any s.418 benefits received. The value of t he dividend will be calculat ed using t he nor mal benef it r ules and will be subj ect t o higher r at e t ax wher e appr opr iat e.

As f ar as t he company is concer ned, t he cost of pr oviding t hat benef it will not be deductible as it is t r eat ed as an appr opr iat ion f r om pr of it .

The except ion t o t his r ule is the write off of a loan to a participator. A loan wr it e of f is always treated as a distribution.


SUMMARY – CLOSE COMPANY IMPLICATIONS (2)

I f a close company pr ovides a benef it t o an employee/ shar eholder , it is t axed under t he nor mal ear nings r ules. I f t he shar eholder is not an employee, t he value of t he benef it is t r eat ed as a dividend paid t o t he shar eholder . The wr it e of f of a loan t o a par t icipat or is always t r eat ed as a dividend. Close I nvest ment Holding Companies, ar e companies whose main act ivit y is making invest ment s, r at her t han t r ading. A CI HC is always t axed at t he f ull CT r at e, cur r ent ly 30%. The income f r om j oint ly held shar es will be t axed accor ding t o act ual owner ship of each spouse f r om 6 Apr il 2004.

C21: INVESTMENT COMPANIES

This chapt er explains t he basic r ules in r elat ion t o t he t axat ion of companies wit h invest ment business including: - def init ion of an invest ment company and a company wit h invest ment business; - t r eat ment of management expenses pr e and post 1 Apr il 2004; - change in owner ship pr ovisions f or companies wit h invest ment business; - def init ion of CI HC; - r elief available f or invest ment companies f or losses on sale of shar es.

C21.1 Definition

A company with investment business is def ined in t he legislat ion as a “company whose business consist s wholly or partly in t he making of invest ment s”. This def init ion was int r oduced by FA 2004 wit h ef f ect f r om 1 Apr il 2004 and is par t icular ly r elevant in r elat ion t o claiming r elief f or management expenses. A company wit h invest ment business is not simply a company t hat holds invest ment s or r eceives invest ment income. I t is a company t hat has a business of making invest ment s. Pr ior t o FA 2004, a company had t o be an investment company in or der t o obt ain r elief f or management expenses. An invest ment company is a “company whose business consist s wholly or mainly in t he making of invest ment s and the

principal part of whose income is derived therefrom”. I t can be seen t hat t he def init ion of a company wit h invest ment business is wider t han t hat of an invest ment company and t hat all invest ment companies ar e also companies wit h invest ment business. The t er m invest ment company is now only r elevant when consider ing which companies may claim r elief against income f or capit al losses on sales of cer t ain shar es. Mor e on t his lat er .

The Revenue, in Tax Bullet in 19, t ell us t o look at t he t ot alit y of t he company' s

f unct ions and act ivit ies t o ident if y a business wholly or par t ly in t he making of invest ment s.

Consider a f lat management company t hat owns t he f r eehold of a block of f lat s

and all t he f lat owner s have a shar e in t he company. This t ype of company would not be t r eat ed as a company wit h invest ment business as it s business is not t hat of making invest ment s; it s business is t he pr ovision of management ser vices.

s.573

s.130


I n t he case of Cook v t he Medway Housing Societ y Limit ed in 1997, it was held t hat a Housing Associat ion pur chasing pr oper t y f r om a Local Aut hor it y, and r eceiving r ent al income, wit h t he aim of applying any pr of it s t o eit her buy mor e pr oper t y or pass it t o char it y, was an investment company because it had a business of making invest ment s and had an int ent ion of making a pr of it able r et ur n. I t did not mat t er t hat t he r et ur n was never going t o be paid t o t he shar eholder s. The int ent ion was enough f or invest ment company st at us t o apply. We can cont r ast t his wit h t he case of Tint er n Close Resident s Societ y Lt d. I n 1995 t his company owned and managed an est at e t hat consist ed of 21 houses 1 f lat and 22 lock up gar ages. The company’s income consist ed of member s’ subscr ipt ions and gr ound r ent s. I t was held t hat t he main f unct ion and act ivit y of t he company was t he management and maint enance of t he pr oper t y. Alt hough it had been f or med t o pur chase land, it was not f or t he pur pose of t ur ning t he land t o pr of it .

I n t he case of J ar r et t v O' Neill and Br ennan Const r uct ion Limit ed, it was held

t hat a company deposit ing f unds int o a bank account and r eceiving int er est , did not const it ut e a business and t her ef or e, f or associat ed company pur poses, it was t r eat ed as dor mant .

C21.2 Management expenses post 1 April 2004

Fr om 1 Apr il 2004, t he abilit y t o claim management expenses has been ext ended t o include companies with an investment business - not j ust t hose qualif ying as invest ment companies - and also t o include non UK resident companies. The ext ension t o companies wit h an invest ment business will be impor t ant f or companies who hold shar es in subsidiar ies as well as having t heir own t r ade.

FA 2004 r eplaced t he exist ing r ules r elat ing t o management expenses wit h a new

s.75 t hat applies t o all account ing per iods beginning on or af t er 1 Apr il 2004. Wher e an account ing per iod st r addles t his dat e t he company will be t r eat ed as having t wo not ional account ing per iods.

Management expenses ar e deduct ible against t he t ot al pr of it s of a company wit h an invest ment business. The expenses will be deducted based on when they

are debited in the accounts. The account s must be dr awn up in accor dance wit h GAAP. Wher e t he per iod of account exceeds t welve mont hs, management expenses will be t ime appor t ioned.

s.75A

No expenses can be deduct ed as management expenses if t hey ar e otherwise

deductible for tax.

s.75(2)

Expenses of a capital nature are not management expenses, unless t hey r elat e t o capit al allowances. Thus f or t he f ir st t ime t her e is st at ut or y aut hor it y t o exclude capit al expendit ur e f r om management expenses. This has ar isen as a r esult of case law in t his ar ea, as we shall see below.

s.75(3)

I nvest ment Companies

273

Expenses will only qualif y f or a deduct ion t o t he ext ent t hat t hey ar e made in r espect of t he company’s invest ment business and t o t he ext ent t hat t hey ar e not made for an unallowable purpose.

s.75(4)

An invest ment is held f or an unallowable purpose t o t he ext ent t hat it is not held f or a business or ot her commer cial pur pose, or is held f or act ivit ies out side t he char ge t o cor por at ion t ax. This will exclude invest ment s held f or social or r ecr eat ional pur poses and invest ment s of a non r esident company wit h a per manent est ablishment in t he UK, if t he invest ment is not par t of t he business of t he PE.

Surplus capital allowances are added to management expenses.

Examples of management expenses include:

(i) Commissions paid to agents, such as st ockbr oker s who manage t he por t f olio of shar es;

(ii) Capital allowances on plant used to manage the investments, such as comput er equipment used t o monit or t he pr ogr ess of t he invest ment s;

(iii) Reasonable salaries, which includes r edundancy cost s. The Revenue may seek t o disallow excessive dir ect or s’ r emuner at ion wher e it cannot be j ust if ied given t he amount of input t he dir ect or s have in managing t he invest ment s against t he r et ur n der ived f r om t hem. I f t he Revenue f eel t he amount is excessive, t hey will seek t o disallow some management expenses. However , t hey will st ill t ax t he dir ect or ’s f ull salar y and subj ect t he company t o Class 1 secondar y Nat ional I nsur ance on t he salar y being paid;

(iv) Premises costs, f or inst ance r elat ing t o t he of f ices used t o manage t he invest ment s;

(v) Audit and accountancy costs.

Remember t hat commitment fees and guarantee commissions, ar e par t of t he cost of r aising loans, and so ar e not management expenses - t hey will be deduct ible f r om DI I I under t he loan relationships r ules.

Any expenses r elat ing t o specif ic income must be set against t hat sour ce only,

f or example under Schedule A. Expenses r elat ing specif ically t o pr oper t ies being let out must be set against t he Schedule A income, not t r eat ed as a management expense. All I nt angible Fixed Asset s held will be held f or non-trading purposes. Thus f r om 1 Apr il 2002 r oyalt y payment s and r eceipt s will go int o t he DVI pool.


C21.3 Management expenses prior to 1 April 2004

Many of t he r ules we looked at above applied pr ior t o t he FA 2004 changes hence we will j ust concent r at e on t he dif f er ences her e. I n account ing per iods beginning before 1 April 2004, management expenses could only be deduct ed by UK resident invest ment companies. They wer e deduct ible in t he account ing per iod in which t hey wer e disbursed. Ther e ar e transitional provisions t o ensur e t hat amount s ar e not deducted twice or missed, as we move t o deduct ion accor ding t o when t he expense is debit ed in t he account s.

The old s.75 did not include any r ef er ence t o capit al expendit ur e or t o invest ment s held f or unallowable pur poses.

C21.4 Management expenses case law

I n Capit al and Nat ional Tr ust Lt d v Golder t he point at issue was whet her t he company could claim r elief f or br oker age and st amp dut ies as management expenses. I t was held t hat t hese sums wer e not allowable as management expenses. The r eason was t hat , wher e invest ment s ar e being changed, ' management ' does not ext end beyond t he t ime when a pur chase or sale is ef f ect ed. Ther ef or e, expendit ur e af t er t hat t ime cannot be an expense of management ; it is ' an int egr al par t of t he selling pr ice' . Sun Lif e Assur ance Societ y v Davidson also looked at t he issue of whet her t he company could claim r elief f or br oker age and st amp dut ies as management expenses. The company was a life assurance company. I t included in it s management expenses claim sums f or br oker age and st amp dut ies in connect ion wit h pur chases and sales of invest ment s. Sun Lif e sought t o dist inguish it s business f r om t hat of Capit al and Nat ional Tr ust Lt d because, it said, buying and selling st ocks and shar es was par t of it s t r ading act ivit y. I t was decided t hat t hese sums wer e not allowable as management expenses. They concluded t hat t he br oker age and st amp dut ies wer e not gener al expenses of conduct ing t he Societ y' s business, but expenses of t he pur chase of invest ment .

Alt hough t he j udgement s in t hese t wo cases per haps say mor e about what is not an expense of management , t her e ar e t hr ee br oad point s t hat ar e wor t h not ing.

• The wor ds have no special meaning.

• The phr ase does not include ever y expense.

• The phr ase should be given a ' wide' meaning. I n anot her case it was st at ed t hat t he pur pose of management expenses is not t o give invest ment companies an advant age over t r ading companies, but simply t o pr event t hem being at a disadvant age.


275

So we need t o dr aw a dist inct ion bet ween t he cost s of a change in a company' s invest ment s, (including it s shar e por t f olio) and t he acquisition of t he shar e capit al of a new subsidiar y company, as par t of t he expansion of t he gr oup. The cost s of a change in t he company' s invest ment s may be allowable on t he aut hor it y in t he Sun Lif e case. The costs of acquisition of the share capital of a new subsidiary company are not management expenses. Thus when we ar e looking at t he pur chase of a company by a company wit h invest ment business, we have t o consider each st age in t he pr ocedur e. To begin wit h, t he company may be looking at sever al companies and so at t his st age t he cost s incur r ed will be in r elat ion t o making and managing it s invest ment s. However at some point when a specif ic t ar get is ident if ied, t he cost s such as due diligence will become par t of t he capit al cost of pur chase. The Revenue have r ecent ly lost a case of Camis v At kinson at t he Cour t of Appeal. I n t his case a company incur r ed subst ant ial expendit ur e in evaluat ing a pr oj ect ed acquisit ion of anot her company. The company did not pr oceed wit h t he acquisit ion, and claimed r elief f or t he expendit ur e as management expenses. The Cour t of Appeal held t hat t he r elevant act ivit ies ‘wer e all par t of t he pr ocess of manager ial decision-making’ and t hat capit al expendit ur e was not excluded by t he legislat ion as in f or ce at t he r elevant t ime. This decision was t aken bef or e FA 2004 was passed. As we have seen above, t he new s.75(4) st at es t hat expenses of a capit al nat ur e ar e excluded f r om deduct ion as management expenses.

I n t he case of J ames Snook and Co v Blasdale, a t r ading company was bought . As par t of t he t akeover , t he exist ing dir ect or s agr eed t o r esign. They wer e paid compensat ion f or loss of of f ice. I t was held t hat t he cost was not deduct ible as it was t oo closely linked wit h t he t akeover of t he company and t hus f or med par t of t he capit al cost of t he t akeover .

C21.5 Relief for management expenses

Management expenses ar e automatically set against investment income and

gains in the current accounting period. This r elief is aut omat ic and compulsor y.

Management expenses ar e deduct ed before charges on income and bef or e any loss relief claims under sect ion 393A.

Wher e t he management expenses exceed the gross income and gains in the

current period, t hey ar e “excess”. I f t he company is par t of a gr oup t hey may

be transferred to a fellow 75% owned company, upon making a claim. Failing t hat , excess management expenses ar e carried forward and set against f ut ur e income and gains of t he company.

s. 75(8)


C21.6 Change in ownership provisions s.768B

We must also be awar e of t he change in owner ship pr ovisions f or a company wit h invest ment business. Ant i-avoidance pr ovisions apply t o prevent the carry

forward of excess management expenses in pr escr ibed cir cumst ances.

I f in t he t hr ee year s leading up t o t he change in owner ship, or in t he t hr ee year s f ollowing t he change in owner ship, t her e has been a major change in the type of

investments held, t hen excess management expenses will be st opped at t he dat e of change in owner ship. For example if bef or e t he change in owner ship t he company held quot ed secur it ies and, f ollowing t he change, it held commer cial pr oper t y, t he Revenue would view t his as a maj or change in t he t ype of invest ment held. However , let us say t hat bef or e t he change of owner ship, t he company held quot ed secur it ies but af t er war ds, it held a dif f er ent por t f olio of quot ed secur it ies, so it sold t he pr evious holdings and r eplaced t hem wit h dif f er ent ones. This is unlikely t o be t r eat ed as a maj or change because t he company essent ially is st ill holding t he same t ype of invest ment s, t hat being quot ed secur it ies. The ant i-avoidance pr ovisions also apply when a company’s act ivit ies ar e small

and negligible prior to the change in ownership, and t hey ar e followed by a

considerable revival. Excess management expenses will st op at t he dat e of t he change. This will be based on t he f act s and degr ee in each individual case but we need t o look at t he number of t r ansact ions t aking place each year , bef or e and af t er t he change in owner ship.

I n addit ion, a significant increase in the capital of the company in the three

years immediately following the change of ownership, will give r ise t o a loss of excess management expenses. A signif icant incr ease is t he lower of t he company’s capit al doubling in t he f ir st t hr ee year s, or t he capit al incr easing by £ 1 million in t he f ir st t hr ee year s.

Illustration 1

The shar e capit al of a company wit h invest ment business bef or e t he change of owner ship is £ 200,000 and, in t he f ir st t hr ee year s f ollowing t he change, it incr eases t o £ 500,000. The capit al has mor e t han doubled and t her ef or e it has given r ise t o a signif icant change. Taking anot her company wit h invest ment business, let us say it s shar e capit al bef or e t he change is £ 2 million and in t he t hr ee year s f ollowing t he change, it incr eases t o £ 3 million. Alt hough t he capit al has not doubled, it has incr eased by £ 1 million and t his will be seen as a signif icant incr ease and excess management expenses will be lost .


277

C21.7 Loan interest

I nt er est paid by companies wit h invest ment business on loans t aken out t o

pur chase invest ment s is a Schedule D Case III debit. The t ax t r eat ment and r elief f or DI I I debit s was cover ed in t he ear lier chapt er on loan r elat ionships. Remember such int er est is never t r eat ed as a Schedule A expense or a management expense.

Commitment fees and guarantee commissions, ar e par t of t he cost of r aising loans, and not management expenses. They will be cover ed by loan r elat ionship r ules.

C21.8 Close investment holding companies (CIHCs) s.13A

A CI HC is any close company (i.e. one under t he cont r ol of 5 or f ewer shar eholder s) t hat does not exist wholly or mainly f or one of t he f ollowing pur poses;

(i) car r ying on a trade or t r ades on a commer cial basis;

(ii) making invest ment s in land and letting the land to unconnected per sons;

(iii) holding shar es and secur it ies or making loans t o gr oup companies;

(iv) co-or dinat ing t he administ r at ion of gr oup companies;

(v) being a member of a t r ading gr oup;

(vi) being t he invest ment company in a gr oup. All of t he pr of it s of a CI HC ar e charged at the full rate of cor por at ion t ax (30%).

C21.9 Losses on sale of shares

Wher e an invest ment company makes a capit al loss on t he disposal of shar es in cer t ain qualif ying companies, it may claim t o set that loss against income. On making a claim wit hin t wo year s of t he end of t he account ing per iod of t he loss, t he loss can be set against income f or t he accounting period of the loss, and if necessar y any previous accounting period ending in the 12 months

before t he st ar t of t he account ing per iod of t he loss. This loss r elief is claimed bef or e any ot her deduct ions including management expenses and char ges. However claims under t he CVS r ules t ake pr ior it y. To be able t o make t he s. 573 claim, t he company must be an investment

company and have been so t hr oughout a cont inuous per iod of six year s. I f t his is not t he case it must not pr eviously have been a t r ading company. The company must have subscribed for shares in a qualifying trading company (as def ined by t he EI S r ules), which has not been associat ed wit h it f r om t he dat e of subscr ipt ion t o t he dat e of disposal. Associat ed her e is t he wide meaning of cont r ol. Not e t hat t his r elief can only be claimed by investment companies. I t does not extend to companies with an investment business.

s. 573


SUMMARY – COMPANIES WITH INVESTMENT BUSINESS

A company wit h invest ment business is a company der iving it s income wholly or par t ly f r om t he making of invest ment s. The PCTCT of a company wit h invest ment business is f ound by adding t oget her invest ment income and gains and deduct ing management expenses. Management expenses include agent ’s commissions, pr of essional f ees, pr emises cost s and r easonable dir ect or ’s salar ies, but exclude expenses of a capit al nat ur e or f or an unallowable pur pose. Since 1 Apr il 2004 management expenses ar e deduct ible based on when t hey ar e debit ed in t he account s. Pr eviously t hey wer e deduct ible when disbur sed. I f management expenses exceed pr of it s, a company has “excess management expenses”. These excess management expenses can eit her be gr oup r elieved or car r ied f or war d. The change in owner ship pr ovisions apply t o companies wit h invest ment business blocking t he car r y f or war d of management expenses. An invest ment company is a company wher e business consist s wholly or mainly in t he making of invest ment s and t he pr incipal par t of whose income is der ived t her ef r om. When an invest ment company has a capit al loss on t he disposal of shar es t hat it subscr ibed f or in a qualif ying company, it can claim t o set t hat loss of f against income of t hat per iod or t he pr evious per iod.

C22: CORPORATE VENTURING SCHEME

This chapt er out lines t he r elief s available f or invest ment s under t he CVS scheme cover ing in par t icular : - t he cor por at ion t ax r elief ; - what happens on sale of t he shar es; - condit ions f or t he r elief ; - capit al gains r elief including r elief f or losses; - ant i-avoidance; - claiming t he r elief .

C22.1 The Corporate Venturing Scheme (CVS) Sch 15

FA 2000

The scheme gives t ax r elief t o companies who invest in small unquot ed t r ading companies. The int ent ion is t o encour age lar ger companies t o invest in smaller companies – t he t ax r elief is an incent ive f or t hem t o do so. Tax r elief is given as a tax reducer – i.e. t he r elief r educes t he amount of cor por at ion t ax payable by t he invest ing company. The t ax r educer is usually 20% of the amount invested (or a lower amount if t he t ax r elief r educes t he CT liabilit y t o zer o). Ther e is no upper limit.

Illustration 1

On 1 May 2006, Gener ous Lt d subscr ibes f or £ 200,000 of new shar es issued by St ar t -Up Lt d, a company which sat isf ies t he condit ions of t he Cor por at e Vent ur ing Scheme. Gener ous Lt d has t axable pr of it s of £ 1.8m in t he year ended 31 Mar ch 2007. The cor por at ion t ax payable will be:

£ £ 1.8m x 30% 540,000 Less CVS r elief £ 200,000 x 20% (40,000) Gr oss cor por at ion t ax £ 500,000

Not e t hat t he CVS r elief could r educe a company’s t ax liabilit y t o zer o but it cannot cr eat e a t ax r epayment . I f t he company sells the new CVS shares within 3 years, relief is withdrawn. The r elief wit hdr awn will eit her be:

(i) The original relief given if t he shar es ar e sold at a profit; or

(ii) 20% x proceeds if t he shar es ar e sold at a loss.


Illustration 2

Assume in t he above example t hat Gener ous Lt d sold it s shar es in St ar t -Up Lt d f or £ 125,000 on 1 December 2007. As t he CVS shar es have been sold wit hin 3 year s of issue, cor por at ion t ax r elief is wit hdr awn. To withdraw the relief, t he Revenue will issue an assessment (under Schedule DVI ) in t he per iod in which t he r elief was originally given (i.e., t he year of t he or iginal subscr ipt ion of t he shar es). The r evised CT comput at ion f or t he year ended 31 Mar ch 2007 will be:

£ £ 1.8 m x 30% 540,000 Less CVS r elief or iginally given £ 200,000 x 20% (40,000) CT or iginally due 500,000 Add: CVS r elief wit hdr awn £ 125,000 x 20% 25,000 Revised gr oss cor por at ion t ax £ 525,000

Not e t hat as t he shar es wer e sold at a loss, t he wit hdr awal of r elief is r est r ict ed t o 20% of pr oceeds.

C22.2 Conditions for CVS relief

Cer t ain condit ions must be sat isf ied t hr oughout t he qualification period of t he shar es bot h by t he investing company (i.e. t he company acquir ing t he CVS shar es) and t he issuing company (i.e. t he company issuing t he new shar es t o t he invest or s).

Par a 3 Sch 15 FA2000

The qualif icat ion per iod is a per iod st ar t ing wit h t he issue of t he shar es and ending: • I mmediat ely bef or e t he third anniversary of the issue date wher e t he

qualif ying t r ade is alr eady being car r ied on or , • I mmediat ely bef or e t he t hir d anniver sar y of t he dat e on which t he trade

commences.

The invest ing company must not eit her : - have more than 30% of t he or dinar y shar es or vot ing r ight s of t he issuing

company, or

Par a 5&8 Sch 15

FA2000

- be able t o control t he issuing company (i.e. wit h it s associat es). The invest ing company must car r y out a non-financial trade (e.g. it must not be an invest ment company et c). The invest ing company can be t he par ent company of a gr oup, as long as t he gr oup car r ies out non-f inancial t r ades.

Par a 10 Sch 15

FA2000

The invest ing company must subscr ibe f or new shar es in t he CVS company.

Cor por at e Vent ur ing Scheme

281

The issuing company must sat isf y a number of condit ions, many of which ar e similar to the conditions a company must sat isf y in or der t o qualif y under t he Enterprise Investment Scheme (EI S).

Par a 15 Sch 15

FA2000

These ar e:

(i) t he company must not be list ed on a r ecognised St ock Exchange

(i.e. it must be an unquoted company); and

Par a 16 Sch 15

FA2000

(ii) t he company must car r y out a qualifying trade wholly or mainly in

the UK. Qualif ying t r ades will not include f inancial t r ades (e.g. account ing, shar e dealing et c), legal t r ades, pr oper t y dealing, f ar ming or hot els; and

Par a 23 Sch 15

FA2000

(iii) t he company’s asset s bef or e t he shar e issue must not exceed £7m

and af t er t he shar e issue must not exceed £8m (t he limit s wer e £ 15m and £ 16m pr ior t o 6 t h Apr il 2006); and

Par a 22 Sch 15

FA2000

(iv) t he cash raised must be used f or business pur poses within 2

years. At least 80% of t he cash must be used within 12 months; and

Par a 36 Sch 15

FA2000

(v) t he issuing company must not be a 51% subsidiar y of any company

and at least 20% of it s shar es must be owned by independent individuals.

(vi) t he company can be a par ent company as long as all it s subsidiar ies

car r y on a qualif ying t r ade.

Par a 17 Sch 15

FA2000

The shar es must be or dinar y shar es car r ying no pr ef er ent ial r ight s t o dividends or asset s on a winding up and must be subscr ibed f or in cash and f ully paid up at t he t ime of issue.

C22.3 Capital gains relief for CVS shares

I f t he CVS shar es ar e sold at a gain, it is possible t hat t he gain may be exempt

under the substantial shareholdings rules. This exempt ion applies br oadly wher e t he holding is at least 10% and t he shar es have been held for at least a year. The subst ant ial shar eholdings r ules ar e explained in mor e det ail lat er in t his cour se. Pr ovided t hat t he shar es have been held for 3 years, t her e will be no clawback

of the tax relief initially given even if t he gain is exempt under t he subst ant ial shar eholdings r ules.


I f t he CVS shar e gain is not exempt under t he subst ant ial shar eholdings r ules, t hen if t he proceeds are used to acquire new CVS shares, the capital gain

may be deferred.

Par a 73 Sch 15

FA2000

The amount of t he gain which may be def er r ed is t he lower of :

(i) t he gain on t he CVS shar es; and (ii) t he amount r einvest ed.

The company may specif y a lower amount in t he claim if it wishes (f or example t o use up any capit al losses it may have). The deferred gain will become chargeable when the company sells the new

shares (unless pr oceeds ar e r einvest ed in new CVS shar es).

Par a 79 Sch 15

FA2000

Illustration 3

J ones plc subscr ibes f or £ 100,000 of shar es in I -Vent ur e Lt d (a CVS company) in Febr uar y 2006 (RPI 194.2). J ones plc sells t he shar es in J anuar y 2007 (RPI 198.6) f or £ 130,000. As t he shar es have been held f or less t han a year t he subst ant ial shar eholdings exempt ion will not apply her e. The capit al gain is:

£ Pr oceeds 130,000 Less cost (100,000) Less indexat ion 198.6 - 194.2

194.2 x £ 100,000

(2,266)

I ndexed gain £ 27,734 I n Febr uar y 2007 (RPI 199.00), J ones plc subscr ibes £ 35,000 f or a 5% shar eholding in Risky Business Lt d, anot her CVS company. J ones Lt d can t her ef or e make a claim t o def er t he gain made in J anuar y 2007. The maximum claim is t he lower of

(i) £ 27,734 or i.e. £ 27,734

(ii) £ 35,000

This gain of £ 27,734 on t he sale of t he I -Vent ur e Lt d shar es will not be char ged in J anuar y 2007, but will inst ead become char geable when J ones plc sells it s shar es in Risky Business Lt d. Assume t hat J ones Lt d sells t he shar es in Risky Business f or £ 50,000 in Febr uar y 2008 (RPI 203.3).


283

The gains ar ising will be:

Risky Business Lt d £ Pr oceeds 50,000 Less cost (35,000) Less indexat ion 203.3 – 199.00 199.00 x £ 35,000

(756)

I ndexed gain 14,244 Add: def er r ed gain on I -Vent ur e Lt d shar es

27,734

Gain char ged in Febr uar y 2008 £ 41,978

C22.4 Losses on sales of CVS shares

I f a company sells shar es in a qualif ying CVS company and makes a loss on t he sale, once again t he int er act ion wit h t he subst ant ial shar eholdings r ules must be consider ed. I f t he CVS holding qualifies under the substantial shareholdings rules, no capital loss is allowable. I f however t he holding is not a subst ant ial shar eholding, t her e ar e t wo t hings t he company can do wit h t he capit al loss. I t may:

Par a 68 Sch 15

FA2000

(1) set the loss against capital gains in the same accounting period and carry

forward any remaining losses; or (2) deduct t he loss f r om it s other income in the same accounting period and

t her eaf t er of any income in t he preceding 12 months.

s.573 I CTA 1988

The second opt ion is similar t o t he r elief given under s.574 f or individuals who invest in qualif ying t r ading companies (essent ially EI S companies). Any allowable loss is reduced by t he cor por at ion t ax r elief alr eady obt ained.

Illustration 4

Williams plc, a lar ge UK quot ed company, invest ed £ 500,000 in shar es in Or ange Lt d, a qualif ying CVS company, in J une 2006. The holding was not a subst ant ial shar eholding. I n it s year ended 31 December 2006, Williams plc would have r eceived cor por at ion t ax r elief of :

£ 500,000 x 20% = £ 100,000

Williams plc sold t he Or ange Lt d shar es in Sept ember 2007 f or £ 320,000.


As t he shar es have been sold wit hin 3 year s, t he CT r elief will be wit hdr awn. A Schedule DVI assessment will be issued f or t he year in which t he r elief was or iginally given – i.e., t he year ended 31 December 2006. This will have t he ef f ect of incr easing t he t ax liabilit y f or t he year ended 31 December 2006 by:

Par a 46 Sch 15

FA2000

£ 320,000 x 20% = £ 64,000

Williams plc has t her ef or e r eceived t ot al cor por at ion t ax r elief of £ 36,000 (i.e. £ 100,000 or iginally given less £ 64,000 wit hdr awn). As t he holding was not a subst ant ial shar eholding, t he loss on t he sale of t he shar es is calculat ed as f ollows:

£ Pr oceeds 320,000 Less cost 500,000 Less cor por at ion t ax r elief obt ained (36,000) (464,000) Allowable loss £ (144,000)

Williams plc can elect t o set t his loss against it s ot her pr of it s in t he year ended 31 December 2007. Assuming ot her pr of it s ar e £ 1.9m, t he cor por at ion t ax comput at ion will be:

£ Pr of it s bef or e r elief 1,900,000 Less CVS loss r elief (144,000) PCTCT 1,756,000 CT @ 30% 526,800

Example 1

Regan plc has one wholly owned subsidiar y. I n November 2005, Regan plc subscr ibed f or £ 120,000 of shar es in Wat er man Lt d, an unquot ed t r ading company. This r epr esent ed an 8% holding in t hat company. CVS r elief was claimed on t he subscr ipt ion. On 29 December 2006, Regan plc sold it s shar es in Wat er man Lt d f or £ 75,000. I t s r esult s f or t he year ended 31 December 2006 wer e as f ollows:

£ Adj ust ed t r ading pr of it s 148,000 Schedule DI I I 47,000 Gif t aid paid (8,000) Dividend f r om I CI plc 13,500

Assuming all r elevant claims ar e made, calculat e t he PCTCT f or Regan plc f or t he year ended 31 December 2006.


285

C22.5 Anti avoidance

The r elief will be denied if t her e ar e any ar r angement s t hat pr ovide f or a pre-arranged exit or ot her wise pr ovide t he invest or wit h protection against normal

commercial risks. The shar es must be issued f or commer cial pur poses and not as par t of a scheme or ar r angement whose main pur pose or one of whose main pur poses is t o avoid t ax.

Par a 37 Sch 15

FA2000

C22.6 Withdrawal of relief other than on sale Par a 47

Sch 15 FA2000

The r elief can be wit hdr awn if t he r equir ement s r elat ing t o t he issuing company or invest ing company have not been met at any t ime dur ing t he qualif icat ion per iod.

Relief given will be wit hdr awn if dur ing a per iod beginning one year bef or e t he shar es ar e issued and ending when t he qualif icat ion per iod ends (per iod of r est r ict ion) t her e is a receipt of value or t he grant of put or call options over the shares.

The wit hdr awal of t he r elief can be avoided by r epaying t he amount r eceived.

C22.7 Claiming the relief

Bef or e t he issue of t he shar es, t he issuing company can apply for advance

clearance t hat t he r equir ement s of CVS r elief ot her t han t hose t o be met by t he invest ing company ar e being met . I f advance clear ance is applied f or , an advance clear ance not ice will be issued within 30 days, or f ur t her inf or mat ion will be called f or , or t he company will be t old t hat t he Revenue ar e not sat isf ied t hat t he issue meet s t he r equir ement s.

Following t he issue, t he issuing company must provide a compliance statement t o t he Revenue. The st at ement conf ir ms t hat t he condit ions r elat ing t o t he issuing company and t he shar es have been met or ar e being met f or t he t ime being. The Revenue will t hen authorise the issuing company to provide

compliance certificates to the investing companies. The invest ing company can claim t he t ax r elief in it s t ax r et ur n once it has a compliance cer t if icat e.

Par a 41&42 Sch 15

FA2000


Answer 1

CVS shar es sold wit hin 3 year s – t her ef or e cor por at ion t ax r elief will be wit hdr awn by DVI assessment f or y/ e 31.12.05. Wit hdr awal = £ 75,000 x 20% = £ 15,000 As t he holding is only 8% it is not a subst ant ial shar eholding and so t her e is an allowable loss. Loss r elief on sale of Wat er man Lt d shar es can be claimed against gener al pr of it s f or t he per iod. Allowable loss is:

£ Pr oceeds 75,000 Less cost 120,000 Less cor por at ion t ax r elief obt ained (24,000 – 15,000)* (9,000) (111,000) Allowable loss £ (36,000)

* Relief given in y/ e 31.12.05 = £ 120,000 x 20% = £ 24,000 The cor por at ion t ax comput at ion will t her ef or e be:

£ Schedule DI 148,000 Schedule DI I I 47,000 195,000 Less: CVS loss r elief (bef or e char ges) (36,000) 159,000 Less char ges on income (8,000) PCTCT 151,000


287

SUMMARY – THE CORPORATE VENTURING SCHEME

Tax r elief at 20% is available wher e a company subscr ibes f or new shar es in a company which sat isf ies t he condit ions of t he Cor por at e Vent ur ing Scheme. The r elief is wit hdr awn if t he shar es ar e sold wit hin 3 year s. Capit al gains on sales of CVS shar es not cover ed by t he subst ant ial shar eholdings exempt ion can be def er r ed by r einvest ing in ot her CVS shar es. Holding <10% CVS t ax r elief and def er r al of any gain int o ot her CVS shar es only, no subst ant ial shar eholdings exempt ion f or gains 10-30% CVS t ax r elief and any gain cover ed by subst ant ial shar eholdings exempt ion

>30% No CVS t ax r elief but any gain st ill cover ed by subst ant ial shar eholdings exempt ion

Losses on sales of holdings of CVS shar es which ar e not subst ant ial shar eholdings can be set against gener al income. Ther e ar e ant i avoidance measur es t o pr event guar ant eed exit s. Relief can be wit hdr awn if t he invest ing company r eceives value f r om t he issuing company. The issuing company must pr ovide a compliance st at ement t o t he Revenue who will t hen aut hor ise it t o issue a compliance cer t if icat e. The invest ing company needs a compliance cer t if icat e t o be able t o claim t he r elief .

D: Employee Tax Matters

D1: EMPLOYED OR SELF EMPLOYED?

I n t his chapt er you will lear n about t he dist inct ion bet ween employed and self -employed wor ker s including: - t he MI CE t est ; - ot her cr it er ia f or det er mining t he st at us of a wor ker ; - t he implicat ions of being employed or self -employed; - t he t hr ee main cases hear d on t his ar ea.

D1.1 Introduction

I n t he next chapt er we shall t ake a look at legislat ion concer ning per sonal ser vice companies. However , t o under st and t hese r ules we must f ir st examine t he dist inct ion bet ween whet her a wor ker is employed or self -employed f or t ax pur poses.

s.48-61 I TEPA 2003

The t ax legislat ion it self does not t ell us whet her a wor ker is employed or self -employed, so t he dist inct ion bet ween t he t wo is based on case law and on Revenue pr act ice. I n t he vast maj or it y of inst ances it is obvious whet her an individual is an employee or whet her he is in business on his own account as a self -employed t r ader . However t her e is a consider able gr ey ar ea in bet ween t he t wo.

D1.2 The “MICE” test

To dif f er ent iat e bet ween employed or self -employed, we apply what we call t he MICE t est :

Mut ual obligat ions I nt egr at ion Cont r ol Equipment

“M” stands for mutual obligations. I f a wor ker is an employee, his employer is under an obligat ion t o pr ovide him wit h wor k, and t he employee is under a similar obligat ion t o accept t he wor k and t o per f or m t he t asks delegat ed t o him. However , if a wor ker is self -employed, he will have no guar ant ee of wor k and even if wor k is of f er ed t o him he is under no legal obligat ion t o accept t he wor k of f er ed. The exist ence of any mut ual obligat ion bet ween t he par t ies will usually be obvious f r om any ser vice cont r act bet ween t he t wo par t ies. Employees usually have an employment cont r act which set s out t he t er ms and condit ions under which t hey ar e t o per f or m dut ies f or t heir employer .

Employed or Self Employed?

289

“I” stands for integration. An employee will be int egr at ed int o t he business of his employer . By t his we mean t hat t he employee will usually have his or her own desk, a designated computer terminal at which t o wor k, his or her own stationery, access t o normal employee facilities such as t he st af f r est aur ant , and will have unr est r ict ed access t o t he employer pr emises. Employees will also be allowed t o j oin company pension schemes and r eceive invit at ions t o st af f f unct ions such as Chr ist mas par t ies. Cont r ast t his wit h t he posit ion of a self -employed per son, who will not be int egr at ed int o an employer ’s business and will not have a desk or a comput er or access t o t he employer pr emises.

“C” st ands f or cont r ol. I n a t ypical employer / employee r elat ionship, t he employee will exer cise ver y lit t le cont r ol over what he or she does on a day-t o-day basis. An employer will t ypically t ell an employee what t o do, how t o do it and when t o do it by. Ther e is t ypically a mast er / ser vant r elat ionship bet ween an employer and an employee. On t he ot her hand, a self -employed per son will have f ar mor e cont r ol over t he j obs t hat he or she under t akes and t he deadline f or complet ion of t hose j obs. “E” st ands f or equipment . When consider ing whet her a wor ker is employed or self -employed, t he Revenue will always look at who pr ovides t he t ools of t he t r ade. An employee is r ar ely r esponsible f or pr oviding his or her own equipment . When we t ur n up f or wor k we expect our employer s t o pr ovide us wit h a comput er , a t elephone, a f ax and some st at ioner y et c. A self -employed per son, on t he ot her hand, will cust omar ily be r esponsible f or pr oviding t he equipment t o enable him t o under t ake t he wor k of f er ed.

D1.3 Other criteria

Ther e ar e a f ew ot her cr it er ia t he Revenue will apply in det er mining whet her a wor ker is employed or self -employed. They will look at t he degree of financial risk t aken by t he wor ker . I f t he wor ker has no f inancial r isk, has no oppor t unit y t o dir ect ly pr of it f r om t he wor k under t aken and is not r esponsible f or bear ing any losses incur r ed in t he cour se of his wor k, it is highly likely t hat t hat individual will be an employee. Typically self -employed people ar e genuinely r esponsible f or how t heir business is r un, will r isk capit al in t heir business and will have t o meet any losses which ar ise. The number of paymasters is also a det er mining f act or . A t ypical employee has one paymast er – he is paid by his employer and no-one else. However , if a wor ker t ypically per f or ms ser vices f or a number of dif f er ent companies, he is mor e likely t o be able t o per suade t he Revenue t hat he is self -employed. Finally, t he ability to provide a substitute has been somet hing t he Revenue have looked at ver y closely when deciding whet her a wor ker is employed or self -


employed. An employee will have no f r eedom t o send along a subst it ut e in his or her place if , f or what ever r eason, t hey ar e unable t o per f or m t heir dut ies. On t he ot her hand, if a self -employed per son has cont r act ed t o do a j ob and is eit her sick or double-booked, t hat self -employed per son will have t he f r eedom t o pr ovide a subst it ut e t o complet e t he j ob in his place. This was a cr ucial f act or in t he case of Hall v Lor imer . I n t his case t he Cour t , af t er much deliber at ion, concluded t hat a vision mixer was a self -employed per son lar gely because on a handf ul of occasions, he had been able t o pr ovide a subst it ut e t o f ulf il par t icular cont r act s.

When consider ing whet her a wor ker is employed or self -employed, it is impor t ant t o take a “balance of probabilities approach”. This means t hat no individual f act or can be conclusive in it s own r ight . The I nspect or will look at t he f act s and cir cumst ances of each case, apply t he var ious cr it er ia which we have j ust looked at , and, on balance, decide whet her t he wor ker is likely t o be an employee or whet her he is mor e likely t o be self -employed. The maj or it y of Revenue Tax Of f ices will have a designat ed “st at us” Of f icer whose j ob it is t o look at whet her wor ker s ar e employees or not .

D1.4 Implications

I t is impor t ant t o est ablish why we need t o dist inguish bet ween whet her a wor ker is employed or self -employed. An employee will pay tax under t he employment income r ules on ear nings f r om his employment . A self-employed

trader will pay tax on t he pr of it s of his t r ade. The r ules f or det er mining t axable ear nings ar e dif f er ent t o t hose used t o calculat e t r ading pr of it s. One ar ea wher e t he r ules ar e ver y dif f er ent is concer ning expenses. We know t hat it is ver y dif f icult f or an employee t o get a deduct ion f or employment expenses. However , t he expenses t est f or t r ader s is f ar less st r ingent and self -employed t r ader s can deduct much mor e by way of expenses t han an employee. For t his r eason, many t axpayer s would r at her be t r eat ed as self -employed t han as employees.

When ear nings ar e paid t o employees, t he employer must account f or t ax at sour ce under PAYE. Employees pay t ax on t heir ear nings as t hey go along. This is not t he case f or self -employed t r ader s who will pay t heir t ax on 31 J anuar y and 31 J uly under t he Self Assessment r egime. This can give self -employed t r ader s a consider able cash f low advant age. The dist inct ion is ver y impor t ant f or NI C pur poses. Bot h employees and employer s pay Class 1 NIC on earnings. Employer s pay Class 1A Nat ional I nsur ance on benef it s pr ovided t o t heir employees. Class 1 NI C is a consider able cost f or employer s, so f or NI C pur poses, it is ver y expensive f or a company t o t ake on an employee.

Class 1 NI C does not apply when payment s ar e made t o self -employed t r ader s. Self-employed individuals pay NIC under Class 2 and Class 4. As you will see


291

when you st udy t he t axat ion of business income, it is consider ably cheaper f r om an NI C per spect ive f or an individual t o be classed as a self -employed per son.

Employees will t ypically have t he r ight t o j oin an Occupational Pension Scheme pr ovided by t heir employer . Self-employed persons ar e not allowed t o make payment s int o Company Pension Schemes. I f t hey wish t o make pension pr ovision, t hey must do so via a Personal Pension Scheme or a Stakeholder Scheme. We shall look at pensions in a lat er chapt er .

One maj or consolat ion f or employees is t hat t hey do not have t o wor r y about VAT. A self-employed t r ader will have t o r egist er wit h Cust oms & Excise f or VAT pur poses once his t ur nover has exceeded a cer t ain level. VAT r egulat ions place a consider able administ r at ive bur den on self -employed t axpayer s.

Finally, employees ar e protected by the Employment Protection Acts. For example, most employees will be ent it led t o sick pay, holiday pay, and mat er nit y leave and will have t he r ight not t o be unf air ly or wr ongf ully dismissed. On t he ot her hand, self -employed per sons ar e not cover ed by t he Employment Pr ot ect ion legislat ion and will not have t he same r ight s as employees.

For inst ance, if a company chooses t o dispense wit h t he ser vices of a self -employed per son – per haps because t hey have f ound somebody else who will do t he same j ob at a lower pr ice - t he self-employed t r ader will usually have no legal redress. He will simply have t o accept it as par t and par cel of t he day t o day business of a self -employed t r ader .

However , incr easingly legislat ion gives r ight s and obligat ions t o “wor ker s”, f or example under t he Wor king Time Dir ect ive and t he Nat ional Minimum Wage Act 1998. Some individuals who ar e self -employed could have such st at ut or y pr ot ect ion. I n summar y t he main dif f er ences ar e:

Employees Self Employed Employment income Tr ading income Tough expenses t est Easier expenses t est PAYE Self assessment Class 1 NI C (expensive) Class 2 and 4 NI C (cheaper ) Occupat ional pension Per sonal pension No VAT r equir ement s VAT r egist r at ion Employment law pr ot ect ion Less legal pr ot ect ion

D1.5 Case Law

As t he cr it er ia t o det er mine employed v self -employed have been lar gely built up over t he year s in t he Cour t s, it is impor t ant t hat you ar e f amiliar wit h t he leading t ax cases in t his ar ea. I n t his session we shall look at t hr ee t ax cases.

Fall v Hitchen (1973)


This case concer ned a pr of essional dancer . The dancer wor ked f or a t heat r e company under a st andar d cont r act appr oved by Equit y, which is t he Br it ish Act or s Union. Under t he cont r act t he dancer would at t end r ehear sals and per f or mances over a per iod of ar ound f ive t o six mont hs and eit her par t y could t er minat e t he agr eement by t wo weeks wr it t en not ice.

The dancer wor ked specif ied hour s and r eceived a f ixed salar y paid at r egular int er vals. The dancer was pr ovided wit h st age cost umes and was per mit t ed by t he t heat r e company t o seek wor k elsewhere in t imes when he was not needed.

The dancer ar gued t hat he was self -employed and should t her ef or e be assessed on t r ading income. However t he Cour t s r ej ect ed t his claim and held t hat his cont r act was a cont r act of ser vice. As such, he was t r eat ed as an employee and any income was assessed on employment income. Following Fall v Hit chen, t he Revenue assessed all act or s engaged under st andar d Equit y cont r act s as employees.

However , since 1993, it has been agr eed t hat actors in general should be

treated as self-employed individuals r at her t han employees engaged in a succession of employment s. However on occasions wher e an act or is engaged in r egular wor k, f or a f ixed salar y f or a par t icular employer , t he Revenue will r egar d t hat cont r act as a cont r act of ser vice and char ge any income under t he employment income r ules. This will be t he case f or act or s who r egular ly appear on our scr eens in soap oper as et c, as t hey per f or m ser vices f or a r egular salar y f or one pr oduct ion company in a specif ied r ole.

Market Investigations v Minister of Social Security (1969) This case involved a mar ket r esear cher who wor ked as a par t -t ime int er viewer f or a mar ket r esear ch company. Her j ob was t o ask pr e-set quest ions devised by t he mar ket r esear ch company t o member s of t he public. The mar ket r esear cher had lit t le or no cont r ol over what she did on a day t o day basis – she was t old what t o do and how t o do it . I n addit ion, any equipment necessar y f or t he j ob was pr ovided by t he mar ket r esear ch company.

The case was br ought t o t he Cour t s by t he Depar t ment of Social Secur it y who successf ully ar gued t hat t he wor ker should be t r eat ed as an employee f or NI C pur poses. As such, any ear nings paid wer e subj ect t o Class 1 pr imar y and Class 1 secondar y Nat ional I nsur ance Cont r ibut ions.

Subsequent t ax cases on t he subj ect of employed ver sus self -employed have made r ef er ence t o t he J udge’s summar y in t he Mar ket I nvest igat ions case.

I n his summing up, t he J udge made r ef er ence t o t he use of t he var ious cr it er ia we have alr eady looked at , such as t he pr ovision of equipment , t he abilit y t o hir e a helper , and t he degr ee of cont r ol and f inancial r isk et c.

I n t his par t icular case, t he J udge f ound t hat t he mar ket r esear cher was not in business on her own account and could not t her ef or e be r egar ded as a self -employed individual.

Hall v Lorimer (1993)


293

Mr Lor imer was a vision mixer who wor ked f or a number of dif f er ent t elevision companies. His wor k involved him under t aking a ser ies of shor t -t er m cont r act s t ypically of one t o t wo days each. Mr Lor imer wor ked f or a number of dif f er ent pr oduct ion companies, and over a t hr ee or f our year per iod in t he 1980s he r eceived income f r om about 20 dif f er ent companies. Mr Lor imer ’s wor k was always under t aken on company pr emises using equipment pr ovided by t he st udio company. This was lar gely due t o t he specialist nat ur e of t he wor k. Mr Lor imer issued t he pr oduct ion company wit h an invoice af t er each j ob and was r egist er ed f or VAT pur poses. Mr Lor imer was r esponsible f or making good his own losses and r an t he r isk of incur r ing bad debt s. To guar d against losses he had an insur ance policy which cover ed him in t he event of sickness. Dur ing t he per iod in quest ion, Mr Lor imer was unable t o f ulf il his obligat ions on a handf ul of cont r act s and in his place he pr ovided a subst it ut e wor ker . The Revenue ar gued t hat Mr Lor imer had a ser ies of employment s and hence should be t axed on employment income. They put par t icular emphasis on t he f act t hat Mr Lor imer wor ked on st udio pr emises using st udio equipment . However , bot h t he High Cour t and t he Cour t of Appeal agr eed t hat Mr Lor imer was self-employed. The Cour t s comment ed t hat it was impor t ant t o look at all t he r elevant cr it er ia and t o make a j udgement based on an evaluat ion of all t he f act or s r at her t han one or t wo in par t icular . However , t he Cour t s wer e par t icular ly swayed by t he f act t hat Mr Lor imer could, and indeed did, hir e a helper t o assist him in t he per f or mance of his dut ies and t his abilit y t o pr ovide a subst it ut e is not an opt ion t ypically available t o an employee.


SUMMARY - EMPLOYED OR SELF EMPLOYED?

To dif f er ent iat e bet ween employed or self -employed wor ker s, we apply t he MI CE t est :

Mut ual obligat ions I nt egr at ion Cont r ol Equipment

Ot her cr it er ia used include:

Degr ee of f inancial r isk Number of paymast er s Abilit y t o pr ovide a subst it ut e

All t he cr it er ia must be consider ed r at her t hen one f act or being conclusive. The main dif f er ence bet ween employed and self -employed wor ker s ar e summar ised below:

Employees Self Employed Employment income Tr ading income Tough expenses t est Easier expenses t est PAYE Self assessment Class 1 NI C (expensive) Class 2 and 4 NI C (cheaper ) Occupat ional pension Per sonal pension No VAT r equir ement s VAT r egist r at ion Employment law pr ot ect ion Less legal pr ot ect ion

The leading t ax cases in t his ar ea ar e Fall v Hit chen (dancer held t o be an employee as his cont r act was a cont r act of ser vice), Mar ket I nvest igat ions Lt d (mar ket r esear cher held t o be an employee as she was not in business on her account ) and Hall v Lor imer (vision mixer held t o be self -employed as he could and had pr ovided a subst it ut e).

D2: INTRODUCTION TO EMPLOYMENT INCOME & BENEFITS

I n t his chapt er you will lear n t he basic pr inciples of t axat ion of income f r om employment including: - what const it ut es employment income; - t he def init ion of “ear nings” and “emolument s”; - r eceipt s basis; - what a t axable benef it is; - concept of cash equivalent ; - t he case of Pepper v Har t ; - lower paid employees.

Ref er ences in t his chapt er ar e t o t he I ncome Tax (Ear nings & Pensions) Act 2003 unless st at ed ot her wise.

D2.1 Employment Income

The I ncome Tax (Ear nings & Pensions) Act (I TEPA) 2003 t axes income f r om employment as well as ot her income such as t hat f r om pensions and from

certain social security benefits. An “employment ” in t his cont ext includes any employment under a cont r act of ser vice as well as appr ent iceships and ser vices f or t he Cr own. Employment s also cover “of f ice holder s” such as dir ect or s. The Act simply r ef er s t o all employees and dir ect or s as “employees”.

s.4

s.5

Employment income gener ally f alls under t wo main cat egor ies – t hese ar e “general earnings” and “specific employment income”.

s.6

“Gener al ear nings” ar e t he most pr evalent and consist of r emuner at ion paid in normal monetary form – i.e. cash – as well as cer t ain non-monetary rewards such as t axable benef it s. The def init ion of “gener al ear nings” ext ends t o cer t ain ot her payment s such as sick pay, payment s t o non-appr oved pension schemes and payment s f or r est r ict ive covenant s. I n essence, “gener al ear nings” cover s payment s made t o t he employee as a reward for services rendered.

s.7(3)

“Specif ic employment income” br oadly cover s payment s made t o t he employee by his employer which ar e not part of the usual remuneration package and is def ined as “any amount which counts as employment income excluding any exempt income”. We shall deal wit h exempt income in lat er chapt er s.

s.7(4)

I ncome which “count s as employment income” is divided int o t hr ee being:

s.7(6)

a) income which is not ear nings or “shar e r elat ed”; b) “shar e r elat ed income; or c) any ot her enact ment (i.e. employment income which is t axable but which

doesn’t “f it ” any of t he ot her cat egor ies). “Non-shar e r elat ed” income br oadly encompasses termination payments and employer cont r ibut ions t o non-appr oved pension schemes.


“Shar e r elat ed” income cover s pr of it s and gains made by employees f r om var ious share option and share incentive schemes of f er ed by t he employer . We will deal wit h each of t hese in lat er chapt er s.

D2.2 Definition of “earnings”

“Ear nings” ar e def ined wit hin s.62 I TEPA 2003 as: s.62

a) any salar y, wages or f ee; b) any gr at uit y or ot her pr of it or incident al benef it of any kind obt ained by t he

employee if it is money or money’s wor t h; c) anyt hing else t hat const it ut es an emolument of t he employment . Br oadly speaking, “ear nings” ar e cash remuneration or any f or m of payment of direct monetary value, or which can be converted into cash. This will cover obvious f or ms of payment such as salar ies and bonuses, but will also cover tips and gratuities r eceived in t he cour se of car r ying out one’s employment dut ies or payment s in t he f or m of cash voucher s or pr emium bonds which can be sur r ender ed f or cash. The def init ion of “ear nings” does not specif ically cover benef it s in kind (eg company car s, cheap loans, living accommodat ion, et c.) as such r emuner at ion is neit her cash nor of dir ect monet ar y value. However , t he pr ovision of such benef it s is br ought wit hin t he char ge t o income t ax by t he “Benef it s Code”. We shall look at benef it s in det ail in lat er chapt er s.

D2.3 “Emoluments” of the employment

Ther e is a signif icant body of case law t o det er mine t he exist ence of an “emolument” of an employment . This t er m was par t of t he old st at ut or y pr ovisions and was specif ically r et ained in I TEPA 2003 t o ensur e t hat t he case law was st ill applicable.

“Emolument s of an employment ” ar e char geable t o t ax under s.62. The key wor ds her e ar e “of the employment”. J ust because a payment is made by an employer t o an employee, it does not aut omat ically f ollow t hat t he payment is f r om t he “employment ”. For a payment t o be t r eat ed as being “f r om an employment ”, t he payment must gener ally be made in return for services (past , pr esent or f ut ur e). I n Hochst r asser v Mayes (1959), an employee (wor king f or I CI plc) was r elocat ed t o anot her par t of t he UK. The employee had t o sell his house and r eceived compensat ion f r om his employer f or t he loss on sale. The quest ion ar ose as t o whet her such compensat ion was an emolument f r om t he employment .

s.62

I nt r oduct ion t o Employment I ncome & Benef it s

297

I n t heir j udgement t he House of Lor ds st at ed t hat

“…if it is t o be t he subj ect of an assessment , it must ar ise from the

employment. I t is not suf f icient t o r ender a payment assessable t hat an employee would not have r eceived it unless he had been an employee …it is assessable if it has been paid t o him in r et ur n f or act ing or being an employee”.

The Lor ds held t hat t he compensat ion payment was made t o t he individual in his capacit y as a homeowner r at her t han “in r et ur n f or act ing or being an employee”. As t he payment was not made by r ef er ence t o any ser vices per f or med, it was not an emolument of t he employment . [Not e: t his was a 1959 case and such payment s ar e now dealt wit h under s.271 t o s.289 concer ning r emoval expenses]. To illust r at e t he subt le complexit ies of case law, a dif f er ent decision was ar r ived at in t he case of Hamblet t v Godf r ey (1987). I n t his case, an employee of a gover nment agency (GCHQ in Chelt enham) was of f er ed £ 1,000 as compensat ion f or agr eeing t o give up her r ight s t o j oin a t r ade union. The employee cont ended (cit ing Hochst r asser v Mayes) t hat t he payment was not an emolument f r om her employment as it was not being made in r et ur n f or ser vices.

I n t his case t he Cour t s disagr eed and f ound t he payment t o be a t axable emolument . The r ight t o j oin a t r ade union is par t and par cel of “acting or being an employee”. The payment was t oo closely linked t o t he employer –employee r elat ionship f or it t o be t r eat ed as anyt hing ot her t han an emolument . I n Shilt on v Wilmshur st (1991), a f oot baller (England goalkeeper Pet er Shilt on) t r ansf er r ed f r om Not t ingham For est t o Sout hampt on f oot ball club. As t he player was under cont r act t o Not t ingham For est , t he club agr eed t o pay Mr Shilt on £ 75,000 t o agr ee t o t he t r ansf er . Again t he quest ion ar ose as t o whet her t his payment ar ose “f r om t he employment ”. Mr Shilt on cont ended t hat t he payment was made t o him by his f or mer employer in connect ion wit h t he t er minat ion of his employment (such t er minat ion payment s being t ax f r ee up t o £ 30,000). The Revenue ar gued t hat t he payment was a r ewar d or inducement f lowing f r om t he ser vices he was about t o of f er t o Sout hampt on FC. The Cour t s agr eed wit h t he Revenue and f ound t he payment t o have ar isen from

Mr Shilton’s employment (t her ef or e f ully t axable). Mr Shilt on had r eceived payment “to remain or become an employee” – t he payment was t o induce t he player t o become an employee of Sout hampt on FC and f or no ot her r eason. Similar ly in Glant r e Engineer ing Lt d v Goodhand (1983), an inducement payment t o per suade an account ant t o leave Er nst & Young (as is now) and j oin a small engineer ing f ir m was held t o be an emolument as it was paid by r ef er ence t o ser vices “t o be per f or med” f or t he new company.


I n Mair s v Haughey (1993), an employee moved f r om a gover nment owned company t o a new pr ivat e company, and in r et ur n f or accept ing t he new employment he r eceived t he f ollowing: (i) £ 4,506 paid by t he gover nment owned company as compensat ion f or t he

employee giving up his r ight s under t heir r edundancy scheme; and (ii) £ 1,300 f r om t he new company as an “ex gr at ia” incent ive t o j oin. The Cour t s held t hat t he lat t er was t axable being an inducement payment r ef er able t o ser vices t o be per f or med. However , compensat ion payment s f or loss of r edundancy r ight s wer e not wit hin t he def init ion of an emolument .

D2.4 Amount of employment income charged to tax

S.9 I TEPA 2003 deals wit h how much of a t axpayer ’s income is char geable t o income t ax f or a par t icular t ax year .

s.9

I n t he case of “gener al ear nings”, t he amount char ged t o t ax is t he “net taxable earnings” f r om t he employment in t he t ax year . “Net t axable ear nings” ar e “t axable ear nings” less any deductions allowed from those earnings under t he “expenses pr ovisions” wit hin t he Act . Essent ially employees r eceive t ax r elief in r espect of any expenses “wholly, exclusively and necessarily” incur r ed in doing t heir j ob. We shall look specif ically at employment expenses in a lat er chapt er .

s.11

Net t axable ear nings can t her ef or e be br oadly summar ised as:

£ £ Cash r emuner at ion: Salar y, bonus et c X Ot her emolument s which have dir ect monet ar y value X

Non cash r emuner at ion: Benef it s X Less: exempt income (X) Taxable ear nings X Less: allowable deduct ions: Employment expenses X Ot her deduct ions (X) NET TAXABLE EARNINGS X

D2.5 The “receipts” basis

S.15 I TEPA 2003 deals wit h gener al ear nings (cash plus benef it s) of an employee r esident or dinar ily r esident and domiciled in t he UK and t ells us t hat …

s.15

“The full amount of any ear nings …which ar e received in a t ax year is an amount of “taxable earnings” f r om t he employment in t hat t ax year ”.


299

Ther ef or e t he way we t ax an individual’s employment income is on a “receipts basis”. This means t hat employees and dir ect or s will be t axed on t heir employment income when it is received. The r ules f or t axing ear nings ar e slight ly dif f er ent f or employees who ar e eit her r esident , or or dinar ily r esident or domiciled out side t he UK, and t hese will be cover ed in a lat er session.

The dat e of r eceipt of ear nings consist ing of money is t he ear lier of t wo dat es: s. 18

1) t he t ime when payment is made Rule 1

2) t he t ime when a per son becomes entitled to payment Rule 2

Ther ef or e if an employee or dir ect or becomes ent it led t o a payment bef or e he or she is physically paid t he money, t he dat e of ent it lement is t r eat ed as t he dat e of r eceipt and t he payment is t axed at t hat point . I n pr act ice t his dist inct ion is not par t icular ly impor t ant , as f or most of us t he dat e of ent it lement and t he dat e of physical r eceipt ar e usually t he same. Wher e t he r eceipt s basis becomes impor t ant is wit h r egar d t o t he t axat ion of bonuses. Consider a company which dr aws up account s f or t he year ended 31 December 2005. On t he 28 Apr il 2006, t he annual gener al meet ing is held and t he boar d of dir ect or s of t he company sign of f t he account s and agr ee t he pr of it s of t he year j ust ended. At t his point t he company ar e in a posit ion t o det er mine t he bonuses due t o t heir employees. An employee r eceives a bonus at t he end of Apr il 2006 in r espect of wor k car r ied out by him in t he year which ended in December 2005. For employment income pur poses, t he employee is t axed on his bonus not in t he per iod in which t he bonus was ear ned, but inst ead on the date the bonus is physically received.

As such t his bonus is t axable at t he end of Apr il 2006, and t her ef or e goes int o t he employee’s t ax comput at ion f or t he 2006/ 07 t ax year .

This is a gener al pr inciple and t her e ar e always occasional except ions. Cer t ain special rules exist for company directors but in most cases t he nor mal r eceipt s basis will apply.

I n r elat ion t o company dir ect or s, t he dat e of r eceipt is t he ear liest of eit her of t he above t wo dat es, and;

s.18 Rule 3

when sums on account of his ear nings ar e credited in t he company account s; or at t he end of t he company’s account ing per iod if t he ear nings have been det er mined by the end of t hat per iod; or at t he dat e t he ear nings ar e determined if t hat dat e f alls after t he end of t he company’s account ing per iod.


Illustration 1

Mr Mat t hews is a company dir ect or ear ning £ 60,000 per annum. He is ent it led t o an annual bonus based on t he company’s r esult s f or each year ending on 31 December . At t heir Boar d Meet ing on 25 Mar ch 2007, t he Boar d agr ee t he dr af t account s and det er mine Mr Mat t hews’ bonus in t he sum of £ 25,000. This is paid t o Mr Mat t hews on 30 Apr il 2007. Alt hough t he dat e of physical r eceipt is 30 Apr il 2007, as Mr Mat t hews is a dir ect or , we need t o consider Rule 3 in s.18 I TEPA 2003. Mr Mat t hews’ ear nings wer e det er mined af t er t he end of t he company’s account ing per iod, t her ef or e r ule (c) above applies. The dat e of “r eceipt ” f or employment income pur poses is t her ef or e 25 Mar ch 2007 and t he bonus will be t axable in 2006/ 07.

D2.6 Taxable benefits

Benef it s ar e ver y impor t ant as f ar as your exam is concer ned. By benef it s we mean non-cash r emuner at ion. Many employees r eceive such benef it s as par t of t heir over all r emuner at ion package.

s.63

These benef it s of t en include t he use of a company car, t he use of company pr ovided accommodation, or a cheap loan. Private medical insurance or cont r ibut ions by t he employer t o t he employee’s pension scheme ar e also ver y common benef it s, as is t he pr ovision of a mobile phone along wit h associat ed t elephone calls. The maj or it y of t hese benef it s ar e t axable in t he hands of t he employee. Ther e ar e cer t ain benef it s which ar e exempt f r om t ax and we shall deal wit h t hese lat er . For t axable benef it s, we need t o det er mine t he “cash equivalent” of each par t icular benef it . Essent ially we ar e allocat ing a cash f igur e t o each t axable benef it and t her eaf t er we will t ax t hat cash equivalent as if it was an addit ional amount of ear nings.


301

D2.7 Measuring the benefit

Benef it s ar e char geable t o t ax if t hey ar e eit her :

(i) specif ically char ged wit hin t he Benef it s Code; or (ii) “employment -r elat ed” benef it s under s.201 onwar ds I TEPA 2003. We shall look at specif ic benef it s wit hin t he Benef it s Code in lat er sessions, but f ir st we will examine t he r ules f or t axing employment related benefits. An employment r elat ed benef it is a benef it pr ovided eit her f or an employee, or f or a member of t he employee’s family or household, by r eason of t he employee’s employment . Ther ef or e, a t axpayer cannot avoid being t axed on t he pr ovision of a benef it simply by dir ect ing his employer t o pr ovide t he benef it t o, say, his wif e r at her t han himself .

s.201

This means, f or example, if by r eason of J ack’s employment , J ack’s wif e or son ar e pr ovided wit h a company car or ot her benef it , it is J ack who will be char ged t o income t ax on t he cash equivalent of t hat benef it . S.203 I TEPA 2003 t ells us t hat “t he cash equivalent of an employment r elat ed benef it is to be treated as earnings f r om t he employment f or t he t ax year in which it is pr ovided”, and ..

s.203

“The cash equivalent of an employment -r elat ed benef it is t he cost of the benefit less any par t of t hat cost made good by

the employee t o t he per sons pr oviding t hat benef it ”. Under s.204 I TEPA 2003, “t he cost of an employment r elat ed benef it is t he expense incurred in, or in connection with, the provision of t hat benef it ”.

s.204

This means t hat , f or example, if an employer wishes t o pr ovide a benef it t o an employee in t he f or m of , say, pr ivat e medical insur ance, and t he cost t o t he employer of paying t he pr emium is £ 500, t he cash equivalent – i.e. t he amount char ged t o t ax – is £ 500. The f act t hat it might cost t he employee mor e t han £ 500 t o obt ain t he same level of medical cover is ir r elevant – we simply look at what it cost the employer to provide the benefit. Amount s paid by the employee t o t he employer t owar ds t he pr ovision of t he benef it can be deducted f r om t he cash equivalent . Ther ef or e if t he employee r eimbur ses t he employer ’s f ull cost , t he t axable benef it will be zer o. Ever y benef it pr ovided by an employer t o an employee which has a cash equivalent , must be reported to the Revenue by t he employer on a special form called a P11D. The employer should complet e a f or m P11D f or each employee who has r eceived t axable benef it s, and t hese f or ms should be submitted t o t he Revenue no later than 6 July after the end of the tax year. The P11D t ells t he Revenue t he amount of t he cash equivalent of each benef it . A copy is given t o t he employee t o enable him t o complet e his own t ax r et ur n.


I n t he case of cer t ain benef it s, it is ver y dif f icult t o est ablish exact ly what is t he cost t o t he employer of pr oviding t he benef it . I n such cases special r ules exist t o help us calculat e t he cash equivalent . Special r ules ar e in place f or calculat ing company car and f uel benef it s, accommodat ion benef it s, cheap loans and inst ances wher e an employer lends an asset t o an employee. We shall t ake a look at t hese var ious special r ules lat er .

D2.8 Pepper v Hart

The concept of t he “cost of providing” a benef it was t he subj ect of a leading and ext r emely impor t ant t ax case hear d by t he House of Lor ds in 1993. The case of Pepper v Hart concer ned a pr ivat e, f ee-paying school. J ust bef or e t he st ar t of t er m, t he school had some sur plus places, which it had been unable t o sell. The school t her ef or e allowed some of t he schoolmasters t o send their own

children to the school t o be educat ed at a subsidised price. The Revenue and t he schoolmast er s bot h agr eed t hat a benef it had ar isen. This was because an employee or member s of his f amily or household wer e being pr ovided wit h a benef it (i.e. cheap educat ion) by r eason of t he schoolmast er s’ employment . Ther e was no disput e t hat a benef it had ar isen. The ar gument was about how t o det er mine t he “cost t o t he employer ” in pr oviding t he educat ion t o t he childr en involved. Each side put f or war d an alt er nat ive way of est ablishing t he cost t o t he school of pr oviding t he benef it . The Revenue ar gued t hat we should f ir st t ake t he t ot al cost of r unning t he school f or t he year . This f igur e should t hen be divided by t he number of pupils in t he school t o give an aver age cost of pr oviding educat ion per st udent . Fr om t his aver age cost , we deduct t he f ees act ually paid by t he schoolmast er s and t he dif f er ence is t he t axable benef it . The Revenue t her ef or e argued that “cost of providing” as per t he legislat ion actually meant the “average” cost. The t axpayer put f or war d an alt er nat ive suggest ion. He ar gued t hat we f ir st calculat e t he cost of r unning t he school f or it s normal fee paying pupils (i.e. not count ing t hose st udent s r eceiving subsidised educat ion). Next we calculat e t he cost of r unning t he school f or all the pupils, t his t ime including t he addit ional childr en who had paid r educed f ees. The difference bet ween t hese t wo f igur es is t he addit ional cost incur r ed by t he school in pr oviding t hese ext r a places. Ther ef or e t he cost of pr oviding each addit ional place is t his f igur e divided by t he number of ext r a places. Fr om t his we deduct t he f ees paid by t he schoolmast er s and t he dif f er ence is t he t axable benef it . What t he taxpayer was advocat ing was a “marginal” cost method as opposed t o t he Revenue’s aver age cost met hod. The House of Lor ds on a maj or it y decision f ound in f avour of t he taxpayer and decided t hat t he marginal cost method was t he cor r ect way of calculat ing t he cash equivalent in t his inst ance.


303

The case of Pepper v Har t has par t icular r elevance when it comes t o calculat ing t he benef it in r espect of “in-house benefits” as we shall now illust r at e.

Illustration 2

A f light is about t o leave f r om London Heat hr ow air por t t o J FK New Yor k. The f light will cost t he air line £ 20,000. The plane has 100 seat s. This means t hat t he aver age cost t o t he air line is £ 200 per seat . Assume t hat all but one of t he seat s have been sold t o nor mal f ee paying passenger s. A f ew minut es bef or e t he f light is due t o leave, t he air line of f er s t his spar e seat t o one of it s employees f or t he bar gain pr ice of £ 10. Ther e is a benef it ar ising t o t he employee because t he employee is r eceiving a benef it – i.e. a ver y cheap f light – by r eason of his or her employment . The cash equivalent will be t he cost t o t he air line of pr oviding t hat one heavily subsidised seat t o one if it s employees. Following Pepper v Har t we do not t ake t he aver age cost per passenger of £ 200. I nst ead we consider t he mar ginal cost . This will be t he ext r a cost t o t he air line of f lying t hat one ext r a passenger over t o New Yor k. This ext r a cost should be negligible – pr esumably it cost s mor e or less t he same t o f ly 100 passenger s t o New Yor k as it does t o f ly 99. Ther e will be a f ew addit ional cost s such as one ext r a in-f light meal or an ext r a newspaper which should be cover ed by t he £ 10 paid by t he employee. As a r esult f ollowing t he pr inciple est ablished by Pepper v Har t , wher e an employee is using goods or ser vices manuf act ur ed or pr ovided by his employer , t he mar ginal cost is ef f ect ively zer o giving r ise t o a t axable benef it of nil.

D2.9 Lower paid employees s.216

Cer t ain chapt er s of t he Benef it s Code do not apply if t hose benef it s ar e pr ovided t o an employee who def ined as a lower paid employee and who is not a director of a company. These excluded benef it s include company car s and vans, cheap loans, cer t ain shar e r elat ed benef it s and cer t ain expenses payment s. A lower paid employee is one ear ning less t han £ 8,500 in t he t ax year . I n or der t o est ablish whet her an employee ear ns mor e or less t han £ 8,500, we need t o t ake account of cash earnings (including expense r eimbur sement s) and any payment s treated as earnings, f or example under t he Benefits Code. We also need t o add in any amount s r eceived under t he special r ules f or int er mediar ies (see Chapt er 27). We t hen need t o deduct “aut hor ised deduct ions” as list ed in s.217(4) which include payr oll giving and cer t ain pension cont r ibut ions:

s.217


£ Cash ear nings (including r eimbur sed expenses)

X

Payment s t r eat ed as ear nings (eg Benef it s)

X

Ear nings f r om int er mediar ies

X

X

Less: aut hor ised deduct ions

(X)

TEST HERE X

Not e t hat f or t he pur poses of t he t est , we include expense r eimbur sement s but do not deduct gener al business expenses (eg t r avel et c) which ar e allowable under t he expenses r ules as t hese ar e not in t he list of aut hor ised deduct ions. I f t he r esult ing f igur e at t he bot t om is £ 8,500 or mor e, we do not have a lower paid employee. I n t his inst ance, all benef it s and expenses payment s will be t axed in t he nor mal way. The above t est is designed in t his way t o pr event a company paying an employee a cash salar y of £ 8,499 and “t opping-up” his r emuner at ion package wit h a number of non-cash benef it s and expenses. I f an employee is a lower paid employee, t axable benef it s will st ill need t o be r epor t ed t o t he Revenue but t his t ime on a f or m P9D as opposed t o f or m P11D. I t is mor e common f or an employer t o pr ovide benef it s t o employees who ar e not lower paid employees nor dir ect or s, and we will concent r at e on t hese f or t he r est of t his cour se.

D2.10 Pension income and social security income

Par t s 9 and 10 of I TEPA 2003 deal wit h t he t axat ion of pension income and social secur it y income. I ncome f r om pensions is gener ally t axable. This will include t he St at e Pension and any pension income paid by a f or mer employer whet her in t he UK or abr oad. I f a t axpayer is r esident and domiciled in t he UK and r eceives income f r om an over seas pension, only 90% of t he pension income ar ising is t axable. This “10% deduct ion” r ule also applies t o over seas gover nment pensions paid in t he UK.

s. 65(2) I CTA 1988

s.617

Many social secur it y benef it s paid t o UK t axpayer s ar e exempt f r om t ax. Such exempt sour ces include ber eavement payment s, child benef it , council t ax benef it , housing benef it , disabilit y living allowances and t he new wor king t ax cr edit s and child t ax cr edit s.

s.677

Ther e ar e however , st ill a signif icant number of social secur it y benef it s which ar e t axable under I TEPA 2003. These include incapacit y benef it , income suppor t , j ob seeker s allowances, st at ut or y mat er nit y pay and st at ut or y sick pay.

s.660


305

Example 1

Br uno wor ks f or Online Tut or s Limit ed (OTL). Which of t he f ollowing ar e t axable under I TEPA 2003? a) Salar y b) Per f or mance Relat ed Bonus c) M&S voucher f r om employer d) Dividend on shar es in OTL e) I nt er est f r ee loan f r om OTL f ) Pr of it f r om one-of f consult ing j ob f or a local business

Example 2

Chr is and Dean wor k f or Online Tut or s Limit ed. Their ear nings ar e as f ollows: Chr is Dean £ £ Salar y 6,000 5,000 Bonus 1,000 Nil Benef it s (cash equivalent ) 1,400 2,800 Business expenses r eimbur sed 200 600

Which of t hem is a lower paid employee? a) Chris only

b) Dean only c) Bot h of t hem d) Neit her of t hem


Answer 1

Employment income?

a) Salar y X

b) Per f or mance Relat ed Bonus X

c) M&S voucher f r om employer X

d) Dividend on shar es in OTL X (Dividend income) e) I nt er est f r ee loan f r om OTL X

f ) Pr of it f r om one-of f j ob X (Miscellaneous income) Answer 2

The answer is B

Chr is Dean

£ £ Salar y 6,000 5,000 Bonus 1,000 Nil Benef it s 1,400 2,800 Expenses 200 600 TEST 8,600 8,400

“Lower paid” NO YES

Dean would t her ef or e not be t axable on t he benef it s.


307

SUMMARY - EMPLOYMENT INCOME & BENEFITS The I ncome Tax (Ear nings & Pensions) Act 2003 t axes income f r om employment including cash and non-cash r emuner at ion. I t also t axes pensions r eceived, t er minat ion payment s and pr of it s on shar e opt ions. The r eceipt s basis applies so a bonus is t axed when r eceived, not when ear ned. Non-cash benef it s ar e also t axable. Their cash equivalent is equal t o t he cost t o t he employer in pr oviding t he benef it and is r educed by any cont r ibut ion made by t he employee. Benef it s ar e r epor t ed on t he P11D due by 6 J uly f ollowing t he t ax year . The case of Pepper v Har t est ablished t he pr inciple t hat cost t o t he employer should be mar ginal cost . Lower paid employees ear ning < £ 8,500 p.a. who ar e not dir ect or s ar e not t axable on some benef it s.

D3: COMPANY CAR & FUEL BENEFITS

I n t his chapt er you will lear n t he r ules f or t he t axat ion of company car and f uel benef it s including: - how t o f ind list pr ice; - how t he cash equivalent is based on CO2 emissions; - non availabilit y; - f uel benef it .

All st at ut or y r ef er ences ar e t o I TEPA 2003 unless st at ed ot her wise.

D3.1 Introduction

One of t he most common benef it s of f er ed by employer s t o t heir employee is t he pr ovision of a company car and f uel f or pr ivat e mot or ing.

s.114 - s.172

I f a car is pr ovided t o a lower paid employee who is not a dir ect or , the benefit is tax free.

s.216(4)

For ot her employees, special r ules exist t o enable us t o calculat e t he cash equivalent on t he pr ovision of a company car . I f a car is made available by an employee f or t he exclusive use of a par t icular employee, it doesn’t mat t er whet her t he car is owned by t he employer or leased by t he employer f r om a t hir d par t y, t he employee will have a taxable benefit in respect of the

private use of the car. The cash equivalent depends on a number of f act or s.

s.120 & s.121

The st ar t ing point in calculat ing car benef it s is t he list price of t he car when it is f ir st r egist er ed (i.e. when br and new). This is not necessar ily t he same as t he pr ice act ually paid by t he employer f or t he car .

s.122

The cash equivalent also depends on t he vehicle’s carbon dioxide (CO2)

emissions. Essent ially, t he lower the emissions, the lower the benefit. This is an at t empt by t he gover nment t o be r esponsible wit h r egar d t o t he pr ot ect ion of t he envir onment .

s. 139

Also t he benef it depends on whether the car was available for the whole of

the year. As is t he case wit h most benef it s, if t he employee does not have t he benef it f or t he whole of t he year , we need t o do an appor t ionment t o ar r ive at t he cash equivalent .

s.143

Lat er on in t his chapt er we will look at t he separ at e benef it t hat ar ises when an employer pr ovides t he employee wit h f uel f or his or her pr ivat e mot or ing.

s.149

Company Car & Fuel Benef it s

309

D3.2 List price

We will now put all of t hese var iables t oget her int o a company car pr of or ma:

£ List pr ice when new A Accessor ies B Less: capit al cont r ibut ions (max £ 5,000) (C) Revised list pr ice (capped at £ 80,000) D

We st ar t wit h t he list price of the car when new and t o t his we add on the cost of any accessories pr ovided wit h t he car . For example if you buy a new car , t he gar age will char ge you ext r a if you want leat her seat s or a CD player et c, so we need t o add t hese it ems on.

s.121

s.125

The next st ep is t o deduct any capital contributions made t o t he employer by t he employee. A capit al cont r ibut ion is a one-of f payment made by t he employee t o enable t he employer t o pr ovide a bet t er car .

s.132

List pr ice, plus accessor ies, minus capit al cont r ibut ions gives a r evised list pr ice which in t he pr of or ma we have called “D”. This list pr ice cannot exceed £80,000 f or t ax pur poses.

s.121

I f an accessor y is added t o t he car af t er it was f ir st made available t o t he employee, we only need t o add on t he cost t o t he list pr ice if t he accessor y cost mor e t han £ 100. I f not , we can ignor e it .

s.126

Wit h r egar d t o capital contributions, t he maximum deduction f r om t he list pr ice is £5,000. I f an employee makes a capit al cont r ibut ion of £ 1,000, t his amount is deduct ed f r om t he list pr ice. However if an employee makes a capit al cont r ibut ion of £ 6,000, t he list pr ice is r educed by £ 5,000 only.

s.132(3)

D3.3 Cash Equivalent

The basic cash equivalent is t he list price, mult iplied by a cer t ain per cent age. This per cent age will depend on t he amount of CO2 emit t ed by t he car . The minimum char ge is 15%, r ising t o a maximum char ge of 35%.

s.139(2) & (3)

We can see t wo t hings her e. Fir st ly t he benef it depends on t he type of car we have – t he mor e expensive t he car , t he higher t he benef it . Secondly, employees who dr ive ar ound in lar ge car s wit h high CO2 emissions will pay mor e t ax t han t hose who ar e mor e envir onment ally f r iendly and have use of car s wit h low emissions. The list pr ice, mult iplied by t he appr opr iat e per cent age gives us t he basic cash equivalent.


The benef it is r educed if the car has not been available t o t he employee for the whole of the tax year. For example, t he employee may have been given use of t he car par t way t hr ough t he year or he may have r et ur ned t he car t o t he employer bef or e t he end of t he year . We do a pro-rata apportionment by r emoving t he number of mont hs dur ing which t he car was not available t o t he employee. For example, if a t axpayer j oined a company on, say, 1 J anuar y 2007 and was given use of a car on t hat dat e, t hat per son will have had t he car f or only 3 mont hs of 2006/ 07. We t her ef or e r emove nine t welf t hs of t he car benef it .

s.143(1)

As is t he case f or t he vast maj or it y of benef it s, if t he employee is r equir ed t o make a cont r ibut ion t owar ds t he benef it and act ually does so, t hese cont r ibut ions r educe t he cash equivalent . This is quit e common in pr act ice as wit h many car schemes, employees make mont hly cont r ibut ions t o t heir employer f or t he use of t he car . These r educe t he t axable benef it .

s.144

Her e is t he r est of t he pr of or ma t o f ind t he car benef it f or t he t ax year . The f inal cash equivalent will be ent er ed by t he employer on t o t he employee’s P11D:

£ Revised list pr ice D

Basic cash equivalent E D x % - depends on CO2 emissions - minimum 15%, maximum 35% Less: non availabilit y (n/ 12) (F)

G Less: employee cont r ibut ions (H)

Car Benef it I

D3.4 Determining the percentage s. 133

The next st ep is t o det er mine t he r elevant per cent age. List pr ice is mult iplied by a per cent age which depends ent ir ely on t he car ’s r ecor ded CO2 emissions. The higher t he emissions, t he higher t he per cent age. Car bon dioxide emissions ar e measur ed in t er ms of t he grams per kilometre (g/km) of gas emit t ed f r om t he car . For 2006/ 07 t her e is a “baseline” figure of 140 g/km. This means t hat all car s emit t ing CO2 at a r at e of 140 g/km or less will be t axed at t he minimum rate of

15%. The baseline will be t he same f or 2007/ 08 but is t o r educe t o 135 g/ km in 2008/ 09.


311

The r elevant per cent age will increase by 1 for each additional 5 g/km of CO2

emitted above 140 f or 2006/ 07. For example, a car wit h r ecor ded CO2 emissions of 145 gr ams per kilomet r e, will be t axed using a per cent age of 16%, and so on.

s.139(3)

The f or mula f or calculat ing t he per cent age is:

% = [(Emissions – 140) 5] + 15%

We t ake t he CO2 emissions of t he car and deduct t he baseline f igur e of 140. We divide t he r esult by 5 and add it t o t he minimum of 15% t o give t he r elevant per cent age. This is t hen mult iplied by t he list pr ice of t he car t o give t he basic cash equivalent . Illustration 1

An employee has use of a company car wit h a list pr ice of £ 20,000. Accessor ies ar e added t o t he car at a cost of £ 2,000. The employee made a one-of f capit al cont r ibut ion of £ 4,000 f or t he use of t he car . The car has r ecor ded CO2

emissions of 195 g/ km. £ List pr ice 20,000Add: Accessor ies 2,000Less: Capit al cont r ibut ion (4,000)Revised list pr ice £ 18,000 Cash equivalent £

£ 18,000 x 26% [(195-140) ÷ 5 = 11 + 15] 4,680

D3.5 Further points

I n r ealit y, CO2 emissions f igur es ar e exact numbers and ar e not r ounded t o t he near est whole mult iple of 5. For t ax pur poses, we ar e allowed t o round down to

the nearest 5 g/km.

s.139(5)

For example, if a car has a CO2 emissions f igur e of 199 g/ km, we would r ound t his down t o 195 t o det er mine t he per cent age. The per cent age can never exceed 35%. This r at e will t her ef or e apply f or all car s wit h an emissions f igur e of 240 g/ km or above. Ther e is a 3% supplement f or car s which r un on diesel – i.e. an addit ional 3% is added t o t he r elevant per cent age. This is because diesel engines ar e less envir onment ally f r iendly t han pet r ol engines. The minimum percentage which can t her ef or e be applied t o a diesel vehicle is 18%. The 3% supplement cannot t ake t he r elevant per cent age above 35%.

s.141


Electric car s pr oduce no CO2 emissions and r eceive a 6% discount. The per cent age t o be applied in t hese cases will t her ef or e be 9%. Ther e ar e also discount s f or car s r unning on r oad f uel gas (e.g. liquid pet r oleum gas or LPG).

SI 2001/ 1123

s.146

Fr om 2008/ 09, a f ixed r at e of 10% will apply f or car s wit h CO2 emissions of 120 g/ km or less.

D3.6 No emissions figure s. 140, s.142

Cer t ain vehicles, par t icular ly old ones, will have no r ecognised or r ecor ded CO2 emissions f igur e. I n t hese cases, t he per cent age we use t o calculat e t he benef it will be based on the engine size of t he vehicle. The engine size is measur ed in t er ms of t he vehicle cylinder capacit y in cubic cent imet r es. The per cent ages f or car s r egist er ed before 1 January 1998 ar e shown in t he t able below and r ise f r om a minimum of 15% f or small car s t o 32% f or lar ger vehicles. The per cent ages ar e slight ly dif f er ent f or car s r egist er ed on or after 1

January 1998. Again t he minimum is 15%, t his t ime r ising t o t he usual upper limit of 35%. Once again, a 3% supplement is added f or diesel car s, again capped at a maximum of 35%.

Engine Size Pre 1.1.98 Post 1.1.98

0 - 1,400 cc 15% 15% 1,401 – 2,000 cc 22% 25% over 2,000 cc 32% 35%

D3.7 Non-availability s.143

The benef it is r educed if t he employee does not have use of t he car t hr oughout t he whole of t he t ax year . This will apply if an employee joins a company par t way t hr ough t he year and is given use of a car , or if an employee leaves t he company and has t o r et ur n t he car . Appor t ionment is done on a mont hly basis by r emoving t he benef it ar ising in t he per iod in which t he employee did not have use of t he car . I f a car is being r epair ed or ser viced, or having it s MOT, a non-availabilit y deduct ion can only be made if t he car is of f t he r oad f or a cont inuous per iod of at least 30 days.

s.143(2)

So, if t he car is in t he gar age f or one week having a f ew minor r epair s, t his will have no ef f ect what soever on t he car benef it calculat ion. However if t he car is involved in a ser ious accident and is of f t he r oad f or , say, 2 mont hs, we would t ake a non-availabilit y deduct ion of 2 out of 12 mont hs.


313

Illustration 2

An employee has use of a company car wit h a list pr ice of £ 12,000. The car has a CO2 emissions level of 152 g/ km. The employee is given use of t he car f or t he f ir st t ime on 1 J uly 2006. The employee makes cont r ibut ions of £ 40 per mont h t o t he employer f or t he use of t he car . Dur ing t he year , t he car was of f t he r oad f or 3 weeks having some minor r epair s af t er an accident . To calculat e t he benef it f or 2006/ 07 t he st ar t ing point is t he list pr ice of £ 12,000. We mult iply t his by a per cent age based on t he car ’s CO2 emissions, which we know t o be 152 g/ km. As t his is not exact ly divisible by 5, we r ound down and use an emissions f igur e of 150 in t he f or mula. As t he car was only available t o t he employee f r om 1 J uly 2006 – i.e. f or 9 mont hs of t he t ax year – we must t ake a non-availabilit y deduct ion f or 3/ 12t hs of t he benef it . Not e t hat no r educt ion has been made f or t he 3 weeks dur ing which t he car was being r epair ed as t his per iod is less t han 30 days. The employee is r equir ed t o make a cont r ibut ion of £ 40 per mont h f or t he use of t he car . As is t he case f or t he maj or it y of benef it s, employee cont r ibut ions act t o r educe t he cash equivalent .

£ List pr ice 12,000 Cash equivalent

12,000 x 17% [(150 – 140) ÷ 5 = 2 + 15] 2,040

Less: non-availabilit y

312 x 2,040

(510)

Less: cont r ibut ions 40 x 9 (360) Benef it £ 1,170

D3.8 More than one car

An employee may have use of t wo company car s or he may have one car himself and a second car f or a member of his f amily or household. I n t his inst ance, t he employee simply has two benefits, each calculat ed in t he same way – i.e. using list pr ice and CO2 emissions. Not e t hat if a car is made available by an employer f or a member of t he employee’s f amily, it is t he employee who will have the benefit, not the family member.


D3.9 Classic cars s.147

A "classic car ” is one t hat is mor e t han 15 year s old and whose mar ket value at t he end of t he t ax year is mor e t han £ 15,000.

I f an employee is pr ovided wit h a classic car , t o wor k out t he cash equivalent we use the market value of the car when it was given t o t he employee inst ead of t he list pr ice when new.

D3.10 Pool cars and emergency vehicles s.167

No benef it will ar ise if t he employee has some incident al pr ivat e use of a pool car . A pool car is essent ially a shar ed vehicle which is mainly used f or business pur poses.

As long as pr ivat e use is incidental and t he pool car is not normally kept

overnight at the employee’s residence, no benef it will ar ise. Many employer s have a small f leet of pool car s which ar e nor mally kept somewher e on t he pr emises and which ar e used f or business j our neys. Ther e is also no t axable benef it when emer gency ser vice vehicles used by f ir e, police or ambulance wor ker s ar e t aken home when on-call.

D3.11 Administration

Employer s have t o f ile quar t er ly r et ur ns t o t he Tax Of f ice on f or m P46 (car ) giving det ails of any changes in car s pr ovided t o employees.

D3.12 Fuel benefits

A separate benefit will ar ise wher e private petrol costs ar e r eimbur sed. I f t he employer only pays f or f uel f or business pur poses, no benef it will ar ise.

s. 149, s.151(3)

I f an employee is pr ovided wit h f uel f or pr ivat e mot or ing, t he t axable benef it is ident if ied by using t he f or mula below:

£ 14,400 x % based on CO2 emissions s. 150

To calculat e t he appr opr iat e per cent age, we use exact ly t he same r ules as above f or car benef it pur poses. No f uel benef it will ar ise if an employee is r equir ed t o r eimbur se t he whole of t he expense incur r ed by t he employer in pr oviding pr ivat e f uel and act ually does so. I f t he employee only makes a par t ial r eimbur sement , t his will have no ef f ect and t he benef it will be calculat ed as above. Ther ef or e an employee cont r ibut ion t owar ds t he cost s of pr ivat e f uel will not r esult in a “pound-f or -pound” r educt ion in t he t axable amount as is t he case f or ot her benef it s.

s. 151(2)

s.248A


315

The f uel benef it will be r educed if pr ivat e use f uel is not pr ovided t o t he employee f or t he whole of t he t ax year . However , if pr ivat e f uel is wit hdr awn but t hen r einst at ed in t he same t ax year , t he benef it char ge will apply f or t he whole t ax year . So it is not possible t o opt in and out of t he car f uel benef it , f or example dur ing holidays.

s. 152

Illustration 3

Ralf is pr ovided wit h a car by his employer on 1 Oct ober 2006. The car has a list pr ice of £ 15,000 and CO2 emissions of 168g/ km. All f uel cost s ar e met by t he company. The cost s of pr ivat e f uel amount ed t o £ 2,000 of which Ralf r eimbur sed £ 750. The t axable benef it s in 2005/ 06 ar e:

£ Car : £ 15,000 x 20% [(165 – 140) ÷ 5 = 5% + 15% = 20%] 3,000 Less: non-availabilit y

£ 3,000 x 6/ 12 (1,500) Car benef it 1,500 Fuel benef it £ 14,400 x 20% x 6/ 12 1,440 Tot al £ 2,940

No r educt ion f or par t ial r eimbur sement of pr ivat e f uel. Not e a r educt ion would have been made if Ralf had cont r ibut ed £ 750 t owar ds t he gener al r unning cost s of t he car it self (r at her t han t he f uel dir ect ly), pr ovided t hat t his was a condit ion st ipulat ed by t he employer . Example 1

Eddie is pr ovided wit h use of a J aguar car f or t he whole of 2006/ 07. The list pr ice is £ 32,000 and CO2 emissions ar e 233 g/ km.

Eddie pays £ 50 per mont h f or t he use of t he car . All his pet r ol cost s ar e met by t he company. Calculat e Eddie’s t axable benef it f or 2006/ 07.

Example 2

J ensen has use of a Volvo car (list pr ice £ 12,000 and CO2 emissions 148g/ km). On 1 J uly 2006 his employer exchanged t he Volvo f or an Audi (list pr ice £ 14,000 and CO2

emissions 139 g/ km). The Audi r uns on diesel. The company r eimbur se J ensen f or business f uel cost s only.

Calculat e J ensen’s t axable benef it f or 2006/ 07.


Answer 1

List pr ice £ 32,000 Cash equivalent £

£ 32,000 x 33% [(230-140) ÷ 5 = 18 + 15] 10,560

Less: employee cont r ibut ions (12 x £ 50) (600) Car Benef it 9,960 Add: Fuel benef it - £ 14,400 x 33% 4,752 Taxable Benef it s £14,712

Answer 2

Volvo (3 mont hs) List pr ice £ 12,000

Cash equivalent £ £

£ 12,000 x 16% [(145-140) ÷ 5 = 1 + 15] 1,920

Less: non availabilit y

£ 1,920 x 912 (1,440)

480 Audi (9 mont hs) List pr ice £ 14,000 Cash equivalent

£ 14,000 x 18% [15% + 3%] 2,520 (<140g/ km plus diesel supplement )

Less: non availabilit y

£ 2,520 x 312 (630)

1,890 Tot al benef it £2,370


317

SUMMARY - COMPANY CAR & FUEL BENEFITS

Company car benef it is not char geable on lower paid employees who ar e not dir ect or s Company car benef it is based on a number of f act or s including list pr ice and CO2 emissions. List pr ice includes accessor ies and is r educed by capit al cont r ibut ions of up t o £ 5,000. Ther e is an over all cap of £ 80,000. A per cent age is applied t o t he list pr ice. The per cent age will be bet ween 15% and 35%. The “baseline” f igur e f or CO2 emissions f or 2006/ 07 is 140g/ km. The r elevant per cent age is calculat ed as

% = [emissions – 140] ÷ 5 + 15%

The emissions f igur e is r ounded down t o t he near est 5g/ km. Ther e is a 3% supplement f or car s which r un on diesel. As elect r ic car s pr oduce no emissions a per cent age of 9% only is used. Older car s wit h no r ecor ded emissions f igur e use per cent ages based on engine size which var y accor ding t o whet her t he car was r egist er ed bef or e or af t er 1 J anuar y 1998. I f t he employee has had t he car f or less t han a year , t he benef it is t ime appor t ioned. Non-availabilit y deduct ions only apply if t he car is of f t he r oad f or 30 days. Classic car s ar e t hose over 15 year s old and wor t h mor e t han £ 15,000 at t he end of t he t ax year . Mar ket value is used inst ead of list pr ice. Wher e f uel is pr ovided f or pr ivat e mot or ing, t he t axable benef it is:

£ 14,400 x % (based on CO2 emissions) Fuel benef it s cannot be r educed by employee cont r ibut ions but can be t ime appor t ioned if appr opr iat e.

D4: LIVING ACCOMMODATION – TAXABLE BENEFITS

I n t his chapt er you will cover t he way in which t axable benef it s f or living accommodat ion pr ovided by t he employer ar e calculat ed including: - j ob r elat ed accommodat ion; - r ent ed accommodat ion; - employer owned accommodat ion; - accommodat ion cost ing > £ 75,000; - t he 6 year r ule; - household expenses.

St at ut or y r ef er ences ar e t o I TEPA 2003 unless st at ed ot her wise.

D4.1 Introduction

I f a house, f lat or any pr oper t y t hat is owned or r ent ed by t he employer is made available f or use by an employee, t her e will be a t axable benef it f or t he employee as he is occupying a pr oper t y pr ovided t o him by his employer . The pr ovision of living accommodation is a taxable benefit for all employees even lower paid employees. The way t hat t he benef it is t axed depends on whet her t he accommodat ion is “j ob r elat ed” or “non j ob r elat ed”.

D4.2 “Job related” accommodation s.99

I f an employer pr ovides an employee wit h j ob r elat ed accommodat ion, t her e is no benef it ar ising t o t he employee on t he use of t hat accommodat ion. Job related accommodation is accommodat ion which is “necessary” f or t he j ob or is pr ovided f or t he “bet t er per f or mance” of t he employee’s dut ies. Employees such as publicans or caretakers will live in j ob r elat ed accommodat ion. Typically t hese ar e employees who ar e nor mally r equir ed by t heir employer s t o live on sit e in or der t o do t heir j ob. J ob r elat ed accommodat ion also cover s sit uat ions wher e accommodat ion is pr ovided “customarily” f or t he bet t er per f or mance of t he j ob. So f or example it is cust omar y t o pr ovide a vicar wit h a vicar age in t he par ish. This would const it ut e j ob r elat ed accommodat ion. A dir ect or of a company cannot have his living accommodat ion classif ied as “j ob r elat ed” under s.99 unless eit her : a) he does not have a “mat er ial int er est ” in t he company (>5% of t he shar es);

and eit her b) he is employed as a f ull t ime wor king dir ect or or t he company is non-pr of it

making or is est ablished f or char it able pur poses.

Living Accommodat ion – Taxable Benef it s

319

Finally, if accommodat ion is pr ovided by t he employer because t her e is a t hr eat t o t he employee’s physical “security”, t his will also const it ut e j ob r elat ed accommodat ion. Cer t ain polit icians such as t he Chancellor or t he Pr ime Minist er live in j ob r elat ed accommodat ion on Downing St r eet and do not pay t ax on t he pr ovision by t he gover nment of t heir living accommodat ion.

s.100

D4.3 Rented accommodation

For t he r est of t his chapt er we ar e going t o look at how we calculat e t he benef it s wher e t he accommodat ion pr ovided t o t he employee is not j ob r elat ed. We will st ar t by looking at how we calculat e t he cash equivalent wher e t he property is rented by the employer. The benef it - i.e. t he cash equivalent - is the higher of the rents paid by the employer f or t he use of t he pr oper t y, and the annual value of the property.

s.105(4)

The “annual value” of living accommodat ion is def ined as t he rent which might reasonably be expected to be obtained on letting the property if t he t enant paid all t he usual household bills and t he landlor d met all r epair and maint enance cost s. The “annual value” will be pr ovided f or you in t he examinat ion. I n pr act ice, however , t he Revenue will use t he gross rateable value of t he pr oper t y under t he old r at ing syst em as t he annual value. This will be much lower t han t he annual value as def ined in t he Act . I f t he pr oper t y has no r at eable value (f or example because it was built r ecent ly), an est imat e must be made. Any disput es as t o t he amount of t he annual value will be r ef er r ed t o t he Gener al Commissioner s f or r uling.

s.110

We t hen deduct any employee contributions – i.e. any r ent s paid by t he employee t o t he employer f or t he use of t he pr oper t y. This will give us t he cash equivalent .

Higher of : Rent s paid by employer X

Annual value of pr oper t y

Less: employee cont r ibut ions (X) Taxable benef it X

Remember t hat t his met hod of calculat ing t he benef it only applies wher e t he employer is renting t he accommodat ion f r om anot her landlor d.

D4.4 Employer owned accommodation

Ther e ar e similar r ules wher e t he employer owns t he accommodat ion being made available t o t he employee.


Once again, t he st ar t ing point in calculat ing t he benef it is t he annual value. I f t he accommodat ion cost t he employer less t han £ 75,000, t hen t he benef it is equal t o t he annual value.

s. 105(2)

I f t he house cost t he employer more than £75,000, t her e will be an addit ional benef it t o t he employee called t he addit ional year ly r ent – t his extra benefit will be added to the annual value t o give t he t ot al benef it .

s. 106

To calculat e t he addit ional year ly r ent we st ar t by t aking t he cost of t he accommodat ion - her e “cost ” means t he or iginal cost plus any impr ovement s. Fr om t his we deduct £75,000, and multiply t he dif f er ence by t he “ORI” which is t he Revenue’s of f icial int er est r at e at t he start of the tax year. When calculat ing t he “cost ” of t he pr oper t y, only impr ovement s car r ied out bef or e t he beginning of t he t ax year ar e t aken int o account . I mpr ovement s under t aken dur ing t he year will af f ect t he “cost ” used in calculat ing t he benef it f or t he f ollowing year .

s. 104

I f t he employee makes a cont r ibut ion t owar ds t he benef it , t his can be deduct ed in ar r iving at t he t axable cash equivalent . I f employee cont r ibut ions exceed t he amount of t he benef it , no loss will ar ise. The r esult is simply a benef it of zer o.

Annual Value X Add: Addit ional year ly r ent if Cost > £ 75,000 £ (Cost – £ 75,000) x ORI at st ar t of year X X

Less: employee cont r ibut ions (X) Taxable Benef it X

Illustration 1

An employee lives in accommodat ion t hat is owned by his employer . The house cost t he employer £ 100,000 and has an annual value of £ 1,000. The employee pays r ent t o t he employer of £ 100 per mont h f or t he use of t he house. Assume t he Revenue’s of f icial r at e of int er est is 5%. The calculat ion t he t axable benef it t hat will be ent er ed ont o t he employee’s f or m P11D will be as f ollows:

£ Annual Value 1,000 Addit ional year ly r ent : (100,000 – 75,000) x 5% 1,250 2,250 Less: employee cont r ibut ions: (£ 100 x 12) (1,200) Taxable Benef it £1,050


321

D4.5 The “6 year” rule s. 107

The “6 year r ule” applies when a house was bought by an employer and is made available f or use by t he employee mor e t han 6 year s af t er it had been f ir st acquir ed. The addit ional year ly r ent al in r espect of accommodat ion will not be based on cost . I nst ead, t he char ge will be based on t he mar ket value of t he house on t he dat e t he pr oper t y was made available t o t he employee. I n ef f ect we ar e subst it ut ing mar ket value in place of or iginal cost . Not e t hat t his r ule only applies wher e t her e ar e mor e t han 6 year s bet ween t he pr oper t y being acquir ed by t he employer and it being made available t o t he employee.

Illustration 2

An employee was pr ovided wit h a house by his employer in J une 1998. He pays £ 100 a mont h f or use of t he house. The house had been pur chased £ 100,000 in 1990 and has an annual value of £ 1,000. The house had a mar ket value of £ 120,000 in J une 1998. Assume an of f icial r at e of int er est of 5%. The benef it will be calculat ed as f ollows: £ Annual Value 1,000 Addit ional year ly r ent £ (120,000 – 75,000) @ 5% 2,250 Less: employee cont r ibut ions (1,200) Taxable Benef it £2,050

As house pr ices nor mally r ise over t ime, we would expect t he or iginal cost t o be less t han a lat er mar ket value. However , if pr oper t y pr ices f all such t hat when t he employee moves in mor e t han 6 year s lat er , t he mar ket value is less t han or iginal cost , this market value of the property will still be used to calculate

the benefit even t hough it is less t han or iginal cost .

I f t he or iginal cost of t he accommodat ion is less than £75,000, t her e will not be additional yearly rent, r egar dless of cur r ent mar ket value. For example, if a company buys a house in London in t he 1960s f or , let ’s say, £ 20,000, and t he employee is given use of t he pr oper t y t oday when t he house is wor t h, say, one million pounds, t her e is no addit ional char ge because t he or iginal cost is below t he £ 75,000 t hr eshold.

s. 107(1)(b)

I f t he house is not made available t o t he employee for the whole of the tax

year - i.e. t he employee moves in or moves out dur ing t he year - t he benef it needs t o be appor t ioned. Appor t ionment can be done on a mont hly basis. I f t he same living accommodat ion is pr ovided f or mor e t han one employee at t he same t ime, t he cash equivalent of t he benef it (as calculat ed above) is appor t ioned bet ween t he employees on a “j ust and r easonable” basis.

s. 108


D4.6 Household expenses

I f t he employer pays any household bills on behalf of t he employee, f or example gas, electricity and telephone bills et c, t his will give r ise t o an addit ional and separate benefit. This benef it is calculat ed by t aking t he cost t o t he employer of paying t hese par t icular bills. Ther e is a special r ule r elat ing t o expenses paid on behalf of employees who live in job related accommodation.

Illustration 3

Assume a vicar is living in j ob r elat ed accommodat ion. The vicar will not have a benef it on t he pr ovision of t he house, as t he accommodat ion is j ob r elat ed. The vicar has a salar y of £ 20,000 and his employer pays f or t he gas, elect r icit y and t elephone bills r elat ing t o t he house. These come t o £ 2,300. As t he employer dischar ges t hese bills, t his gives r ise t o an addit ional benef it .

The special r ule says t hat wher e such expenses ar e paid on behalf of employees in j ob r elat ed accommodat ion, t he amount on which t he employee will be t axed in r espect of t his benefit cannot exceed 10% of his other earnings from that

employment for the year.

s. 315(3) & (4)

Her e t he vicar ’s ear nings f or t he year is his salar y of £ 20,000, so t he amount on which t he vicar will be t axed in r espect of t hese r eimbur sed expenses cannot exceed 10% of t his - ie £ 2,000. This 10% r est r ict ion r ule only applies t o expenses pr ovided f or employees in j ob r elat ed accommodat ion. Where the accommodation is not job related, the full

amount of the expenses are taxable.

Example 1

Neil lives in a company owned f lat . The f lat cost t he company £ 150,000 in 2002. The annual value is £ 800 and Neil pays r ent of £ 150 per mont h. Neil moved out of t he f lat on 1 J anuar y 2007 and bought his own house. Calculat e Neil’s t axable benef it assuming t hat t he of f icial int er est r at e is 5%.

Example 2

Alf is t he manager of t he Golden Lion Public House. He is employed on a salar y of £ 18,000 and is r equir ed t o live in t he f lat above t he pub. His benef it s f or t he year ar e as f ollows:

£ Pr ivat e medical insur ance 500 Gas and elect r icit y bills f or f lat 2,200

Calculat e Alf ’s t axable employment income f or t he year .


323

Answer 1

£ Annual value 800 Addit ional char ge: £ (150,000 – 75,000) @ 5% 3,750 4,550

x 912 (6.4.05 - 1.1.06)

3,412

Less: employee cont r ibut ions (£ 150 x 9) (1,350) Taxable Benef it £2,062

Answer 2

£ Salar y 18,000 Medical I nsur ance (amount t r eat ed as ear nings) 500 18,500 Living expenses £ 2,200 Rest r ict ed t o 10% x £ 18,500 1,850 Tot al employment income £20,350

Accommodat ion is j ob r elat ed so t he r est r ict ion in s.315 applies.


SUMMARY - LIVING ACCOMMODATION

J ob r elat ed accommodat ion is a t ax f r ee benef it . This is wher e t he accommodat ion is: a) necessar y f or t he j ob; or b) cust omar y or pr ovided f or t he bet t er per f or mance of t he j ob; or c) pr ovided because of a t hr eat t o t he employee’s secur it y Non-j ob r elat ed accommodat ion is a t axable benef it f or all employees. The benef it f or r ent ed accommodat ion is t he higher of r ent s paid by t he employer and t he annual value. I f t he employer owns t he pr oper t y, t he benef it is t he annual value. Addit ional year ly r ent is calculat ed if t he pr oper t y cost > £ 75,000 as:

(Cost - £ 75,000) x ORI at st ar t of year ORI is t he of f icial r at e of int er est . I f t her e was mor e t han 6 year s bet ween t he pur chase of t he pr oper t y and t he employee moving in, t he mar ket value of t he pr oper t y at t he dat e t he employee moved in is subst it ut ed f or cost in t he above f or mula. Any household expenses paid by t he employer also lead t o a benef it f or t he employee. I f t he employee is in j ob r elat ed accommodat ion, t he benef it is limit ed t o 10% of t he ot her ear nings f r om t his employment f or t he year .

D5: LOANS TO EMPLOYEES & USE OF ASSETS

I n t his chapt er you will cover t axat ion of t he f ollowing benef it s: - t he pr ovision of a t axable cheap loan; - use of a company owned asset ; - t r ansf er of an asset f r om employer t o employee.

St at ut or y r ef er ences in t his chapt er ar e t o I TEPA 2003 unless st at ed ot her wise.

D5.1 Loans to employees s.173 – s.191

When a company lends money t o an employee, t his is likely t o give r ise t o a t axable benef it called a t axable cheap loan. The cash equivalent of t he benef it is calculat ed using t he Revenue’s of f icial r at e of int er est . I f no int er est is char ged or t he int er est r at e is less t han t he of f icial r at e of int er est , t he cash equivalent is t he dif f er ence bet ween t he int er est t hat would have been payable at t he of f icial r at e of int er est and any int er est which is paid.

s.175

Ther e ar e t wo ways in which we can calculat e t he cash equivalent . The f ir st is by using t he average method, and t he second uses t he strict method. The aver age met hod is per haps mor e commonly used alt hough eit her t he t axpayer or t he Revenue can insist t hat t he st r ict met hod is used inst ead.

s.182 s.183

The employee will have no t axable benef it if t he aggr egat e of all loans out st anding t hr oughout t he t ax year is £ 5,000 or less. Ther ef or e if t he employee makes one loan t o t he employee and t hr oughout t he t ax year t his loan never exceeds

£5,000, the taxable benefit is zero.

s.180

This pr ovision is int ended t o exempt such t hings as season t icket loans, so f or t hose of you who t r avel t o wor k on public t r anspor t and have an annual t r avel car d obt ained via a loan f r om your employer , as long as t he t r avel car d cost s £5,000

or less (and you don’t have any mor e loans), you will not have a t axable benef it . Not e her e t hat t he £5,000 rule refers to the aggregate of all loans in t he year – t his is t o pr event an employer abusing t he r ules by of f er ing a ser ies of loans t o t he same employee, each of j ust under £ 5,000.

s.180(2)

D5.2 Average Method s.182

Under t he aver age met hod we st ar t by t aking t he loan out st anding at t he start of t he t ax year – i.e. at 6 Apr il – and t o t his we will add on t he loan out st anding as at t he end of t he t ax year – i.e. at t he f ollowing 5 Apr il. Having added t hese t oget her , we divide by t wo t o give t he average loan outstanding dur ing t he year .


I f t her e is no loan out st anding at t he st ar t of t he t ax year – f or example t he employer makes t he loan t o t he employee par t way t hr ough t he year – we st ar t by using t he amount of t he loan at the point it was made. Similar ly if t he loan out st anding at t he end of t he year is nil – f or example if t he loan is complet ely r epaid dur ing t he year – we add on t he amount of t he loan at the point it was

repaid. Having ar r ived at t he aver age loan f or t he year , we mult iply t his by t he Revenue’s aver age of f icial r at e of int er est (ORI ) f or t he year . Loan at 6 Apr il + Loan at 5 Apr il x aver age ORI f or t ax year 2 I f t he employee is r equir ed t o make some sor t of cont r ibut ion – i.e. if t he employee pays some int er est t o t he employer on t he loan – t hese contributions reduce the cash equivalent.

D5.3 Strict method s.183

Under t he st r ict met hod we simply calculate interest on a daily or monthly

basis on t he exact amount s of t he loan out st anding dur ing t he t ax year .

Eit her t he t axpayer or t he Revenue has t he r ight t o insist t hat t he st r ict basis be used inst ead of t he aver age basis.

s.183(1)

I f t he st r ict basis gives a lower cash equivalent t han t he aver age basis, t he t axpayer would be advised t o elect f or t his st r ict basis t o apply. Alt er nat ively, if t he st r ict basis gives r ise t o a higher benef it , you would expect t he Revenue t o insist t hat we use t his st r ict basis. However t he Revenue will only insist on t he st r ict basis if t he aver age basis gives a significantly distorted result – if t her e is only a f ew pounds dif f er ence bet ween t he t wo, t he Revenue will not insist on t he st r ict basis.

Illustration 1

Paul bor r ows £ 100,000 f r om his employer in 1999 and uses t he money t o buy a house. The loan is int er est f r ee so Paul is not r equir ed t o make any employee cont r ibut ions. Paul r epays £ 20,000 of t he loan on 1 December 2006.

I n or der t o f ind t he cash equivalent we must calculat e t he benef it using bot h t he aver age and t he st r ict basis t hen compar e t he r esult s. We will assume an of f icial r at e of 5%.

Loans t o Employees & Use of Asset s

327

Aver age basis: 100,000 + 80,000 = 90,000 x 5% 2

£ 4,500

St r ict basis:

100,000 x 812 x 5%

3,333

80,000 x 412 x 5%

1,333

£4,666

Either the Revenue or the taxpayer can insist on the use of the strict basis. I t makes no sense f or Paul t o make an elect ion her e as t he st r ict basis gives a higher benef it . The Revenue will only insist on using t he st r ict basis – i.e. on t axing t he £ 4,666 – if t hey f eel t hat t he aver age basis had signif icant ly dist or t ed t he benef it . Her e, t he Revenue would not bot her so t he aver age basis would be used. The t axable cash equivalent would t her ef or e be £ 4,500. I f t he loan r emains r easonably const ant t hr oughout t he year , when pr epar ing t he P11D t he aver age basis is usually used. However if t he loan out st anding is changing – i.e. amount s ar e being r epaid or addit ional loans ar e being t aken out – it will be mor e usual t o pr epar e t he P11D using t he st r ict basis.

D5.4 Use of employer’s assets s.205

I f an employer lends an asset t o one of his employees, t his will give r ise t o a taxable benefit. Not e t hat t he employer is allowing t he employee t o use t he asset – owner ship of t he asset r emains wit h t he employer and does not t r ansf er t o t he employee. The benef it in t his inst ance is t he higher of : a) t he annual value of t he use of t he asset ; or b) t he sums paid by t he employer in pr oviding t he asset by way of r ent or hir e

char ge. The “annual value” r ef er r ed t o above is 20% of the market value of t he asset at t he t ime it was f ir st made available t o t he employee. I f t he employee makes a contribution – i.e. he pays some sor t of r ent t o t he employer f or t he use of t he asset – we can deduct t his t o ar r ive at t he t axable cash equivalent .


I f t he asset is lent t o t he employee par t way t hr ough t he year , having calculat ed t he basic cash equivalent , we must t hen apportion t his f or t he number of mont hs in t he year in which t he employee had use of t he asset .

This r ule will of t en apply in r elat ion t o f ur nit ur e pr ovided by t he employer in living accommodat ion made available t o t he employee. Because t he asset r emains t he pr oper t y of t he employer , at some point t he employee will be r equir ed t o give it back. I f t he employee doesn’t r et ur n t he asset t o t he employer – i.e. t he employer allows t he employee t o keep t he asset - t her e will be a t axable benef it on t his t r ansf er .

D5.5 Transfer of assets

The benef it will be t he higher of : s.206

a) The mar ket value of t he asset at t he dat e it was t r ansf er r ed t o t he

employee. b) The mar ket value of t he asset at t he dat e it was or iginally lent t o t he

employee r educed by any amount s which have been char ged t o t ax in r espect of t he employee’s use of t he asset .

S.206 I TEPA 2003 cont ains a “st ep-by-st ep” appr oach in how t o comput e t his benef it .

The Revenue will t ake whichever is t he higher and will t ax t his f igur e. Any payment s made by t he employee t o t he employer f or t he t r ansf er of t he asset can be deduct ed.

Illustration 3

An employer lends a paint ing t o an employee on 1 J anuar y 2004. At t his dat e t he paint ing was wor t h £ 100,000. On 30 Sept ember 2006, t he employer allows t he employee t o keep t he paint ing. I t is wor t h £ 40,000 at t his point .

Benef it f or use of paint ing: £

2003/ 2004: £ 100,000 x 20% x 312

5,000

2004/ 2005: £ 100,000 x 20% 20,000 2005/ 2006: £ 100,000 x 20% 20,000

2006/ 2007: £ 100,000 x 20% x 612

10,000

55,000 Benef it on gif t is higher of : a) MV @ t r ansf er 40,000 b) Or iginal MV 100,000


329

Less: alr eady char ged f or use (55,000) 45,000 i.e. 45,000 Benef it f or use in 2006/ 07 (f r om above) 10,000 Benef it on t r ansf er 45,000 Tot al Benef it in 2006/ 07 £ 55,000

D5.6 Transfers of cars or houses

The r ules above on t r ansf er s of asset s do not apply when asset s such as cars or houses ar e given t o employees. Wher e an employee has use of a company car and at a lat er dat e t hat car is t r ansf er r ed t o t he employee, t he benef it is t he market value of the car at t he dat e of t he t r ansf er minus any payment s made by t he employee f or t he t r ansf er of t he car . The r ules r egar ding amount s pr eviously char ged t o t ax do not apply her e. This ar r angement commonly applies as par t of a t er minat ion agr eement . I f an employee is made r edundant , t o sof t en t he blow t he employer may allow t he ex-employee t o keep his company car .

The same r ule applies t o t r ansf er s of houses.

D5.7 Use of computers – rules up to 2005/06 s.320

I f “comput er equipment ” is lent by an employer t o an employee and t he employee uses t hat equipment f or pr ivat e pur poses, t his will give r ise t o a t axable benef it . The benef it is calculat ed using t he “20% r ule” as descr ibed above. “Comput er equipment ” includes pr int er s, scanner s, modems and ot her similar devices, as well as t he r ight t o use comput er sof t war e. I t does not , however , include “access t o, or t he use of , public elect r onic communicat ions” (f or example, line r ent al t o f acilit at e use of t he I nt er net ). Blackber r ies have now been classif ied as comput er equipment (having pr eviously been r egar ded as mobile phones). Up t o 5 Apr il 2006, t he first £500 of t he benef it is exempt f r om t ax. The benefit in excess of £500 is taxable. Ther ef or e if an employer had a comput er wor t h £ 2,500 and t his was lent t o an employee t o use pr ivat ely, t he benef it was 20% of t he £ 2,500 being £ 500. This benef it would t hen have been complet ely exempt f r om t ax. Char ges t her ef or e only ar ose wher e t he cost of equipment exceeded £ 2,500.

I t is common in pr act ice f or an employer t o allow an employee t o use a desk t op or a lap t op f or some pr ivat e pur poses. The “£ 500 r ule” meant t hat most employees wer e unlikely t o have a benef it in r espect of t heir incident al pr ivat e use.


I f t he comput er is subsequent ly t r ansf er r ed t o t he employee, t he benef it is calculat ed by using t he mar ket value of t he comput er at t he dat e of t r ansf er . The or iginal acquisit ion cost calculat ion is not used in t his case.

D5.8 Use of computers – rules from 2006/07

The £ 500 exempt ion has been r emoved wit h ef f ect f r om 6 Apr il 2006. However , t he exempt ion cont inues t o be available f or employees who had been provided with computer equipment before 6 April 2006. I n ef f ect , t he exempt ion is only r emoved wher e comput er equipment is first made available t o t he employee on or af t er 6 Apr il 2006. Employees who had use of a comput er bef or e Apr il 2006 but who lat er r eceived a r eplacement under war r ant y, will st ill be able t o claim t he £ 500 exempt ion. However if a new comput er is pr ovided out side t he war r ant y per iod, t he exempt ion is not available. I f comput er equipment is pr ovided t o an employee solely for business use, t her e is no taxable benefit (hence t he £ 500 exempt ion is not r elevant in t his sit uat ion).

A mor e dif f icult issue ar ises when an employee uses t he comput er equipment par t ly f or business and par t ly f or non-business pur poses. I n t his inst ance, t he t ax t r eat ment depends on when t he comput er was f ir st made available t o t he employee. To calculat e t he annual benef it , we apply t he f ollowing st eps; I f available before 6 Apr il 2006: calculat e t he benef it using t he 20% r ule; deduct £ 500; t hen deduct t he business pr opor t ion t o calculat e t he t axable benef it . I f available after 5 Apr il 2006: calculat e t he benef it using t he 20% r ule; t hen deduct t he business pr opor t ion t o calculat e t he t axable benef it . Illustration 4

Chancer y Lt d pr ovides J ames, an employee, wit h a deskt op comput er , wit h pr int er , scanner and int egr at ed sof t war e. The package cost t he company £ 8,000. J ames wor ks f r om home and uses t he equipment 70% of t he t ime f or business pur poses.


331

(i) Assume equipment pr ovided on 31 Mar ch 2006. The 2006/ 07 t axable benef it is as f ollows:

£ Basic cash equivalent (£ 8,000 x 20%) 1,600Less: exempt ion (500)Excess 1,100Less: business use (70% x £ 1,100) (770)Taxable benef it f or pr ivat e use £ 330

(ii) Assume equipment pr ovided on 7 Apr il 2006. The 2006/ 07 t axable benef it is as f ollows:

£ Basic cash equivalent (£ 8,000 x 20%) 1,600 Less: exempt ion nil Excess 1,600 Less: business use (70% x £ 1,100) (1,120) Taxable benef it f or pr ivat e use £ 480

The r emoval of t he exempt ion has t her ef or e cr eat ed addit ional t echnical complicat ions as well as incr easing t he compliance bur dens on employer s who will have t o keep t r ack of when t he equipment is pr ovided in or der t hat t hey can cor r ect ly calculat e t he benef it s f or t he pur poses of pr epar ing P11Ds. However , some help is available by vir t ue of S.316(2) I TEPA 2003 which says t hat no liabilit y t o t ax will ar ise wher e t he employees pr ivat e use of an employer s asset s “is not signif icant ”. Ther e is no st at ut or y def init ion of what is “signif icant ”, but t his is accept ed by t he Revenue as applying t o cases wher e t he asset is pr imar ily pr ovided f or business pur poses but wher e pr ivat e use is incident al or t r ivial and “ver y much t he except ion in t er ms of t he pat t er n of use by t hat employee in t hat t ax year ”. The Revenue (in t heir Employment Manual) will accept t hat no t axable benef it ar ises wher e: • t he employer ’s policy concer ning pr ivat e use of comput er s is clear ly

st at ed t o employees, set t ing out cir cumst ances wher e occasional pr ivat e use can be made;

• and a decision of t he employer not t o r ecover t he cost s of employees’

pr ivat e use is a commer cial decision as t he administ r at ive cost s of so doing would exceeds t he amount s involved; and

• t her e ar e r easonable checks t o ensur e t hat t he employer ’s policy is being

f ollowed in pr act ice.


Even wit h t he par t ial r emoval of t he £ 500 exempt ion t her ef or e, employer s who have a st at ed policy per mit t ing incident al pr ivat e use of comput er equipment , should not need t o disclose t axable benef it s on employees’ P11Ds.

Example 1

Ron bor r owed £ 50,000 f r om his employer t o buy a house on 1 May 2006. The loan is int er est f r ee. On 1 August 2006 Ron bor r owed a f ur t her £ 40,000 t o add an ext ension. Calculat e Ron’s t axable benef it assuming an of f icial int er est r at e of 5% t hr oughout .

Example 2

Lesley bor r ows a wide scr een TV and DVD player f r om her employer on 30 Sept ember 2005. The equipment was wor t h £ 800 at t hat dat e. On 1 J uly 2006, Lesley bought t he equipment f r om her employer f or £ 200. I t was wor t h £ 450 at t hat dat e. Calculat e Lesley’s t axable benef it f or 2006/ 07.


333

Answer 1

Aver age met hod:

50,000 + 90,000 = 70,000 x 5% x 1112

2

£ 3,208

St r ict met hod: £

50,000 x 5% x 312

625

90,000 x 5% x 812

3,000

£3,625

The Revenue may elect f or t he st r ict basis as t he aver age basis dist or t s t he benef it .

Answer 2

Benef it s f or use £ £2005/ 06:

800 x 20% x 612

80

2006/ 07:

800 x 20% x 312

40

120Tr ansf er of equipment Higher of : a) MV at t r ansf er 450 b) Or iginal MV 800 Less: char ged alr eady f or use (120) 680 2006/ 07 £Use of asset 40Tr ansf er of asset 680Less: paid by employee (200)Tot al t axable benef it £520


SUMMARY - LOANS TO EMPLOYEES & USE OF ASSETS I f a cheap loan is made t o an employee by his employer , it only leads t o a t axable benef it if t he aggr egat e of all loans out st anding t hr oughout t he t ax year exceeds £ 5,000. Ther e ar e t wo met hods t o calculat e t he benef it . The aver age met hod is as f ollows: Loan at 6 Apr il + Loan at 5 Apr il x aver age ORI f or t ax year 2

The st r ict met hod calculat es int er est on a mont hly basis using t he exact loan out st anding dur ing t he year . The t axpayer can elect f or t he st r ict basis if it is lower , t he Revenue will insist on t he st r ict basis if t he benef it would ot her wise be signif icant ly dist or t ed. I f t he int er est is on a f ully qualif ying loan, t her e is no t axable loan or deduct ion f or t he int er est . I f t her e is a pr ivat e or non qualif ying element , t he loan is a t axable loan, but r elief is given f or t he r elevant amount of qualif ying int er est . I f an employee has t he use of an asset owned by his employer t he benef it is:

20% x MV of asset when f ir st pr ovided t o t he employee I f t he employer allows t he employee t o keep an asset , t he benef it is t he higher of : a) MV when given; b) MV when or iginally pr ovided less amount s alr eady char ged f or use of t he asset . These t r ansf er r ules do not apply t o car s nor houses given t o an employee, t he benef it her e is j ust MV less any amount paid by t he employee. The f ir st £ 500 of benef it calculat ed f or use of comput er equipment was t ax f r ee pr ior t o 2006/ 07. Fr om 6 Apr il 2006 t he exempt ion is r emoved f or comput er equipment pr ovided af t er t his dat e.

D6: MISCELLANEOUS BENEFITS

I n t his chapt er you will lear n about some miscellaneous benef it s including: - company vans; - voucher s; - mileage allowances; - t ax exempt benef it s.


D6.1 Company vans

Wher e an employer allows an employee exclusive use of a company owned van, t her e will be a t axable benef it . A “van” in t his cont ext is a mechanically pr opelled r oad vehicle which is a goods vehicle weighing less t han 3.5 t onnes. As a van is not a car , we do not use t he company car r ules t o calculat e t he benef it . The van r ules ar e ver y simple.

s.115(1)

I f an employee has use of a new van, t he benef it is a f lat £500 per annum. I f t he employee has use of an old van, t he benef it is £350. A van is new if it is less than 4 years old at the end of the tax year.

s.155

These char ges ar e apportioned if t he van is not available f or t he whole of t he year . Wher e t he van is “shar ed” - i.e. concur r ent ly available t o mor e t han one employee –the cash equivalent is split between the employees based on t he days it was available. The benef it char ge cover s t he pr ovision of f uel f or pr ivat e use, unlike t he benef it char ge f or car s.

s.158

The van r ules will change f r om 2007/ 08. A van wit h unr est r ict ed pr ivat e use will have a f lat r at e benef it of £ 3,000 r egar dless of t he age of t he van. I n addit ion t her e will be a scale char ge of £ 500 wher e f uel f or pr ivat e use is pr ovided by t he employer .

D6.2 Mobile phones s.319

I f an employer pr ovides an employee wit h a mobile phone, t his is a tax exempt benef it even if t he employer is paying f or t he employee’s per sonal t elephone calls.

I t is quit e common in pr act ice f or employees, par t icular ly t hose who ar e not of f ice based, t o be pr ovided wit h a company mobile phone. The Revenue r ecognises t hat t her e will inevit ably be some per sonal calls made by t he employee but t hey have chosen not t o t r eat t his as a t axable benef it . The exempt ion only cover s t he “pr ovision f or an employee.....of a mobile phone”. Ther ef or e if an employee has his own mobile phone and t he employer r eimbur ses any pr ivat e calls or st anding char ges t her e will be a t axable benef it equal t o t he cost t o t he employer of r eimbur sing such expenses.


Fr om 2006/ 07 onwar ds t he number of mobile phones t hat can be loaned wit hout giving r ise t o a benef it is r est r ict ed t o one per employee; t her e will be no exempt ion f or phones loaned t o t he member of t he employees f amily or household.

D6.3 Vouchers

I f an employer pr ovides voucher s t o an employee – f or example a high st r eet st or e voucher – t her e will be a t axable benef it . The cash equivalent will be t he cost to the employer of providing the voucher t o t he employee. This is common at Chr ist mas wher e employer s of t en give bonuses t o employees in t his f or m.

s.87

Wher e an employer pr ovides meal vouchers t o an employee, t his is also a taxable benefit except t hat t he first 15 pence per day of vouchers pr ovided is exempt

f r om t ax. So, if t he employer gives a one pound meal voucher t o an employee, only 85 pence of t his is t axable.

s.89

Similar ly if an employee is pr ovided wit h some f or m of “cr edit t oken” – f or example, a cr edit car d, debit car d or ot her t oken or document giving t he employee t he r ight t o obt ain goods or ser vices – t he cost of pr oviding such a t oken will be a t axable benef it f or t he employee.

s.90

D6.4 Mileage allowances s.229

Mileage allowances will be paid when an employee uses his own car for work pur poses. When an employer pays a mileage allowance t o t he employee, he is r eimbur sing t hat employee at a f ixed amount per mile f or using his own car . The mileage allowances r ules do not t her ef or e apply t o company vehicles.

s.229(4)

The Revenue want t o make sur e t hat t he employee is not making a pr of it f r om t he mileage allowance paid t o him. I f t her e is a pr of it – i.e. t he cost t o t he employee of using his car is less t han t he allowance paid – t he Revenue will t ax t hat pr of it as employment income.

To wor k out t he pr of it , t he Revenue has tax-exempt limits which we need t o apply. I f allowances ar e paid above t hese limit s t he employee will be making a pr of it – if allowances ar e paid below t hese limit s, t he employee will be making a loss.

The t ax-exempt limit s depend on t he employee’s business mileage in t he year . Remember t hat business mileage does not include t r avelling f r om home t o wor k. I f an employer r eimbur ses an employee’s t r avel cost s f r om home t o wor k, t his will be a f ully t axable benef it .

Miscellaneous Benef it s

337

The limit s ar e given in t he Tax Tables pr ovided wit h your cour se and ar e also r epr oduced below.

Vehicles Fir st 10,000 Addit ional Business miles Business miles Car s 40p 25p Mot or cycles 24p 24p Bicycles 20p 20p

Not e f r om t he t able t hat t he t ax-exempt limit s change once t he business mileage t hr eshold of 10,000 miles has been exceeded.

Remember t hat t he point of t his scheme is t o det er mine whet her t he employee is making a pr of it or loss f r om using his own car f or wor k. To det er mine t he pr of it , we simply t ake t he allowance r eimbur sed and deduct t he t ax-exempt limit . Pr of it s ar e t axable whilst losses ar e deduct ible.

Illustration 1

An employee owns his own car f or occasional business j our neys. I n t he t ax year t he employee did 15,000 business miles. His employer r eimbur ses him at a f ixed r at e of 60 pence f or ever y business mile t r avelled. The calculat ion is as f ollows:

£ Reimbur sed

15,000 x 60p 9,000 Less: t ax exempt limit s 10,000 x 40p (4,000) 5,000 x 25p (1,250) Taxable pr of it £3,750

Illustration 2

I f t he employee in t he illust r at ion above was r eimbur sed at a lower r at e of 20 pence per mile, t he calculat ion is as f ollows: £ Reimbur sed 15,000 x 20p 3,000 Less: t ax exempt limit s 10,000 x 40p (4,000) 5,000 x 25p (1,250) Loss (deduct ible f r om ear nings) £(2,250)

The t axpayer is allowed t o deduct t his loss f r om his ot her t axable ear nings f or t he year .

s.231

I n pr act ice, many employer s make sur e t hat t hey r eimbur se t heir employees at a r at e exactly equal to the tax exempt limits, so year on year employees using t heir own car s f or business pur poses will neit her have a pr of it nor a loss.


D6.5 Passenger payments s.233

I n an at t empt t o encour age dr iver s t o shar e business j our neys wher ever possible, t he Revenue has int r oduced a scheme wher eby payments can be made

free of tax and NI C t o an employee carrying one or more passengers. “Passenger payment s” can be made t ax exempt t o an employee if : • t he dr iver and passenger (s) ar e fellow employees making t he same business

j our ney; and • t he “passenger payment s” do not exceed t he “appr oved amount ” of 5p

per business mile; and

s.234

• t he employee physically receives the passenger payment f r om t he employer (i.e. an employee who is not paid ext r a f or car r ying passenger s cannot claim an addit ional 5p per mile allowance).

Only payment s in r espect of business mileage ar e t ax-f r ee – t he passenger payment scheme does not ext end t o pr ivat e mileage such as home t o of f ice t r avel. The “passenger allowance” applies per passenger (eg 10p per business mile f or 2 passenger s et c) and applies t o bot h company vehicles and f or employees using t heir own car s f or business pur poses.

D6.7 Tax exempt benefits

Ther e is a long list of benef it s which ar e complet ely exempt f r om t ax. Her e we will pick up a dozen or so of t he mor e f amiliar t ax exempt benef it s. One of t he most valuable benef it s t hat employees r eceive f r om t heir employer s, is an employer’s contribution to the employee’s pension scheme. This is exempt f r om t ax as long as t he pension scheme has Revenue appr oval. Ther ef or e if an employer pays int o eit her t he employee’s occupat ional pension scheme or int o t he employee’s per sonal pension scheme, no t axable benef it will ar ise. The level of employer ’s cont r ibut ions is ir r elevant .

s.307

The pr ovision of a mobile phone and associated calls is a t ax-exempt benef it .

s.319

The reimbursement of removal expenses is exempt, up to a maximum amount of £8,000. For example, if an employee is t r ansf er r ed t o anot her of f ice and t he employer pays t he r elocat ion expenses, no t axable benef it will ar ise as long as t he cost of t he move is less t han £ 8,000.

s.287

The exempt ion applies t o “r emoval benef it s” and t o t he “payment or r eimbur sement of r emoval expenses”. Such expenses will qualif y if t hey ar e “r easonably pr ovided in connect ion wit h a change in t he employee’s r esidence” – i.e. in r espect of a change in t he dut ies and/ or locat ion of t he employment or on t he employees becoming employed.


339

Qualif ying r emoval expenses will include: • legal f ees in connect ion wit h t he acquisit ion of a new r esidence (including

st amp dut y land t ax); • any such abor t ive acquisit ion cost s; • legal f ees in connect ion wit h t he disposal of a f or mer r esidence; • cost s of t r anspor t ing belongings (including t empor ar y st or age cost s); • t r avel and subsist ence f or t he employee (and f amily) t o visit t he new ar ea. A det ailed br eakdown of allowable cost s is given at s.277 – s.283 I TEPA 2003. Qualif ying r emoval expenses will also include t he addit ional int er est paid on a br idging loan t aken out bet ween buying a new pr oper t y and disposing of an old one.

s.284

The pr ovision by t he employer of a cr èche or nur ser y f or employee’s childr en is a t ax-exempt benef it . The f acilit ies must usually be exclusively f or t he employer .

s.318

Ther e is a par t ial exempt ion of up t o £ 55 a week f or childcar e voucher s. This also applies t o ot her childcar e wher e t he employer cont r act s dir ect ly wit h t he childcar e pr ovider such as a commer cial nur ser y. The pr ovision of “wor kplace par king” is a t ax-exempt benef it . This cover s not j ust a space in t he employer ’s car par k but would also ext end t o t he cost s of a season t icket at a public car par k close t o wor k. Similar ly t he pr ovision of mot or cycle or bicycle spaces at or near wor k is a t ax-exempt benef it .

s.237

Subsidised st af f cant eens ar e t ax-exempt benef it s as long as t he cant een f acilit ies ar e available t o all employees. Ther ef or e if a company has a cant een or r est aur ant t hat is r eser ved f or use by senior execut ives only, t hose execut ives will have a t axable benef it on t he cost s of t he f r ee or subsidised meals pr ovided.

s.317

Incidental expenses paid by an employer t o employees wor king away f r om home ar e t ax exempt up t o a daily limit . These limit s ar e £ 5 per night while wor king in t he UK and £10 per night whilst working abroad.

s.240 & s.241

Cost s incur r ed by t he employer in pr oviding f ull t ime, day r elease or block r elease t r aining ar e t ax-exempt benef it s.

SP4/ 86

The pr ovision by t he employer of a Chr ist mas par t y or ot her similar f unct ion f or t he employees, will not give r ise t o a t axable benef it f or t he employees as long as t he cost s of t he par t y did not exceed £ 150 per head. This will mean t hat f or most of f ice par t ies, t her e will be no cor r esponding t ax char ge on t he employees. However , if t he employer t hr ows a par t icular ly lavish par t y which cost s, say, £ 200 per head, t he t axable benef it f or each employee will be t he f ull £ 200 and not j ust t he excess over £ 150. I t is an all or not hing benef it .

s.264

SI 2003/ 1361

Awar ds by an employer t o an employee f r om a st af f suggest ion scheme ar e gener ally t ax exempt pr ovided t hat t he awar d does not exceed £ 5,000.

s.321 & s.322

s. 318A


Long ser vice awar ds of up t o £ 50 per year of ser vice, as long as t he employee had at least 20 year s ser vice wit h t he same employer ar e also exempt . This exempt s gif t s such as gold wat ches et c t o a long ser ving employee on r et ir ement .

s.323

SI 2003/ 1361

Employer s can make t ax-exempt payment s t o an employee in r espect of r easonable addit ional cost s incur r ed f or wor king at home. This must be under a homewor king ar r angement wher e t he employee r egular ly wor ks at home.

s.316A

Ther e is no limit t o such payment s st at ed in st at ut e. However , t he Revenue has st at ed t hat no r ecor ds need t o be kept by employer s f or payment s up t o £ 2 per week or £ 104 per year . I f payment s exceed t hese limit s, t he employer should keep r ecor ds t o pr ovide evidence t hat t he higher payment s wer e wholly in r espect of addit ional household expenses incur r ed by t he employee in wor king f r om home. This cover s t he most common t ax exempt benef it s but it is by no means a def init ive list . Ot her benef it s which ar e t ax exempt include: - wor kplace spor t s or r ecr eat ional f acilit ies f or use by st af f gener ally s.261 -“t hir d par t y benef it s” – i.e. benef it s f r om someone ot her t han one’s employer not exceeding £ 250 per year .

s.324 SI 2003/1361

- lat e night t axis et c when t he employee is occasionally r equir ed t o wor k lat e (i.e. af t er 9 pm)

s.248

- hospit alit y or ent er t aining if pr ovided by someone ot her t han t he employer s.265

- eye t est s or cor r ect ive glasses wher e an employee is r equir ed t o use a visual-display unit (VDU) in t he employment

Example 1

Which of t he f ollowing benef it s ar e t ax exempt in 2006/ 07?

a) Use of company van b) £ 500 loan t o buy annual t r avelcar d c) £ 40 per week childcar e voucher s d) Car par k voucher near wor k e) Employer payment t o wor k pension scheme f ) Loan of comput er cost ing £ 1,000 in May 2006

Example 2

Rodney uses his own car f or wor k. I n 2006/ 07 he did 25,000 miles, half of which wer e f or business pur poses. His employer r eimbur sed Rodney at 40p f or each business mile.

Calculat e Rodney’s t axable benef it .


341

Answer 1

Tax exempt Taxable

a) Use of company van X

b) £ 500 t r avelcar d loan X c) £ 40 per week childcar e voucher s X d) Car par k voucher X e) Payment t o pension scheme X f ) Loan of comput er X

Answer 2

£ £ Mileage r eimbur sed 12,500 @ 40p 5,000 Less: t ax exempt limit s 10,000 @ 40p 4,000 2,500 @ 25p 625 (4,625) Taxable pr of it £375


SUMMARY - MISCELLANEOUS BENEFITS

I f an employee is pr ovided wit h a company van, t he benef it is £ 500 f or t he year . I f t he van is ≥ 4 year s old at t he end of t he t ax year t he benef it is £ 350. These r ules ar e changing f r om Apr il 2007. I f an employee is given voucher s, t he cost of pr oviding t hese is t axable as a benef it . However t he f ir st 15p per day of meal voucher s is exempt f r om t ax. I f t he employer r eimbur ses t he employee f or business mileage incur r ed using his own car , t he amount r eimbur sed must be compar ed wit h t he t ax exempt limit s set by t he Revenue. I f t he amount r eimbur sed exceeds t he limit s t his excess is t axable. I f it is less t han t he limit s, t he shor t f all is deduct ible. Ther e ar e a number of t ax exempt benef it s including:

Employer cont r ibut ions t o an appr oved pension scheme Mobile phones (only one per employee) Removal expenses up t o £ 8,000 Exclusive nur ser y up t o £ 55 per week childcar e voucher s/ ot her dir ect ly pr ovided childcar e Car par king at or near t he place of wor k St af f cant eens pr ovided available t o all employees I ncident al expenses f or wor king away f r om home (£ 5 in UK, £ 10 if abr oad) Tr aining cost s Chr ist mas par t y or ot her f unct ions cost ing below £ 150 per head St af f suggest ion scheme awar ds up t o £ 5,000 Long ser vice awar ds up t o £ 50 per year of ser vice if ser ved at least 20 year s Addit ional cost s of wor king f r om home under a homewor king ar r angement

D7: EXPENSES OF EMPLOYMENT

I n t his chapt er you will lear n how t o t r eat payment s r eceived f r om t he employer in r espect of expenses including: - expenses t hat ar e ‘wholly, exclusively and necessar ily’ incur r ed; - qualif ying t r aveling expenses - pr of essional f ees and subscr ipt ions; - payr oll deduct ion scheme.

D7.1 Introduction

I n t his chapt er we shall look at t he expenses t hat ar e allowed as a deduct ion in ar r iving at net t axable ear nings. Bef or e we do so, let ’s r emind our selves wher e t hey f it int o t he ear nings pr of or ma.

Cash r emuner at ion X Benef it s X X Less: exempt income (X) Taxable ear nings X Less: allowable deduct ions (X) Net t axable ear nings X

We st ar t wit h cash r emuner at ion such as salar y and bonuses. We also need t o add any expenses r eimbur sed t o t he employee by t he employer . All expenses paid by an employer t o an employee ar e t r eat ed in t he f ir st inst ance as cash ear nings – i.e. money r eceived by t he employee. To t his we add any benef it s.

At t his point we can t ake a deduct ion f or any allowable deduct ions. Taxable ear nings less allowable deduct ions gives net t axable ear nings f or t he year . I t is t his f igur e t hat goes int o t he income t ax comput at ion as non-savings income. Allowable deduct ions br oadly f all int o f ive main cat egor ies.

a) Expenses deduct ible under s.336 ITEPA 2003.

b) Tr avel expenses (s.337 – s.340 I TEPA 2003).

c) Payment s made by an employee to an occupational pension scheme - t he det ailed r ules wit h r egar d t o pension cont r ibut ions will be dealt wit h in a lat er chapt er .

d) Professional fees or subscriptions paid t o an or ganisat ion appr oved by t he Revenue.

e) Donations made by an employee t o charity under t he Payr oll Deduct ion Scheme.


D7.2 Section 336 – “deductions for expenses: the general rule”

Sect ion 336 lays out t he gener al r ules f or deduct ions t o be made f r om t axable ear nings. A deduct ion under t he gener al r ules is allowed if :

s.336

a) t he employee is obliged to incur and pay the expense as holder of t he

employment ; and b) t he amount is incur r ed “wholly, exclusively and necessarily” in t he

per f or mance of t he dut ies.

I n or der t o ascer t ain whet her an expense is deduct ible, we t her ef or e need t o look closely at t he t er ms “wholly, exclusively and necessarily”.

The wor d “necessar ily” is t he biggest obst acle t o us when t r ying t o per suade t he Revenue t hat expenses ar e allowable. The quest ion t he Revenue will ask us is “could t he employee do his j ob wit hout incur r ing t hat par t icular expense?”.

I f t he answer t o t his quest ion is “yes” – i.e. he could do his j ob if t hat expense had not been incur r ed – t he Revenue will ar gue t hat t he expense is not

absolutely necessary and is not therefore deductible f r om t axable ear nings.

However , if t he answer is “no” – i.e. he cannot do his job without incurring that

expense - t he expense will be necessar y f or t he per f or mance of t he dut ies and will t her ef or e be allowable. The Revenue ar e ver y st r ict in applying t his r ule and it is notoriously difficult for employees to get relief for expenses under Section 336. Lat er on we will have a look at a couple of t ax cases, and you will see t hat t he Revenue have been successf ul mor e of t en t han t he t axpayer and most disput ed claims f or expenses have been disallowed.

D7.3 Travel expenses

Sect ions 337 and 338 deal wit h t he deduct ibilit y of t r avel expenses. Under gener al pr inciples a deduct ion f or t he employee’s t r avel cost s will be allowed if t he expenses ar e:

s.337-338

(i) necessarily incurred on t r avelling in t he per f or mance of t he dut ies of

t he employment ; or (ii) at t r ibut able t o t he employee’s necessary attendance at any place in t he

per f or mance of t he dut ies of t he employment . Sect ion 338 specif ically denies a deduct ion f or “expenses of ordinary

commuting”. “Or dinar y commut ing” in t his cont ext is def ined as t r avel bet ween eit her : a) t he employee’s home and a permanent workplace; or b) a place t hat is not a wor kplace (eg a hot el or someone else’s home) and a

per manent wor kplace.

Expenses of Employment

345

This means t hat if an employee incur s t r avel expenses in going f r om his home t o his normal place of work, t hese expenses will not be allowable, as t hey const it ut e expenses of or dinar y commut ing. You will be awar e of t his alr eady as your employer does not r eimbur se you f or home t o of f ice t r avelling and you do not get t ax r elief f or t hese cost s. No deduct ion is allowed f or t r avel bet ween any t wo places t hat is, f or pr act ical pur poses, substantially ordinary commuting. This means t hat if an employee, f or inst ance, is r equir ed t o at t end a t r aining college and t he j our ney t o t he college is subst ant ially t he same as t hat t o t he usual place of wor k (and at a similar expense), no deduct ion will be allowed f or t r avel cost s t o t he college.

However , once at wor k, if an employee incur s expenses in t r avelling f r om his nor mal place of wor k t o visit a client, t hat is not “or dinar y commut ing” but is inst ead t r avel in t he per f or mance of t he dut ies and as such t hese expenses will be deduct ible. Ther ef or e, office to client travel is allowable.

But what if t he employee t r avels dir ect ly f r om his home t o a client ’s pr emises and doesn’t go int o t he of f ice f ir st ? The Revenue have accept ed t hat t hese t r avel expenses ar e allowable as t hey ar e not or dinar y cost s of commut ing but only pr oviding t hat t he client ’s pr emises const it ut e a “temporary workplace”.

A “t empor ar y wor kplace” is def ined as a place which t he employee at t ends in t he per f or mance of his dut ies in or der to perform a task of limited duration or f or some ot her t empor ar y pur pose.

s.339

A wor kplace will not be “t empor ar y” if the employee attends for a period of

continuous work lasting more t han 24 mont hs. Ther ef or e if an employee is visit ing a client f or a day, or a f ew days or even a f ew mont hs, t he client pr emises will be a “t empor ar y wor kplace” and t r avel t o and f r om t hat wor kplace will be deduct ible expenses. A “t empor ar y wor kplace” may become a “per manent wor kplace” if eit her : a) t he employee has wor ked at t hat locat ion f or a cont inuous per iod of 24

mont hs; or b) it becomes appar ent t hat t he absence f r om t he or iginal per manent

wor kplace will exceed 24 mont hs.

I n t hese inst ances, t r avel cost s up t o t he point of “change” ar e deduct ible, but cost s af t er t hat dat e ar e not . An “ar ea” could be r egar ded as a per manent wor kplace and t r avel cost s t o and f r om t hat ar ea would not be deduct ible. An “area based employee” is one whose employment dut ies ar e def ined by r ef er ence t o an “ar ea” (r at her t han a specif ied sit e or building) and wher e t he employee at t ends dif f er ent places in t he ar ea in t he cour se of his j ob.

s.339(8)


Cer t ain “site based” employees will have no per manent wor kplace and will t r avel t o var ious dif f er ent “sit es” t o per f or m t heir dut ies. Pr oviding t hat a j ob at a par t icular sit e is not expect ed t o last mor e t han 24 mont hs, cost s of t r avelling f r om home t o sit e (and back again) will be deduct ible. Finally, t he Revenue do not accept t hat an employee whose employment cont r act is f or less t han 24 mont hs is by def init ion t r avelling t o and f r om a t empor ar y wor kplace. Deduct ions f or t r avel cost s in t hese inst ances will be denied.

I RPR 16.5.95 s.339(5)

(a)(ii)

D7.4 Professional fees and subscriptions

A deduct ion f r om t axable ear nings is allowed f or an amount paid by an employee in r espect of a professional fee. The deduct ion is allowed pr ovided t hat t he employment involves the practice of the profession to which the fee relates and t he payment of t he f ee is a condition which must be met if t hat pr of ession is t o be pr act iced.

s.343

Sect ion 343 cont ains a list of deduct ible f ees and t hese include pr act ice f ees f or doct or s, dent ist s, opt icians, vet s, lawyer s, ar chit ect s and t eacher s. A deduct ion f r om t axable ear nings is also allowed f or annual subscriptions paid t o an “appr oved body”. The Revenue has a published list of such bodies. The subscr ipt ion will be deduct ible as long as t he act ivit ies of t he body ar e of dir ect benef it t o, or concer n t he pr of ession pr act iced in, t he per f or mance of t he dut ies.

s.344

For example, a subscr ipt ion by a company dir ect or t o t he I nst it ut e of Dir ect or s would be deduct ible because t he subscr ipt ion r elat es t o t he employment and is t o an appr oved body. However if t he same dir ect or t hen paid a subscr ipt ion t o his local golf club, t his would not be deduct ible as t his has not hing t o do wit h t he employment . The Revenue would not accept an ar gument t hat it is “necessar y” f or t his employee t o be a member of t he golf club, even t hough he may meet client s and do some business at t he club. This was t est ed in t he t ax case of Br own v Bullock wher e a bank manager ' s Gent leman’s Club f ees wer e disallowed by t he cour t s on t he gr ounds t hat t hey wer e not absolut ely necessar y. He could do his j ob as a bank manager wit hout being a member of t he club. The f act t hat his club member ship occasionally won him some business was held t o be ir r elevant .

D7.5 Charitable donations s. 713

Ther e ar e t wo met hods of obt aining t ax r elief on char it able donat ions.

As we have seen alr eady, t he f ir st is via t he Gift Aid scheme. Gif t Aid payment s ar e made net of basic r at e t ax and we give higher r at e r elief by ext ending t he basic r at e band by t he gr oss amount of t he donat ion.


347

The second way in which a t axpayer can get t ax r elief on a donat ion t o char it y is by using t he Payr oll Deduct ion Scheme. You may also see t his r ef er r ed t o as t he Give As You Earn (GAYE) scheme.

Donat ions ar e made gross – i.e. t her e is no wit hholding of basic r at e t ax at sour ce. This gr oss donat ion is deducted from taxable earnings f or t he year .

I n pr act ice, t he gr oss donat ion is deduct ed by t he payr oll depar t ment bef or e PAYE is applied t her eby giving t he employee t ax r elief as he goes along. The employer will t hen pass on t he amount s wit hheld t o t he r elevant char it y.

D7.6 Employee liabilities and indemnity insurance s.346

I f an employee pays a pr emium under a qualif ying insur ance cont r act , t hat pr emium is deduct ible f r om t axable ear nings. A qualif ying insur ance cont r act is essent ially a cont r act which pr ovides f or t he employee t o be indemnif ied against any cost s or damages ar ising f r om act ion t aken against him. Most employer s will have t heir own Pr of essional I ndemnit y I nsur ance which cover s t he act ions of t heir employees, so f ew employees will need t o consider t aking out an indemnit y policy f or t hemselves.

D7.7 Reimbursed expenses

Most business expenses incur r ed by employees will be r eimbur sed by t heir employer s at a lat er dat e when t he employee makes an expense claim. As f ar as t he t ax comput at ion is concer ned, we need t o do t wo t hings. Fir st we treat the expenses reimbursed by the employer to the employee as

earnings from the employment - i.e. we include t his payment t o t he employee’s t axable ear nings. As such, t he amount r eimbur sed should be r ef lect ed by t he employer as a benef it on t he employee’s P11D. Having t r eat ed t he r eimbur sed expense as income, we need t o determine

whether that expense can be deducted t o ar r ive at next t axable ear nings. I t will be allowable if it is eit her wholly, exclusively & necessarily incurred in t he per f or mance of t he dut ies, or if it is a qualifying travelling expense or it is a pr of essional f ee or subscr ipt ion. I n t hese cases, t he expense can be deduct ed f r om t axable ear nings.

I n t he case of genuine business expenses, t he amount which goes int o t he comput at ion as income and t he amount t hat is deduct ed as an allowable expense, will cancel out leaving not hing t axable.


This will not be t he case however if t he expense is not wholly, exclusively & necessar ily incur r ed in t he per f or mance of t he dut ies. I n t his case, no deduct ion will be allowed f or t he expense and t he amount r eimbur sed by t he employer will be t axed in t he same way as a benef it . This will be t he case if per sonal expenses ar e r eimbur sed by t he employer .

D7.8 Dispensations s.65

A “dispensat ion” is a not ice pr ovided by t he Revenue t o an employer agr eeing t hat no additional tax will be payable by an employee who r eceives cer t ain payment s or benef it s. The payment s in quest ion will be genuine business

expenses r eimbur sed by t he employer t o t he employee. I n t he absence of a dispensat ion, expenses r eimbur sed t o an employee will be t r eat ed as earnings in t he f ir st inst ance and ent er ed on f or m P11D. The employee will t hen be lef t t o claim r elief f or t he expense via his self assessment r et ur n. I f an employer makes an applicat ion f or dispensat ion, t his unnecessar y “paper chase” can be avoided.

Illustration 1

Chr is makes a business t r ip t o Edinbur gh and his r et ur n t r ain t icket cost s £ 75. When he r et ur ned t o t he of f ice, he made an expense claim and his employer , Online Tut or s Lt d, r eimbur sed t his £ 75.

Chr is is employed on a salar y of £ 25,000. St r ict ly what should happen is t hat t he expenses r eimbur sed of £ 75 should be t r eat ed as income, and t he employer should pr oduce a f or m P11D f or Chr is including t his £ 75 as a benef it . Chr is’s t ot al ear nings f or t he year will now be £ 25,075.

As f ar as Chr is is concer ned, t he £ 75 is a qualif ying t r avelling expense and is t her ef or e deduct ible f r om his t axable ear nings. He will make a claim under s.337 on his t ax r et ur n and t he £ 75 will be deduct ed, leaving Chr is wit h t axable income of £ 25,000. This is exact ly t he same as t he salar y f igur e so you will see t hat t he t wo ent r ies of £ 75 have cancelled each ot her out .

s.337

£ Salar y 25,000Add: r eimbur sed expense 75Taxable ear nings 25,075Less: t r avel expenses (75)Net t axable ear nings £ 25,000

What we have achieved is t o cr eat e a lot of paper wor k wit h no end r esult . The company has t o pr epar e a P11D t o show a benef it of £ 75, and Chr is has t o pr epar e a t ax r et ur n t o claim t his amount as an expense of his employment .


349

This is a wast e of t ime, so in t hese cir cumst ances t he Revenue will issue a not ice of nil liabilit y or dispensat ion t o t he employer in r espect of t he business t r avelling expenses. This means t hat t he employer her e can ignor e t hese t r avel expenses when pr epar ing P11Ds.

Employer s must apply to their local Tax Office for dispensations, and dispensat ions ar e issued by t he I nspect or in r espect of specif ic cat egor ies of expendit ur e – business t r avel being t he most common.

Not e t hat if an employer does not have a dispensat ion f or a par t icular t ype of expense, such expenses r eimbur sed t o employees must be reflected on the

P11D and t he employee will t hen make a claim via his t ax r et ur n if he t hinks t he expense is deduct ible.

D7.9 Round Sum Allowances

A r ound sum allowance is a gener al allowance – usually a f ixed amount of cash – paid t o t he employee in advance t o cover his or her expenses f or a par t icular per iod. For example, Online Tut or s Lt d could pay a r ound sum of £ 1,000 t o Chr is t o cover f or t hcoming expenses.

A round sum allowance should be t r eat ed in t he f ir st inst ance as salar y and t he employer should withhold tax under PAYE. This will nor mally happen aut omat ically as t he payment is of t en made via t he payr oll syst em. Ther e is no way ar ound t his as t he I nland Revenue will not issue dispensat ions f or r ound sum allowances.

Chr is will spend t he money on var ious it ems and will claim a deduct ion, via his end of year t ax r et ur n, f or any amount s spent f or business pur poses – i.e. any expenses incur r ed wholly, exclusively & necessar ily in t he per f or mance of his dut ies.

One impor t ant t hing t o be awar e of her e is t hat t he Revenue do not regard

expenses incurred in entertaining customers or clients as genuine business

expenses. Ther ef or e if Chr is spends par t of his r ound sum allowance on client ent er t aining, no deduct ion will be allowed.

s.356

However , r elief f or t he ent er t aining expense will be allowed if the amount falls

to be disallowed in comput ing t he employer ’s t axable t r ading pr of it s as will be t he case f or client ent er t aining. I n t his case, t he employee will be able t o t ake a deduct ion f or t he ent er t aining cost s in calculat ing net t axable ear nings.

s.357

The above r est r ict ion f or “client ” ent er t aining does not apply t o expenses of ent er t aining fellow employees. These cost s ar e gener ally f ully deduct ible.

s.358


Example 1

Mr Br oker (a Cit y analyst ) incur s t he f ollowing expenses:

a) Tube f ar e t o wor k b) Taxi f ar e f r om of f ice t o client c) Payment t o company pension scheme d) Financial Times t o r ead on t he t ube e) Subscr ipt ion t o t he I nst it ut e of St ockbr oker s f ) Pinst r ipe suit and br aces f or of f ice.

Which of t hese expenses ar e deduct ible in ar r iving at net t axable ear nings?


351

Answer 1

Allowable Not Allowable

a) Tube f ar e t o wor k X b) Taxi f ar e t o client X c) Pension payment X d) Financial Times (see Not e 1 below) X e) Subscr ipt ion t o I nst it ut e of St ockbr oker s X f ) Pin st r ipe suit and br aces (see Not e 2 below) X

Not e 1

Mr Br oker ’s newspaper cost s will not be allowed by t he Revenue. Mr Br oker would ar gue t hat , as a st ockbr oker , it is necessar y f or him t o r ead t he Financial Times on a daily basis, but a similar claim has alr eady been hear d and r ej ect ed by t he cour t s. I n t he case of Smith v Abbott, a j our nalist f or a nat ional daily newspaper ar gued t hat it was necessar y f or him t o buy and r ead t he daily newspaper s of his compet it or s in or der t o do his j ob. The cour t s agr eed wit h t he Revenue and disallowed t his expense as it was held not t o be absolut ely necessar y as it was possible f or t his j our nalist t o do his j ob wit hout incur r ing t hat expense. The cour t s said t hat t he expendit ur e simply enabled t he employee t o do his j ob bet t er and t his was not enough t o pass t he st r ingent t est s laid down in s.336.

Not e 2

The Revenue have again been successf ul bef or e t he cour t s in ar guing t hat t he cost s of suit s et c ar e not allowable on t he gr ounds t hat t he expense is not exclusively f or t he per f or mance of t he dut ies. The cour t s have said t hat we buy clot hing not j ust f or business pur poses but also t o pr ovide us wit h war mt h and decency and hence t he expense has a dualit y of pur pose and is not allowable. Deduct ions will only be available f or such t hings as pr ot ect ive clot hing or cost umes or unif or ms – i.e. clot hing which could not be wor n in an ever yday cont ext .


SUMMARY - EXPENSES OF EMPLOYMENT

Any amount s r eceived f r om an employer in r espect of expenses incur r ed ar e included as par t of t axable ear nings. A deduct ion will t hen be given if t he expense was ‘wholly, exclusively and necessar ily’ incur r ed which is a st r ict t est . Qualif ying t r avelling expenses ar e also deduct ible but t hese exclude or dinar y commut ing (ie home t o wor k). Tr avel f r om t he of f ice or f r om home t o a t empor ar y wor kplace (less t han 24 mont hs) will be deduct ible. Pr of essional f ees and subscr ipt ions ar e deduct ible pr ovided t hey ar e paid t o an appr oved body. Payment s t o char it y can be made via t he Payr oll Deduct ion Scheme wher eby t he payment is made gr oss and is deduct ed f r om salar y bef or e applying PAYE t o give r elief . This is an alt er nat ive t o obt aining r elief via Gif t Aid. Reimbur sed expenses ar e br ought in as t axable ear nings unless t he employer has a dispensat ion which saves including t hem on t he P11D only f or t hem t o be claimed as a deduct ion lat er . Round sum allowances will always be t axable in t he f ir st inst ance but a deduct ion can be claimed f or what is spent on allowable expenses. This however excludes any amount spent on client ent er t aining, unless t he amount has been disallowed in t he employer ’s t ax calculat ion.

D8: CALCULATING THE INCOME TAX LIABILITY

I n t his chapt er you will lear n how t o use a pr of or ma f or calculat ing income t ax on non savings income including: - t he per sonal allowance; - t he r at es of t ax f or non savings income; - t ax deduct ed at sour ce.

Ref er ences in t his chapt er ar e t o t he I ncome & Cor por at ion Tax Act 1988 (I CTA 1988) unless ot her wise st at ed.

D8.1 Introduction

The f ir st st ep in calculat ing an individual’s t ax liabilit y f or t he t ax year 2006/ 07, is t o ar r ive at t axable income f or t he year . Having ar r ived at t axable income, we t hen apply 2006/ 07 t ax r at es t o t hat income t o give a t ax liabilit y f or t he year .

The pr of or ma f or calculat ing an individual’s t ax liabilit y is ver y impor t ant . The income t ax pr of or ma dif f er ent iat es bet ween three different types of income. The f ir st t ype of income is non-savings income. Non-savings income essent ially means income f r om employment , income f r om self employment and r ent al income. The second f or m of income is bank or building societ y interest and t he t hir d and f inal f or m of income r eceived by individuals is dividend income. We separ at e t hese t hr ee f or ms of income wit hin t he comput at ion because t hey ar e t axed in dif f er ent ways and at dif f er ent r at es.

D8.2 Proforma income tax calculation

Non savings Interest Dividends Ear nings X

Tr ading income X

Pr oper t y income X

I nt er est X

Dividends X

For eign income X X X Tot al income T T T Less: Char ges on income (X) ___ ___ St at ut or y t ot al income STI STI STI


For eign income could be non-savings income if it ar ose f r om r ent s in a villa in Spain. I t could also be int er est income if it was bank int er est on a J er sey bank account . I t could also be dividend income if it was dividends on shar es in an Amer ican company. Ent r ies could t her ef or e be made in t he non-savings column, t he int er est column or in t he dividend column.

I ncome f r om all sour ces is t hen added t oget her t o give t ot al income. Cer t ain expenses incur r ed by individuals can be deduct ed in or der t o ar r ive at t axable income. These expenses ar e called charges on income.

Char ges on income ar e deduct ed f r om non-savings income first, alt hough if t her e is insuf f icient non-savings income, char ges can be deduct ed f r om int er est and t hen f r om dividends as appr opr iat e. Total income less charges on income gives us “St at ut or y Tot al I ncome” or STI.

St at ut or y t ot al income (STI ) is not t he same as t axable income. Fr om st at ut or y t ot al income we deduct the personal allowance f or t he year in or der t o ar r ive at t axable income.

Non Savings Interest Dividends St at ut or y Tot al I ncome X X X Less: Per sonal Allowance (PA) __ __ Taxable I ncome X X X

As wit h char ges on income, t he per sonal allowance is deduct ed f r om non-savings income in pr ior it y t o int er est and in pr ior it y t o dividend income. Having deduct ed t he per sonal allowance f r om t he STI , t his gives us t axable income f r om all sour ces.

The personal allowance f or t he t ax year 2006/07 is £5,035. s. 257

The per sonal allowance is available t o all individuals who ar e r esident in t he UK,

and cer t ain individuals who ar e r esident abr oad. A per sonal allowance is given t o ever ybody, even t o childr en.

Illustration 1

Mr Br own has t he f ollowing income and expendit ur e f or 2006/ 07:

£ Salar y f r om his j ob 30,000 Benef it s f r om his employment 8,000 Rent s f r om f lat in Br ight on 7,000 Rent s f r om chat eau in Fr ance 4,500 Char ge on income paid (1,000)

Calculat ing t he I ncome Tax Liabilit y

355

Mr Br own’s t axable income is calculat ed as f ollows:

Non Savings £ I ncome f r om ear nings (30,000 + 8,000) 38,000 Pr oper t y income 7,000 For eign income 4,500 49,500 Less: Char ge on income (1,000) St at ut or y Tot al I ncome (STI ) 48,500 Less: Per sonal Allowance (5,035)

Taxable Income £43,465

D8.3 Calculating the tax liability

To calculat e an individual’s t ax liabilit y, we st ar t by looking at how non-savings income is t axed f or t he t ax year . Thr ee r at es of t ax apply t o non-savings income. We have a lower r at e of 10%, a basic r at e of 22% and a higher r at e of 40%.

The f ir st £ 2,150 of an individual’s t axable income is char ged t o t ax at t he lower r at e of 10%.

The next chunk of an individual’s income is char ged at t he basic r at e of t ax,

which is 22%. The basic r at e applies t o t axable income bet ween £ 2,150 and £ 33,300. As you will see, t his gives us a basic r at e band of £ 31,150.

LOWER RATE 10%

BASI C RATE 22%

HI GHER RATE 40%

£ 33,300

£ 2,150

£ 0

TAXABLE I NCOME

Excess

Next £ 31,150

Fir st £ 2,150


For individuals wit h t axable income in excess of £ 33,300, t he higher r at e of t ax applies. This is cur r ent ly 40%. This applies t o all t axable income in excess of t he basic r at e t hr eshold.

Remember t hat t he 10%, 22% and 40% rates apply t o non-savings income only. Dif f er ent r at es apply t o int er est and dividends, as we shall see lat er .

Illustration 2

Cont inuing t he pr evious illust r at ion, Mr Br own’s t ax liabilit y is calculat ed as f ollows:

Taxable I ncome £ 43,465

Tax £

2,150 @ 10% 215

31,350 @ 22% 6,853

10,165 @ 40% 4,066

43,465

Tax liabilit y

_______

£11,134

D8.4 Tax already paid

Any income t ax which Mr Br own has alr eady paid dur ing t he cour se of t he year can be deduct ed f r om t ax liabilit y t o give a f inal f igur e of t ax due and payable t o t he Revenue. The t ax due will be collect ed by t he Revenue under t he self assessment r egime.

I f t he t ax paid at sour ce in t he t ax year exceeds t he t ax liabilit y, t he t axpayer will be due an income t ax r epayment f r om t he Revenue.

Illustration 3

Assume t hat Mr Br own f r om t he pr evious illust r at ion had paid t ax on his employment income under t he Pay As You Ear n (PAYE) syst em of £ 9,000. This £ 9,000 can be deduct ed f r om t he t ax liabilit y t o give a f igur e of t ax due as f ollows:

£ Tax liabilit y 11,134 Less: PAYE (9,000) Tax due £2,134


357

Example 1

Mr s Whit e has t he f ollowing income/ expenses in 2006/ 07:

£ Ear nings f r om employment (gr oss) 32,000 (PAYE deduct ed £ 6,000) Rent f r om apar t ment in New Yor k 9,500 Char ge on income paid (1,200)

Calculat e her I ncome Tax due.

Example 2

Mr Gr een has t he f ollowing income in 2006/ 07:

£ Salar y (PAYE £ 3,000) 12,000 UK r ent al income 3,500 Pr emium bond winnings 2,000

Calculat e his income t ax due/ r epayable.


Answer 1

Non Savings

£ Ear nings 32,000 For eign income 9,500 Less: Char ge on income (1,200) STI 40,300 Less: Per sonal allowance (5,035) Taxable I ncome £ 35,265

Tax £ 2,150 @ 10% 215 31,150 @ 22% 6,853 1,965 @ 40% 786 Tax liabilit y 7,854 Less: t ax paid under PAYE (6,000) Tax due £1,854

Answer 2

Non savings

£ Ear nings 12,000 Pr oper t y I ncome 3,500 Pr emium bond winnings Exempt STI 15,500 Less: Per sonal allowance (5,035) Taxable I ncome £ 10,465

Tax £ 2,150 @ 10% 215 8,315 @ 22% 1,829 Tax liabilit y 2,044 Less: PAYE deduct ed (3,000) Tax r epayable t o Mr Gr een £(956)


359

SUMMARY - CALCULATING THE INCOME TAX LIABILITY

Taxable income is calculat ed by combining all sour ces of income, deduct ing char ges on income paid and f inally deduct ing t he per sonal allowance which is £ 5,035 f or 2006/ 07. Non savings income is t hen t axed as f ollows: Fir st £ 2,150 at 10% Next £ 31,150 at 22% Rest at 40% Finally any t ax paid at sour ce, such as PAYE, is deduct ed t o f ind t he t ax due or r epayable f or t he year .

D9: INTRODUCTION TO PAYE

I n t his chapt er you will lear n about t he PAYE syst em which collect s t ax f r om employment income including: - what PAYE applies t o; - how t he syst em wor ks; - t ax codes; - under payment s of t ax; - K codes.


D9.1 Introduction

The Pay As You Ear n (or PAYE) syst em is a met hod by which t ax is deduct ed f r om employment income at sour ce. PAYE is not a t ax in it self – it is simply a syst em under which t ax on employment income and Nat ional I nsur ance is t aken f r om salar ies at t he point of payment and handed over t o t he Revenue.

s. 684 SI 2003/ 2682

PAYE schemes ar e oper at ed by employer s. The Revenue use employer s as unpaid t ax collect or s on t heir behalf . I f employer s f ail t o oper at e PAYE cor r ect ly t her e ar e penalt ies f or t hese f ailur es.

The PAYE syst em aims t o r ecover t ax and Nat ional I nsur ance wher ever “PAYE income” is paid t o an employee. Nat ional I nsur ance Cont r ibut ions ar e paid by bot h employer s and employees and we shall t ake a det ailed look at NI C in a separ at e chapt er . The PAYE r egulat ions also cont ain det ailed pr ovisions wit h r egar d t o t he collect ion and r ecover y of t ax and NI C, t he r et ent ion and pr oduct ion of r ecor ds, int er est and penalt ies f or compliance f ailur es and PAYE appeal pr ocedur es. PAYE must be applied at t he “t ime of payment ”. The dat e at which PAYE income is “paid” is def ined in Sect ion 686 as t he ear lier of :

s. 684 (2) s. 686

(i) t he t ime when payment is made; and (ii) t he t ime when t he per son becomes ent it led t o t he payment . Ther e ar e special r ules f or dir ect or s as discussed in Chapt er 15.

Employer s pay t he PAYE t ax and NI C t o t he Revenue on a mont hly basis on t he 19 t h of each mont h. The due date f or payment is 14 days after t he end of the tax month of payment , and each t ax mont h ends on t he 5th of t he mont h.

I nt r oduct ion t o PAYE

361

Ther e is one except ion t o t his. I f t he t ot al t ax and Nat ional I nsur ance Cont r ibut ions payable by t he employer ar e less t han £ 1,500 per mont h on aver age, t he employer has t he opt ion t o make payment s under PAYE on a quar t er ly basis. For t his pur pose, t he f our t ax quar t er s end on 5 J uly, 5 Oct ober , 5 J anuar y and 5 Apr il, so PAYE payment s ar e due 14 days af t er each of t hose quar t er ends.

D9.2 PAYE income

I TEPA 2003 def ines “PAYE income” in s.683. I t consist s of : (i) PAYE employment income (see below). (ii) PAYE pension income (e.g. payment s by employer s t o f or mer employees

under pension schemes); and (iii) PAYE social secur it y income (e.g. St at ut or y Sick Pay and St at ut or y

Mat er nit y Pay paid by employer s t o r elevant employees). We ar e most ly concer ned wit h PAYE employment income which consist s of : (i) any t axable ear nings f r om an employment in t he year ; and (ii) any t axable specif ic income f r om an employment in t he year . This def init ion t her ef or e cover s most cash payment s made by employer s t o employees including salar ies, bonuses and t er minat ion payment s. Ther e ar e some cash payment s made by an employer t o an employee t hat will not be subj ect t o PAYE. The main example is t he payment of excluded business expenses. These ar e expenses which would not give r ise t o a t axable benef it which t he I nland Revenue has aut hor ised t he employer t o ignor e. PAYE is not j ust r est r ict ed t o payment s in cash. Payment s t o employees in t he f or m of “readily convertible assets” ar e also subj ect t o PAYE. A “r eadily conver t ible asset ” is an asset which is t r adeable on a r ecognised St ock or Commodit ies Exchange. These asset s will include quot ed shar es – i.e. shar es list ed on a r ecognised St ock Exchange – or gold bullion.

s.696 s.702

For example, if an employee wor ks f or Mar ks & Spencer plc, and as par t of his r emuner at ion he is given shar es in Mar ks & Spencer plc, as t hese shar es ar e list ed on t he UK St ock Exchange, t hey ar e r eadily conver t ible asset s and t ax at sour ce under PAYE would have t o be deduct ed f r om t he payment . A r eadily conver t ible asset also includes any asset f or which t r ading ar r angement s exist . A t r ading ar r angement basically means t hat t he employer has ar r anged f or t he employee t o be able t o sell t he asset which has been awar ded t o him – ie, t he employer ar r anges f or t he employee t o r eceive cash f r om a t hir d par t y in r et ur n f or t he asset .

SI 2003/ 2682 Reg. 70


For example, let us say t hat as par t of an employee’s r emuner at ion, his employer gives a br and new Fer r ar i. Ther e is no r ecognised Commodit ies Exchange f or Fer r ar is, but if , as par t of t he deal, t he employer has ar r anged wit h a t hir d par t y f or t he employee t o be able t o sell t hat Fer r ar i and r eceive cash in r et ur n, t he asset is a r eadily conver t ible asset and PAYE will have t o be applied t o t he payment . Normal benefits such as t he use of a company car or a taxable cheap loan or living accommodation, ar e not gener ally subj ect t o deduct ion of t ax at sour ce under PAYE. These benef it s ar e usually ent er ed on form P11D and t ax is paid on t hese benef it s at t he end of t he year under Self Assessment . However , as we shall see lat er , in or der t o pr event t her e f r om being a lar ge under payment of t ax on benef it s at t he end of t he year , t he Revenue usually t ax benef it s via t he employee’s t ax code. We shall deal wit h t ax codes lat er on in t his chapt er .

D9.3 How the PAYE system works

Once t he employer has ar r ived at t he employee’s PAYE income f or a par t icular ear nings per iod – t he most common ear nings per iod being t hat of one mont h – t his income is ent er ed on t o a PAYE deduct ion car d. The employer t hen calculat es t ax on t he income using t he employee’s tax code. The pur pose of a t ax code is f or t he Revenue t o t ell t he employer what allowances et c., ar e due t o t he employee. All of us will be ent it led t o t he basic per sonal allowance so we can ear n a cer t ain amount of t ax f r ee pay ever y mont h. This t ax f r ee pay is deduct ed f r om t he PAYE income and t he excess is char ged t o t ax.

The employer calculat es t he pr ecise amount of t ax due using t ax t ables. These t ables ar e pr ovided by t he Revenue and t her e ar e separ at e t ables f or t ax and Nat ional I nsur ance Cont r ibut ions. The employer looks at t he mont hly gr oss pay, t hen looks at t he employee’s t ax code and wher e t hese t wo point s meet on t he t ax t ables, t hat is t he income t ax t o be deduct ed f or t hat par t icular mont h. What t he t ables ef f ect ively do is t o t ake gross pay, deduct some personal allowances, and char ge t he excess at 10%, at 22% and, if r elevant , at 40%.

Once t he employer has ar r ived at t he t ax and t he Nat ional I nsur ance t o be deduct ed, t his is wit hheld f r om gr oss pay and t he net amount is paid t o t he employee.

I t is t he employer ’s r esponsibilit y t o keep r ecor ds of all PAYE income paid t o employees and of t he t ax and Nat ional I nsur ance deduct ed f r om t hat income. These pay and t ax det ails will be r ecor ded on var ious r et ur ns sent t o t he Revenue at t he end of t he year . PAYE Ret ur ns will be dealt wit h in t he next chapt er .


363

D9.4 Tax Codes

The tax code is issued by t he Revenue t o employers on form P6.

A det ailed br eakdown of how t he Revenue has ar r ived at t he tax code is given t o t he employee on a dif f er ent f or m - form P2. Not e her e t hat t he employer only r eceives t he “bot t om line” f igur e – i.e. t he employer does not r eceive t he det ailed br eakdown of t he code as t his is conf ident ial inf or mat ion given t o t he employee only. The pur pose of t he t ax code is t o t ell t he employer how many allowances or

reliefs t he employee is ent it led t o. These allowances will include per sonal allowances, age allowances and any ot her r elief s such as qualif ying int er est or EI S r elief et c.

The t ax code will also t ake account of any benef it s t o which t he employee is ent it led. The t ax code t akes t he employee’s allowances f or t he year , deduct s any benef it s t he employee has f or t he year and t he dif f er ence is t he net allowances due t o t he employee.

Allowances f or year X Benef it s (X) Net allowances due X

These net allowances ar e t he employee’s t ax f r ee pay. By r est r ict ing an employee’s allowances by t he amount of his benef it s, what t he Revenue ar e doing is ef f ect ively t axing benef it s on a mont hly basis as t hey go along. The Revenue do t his t o pr event t he employee having a lar ge t ax bill at t he end of t he year .

Illustration 1

Mr J ones is ent it led t o a per sonal allowance in 2006/ 07 of £ 5,035. I n t he t ax year he also r eceives some benef it s f r om his employer . He has a company car wit h a benef it of £ 1,690. He is also pr ovided wit h pr ivat e f uel f or t hat car , giving r ise t o a benef it of £ 2,240. Tax code: £ £

Per sonal allowance 5,035 Benef it s: Car benef it 1,690 Fuel benef it 2,240 (3,930) Net allowances £1,105

Tax Code 110L


The Revenue will conver t t his t ax f r ee pay of £ 1,105 int o a t ax code. To do t his t hey will simply knock of f t he end f igur e – i.e. r emove t he 5 – and r eplace t hat number wit h t he let t er L. So t he t ax code her e is 110L. The suf f ix L simply means t hat Mr J ones is ent it led t o t he nor mal Per sonal allowance. I n pr act ice you may be asked by your client t o check t he det ailed br eakdown of t he code t o make sur e t hat t he allowances and t he benef it s wit hin t he t ax code ar e cor r ect .

What you ar e doing is simply checking t hat t he Revenue ar e deduct ing mor e or less t he cor r ect amount of t ax each mont h under PAYE. Any ext r a t ax owed t o t he Revenue, or any r epayment s due t o t he t axpayer , will be dealt wit h once t he Self Assessment r et ur n has been submit t ed. Not ices of Coding can t ake account of allowances ot her t han t he basic per sonal allowance. For example, t hey can t ake account of t ax r educer s such as subscr ipt ions t o EI S companies and any mar r ied couples r elief due t o older t axpayer s. The codes can also t ake account of Gif t Aid donat ions and any cont r ibut ions t o pension schemes which at t r act t ax r elief . Tax codes ar e also ver y commonly used t o deal wit h t ax under or over payment s f r om pr evious year s.

The t ax code can also be used t o t ax small amount s of ot her income likely t o ar ise in t he t ax year , such as r ent al or invest ment income. However , a t axpayer can obj ect t o t his income being encoded.

D9.5 Underpayments of tax

PAYE is not an exact science, so t he amount of t ax deduct ed at sour ce under PAYE will not always be exact ly t he same as t he t ax liabilit y f or t he year . Most t axpayer s in t he UK will eit her have small under or over payment s at t he year end.

I f t he t ax due f or t he year is less t han £ 2,000, t he Revenue do not r equir e t his t ax t o be paid under Self Assessment on 31 J anuar y. I nst ead t hey ar e happy t o collect t his t ax a lat er t ax year under PAYE. For example, if t he under payment occur s in 2006/ 07, t he Revenue will usually adj ust t he t ax code in 2008/ 09.

The idea is t hat t he employee will pay slight ly mor e t ax in t he lat er year t o cancel out t he t ax under payment f r om t he ear lier year .

Illustration 2

Mr Wood is employed on a salar y of £ 20,000 per annum and has benef it s of £ 500. I n 2004/ 05 Mr Wood had a t ax under payment of £ 150.


365

Mr Wood’s t ax code f or t he t ax year 2006/ 07 is calculat ed as shown:

£ Per sonal allowance 5,035Benef it s (500)Tax under paid 2004/ 05

£ 150 x 10022

(682)

Net allowances £3,853

Tax Code 385L

This calculat ion r equir es some explanat ions. We will st ar t wit h Mr Wood’s allowances. He has a nor mal Per sonal allowance of £ 5,035. Mr Wood’s benef it s f or t he year ar e £ 500, so t hese ar e deduct ed. I n 2004/ 05 Mr Wood had a small under payment t hat we need t o deal wit h via his t ax code. What we need t o do her e is t o r est r ict Mr Wood’s allowances by such an amount so as t o cr eat e an ext r a t ax liabilit y of £ 150 in 2006/ 07. As Mr Wood is a basic r at e t axpayer , we do t his by mult iplying by 100 over 22 giving £ 682. We ar e ef f ect ively pr et ending t hat in 2006/ 07 Mr Wood has ext r a income of £ 682. When mult iplied by t he basic r at e of 22%, t his will cr eat e an ext r a t ax liabilit y of £ 150. This is t he t ax t hat he owes f or t he pr evious year . The net allowances due f or t he year ar e t he t ot al allowances less t he benef it s, giving £ 3,853. We t hen knock of f t he f inal 3 and r eplace t hat wit h t he let t er L f or nor mal per sonal allowances t o give Mr Wood a t ax code f or t he year of 385L.

D9.6 K Codes

A “K” code is a negat ive code and will ar ise wher e benef it s exceed allowances

for the year. So wher eas in t he case of a nor mal code an employee has an amount of t ax f r ee pay each mont h, wher e an employee has a “K” code this will

actually increase the taxable pay.

I f an employee has a nor mal Per sonal allowance and t ot al benef it s of £ 8,000 f or t he year his code will be as f ollows:

£ Per sonal allowance 5,035 Benef it s (8,000) Negat ive allowance £ (2,965) Tax code K295

A “K” code is so-called because t he code is pr ef ixed by t he let t er K. Her e we t ake £ 2,965, we r emove t he f inal 5 t o give us 296, and t hen t he Revenue deduct one t o give 295. The Revenue t hen put a “K” on t he f r ont so t hat t he code becomes K295.


This will be not if ied t o t he employer by t he Revenue on f or m P6. This t ells t he employer t o incr ease t he employee’s PAYE income by a cer t ain amount each mont h, so as t o ef f ect ively t ax t he benef it s at sour ce. This pr event s a lar ge t ax under payment f r om ar ising at t he end of t he year .

When a K code is used, t he maximum amount of tax that can be deducted in

any period cannot exceed 50% of gross pay. For example, if an employee has gr oss cash pay of £ 3,000 in a mont h, t he maximum amount of t ax t hat can be deduct ed under PAYE is £ 1,500. This is t o pr event har dship - i.e. t o pr event an employee’s cash pay f r om being t ot ally wiped out in t ax. The sole pur pose of t he code is t o det er mine how much t ax an employee pays each year under PAYE. I f you t hink back t o your income t ax comput at ion, you always t ax gr oss ear nings and t hen deduct t ax alr eady paid under PAYE at t he bot t om t o give you a f igur e of t ax due or t ax r epayable. As f ar as is possible, t he Revenue will t r y t o make t he t ax deduct ed under PAYE mor e or less equal t o t he employee’s t ax liabilit y f or t he year by using t he t ax code syst em. However t hey under st and t hat PAYE codes cannot be t ot ally accur at e, so small under or over payment s ar e inevit able. I f on r eceiving his f or m P2, an employee t hinks t hat his t ax code is incor r ect , t he employee can make an appeal t o t he Revenue. The appeal can be made in wr it ing or , t he employee can t elephone t he Tax Of f ice and ask t hem t o change t he t ax code.

Example 1

Which of t he f ollowing ar e PAYE income?

a) Per f or mance r elat ed bonus b) St at ut or y sick pay c) Company car d) Non t axable business expenses e) Bonus paid in silver bullion f ) Compensat ion f or loss of of f ice. Example 2

Alber t was 73 on 1 Febr uar y 2006. He is mar r ied t o Elsie who is 69. Alber t has a par t t ime j ob paying £ 12,000 per annum He has no benef it s and no ot her income. Calculat e what his t ax code f or 2006/ 07 will be.


367

Answer 1

PAYE

income?

a) Per f or mance r elat ed bonus X

b) St at ut or y sick pay X

c) Company car X d) Non-t axable business expenses X e) Bonus in silver bullion X

f ) Compensat ion f or loss of of f ice X

Answer 2

£ Per sonal age allowance 7,280 Mar r ied couples r elief £ 6,065 x 10% = £ 607 Given as

607 x 10022

2,759

Tot al allowances £10,039

Tax Code 1003V

Alber t is 73 and so is ent it led t o Per sonal Age allowances. He is mar r ied so he is also ent it led t o Mar r ied Couples r elief as he was bor n bef or e 6 Apr il 1935. Alber t has a salar y of £ 12,000 and no ot her income. This means t hat as his STI is less t han £ 20,100, t hese allowances ar e given in f ull wit h no r est r ict ion.

Alber t ’s Mar r ied Couples r elief will be £ 6,065 at 10%. Mar r ied Couples r elief is given as a t ax r educer so we need t o f act or t his in t o Alber t ’s t ax code. We t her ef or e need t o incr ease Alber t ’s allowances by such an amount t hat it saves Alber t t ax of £ 607. As Alber t is a basic r at e t axpayer we do t his by mult iplying by 100 over 22.

This has t he ef f ect of giving Alber t addit ional allowances of £ 2,759. The idea is t hat by incr easing Alber t ’s allowances by £ 2,759, we save him t ax at 22% giving r ise t o a t ax saving of £ 607.

Adding t hese t oget her gives Alber t t ot al allowances of £ 10,039. We r emove t he last digit t o give us a t ax code of 1003 and t his t ime we add t he suf f ix “V” which denot es age r elat ed Mar r ied Couples allowances. So Alber t ’s t ax code will be 1003V.

(Not e: t he var ious coding suf f ixes (“L”, “V” et c) ar e not impor t ant f or examinat ion pur poses).


SUMMARY - INTRODUCTION TO PAYE

PAYE is t he syst em by which employer s collect t ax on employment income paid t o t heir employees and pass it on t o t he I nland Revenue. PAYE is due on t he 19t h of t he mont h, but can be paid quar t er ly if t he amount is less t han £ 1,500 per mont h on aver age. Most cash payment s ar e subj ect t o PAYE but it also applies t o r eadily conver t ible asset s being asset s t r adeable on a r ecognised exchange or wher e t r ading ar r angement s exist . The employer uses t he employee’s t ax code and some t ax t ables t o calculat e t he t ax and NI C due each mont h. The t ax code r epr esent s t he per sonal allowances t hat t he employee is ent it led t o, and is r educed by benef it s. A r educt ion in t he t ax code can also be made t o collect t ax under paid in an ear lier year . K codes occur when benef it s exceed allowances. The maximum t ax t hat can be collect ed via such a code is 50% of gr oss pay.

D10: PAYE END OF YEAR RETURNS

I n t his chapt er you will lear n about t he PAYE end of year r et ur ns including: - f or ms sent t o t he Revenue; - f or ms given t o t he employee; - due dat es; - int er est ; - penalt ies f or a lat e r et ur n; - penalt ies f or an incor r ect r et ur n.

D10.1 Introduction

A number of end of year r et ur n f or ms have t o be f iled by t he employer t o t he Revenue. I t is t he employer ’s r esponsibilit y t o pr ovide cer t ain det ails t o t he Tax Of f ice at t he end of t he year , and t her e ar e a var iet y of specif ic f or ms t o enable t he employer t o do so.

The f or m P60 cont ains det ails of t axable ear nings paid by an employer t o an employee in t he year along wit h det ails of any t ax and Nat ional I nsur ance deduct ed f r om t hose ear nings. The P60 will also cont ain basic det ails such as t he employer ’s name and addr ess and t he employee’s Nat ional I nsur ance number .

The P60 is given by the employer to the employee no later than 31 May

following the end of the tax year. The employee will t hen use t he det ails on t he P60 t o pr epar e his own Self Assessment t ax r et ur n.

The employer will also complet e a form P14 for each employee. The det ails on t he P14 ar e t he same as t hose on t he P60. The dif f er ence her e is t hat t he P14 is given by the employer to the Revenue.

All t he f or ms P14 ar e ef f ect ively r olled t oget her t o f or m an end of year

summary which is called t he f or m P35. The P35 summar ises all t he individual deduct ion sheet s f or each and ever y employee. For ms P14 and P35 must be submit t ed by t he employer t o t he Revenue no lat er t han 19 May f ollowing t he end of t he t ax year .

SI 2003/ 2682 Par a 73

A f or m P11D is pr ovided t o ever y higher paid employee who r eceives benef it s in t he t ax year . A higher paid employee is any employee who ear ns mor e t han £ 8,500 per annum. I f benef it s ar e pr ovided t o lower paid employees, t hese ar e summar ised on form P9D. Each of t hese f or ms cont ains det ails of t he cash equivalent of each benef it pr ovided. The deadline f or t he submission of f or ms P11D and P9D t o t he Revenue is 6 J uly f ollowing t he end of t he t ax year . The employer will give a copy of t he P11D t o t he employee t o enable t he employee t o put t oget her his Self Assessment Ret ur n.

SI 2003/ 2682 Par a 85


A f or m P45 is given by t he employer t o ever y employee who leaves that

particular employment. P45s ar e also pr ovided in r espect of employees whose employment t er minat es as a r esult of deat h.

The f or m P45 has f our par t s. The employer will send t he f ir st par t of t he f or m t o t he Revenue and give t he ot her t hr ee par t s of t he f or m t o t he employee. The employee will keep one par t of t he P45 f or his own r ecor d pur poses and give t he ot her t wo par t s of t he f or m t o his new employer . The new employer f ills in det ails of t he new employment , t hen keeps one par t of t he P45 f or his own r ecor d pur poses. The employer sends t he f inal par t t o t he Revenue.

The P45 cont ains det ails of pay and t ax f r om t he st ar t of t he t ax year t o t he dat e t he employment t er minat ed. The P45 also cont ains t he code number oper at ed by t he pr evious employer . This code number will t hen be oper at ed by t he new employer unt il a new one is issued by t he Revenue.

I n cer t ain cir cumst ances, an employee will be asked t o f ill in a f or m P46. A P46 is complet ed by employees who j oin an employer but do not have a P45. This will be t he case if t his is t he employee’s f ir st j ob since leaving educat ion or if t he employee has anot her j ob and does not have a f or m P45.

The f or m P46 will ask t he employee t o cer t if y one of t wo t hings.

a) I f t he employee cer t if ies t hat t his is his f ir st or main j ob t he employer will oper at e an “emer gency code”. This emer gency code f or 2006/ 07 will be 503L, which means t hat when t he employer deduct s t ax under Pay As You Ear n, t he employee will simply be given t he nor mal Per sonal allowance as his t ax f r ee amount .

b) I f t he employee cer t if ies on f or m P46 t hat t his employment is neit her his f ir st j ob nor his main j ob, t he employer will oper at e code BR. This means t hat t ax will be deduct ed f r om ear nings at t he basic r at e of 22% wit hout any per sonal allowances being given.

D10.2 Interest

Tax and Nat ional I nsur ance should be paid over t o t he Revenue no lat er t han t he 19th of each month. I f an employer makes t hese payment s lat e, t he Revenue will char ge t he employer int er est on t he lat e paid t ax. The r ules her e however ar e quit e gener ous in t hat interest does not start to run until 19 April following

the end of the tax year. So in r espect of t ax due f or t he t ax year 2006/ 07, if t he employer st ill owes t he Revenue some t ax f or t his t ax year t hen int er est will r un f r om 19 Apr il 2007 t o t he dat e bef or e t he t ax is act ually paid. This means t hat as long as t he employer has paid all of his t ax and Nat ional I nsur ance due under PAYE 19 Apr il f ollowing t he end of t he t ax year , t hen no int er est char ge will be levied.

I f t ax has been over paid by t he employer and a r epayment of t ax is due, t hen r epayment supplement will r un f or t he same per iod.

PAYE End of Year Ret ur ns

371

D10.3 Penalties

I t is t he employer ’s obligat ion t o oper at e Pay As You Ear n cor r ect ly and if he f ails t o do so, t he Revenue has t he r ight t o char ge a penalt y. Penalt ies will be char ged eit her if t he employer sends in his end of year Ret ur ns lat e, or if t hose Ret ur ns ar e incor r ect .

D10.4 Late Returns s. 98A

TMA 1970

For ms P35 and P14 ar e due f or submission on 19 May f ollowing t he end of t he t ax year . However t he Revenue has conf ir med t hat , by concession, t hey will not

charge a penalty if the P35 or P14 is submitted within 7 days of the normal

due date. I f t he P35 or P14 is mor e t han 7 days lat e, t he penalt y will be £100 per month

(or par t mont h) for each group of up to 50 employees. So f or example, if a f or m P35 is one mont h lat e and t he company has 110 employees, t he penalt y will be £ 100 mult iplied by 1 mont h mult iplied by 3 - 110 employees const it ut ing 3 separ at e gr oups of 50 employees. This penalt y is f ixed and cannot be mit igat ed at t he discr et ion of t he I nspect or . I f t he r et ur ns ar e more than 12 months late, a further penalty of up to 100% of the tax unpaid at that time may also be levied. For ms P11D or P9D should be submit t ed no later than 6 July following the end

of the tax year. I f t hese f or ms ar e lat e, t he Revenue can char ge an initial penalty of up t o £300 per late form and can thereafter char ge a f ur t her penalt y of up t o £60 per day f or each day t hat t he f ailur e cont inues. These penalt ies can be mit igat ed at t he discr et ion of t he Revenue.

D10.5 Incorrect Returns s. 98A TMA 1970

I f an employer f iles an incor r ect f or m P35 or P14, t he maximum penalt y t hat may be char ged is up t o 100% of any t ax or Nat ional I nsur ance lost as a r esult of t he er r or . This is not a f ixed penalt y and it can be r educed by t he Revenue depending on t he f act s and cir cumst ances of each case. The penalty f or submit t ing an incorrect form P11D or form P9D is up t o £3,000 for each incorrect form. This means t hat if an employer pr ovides benef it s t o 100 employees and get s each of t he f or ms P11D wr ong, t he Revenue could char ge a penalt y of £ 3,000 t imes 100 - i.e. a t ot al penalt y of £ 300,000.


D10.6 Recovery of tax SI 2003/ 2682Reg 80

Wher e an employer fails to operate Pay As You Earn correctly, and t his r esult s in an under payment of t ax, t he Revenue can eit her r ecover t he t ax f r om t he employer or f r om t he employee. I n t he maj or it y of inst ances t he Revenue will choose t o r ecover t he t ax f r om t he employer by using a Regulation 80

determination.

Having quant if ied t he t ax under paid, t he Revenue will issue a not ice under Regulat ion 80 of t he PAYE Regulat ions. The employer has a r ight t o appeal t his det er minat ion if he t hinks it is incor r ect but if no appeal is lodged, t he det er minat ion becomes f inal and conclusive wit hin 30 days. I f t he Revenue ar e sat isf ied t hat t he employer t ook r easonable car e t o comply wit h t he PAYE Regulat ions and any under payment of t ax ar ose due t o an er r or made in good f ait h, t he Revenue will inst ead seek r ecover y of t he t ax f r om t he employee.

Reg 72

The Revenue will also seek collect ion of t he t ax f r om t he employee if t hey have r eason t o believe t hat t he employee accept ed his ear nings in t he f ull knowledge t hat t he employer had under deduct ed t ax. Remember t hat int er est will always r un on lat e paid t ax f r om 19 Apr il f ollowing t he t ax year t o t he dat e bef or e payment is made.

D10.7 Electronic filing

Tax Bullet in

No. 63

The Revenue has st at ed t hat all employer s will be r equir ed t o f ile t heir End of Year r et ur ns (P14s, P35s, P11Ds, et c) elect r onically by 2010. This can be done eit her dir ect ly by t he employer or via an int er mediar y such as a payr oll bur eau or agent . “Lar ger ” employer s (t hose wit h 250 or mor e employees) wer e r equir ed t o “e-f ile” t heir year end r et ur ns by May 2005. Many wer e doing so alr eady, so f or lar ger employer s t his was not an addit ional bur den. The compulsor y elect r onic f iling dat e will t her eaf t er depend on t he number of employees t he employer has:

s.135 & s.136 FA2002

Number of employees Fir st compulsor y elect r onic Ret ur n Deadline 250+ Tax year 2004/ 05 May 2005

50-249 Tax year 2005/ 06 May 2006 Under 50 Tax year 2009/ 10 May 2010

A penalt y will be levied f or a f ailur e t o comply wit h t hese deadlines. This will be £ 3,000 per annum per PAYE scheme f or an employer ’s f ailur e t o make an elect r onic r et ur n. This penalt y is in addit ion t o t he usual ar r ay of penalt ies f or lat e f iling.


373

“Small” employer s (t hose wit h f ewer t han 50 employees) will be of f er ed f inancial incent ives t o encour age t hem t o make an ear ly t r ansit ion t o e-f iling. These ar e as f ollows:

End of year r et ur n I ncent ive £

2004/ 05 250 2005/ 06 250 2006/ 07 150 2007/ 08 100 2008/ 09 75

This income is not t axable.

Example 1

By what dat e must t he employer f ile his f or m P35 f or 2006/ 07 t o avoid a penalt y being char ged?

Example 2

Tar dy Lt d has 63 employees. The Finance Dir ect or sends t he f or m P35 f or 2006/ 07 t o t he Revenue on 27 J uly 2007. What will t he penalt y char ged on Tar dy Lt d be?


Answer 1

The nor mal due dat e f or t he submission of a P35 is 19 May f ollowing t he end of t he year . However t he Revenue allow a 7 day per iod of gr ace, so long as t he P35 is submit t ed by 26 May 2007 no penalt y will be char ged.

Answer 2

Due dat e f or P35 was 19 May 2007 Filing dat e was 27 J uly 2007

So P35 was j ust over 2 mont hs lat e – t his equals 3 mont hs

Penalt y £ 100 per mont h per gr oup of up t o 50 employees 63 employees is 2 gr oups £ 100 x 3 mont hs x 2 = £600


375

SUMMARY - PAYE END OF YEAR RETURNS

The main end of year r et ur ns t o be submit t ed ar e as f ollows: P60 Given t o employee, det ails of t ot al pay and deduct ions Due by 31 May P14 As P60 but given t o Revenue Due by 19 May P35 Summar y of all t he P14s given t o t he Revenue Due by 19 May P11D Given t o employee and Revenue, summar y of benef it s

given t o a higher paid employee Due by 6 J uly

P9D As above but f or lower paid employee Due by 6 J uly The P45 is pr epar ed when an employee leaves. One par t is given t o t he Revenue, t hr ee par t s ar e given t o t he employee who keeps one and gives t he ot her t wo t o t he new employer . A new employer f ills in det ails of t he new employment on t he P45 and sends one par t t o t he Revenue and keeps t he ot her . I f no P45 is available, a P46 is complet ed by t he new employee. The employer will use t he emer gency code if it is t he employee’s f ir st j ob, or t he BR code if it is a second j ob. I nt er est r uns on lat e paid PAYE and NI C f r om 19 Apr il f ollowing t he t ax year . Lat e r et ur ns at t r act penalt ies. For t he P14 and P35 t her e is a gr ace per iod of 7 days. P14/ P35 > 7 days lat e £ 100 per mont h per 50 employees > 12 mont hs lat e 100% of t he t ax unpaid P11D/ P9D if lat e I nit ially £ 300 per f or m or £ 60 per day if

f ailur e cont inues I ncor r ect P14/ P35 at t r act s a penalt y of 100% of t he t ax lost . I ncor r ect P11D/ P9D penalt y is £ 3,000 per f or m. I f PAYE is oper at ed incor r ect ly any under payment can be collect ed f r om t he employer via a Regulat ion 80 det er minat ion. This becomes f inal if not appealed wit hin 30 days. The Revenue ar e encour aging businesses t o move t o elect r onic f iling f or year end r et ur ns. All employer s must e-f ile r et ur ns f or t he t ax year 2009/ 10 onwar ds.

D11: CLASS 1 NATIONAL INSURANCE CONTRIBUTIONS

I n t his chapt er you will lear n about Class 1 NI C including: - an over view of t he six classes of NI C; - def init ion of ear nings; - Class 1 pr imar y cont r ibut ions; - r ules f or dir ect or s; - Class 1 secondar y cont r ibut ions; - cont r act ing out of St at e Second Pension.

Ref er ences in t his chapt er ar e t o Social Secur it y Cont r ibut ions & Benef it s Act (SSCBA) 1992 unless st at ed ot her wise.

D11.1 Introduction

NI C is a ver y impor t ant money-r aising t ool f or t he Tr easur y and, year on year , Nat ional I nsur ance Cont r ibut ions br ing in ar ound 20 t o 21 per cent of t ot al Gover nment r evenue. Collect ion of NI C is administ er ed by t he Nat ional I nsur ance Cont r ibut ions Of f ice (NI CO) which is now par t of t he HM Revenue and Cust oms. Ot her par t s of t he HMRC assist NI CO in t he collect ion of Nat ional I nsur ance Cont r ibut ions, par t icular ly via t he PAYE syst em. The pur pose of Nat ional I nsur ance Cont r ibut ions is t o pr ovide cer t ain r et ir ement benef it s such as t he St at e Pension, as well as t o f und cer t ain Social Secur it y benef it s such as J ob Seeker s Allowance and I ncapacit y Benef it . I f t he amount r aised by NI CO by way of Nat ional I nsur ance Cont r ibut ions is insuf f icient t o cover t hese benef it s, any def icit is made up by a gr ant f r om t he Tr easur y.

At pr esent t her e ar e six classes of Nat ional I nsur ance:

a) Class 1 - paid by bot h employees and employer s on ear nings f r om employment . s. 1

b) Class 1A - paid by employer s only on benef it s awar ded t o employees.

c) Class 1B - paid by employer s only on Pay As You Ear n Set t lement Agr eement s (PSAs).

d) Class 2 - paid by self -employed per sons on t he pr of it s f r om t heir t r ade.

e) Class 3 - volunt ar y cont r ibut ions paid by t axpayer s who wish t o t op-up t heir cont r ibut ion r ecor d in or der t o pr eser ve t heir ent it lement t o St at e benef it s.

f ) Class 4 - paid by self -employed per sons on t he pr of it s f r om t heir t r ade. Classes 2 and 4 will be cover ed in t he business t ax sect ion of your cour se.

This gives us an over view of Nat ional I nsur ance. I n t his chapt er we shall concent r at e solely on Class 1 NI C.

Class 1 Nat ional I nsur ance Cont r ibut ions

377

D11.2 Class 1 NIC s. 2

Class 1 Nat ional I nsur ance Cont r ibut ions ar e br oken down int o primary cont r ibut ions or secondary cont r ibut ions. Primary cont r ibut ions ar e paid by employees whilst secondary cont r ibut ions ar e paid by employers.

Class 1 NI Cs ar e paid on ear nings f r om t he employment . I f an employee r eceives ear nings, t hat employee will pay Class 1 pr imar y cont r ibut ions whilst if an employer pays ear nings t o an employee, t he employer makes a secondar y Class 1 cont r ibut ion.

Bot h pr imar y and secondar y cont r ibut ions ar e account ed f or under t he PAYE syst em and ar e paid over t o t he Revenue, along wit h income t ax, on t he 19th of

each month.

Ever y t ime an employer makes a payment of ear nings t o an employee, t hat employer will have t o account f or Class 1 secondar y NI Cs cur r ent ly at a r at e of 12.8%. This is a ver y subst ant ial addit ional cost bor ne by employer s and t he maj or it y of NI Cs r aised by t he Tr easur y ar e collect ed f r om employer s r at her t han employees.

D11.3 Earnings s. 3

Class 1 cont r ibut ions ar e paid on “ear nings”. I t is ver y impor t ant t hat we est ablish what const it ut es “earnings” f or Nat ional I nsur ance pur poses. Any

cash payment made by an employer t o an employee is likely t o be ear nings f or NI C pur poses. This will include salar ies and bonuses but will not include t he r eimbur sement of genuine business expenses. I f an employer makes a non-cash payment t o an employee – i.e. some f or m of payment in kind – and t hat payment in kind can be surrendered for cash, t hat payment will also be earnings f or NI C pur poses. A payment in t he f or m of a pr emium bond f or example, will const it ut e ear nings f or NI C because t he employee can t ake t he pr emium bond t o t he Post Of f ice and has a legal r ight t o be able t o exchange t he pr emium bond in r et ur n f or cash.

Not e her e t he specif ic use of t he wor d “sur r ender ”. This is ver y dif f er ent t o t he wor d “sale”. For example, if an employee wer e given a yacht as a bonus by his employer , t his would not const it ut e ear nings f or NI C pur poses as he could not t ake t he yacht back t o t he shop and demand cash f r om t he shop owner . This is not an asset t hat can be “sur r ender ed” f or cash in t he same way as a pr emium bond.


Payment s in t he f or m of “readily convertible assets” ar e ear nings f or NI C pur poses. You will r ecall f r om t he PAYE chapt er , t hat a r eadily conver t ible asset is an asset t hat is t r aded on a r ecognised St ock or Commodit ies Exchange or an asset f or which t r ading ar r angement s exist . The def init ion of a r eadily conver t ible asset f or NI C is exact ly t he same as t he def init ion we looked at f or PAYE. The r eadily conver t ible asset s legislat ion was put in r elat ively r ecent ly as many employer s had int r oduced imaginat ive NI C avoidance schemes t o r educe t heir NI C liabilit ies.

s. 702 I TEPA 2003

I f an employer settles an employee’s personal liability, t his payment will also const it ut e ear nings f or Nat ional I nsur ance. For example, if an employee makes a visit t o t he super mar ket and spends £ 100 on goods, and t hat £ 100 is subsequent ly r eimbur sed by t he employer , t he employer has paid f or an employee’s per sonal bill, and t hat payment will const it ut e ear nings f or NI C. As such, t he £ 100 will be char ged t o Nat ional I nsur ance.

Vouchers are ear nings f or NI C. Most commonly t hese will include High St r eet st or e voucher s. Childcar e voucher s given t o employees ar e specif ically excluded and ar e not ear nings f or NI C.

Finally, certain share option rewards will const it ut e ear nings f or NI C. The vast maj or it y of common benef it s will not be ear nings f or NI C pur poses. For inst ance, if an employee is given use of a company car or has a t axable cheap loan, t hat benef it will be char ged t o income t ax but it will not t hen be char ged t o Nat ional I nsur ance Cont r ibut ions in t he hands of t he employee.

D11.4 Class 1 Primary contributions s. 5

Pr imar y cont r ibut ions ar e paid by employees on ear nings in an “ear nings per iod”. Most UK employees have a mont hly ear nings per iod – i.e. we r eceive our salar y et c on a mont hly basis. Some employees, t ypically in manuf act ur ing indust r ies, st ill r eceive t heir ear nings weekly.

s.6

The cur r ent r at es of Nat ional I nsur ance ar e given in t he t ax t ables. For employees who r eceive t heir r emuner at ion weekly, no National Insurance is

charged on the first £97 per week of an employee’s ear nings. This is called t he “ear nings t hr eshold” (ET). On earnings between £97 per week and £645 per

week, t he main r at e of Class 1 NI C is 11%. The weekly limit of £ 645 is called t he “upper ear nings limit ” (UEL). Employees also pay Class 1 NI Cs at t he addit ional r at e of 1% on earnings in

excess of the upper earnings limit i.e. above £645 per week.


379

The t ables also give us t he annual limit s. Most employees have a mont hly ear nings per iod, so t o conver t t he annual limit s int o mont hly limit s, we simply divide by 12. For employees wit h a monthly earnings period, f or ear nings up t o £ 420 per mont h, NI C is char ged at zer o per cent . For ear nings bet ween £ 420 and £ 2,795 per mont h, t he r at e is 11% and t her e is a f ur t her NI C liabilit y of 1% on ear nings in excess of £ 2,795 per mont h.

s.8

The mont hly and weekly limit s have been specif ically chosen t o equat e t o an ear nings t hr eshold of £ 5,035 per annum, which coincides wit h t he per sonal allowance. This is illust r at ed by t he diagr am below: Nil 11% 1% £ 0 £ 97 pw £ 645 pw £ 420 pm £ 2,795 pm £ 5,035 pa £ 33,540 pa An employee will st ar t t o pay Class 1 pr imar y cont r ibut ions wit h ef f ect f r om his 16t h bir t hday and will st op paying NI C at t he dat e of r et ir ement , which f or a man is cur r ent ly 65 and, f or a woman, is 60. NI Cs ar e calculat ed f or ear nings per iods. An employee who is paid mont hly will have 12 ear nings per iods in any par t icular t ax year , so t o calculat e his NI C f or t he year , we do 12 separ at e NI C calculat ions and add t hem t oget her . Illustration 1

An employee has a salar y of £ 18,000 per annum which is paid mont hly. The employee has use of a company car giving r ise t o a benef it of £ 2,500. The employee get s a cash bonus at Chr ist mas of £ 5,000. The salar y and t he Chr ist mas bonus const it ut e ear nings f or Class 1 NI C but t he company car benef it does not .

The mont hly limit s ar e:

Ear nings t hr eshold: £ 5,035 / 12 = £ 420

Upper ear nings limit : £ 33,540 / 12 = £ 2,795 For 11 mont hs of t he year his ear nings will be 18,000/ 12 = £ 1,500. I n December his ear nings will be 1,500 + 5,000 = £ 6,500.


The calculat ion will t her ef or e be as f ollows:

£Class 1 pr imar y NI C 11 mont hs wit h ear nings of £ 1,500 £ (1,500 – 420) x 11% x 11 mont hs 1,307 1 mont h wit h ear nings of £ 6,500 £ (2,795 – 420) x 11% x 1 mont h 261 £ (6,500 – 2,795) x 1% x 1 mont h 37NI C payable £1,605

The ef f ect of t his is t hat par t of t he £ 5,000 bonus paid in December 2006, will only have been char ged t o NI C at 1%.

D11.5 Directors

The above r ules do not apply t o dir ect or s. All directors have an annual earnings period. This means t o calculat e a dir ect or ’s NI C we look at t heir ear nings in t he whole of t he t ax year , ir r espect ive of whet her t he dir ect or was paid on a weekly or mont hly basis. This is t o pr event a company dir ect or f r om manipulat ing t he NI C r ules by paying himself in such a way as t o minimise his NI C f or t he year . Illustration 2

Let us t ake t he f igur es in t he pr evious illust r at ion but t his t ime assume t hat t he salar y, t he car benef it and t he Chr ist mas bonus ar e accr uing t o a dir ect or r at her t han a nor mal employee.

To calculat e t he dir ect or ’s NI C we need t o aggr egat e his ear nings f or t he whole of t he t ax year and compar e t o t he annual limit s.

Annual ear nings £ (18,000 + 5,000) = £ 23,000 Class 1 pr imar y NI C £ (23,000 – 5,035) @ 11% £1,976

We see her e t hat , unlike as wit h t he employee in t he pr evious illust r at ion, none of t he dir ect or ’s ear nings will at t r act t he 1% r at e of NI Cs and f or t his r eason it t ends t o be mor e expensive f r om an NI C per spect ive t o be a dir ect or r at her t han a nor mal employee.


381

D11.6 Class 1 Secondary contributions

Class 1 secondar y cont r ibut ions ar e paid by employer s on any ear nings paid t o employees. The cur r ent r at e of Class 1 secondar y cont r ibut ions is zer o per cent on ear nings up t o t he ear nings t hr eshold and 12.8% on t he excess. The weekly, mont hly and annual ear nings t hr esholds are t he same f or employer s as t hey ar e f or employees.

s.9

Nil 12.8% £ 0 £ 97 pw £ 420 pm £ 5,035 pa You will also not e t wo t hings her e. The f ir st is t hat t he rate of NIC is higher

for employers than for employees – i.e. 12.8% as opposed to 11%. The second t hing t o not e is t hat t her e is no upper earnings limit f or employer ’s cont r ibut ions, i.e. t he 1% r at e does not apply f or employer s. So f or ever y one pound of ear nings paid t o an employee above t he ear nings t hr eshold, t he employer will have t o pay 12.8 pence in Nat ional I nsur ance Cont r ibut ions.

This is a subst ant ial cost f or employer s t o have t o bear and, ef f ect ively, adds near ly anot her 12.8% t o t heir t ot al wages bill. I n t he case of an employee or dir ect or ear ning £ 23,000 per year , t he secondar y liabilit y t o be paid by t he employer is:

£ (23,000 – 5,035) @ 12.8% = £ 2,300

Employer secondar y cont r ibut ions begin wit h ef f ect f r om t he employee’s 16t h bir t hday but t her e is no upper age limit . So if a salar y is paid t o an employee who is 68 year s old, t he employee will have no Class 1 pr imar y liabilit y but t he employer will st ill have t o pay Class 1 secondar y cont r ibut ions at 12.8%.

D11.7 State Second Pension

When we calculat ed t he employee’s Class 1 NI C liabilit y in t he pr evious illust r at ions, we did so on t he assumpt ion t hat t he employee had not “cont r act ed out ” of t he St at e Second Pension. The St at e Second Pension pr ovides individuals wit h an Addit ional St at e Pension. The amount of t he pension r elat es t o t he ear nings of t he employee but is mor e gener ous f or t he low paid. I t is possible f or an employee to contract out of the State Second Pension and if he does so, he is inf or ming t he Gover nment t hat he will make his own pension ar r angement s. Ther e ar e cer t ain advant ages f r om an NI C point of view of cont r act ing out of t he St at e Second Pension.


I f an employee cont r act s out of t he St at e Second Pension and inst ead has an occupat ional pension scheme wit h his employer , t hat employee will get a 1.6% r ebat e on his Nat ional I nsur ance Cont r ibut ions. This means t hat t he r at e of NI C he will pay f alls f r om 11% t o 9.4%. I f an employee cont r act s out of t he St at e Second Pension and has a per sonal pension, t he employee will cont inue t o pay NI C at t he normal rate of 11% but

t he Nat ional I nsur ance Cont r ibut ions Of f ice will then take the rebated amount

of 1.6% and redirect it into the employee’s personal pension scheme.

Wher e an employee has cont r act ed out of t he St at e Second Pension, employer ’s secondar y cont r ibut ions bet ween t he ear nings t hr eshold and t he upper ear nings limit will be 9.3% as opposed t o 12.8%.

D11.8 Overseas aspects

Per sons (individuals or companies) ar e not r equir ed t o pay Class 1 NI Cs unless t hey ar e “r esident or pr esent ” in Gr eat Br it ain.

s. 1(6)

Gr eat Br it ain means England, Scot land and Wales (i.e. not Nor t her n I r eland) alt hough t he det ailed r egulat ions in SI 2001/ 1004 (par agr aph 145 onwar ds) do ext end t hese pr ovisions t o Nor t her n I r eland. For t he r est of t his session, we shall use t he t er m “UK”. Class 1 pr imar y cont r ibut ions ar e payable by employees who ar e eit her - resident, or - present, or - ordinarily resident

in t he UK. Secondar y cont r ibut ions ar e payable by employer s who ar e r esident or pr esent in t he UK when cont r ibut ions become payable or who have a place of business in t he UK at t hat point . “Residence” and “or dinar y r esidence” ar e not separ at ely def ined f or NI C and will t her ef or e t ake t he meaning as out lined in t he Revenue’s booklet I R20 (i.e. as f or income t ax). The t er m “pr esent ” is similar ly undef ined but has a looser int er pr et at ion t han f or mal “r esidence”. Any quest ions as t o whet her an employed ear ner is “pr esent ” in t he UK will be dealt wit h on a case by case basis. For employees coming t o t he UK or leaving t he UK, t he Class 1 NI C posit ion can be complex and depends lar gely on whet her t he UK has a reciprocal social

security agreement wit h t he ot her count r y. As a gener al r ule, social secur it y agr eement s t r y t o ensur e t hat an employee pays “social secur it y” (i.e. NI C) only in t he count r y in which he is act ually employed. The UK has such r ecipr ocal agr eement s wit h EU count r ies and wit h ot her count r ies such as t he USA.


383

Pr oblems only t her ef or e t end t o ar ise if an employee is going t o or coming f r om a “non r ecipr ocal” count r y. (i) Leaving t he UK

I f an employee leaves t he UK t o t ake up employment abr oad, liabilit y t o pay Class 1 NI Cs can continue for a period of 52 weeks f r om t he dat e of depar t ur e. Class 1 secondar y liabilit ies will also cont inue. This “52 week NIC extension” will only apply if SI 2001/ 1004

par a 146

- t he employer has a place of business in t he UK; and - t he employee is or dinar ily r esident in t he UK; and - immediat ely pr ior t o commencing employment abr oad t he

employee was r esident in t he UK. Ther ef or e t he 52 week NI C ext ension will t ypically apply t o employees wor king over seas f or shor t per iods. I f an employee leaves t he UK t o t ake up per manent employment abr oad, he would be t r eat ed as not or dinar ily r esident and liabilit y t o pay Class 1 NI C would cease at t he dat e t he UK employment ceased. Any employee not paying Class 1 NI Cs is ent it led t o make voluntary Class 3 contributions in order to preserve entitlements to state benefits

et c. (ii) Coming t o t he UK SI 2001/ 1004

par a 145(2)

Wher e an employed ear ner comes t o t he UK, one of t wo t hings will happen f or NI C pur poses: 1. I f t he employee comes t o t he UK f r om a count r y wit h which t he UK

has a r ecipr ocal agr eement , Class 1 NI Cs (pr imar y and secondar y) will eit her commence from the date of arrival, or t he employee will continue to pay contributions in the home country. The t r eat ment depends on how long t he employee is st aying in t he UK and on t he t er ms of t he r ecipr ocal agr eement .

2. I f t he employee comes t o t he UK f r om a count r y wit h which t he UK

has no r ecipr ocal agr eement , pr oviding t hat - t he employee is not or dinar ily r esident in t he UK; and - t he employment is mainly out side t he UK wit h an employer whose

place of business is out side t he UK; no Class 1 NICs are payable for 52 weeks f ollowing t he employee’s ar r ival.

This “52 week NIC holiday” would most commonly apply t o employee’s wor king t empor ar ily in t he UK f or an over seas employer .

Af t er 52 weeks, Class 1 pr imar y and secondar y cont r ibut ions will become payable in t he usual way.


D11.9 NIC administration

NI Cs ar e dealt wit h on a day t o day basis by t he National Insurance

Contributions Office (NICO). The collect ion and payment of Class 1 NI Cs is t he r esponsibilit y of t he employer under t he PAYE r egulat ions. I f an employer f ails t o comply wit h t he r egulat ions, not ices under Sch 4 SI 2001/ 1004 can be issued t o r ecover any NI Cs under paid.

SI 2001/ 1004

Reg 67

S.203

Class 1 NI Cs ar e due f or payment wit hin 14 days of t he end of t he income t ax mont h. Quarterly payments can be made if t he income t ax and NI C t o be account ed f or is less than £1,500 per month on average.

Sch 4 Par a 10

I nt er est is char ged on Class 1 cont r ibut ions paid lat e. The r ules f or char ging int er est ar e gener ous in t hat int er est will only st ar t t o accr ue f r om t he “r eckonable dat e” which is 14 days af t er t he end of t he t ax year f or which t he NI Cs wer e due. Ther ef or e f or NI Cs paid lat e in 2006/ 07, int er est will only st ar t t o r un f r om 19 Apr il 2007.

Sch 4 Par a 17

Det ails of Class 1 pr imar y and secondar y NI Cs payable must be included on t he employer ’s end of year summar y (f or m P35). Penalt ies f or lat e or incor r ect f or ms P35 ar e as f or income t ax (see Chapt er 22). Penalties cannot be charged twice for tax and NIC failures in respect of the same form(s). Taxpayer s have a r ight of appeal against any assessment of nat ional insur ance cont r ibut ions, and t he appeals pr ocedur e is laid out in t he Social Secur it y Act (SSA) 1998. The NI C appeals pr ocedur e f ollows t hat f or income t ax. Appeals ar e made in t he f ir st inst ance t o t he Of f icer of Revenue and Cust oms and, if no agr eement can be r eached, t he appeal will be list ed f or hear ing bef or e t he Gener al (or Special) Commissioner s. Appeals against a Commissioner s decision can only be made on a point of law and such appeals will t her eaf t er be r ef er r ed by a “case st at ed” t o t he High Cour t , Cour t of Appeal and f inally t he House of Lor ds. The power s of Of f icer s t o enf or ce collect ion of NI Cs and t o obt ain inf or mat ion pur suant t o t he assessment and collect ion of NI Cs ar e cont ained at s.109A – s.109C Social Secur it y Administ r at ion Act (SSAA) 1992. These pr ovisions give Of f icer s t he r ight t o

- issue not ices t o any per son r esponsible f or t he payment of NI Cs (and cer t ain ot her per sons such as t r ader s, local aut hor it ies, agent s or t r ust ees), r equir ing t hat per son t o pr ovide inf or mat ion as specif ied in t he not ice which t he Of f icer may “r easonably r equir e”; and


385

- ent er any pr emises t o eit her examine t he pr emises or conduct any enquir y t her e as “appear s t o him appr opr iat e”. Such pr emises may include places of employment or ot her pr emises as list ed in s. 109C. The Of f icer must , if r equir ed, pr oduce a cer t if icat e of aut hor isat ion.

Wher e a per son f ails t o pr oduce inf or mat ion as specif ied in a not ice or “int ent ionally delays or obst r uct s an Of f icer in t he exer cise of any power ”, a penalt y will be char ged. This penalt y is up t o £ 1,000 plus up t o £ 40 per day t her eaf t er if t he f ailur e cont inues. A f ine of up t o £ 5,000 (or up t o 3 mont hs impr isonment in ser ious cases) can be char ged on any per son who knowingly makes a f alse st at ement or knowingly pr oduces f alse document s, inf or mat ion or ot her mat er ial. Penalt ies ar e also imposed by s. 113 and s. 114 SSAA 1992 f or br eaches of NI r egulat ions or f r audulent evasion of NI Cs.

Example 1

Which of t he f ollowing f or ms of r emuner at ion ar e ear nings f or Class 1 NI C pur poses?

a) I nt er est f r ee loan b) £ 5,000 of pr emium bonds c) £ 20,000 of gold bullion d) J ohn Lewis st or e voucher e) Reimbur sement of home t elephone calls f ) Reimbur sement of business expenses

Example 2

Har r y is an employee ear ning £ 26,000 per year . He is paid weekly and in Mar ch 2007 he r eceived a bonus of £ 1,000. Calculat e his Class 1 NI C due f or 2006/ 07.


Answer 1

Ear nings? a) I nt er est f r ee loan X (No NI Cs on benef it s) b) £ 5,000 of pr emium bonds X (Sur r ender ed f or cash) c) £ 20,000 of gold bullion X (Readily conver t ible asset ) d) J ohn Lewis st or e voucher X e) Home t elephone bill X (Set t lement of employee’s

liabilit y) f ) Reimbur sed business expenses X

Answer 2

Ear nings: 51 weeks @ £ 500 1 week @ £ 1,500 NI C: £ £ (500 – 97) @ 11% x 51 2,261 £ (645 – 97) @ 11% x 1 60 £ (1,500 – 645) @ 1% x 1 9 Tot al £2,330


387

SUMMARY - CLASS 1 NATIONAL INSURANCE

Class 1 cont r ibut ions ar e paid by bot h employees (pr imar y cont r ibut ions) and employer s (secondar y cont r ibut ions) on ear nings f r om employment . Ear nings include:

Cash payment s (ot her t han r eimbur sement of genuine business expenses) Payment s in kind t hat can be sur r ender ed f or cash Readily conver t ible asset s Set t lement of employee’s per sonal liabilit y Voucher s (except childcar e) Cer t ain shar e opt ion r ewar ds

The calculat ion of Class 1 pr imar y cont r ibut ions is done f or an ear nings per iod f or employees. The weekly limit s ar e:

Fir st £ 97 no NI C £ 97 - £ 645 11% Above £ 645 1%

Mont hly limit s ar e obt ained by mult iplying by dividing t he annual limit s by 12. The cont r ibut ions st ar t at age 16 and st op at r et ir ement age (65 f or men, 60 f or women). For a dir ect or an annual ear nings per iod must be used. Class 1 secondar y cont r ibut ions ar e at 12.8% on t he excess above t he ear nings t hr eshold. The cont r ibut ions st ar t at 16 but t her e is no upper age limit . I f t he employee cont r act s out of t he Second St at e Pension, a lower r at e of NI C will be payable. Class 1 NI C is only payable in r espect of employees who ar e r esident , pr esent or or dinar ily r esident in t he UK. For employees coming t o or leaving t he UK, t he Class 1 NI C posit ion will be gover ned by a r ecipr ocal social secur it y agr eement if t he UK has one wit h t he ot her count r y. I f t her e is no r ecipr ocal agr eement t her e may be a 52 week NI C ext ension f or leaver s and a 52 week NI C holiday f or ar r iver s depending on t he cir cumst ances. NI CO is par t of HM Revenue and Cust oms and is r esponsible f or t he administ r at ion of NI C. The due dat es, int er est and penalt y posit ion essent ially mir r or s t hat f or PAYE.

D12: CLASS 1A AND 1B NATIONAL INSURANCE CONTRIBUTIONS

I n t his chapt er you will cover t he t wo f ur t her classes of NI C payable by employer s including: - Class 1A NI C; - Class 1B NI C; - PAYE set t lement agr eement s.

All r ef er ences in t his chapt er ar e t o SSCBA 1992 unless ot her wise st at ed.

D12.1 Introduction

Class 1A NI C is paid by employers only. Employees do not pay Class 1A Nat ional I nsur ance.

s. 10

Class 1A NI C is paid by employer s on t he cash equivalent of benefits as t hey appear on t he f or m P11D. As Class 1A NI C is t he liabilit y of t he employer , it is char ged at t he employer ’s r at e of 12.8%. Payment is made in one sum on 19 J uly f ollowing t he end of t he t ax year . This is deliber at ely t imed so as t o be t wo weeks af t er t he submission of t he f or m P11D t o t he Revenue. So having ar r ived at t he cash equivalent of t he benef it , it is easy f or t he employer t o t hen go ahead and calculat e his Class 1A NI C liabilit y. Class 1B is also paid by employers only. Class 1B NI C is char ged on ear nings which ar e included wit hin a Pay As You Ear n Set t lement Agr eement (PSA). We will look at PSAs lat er in t his session. The r at e of NI C is 12.8%. Class 1B NI C is collect ed annually on 19 Oct ober f ollowing t he end of t he t ax year .

s. 10A

D12.2 Class 1A

Ther e is no Class 1A char ge if t her e is no associat ed income t ax liabilit y. This means t hat exempt benef it s such as a mobile phone, a wor k car par king space, or exclusive nur ser y et c, will not be char ged t o Class 1A NI C. The £ 50 exempt ion f or ot her t ypes of childcar e applicable t o income t ax also applies t o Class 1A NI Cs. Similar ly, if benefits ar e pr ovided to lower paid employees – i.e. employees ear ning less t han £ 8,500 per annum – no P11D will be pr epar ed by t he employer so accor dingly t her e is no liability to Class 1A Nat ional I nsur ance Cont r ibut ions. I f a payment in kind is cat egor ised as ear nings, and as such is char ged t o NI C under t he nor mal Class 1 r ules, t hat benef it will not be char ged on t he employer under Class 1A.

Class 1A and 1B Nat ional I nsur ance Cont r ibut ions

389

Ther ef or e if an employer pr ovides an employee wit h benef it s such as pr emium bonds or r eadily conver t ible asset s or High St r eet st or e voucher s, t he employer will have t o pay Class 1 secondar y cont r ibut ions on t hose benef it s because t hey ar e classif ied as ear nings. The employer will not have t o pay Class 1A as well. As we shall see lat er , if a benef it is char ged t o Nat ional I nsur ance under Class 1B, t his also t akes pr ior it y over Class 1A. Finally, if an employer r eimbur ses genuine business expenses t o an employee, as t his is not a t axable benef it , it will not give r ise t o a Class 1A NI C char ge.

Illustration 1

An employee r eceives t he f ollowing r emuner at ion package f or 2006/ 07:

£ Salar y (paid mont hly) 24,000 Company car benef it 4,200 Medical insur ance benef it 600 High st r eet st or e voucher (awar ded December 2006) 200 Cash bonus (Mar ch 2007) 10,000

To calculat e t ot al Nat ional I nsur ance Cont r ibut ions payable f or t he t ax year , we f ir st calculat e t he Class 1 pr imar y cont r ibut ions payable by t he employee on his ear nings. We t hen move on t o calculat e t he Class 1 secondar y cont r ibut ions paid by t he employer on ear nings given t o t he employee. The f inal Nat ional I nsur ance will be t he Class 1A NI C’s payable by t he employer on t he benef it s awar ded t o t he employee.

We st ar t wit h t he Class 1 pr imar y cont r ibut ions. The employee is paid mont hly so he has a mont hly ear nings per iod. For 10 mont hs of t he year he ear ns a salar y of £ 2,000. I n December 2006, he is given a High St r eet st or e voucher . This is r egar ded as ear nings f or Class 1 NI C pur poses so his ear nings f or December 2006 go up t o £ 2,200. Due t o t he cash bonus of £ 10,000 paid in Mar ch 2007, f or t his mont h his ear nings in t he per iod go up t o £ 12,000.

Ear nings: 10 mont hs @ £ 2,000 1 mont h @ £ 2,200 1 mont h @ £ 12,000

Employees pay Class 1 Nat ional I nsur ance Cont r ibut ions at 11% on mont hly ear nings bet ween t he ear nings limit s and at 1% above t he upper ear nings t hr eshold. The mont hly ear nings t hr eshold f or 2006/ 2007 is £ 420 and t he mont hly upper ear nings limit is £ 2,795.


£ Class 1 pr imar y £ (2,000 – 420) @ 11% x 10 mont hs 1,738 £ (2,200 – 420) @ 11% x 1 mont h 196 £ (2,795 – 420) @ 11% x 1 mont h 261 £ (12,000 – 2,795) @ 1% x 1 mont h 92 £2,287

Next we move on t o Class 1 secondar y cont r ibut ions. Tot al ear nings f or t he year ar e t he salar y of £ 24,000, t he st or e voucher s of £ 200 and t he bonus of £ 10,000. Tot al ear nings, subj ect t o secondar y cont r ibut ions in t he year , ar e t her ef or e £ 34,200. As t her e is no upper ear nings limit f or secondar y cont r ibut ions, all ear nings in excess of t he ear nings t hr eshold will be char ged t o NI C at t he r at e of 12.8%. Class 1 secondar y £ (34,200 – 5,035) @ 12.8% £3,733

Finally, we calculat e t he Class 1A liabilit y. The car benef it is £ 4,200. The only ot her benef it which will appear on t he P11D f or t he year is t he medical insur ance of £ 600. We add t his on t o give us t ot al t axable benef it s f or t he year of £ 4,800.

Class 1A £ 4,800 @ 12.8% £614 I n summar y t he f ollowing NI Cs ar e due:

Class 1 primary £2,287 Collect ed mont hly via PAYE syst em Class 1 secondary £3,733 Collect ed mont hly via PAYE syst em Class 1A £614 Paid dir ect ly t o NI CO on 19 J uly 2007

This example demonst r at es t he int er act ion bet ween Class 1 pr imar y and secondar y cont r ibut ions and Class 1A NI C. What it also shows is t hat t he NI C bur den is much heavier on employer s t han on employees. This is par t ly because t her e is no upper ear nings limit f or employer s and also because employees do not have t he bur den of Class 1A cont r ibut ions.

D12.3 Class 1B contributions

To under st and Class 1B cont r ibut ions we f ir st need t o discuss exact ly what we mean by t he t er m Pay As You Earn Settlement Agreement (PSA). For t hose of you who have access t o t he t ax st at ut es, it is cer t ainly wor t h t aking a look at St at ement of Pr act ice Number 5 of 1996 (SP 5/ 96) in which t he I nland Revenue ver y clear ly set out what can and what cannot be included wit hin a PAYE Set t lement Agr eement .

s.703 I TEPA 2003


391

The whole idea of a PSA is t o allow an employer to settle an employee’s tax

liability on minor or irregular benefits. A common example of an ir r egular benef it which could be encompassed wit hin a PSA, would be a st af f Chr ist mas par t y cost ing in excess of t he t ax-f ree t hr eshold of £ 150 per per son. I f an employer pr ovides a Chr ist mas par t y t o an employee, and t he cost of t he par t y is less t han £ 150 per employee, t his is an exempt benef it . However , if t he cost exceeds £ 150, t he employee has a t axable benef it on t he whole cost . I t is t her ef or e cust omar y, as a gest ur e of goodwill, f or t he employer t o meet any t ax liabilit ies ar ising t o employees. The employer will do t his by negot iat ing a t ax set t lement wit h t he Revenue.

The Revenue has also conf ir med t hat PSAs ar e accept able in inst ances wher e it is impr act ical f or t he employer t o be able t o apply Pay As You Ear n t o a par t icular emolument . SP 5/ 96 clear ly st at es t hat Pay As You Ear n Set t lement Agr eement s should not be used as a vehicle f or set t ling t ax liabilit ies on cash payment s or on maj or benef it s such as company car s or low int er est loans et c.

I f t ax on a par t icular benef it is included wit hin a PSA, t hat benef it does not t hen have t o be ent er ed on t o f or m P11D. Similar ly, t he employee will not have t o ent er t he cash equivalent of such benef it s on t o his own Self Assessment Tax Ret ur n. This is because someone else – ie, t he employer - will pay t he t ax. Having agr eed t hat it ems can be included wit hin t he PSA, t he Revenue will t hen negot iat e t he t ax liabilit y wit h t he employer and t he employer will pay t he t ax on a gr ossed up basis.

Illustration 2

A company has 100 employees. I t holds a Summer Ball and t he t ot al cost of t hat f unct ion is £ 20,000, ie exact ly £ 200 per head. Technically each employee will t her ef or e have a benef it of £ 200 as t he cost of t he par t y exceeds t he £ 150 per head t hr eshold. However , as a gest ur e of goodwill, t he company agr ees t o meet t he t ax liabilit ies via a Pay As You Ear n Set t lement Agr eement . Of t he employees, 50 of t hem pay t ax at t he basic r at e of 22%, whilst 50 of t hem pay t ax at t he higher r at e of 40%. I n or der t o wor k out t he amount of t ax t o be paid by t he employer under t he PSA, consider t he basic r at e employees f ir st . Each employee will have a benef it of £ 200. This is a “net ” benef it because t he employee is deemed t o have r eceived a benef it of £ 200 after t he t ax has been set t led by t he employer . To calculat e t he t ax on t his net benef it , as we ar e dealing wit h a basic r at e employee, we need t o mult iply t he net f igur e of £ 200 by 22 over 78. This gives us t ax of £ 56 and gives r ise t o a gr oss benef it of £ 256. I f you wor k t his back, you will see t hat t he gr oss benef it of £ 256 mult iplied by t he basic r at e of t ax of 22% gives a t ax char ge of £ 56.


Basic r at e employee: £

Net benef it 200

Tax @ 2278

56

Gr oss benef it £256

For each higher r at e employee, again we st ar t wit h t he net benef it of £ 200. This t ime we ar r ive at t he t ax by mult iplying t he net benef it by 40/ 60 t o give t ax of £ 133. The gr oss benef it in t his inst ance is £ 333. Again we can check t his by t aking t he gr oss benef it of £ 333 and mult iplying it by t he higher r at e of 40% t o give t ax of £ 133.

Higher r at e employee: £ Net benef it 200

Tax @ 4060

133

Gr oss benef it £333

To f inish t he example, we need t o calculat e t he t ot al t ax t o be included in t he PSA:

Tax in PSA £ 50 employees @ £ 56 2,800 50 employees @ £ 133 6,650 £9,450

Whenever t ax is set t led under a PAYE set t lement agr eement , t he employer also needs t o consider t he impact of Class 1B Nat ional I nsur ance. Class 1B NI C is char ged on benef it s included wit hin a PSA. I ncluded wit hin t he PSA is t he t ot al cost of t he st af f f unct ion - i.e. £ 20,000. We t hen need t o add on any income t ax t hat has been included wit hin t he PSA – i.e. any income t ax paid by t he employer on behalf of it s employees. Class 1B Nat ional I nsur ance is char ged at t he employer ’s r at e of 12.8%.

£ Ear nings wit hin PSA 20,000 I ncome t ax payable 9,450 29,450 Class 1B NI C @ 12.8% £3,770

Class 1B is t he employer’s liability only and t he due date for payment is 19

October following the end of the tax year.


393

At f ir st sight t his may appear a lit t le har sh, in t hat as well as paying income t ax of £ 9,450, t he employer also has t o pay Nat ional I nsur ance at 12.8% on t he income t ax paid. This is because t he income t ax of £ 9,450 is st r ict ly t he liabilit y of t he employees, so what t he employer is doing is set t ling t he employees’ per sonal liabilit y. We know t hat if an employer set t les an employee’s liabilit y under nor mal cir cumst ances, t her e will be a char ge t o Class 1 secondar y cont r ibut ions. Her e t he char ge is under Class 1B inst ead.

Example 1

Nor man r eceives t he f ollowing non-cash benef it s f r om his employer , Techno plc. Techno plc is a company list ed on t he UK st ock exchange.

a) Company car and f uel b) I nt er est f r ee loan of £ 4,000 c) 500 shar es in Techno plc d) £ 100 high st r eet st or e voucher e) Cont r ibut ions t o company pension scheme f ) Member ship of local gym. Which of t he above ar e subj ect t o Class 1A NI C?

Example 2

Br ian is awar ded a holiday t o Flor ida by his employer . The holiday cost £ 3,000 and t he company agr ee t o pay t he t ax on Br ian’s behalf via a PSA. Br ian is a salesman ear ning £ 20,000 per annum. Calculat e t he Class 1B NI C liabilit y f or t he employer .


Answer 1

Class 1A? a) Company car and f uel X P11D it em b) I nt er est f r ee loan of £ 4,000 X Exempt as <£ 5,000 c) 500 shar es in Techno plc X Class 1 applies d) High st r eet st or e voucher X Class 1 applies e) Pension cont r ibut ions X Exempt f ) Local gym member ship X P11D it em

Answer 2

£ Ear nings cover ed by PSA 3,000

Tax @ 2278 (basic r at e t axpayer )

846

£ 3,846 Class 1B NI C @ 12.8% £492


395

SUMMARY - CLASS 1A AND 1B NATIONAL INSURANCE

Class 1A is paid by employer s on benef it s t hat ar e on t he P11D. The r at e is 12.8% and t he due dat e is 19 J uly f ollowing t he t ax year . Class 1A is not paid on benef it s which have alr eady been char ged t o Class 1 secondar y NI C. Also Class 1B t akes pr ior it y over Class 1A. Class 1B is payable on benef it s included in and t ax set t led under a PAYE set t lement agr eement (PSA). The r at e is 12.8% and t he due dat e is 19 Oct ober f ollowing t he t ax year . PSAs ar e used by employer s t o set t le t he t ax on minor or ir r egular benef it s or wher e it would be impr act ical t o apply PAYE. A gr ossing up exer cise must be done t o f ind t he t ax payable.

D13: TERMINATION PAYMENTS

I n t his chapt er you will cover t he way in which t er minat ion payment s ar e t axed including: - f ully t axable payment s; - f ully exempt payment s; - par t ially t axable payment s; - f or eign ser vice; - st at ut or y r edundancy pay; - employees appr oaching r et ir ement age; - payment s in lieu of not ice; - NI C implicat ions.

St at ut or y r ef er ences ar e t o I TEPA 2003 unless st at ed ot her wise.

D13.1 Introduction

Typical t er minat ion payment s will include compensation for loss of office, redundancy payment s, damages f or dismissal, payments in lieu of notice – “PI LONs” – and cer t ain payment s made on r et ir ement .

s.401- s.416

Ter minat ion payment s will eit her be f ully t axable, par t ially t axable, or f ully exempt depending on t he nat ur e of t he payment .

The st at ut or y r ules concer ning t er minat ion payment s ar e cont ained at Sect ions 401 onwar ds I TEPA 2003. To under st and t he t axat ion of t er minat ion payment s we must f ir st r emind our selves of a couple of basic pr inciples. I TEPA 2003 dif f er ent iat es bet ween “gener al ear nings” and “specif ic employment income”. “Gener al ear nings” ar e def ined in s.7(3) as earnings and any amount

treated as earnings (such as benef it s under t he benef it s code). “Ear nings” ar e br oadly def ined in s.62 I TEPA 2003 as salar ies, wages and benef it s (in money or money’s wor t h), or anyt hing else t hat const it ut es an emolument of t he employment . I n a number of decided t ax cases it has been held t hat emolument s ar e “of t he employment ” if t hey ar e given t o t he employee in return for services per f or med under t he employment cont r act . Ther ef or e, in gener al t er ms, payment s made by an employer t o an employee which ar e not in r et ur n f or ser vices per f or med, will not be classed as “general earnings” under I TEPA 2003. This gener al pr inciple is impor t ant as f ar as t er minat ion payment s ar e concer ned, because a t er minat ion payment will gener ally compensat e t he employee f or loss of of f ice r at her t han being any sor t of r ewar d f or ser vices per f or med.

Ter minat ion Payment s

397

As such, most termination payments are not regarded as earnings f r om an employment and ar e t her ef or e taxed in a completely different way t o ot her ear nings such as salar ies and bonuses. I nst ead, t er minat ion payment s will gener ally f all int o t he cat egor y of “specif ic employment income” and will be t axed under t he pr ovisions of s.401 onwar ds I TEPA 2003.

D13.2 Does Section 401 apply?

This is an impor t ant quest ion because t her e ar e cer t ain exemptions and reliefs available wit hin t he legislat ion dealing wit h t er minat ion payment s which would not apply if t he payment wer e t o be t r eat ed as “gener al ear nings” under s.62. Your st ar t ing point should be t o ask yourself whether the termination

payment is contractual. I f t he employment cont r act cont ains a clause under which t he employee has a legal r ight t o r eceive a t er minat ion payment , t he t er minat ion payment will be r egar ded as ear nings f r om t he employment and will be t axed in f ull.

When t her e is any doubt about t he t axat ion of a t er minat ion payment , t he Revenue will ask t o see t he employment cont r act t o see if any r ef er ence is made t o t er minat ion payment s. I f t her e is, t he payment will be r egar ded as being made in r et ur n f or ser vices and will be f ully char ged t o t ax. I f t he cont r act is silent and makes no ment ion of t er minat ion payment s, if t he Revenue can pr ove t hat t her e was “reasonable expectation” on t he par t of t he employee t hat he would r eceive a t er minat ion payment , t he payment will be t axed in f ull. I t can be dif f icult f or t he Revenue t o pr ove t hat an employee expect ed t o r eceive a t er minat ion payment . The Revenue Of f icer will look back at past pr act ice and pr evious policy of t he employer t o see if ot her employees in a similar posit ion r eceived t er minat ion payment s.

I f a termination payment is made outside the employment contract and is t ot ally volunt ar y – ie, t he employee had no expect at ion what soever t hat he was t o r eceive such a payment – t his does not mean t hat t he payment is tax free. I t simply means t hat t he payment will be taxed under Section 401 which is t he sect ion t hat specif ically deals wit h t he t axat ion of genuine t er minat ion payment s. S.401(3) says t hat “t his chapt er does not apply t o any payment or ot her benef it char geable t o income t ax apar t f r om t his chapt er ”. This means t hat if a payment is char ged t o t ax somewhere else in t he legislat ion, Sect ion 401 will not apply. For example, if a payment is t r eat ed as gener al ear nings f r om t he employment it will be t axed as ear nings under t he def init ion in Sect ion 62 which will t ake pr ior it y over Sect ion 401.


This means t hat Sect ion 401 only applies t o non-cont r act ual or “ex gratia” payment s. Ex gr at ia her e lit er ally means “t hank you” – ie, t he payment is ent ir ely voluntary and without any obligation on t he par t of t he employer .

D13.3 Fully exempt payments

Cer t ain payment s f alling wit hin Sect ion 401 ar e f ully exempt f r om t ax. A termination payment made on the death of an employee is f ully exempt f r om t ax. Similar ly, wher e t he employment has been t er minat ed due t o t he injury or disability of t he employee, any subsequent compensat ion payment is exempt f r om t ax.

s.406

I f an employer makes a payment to a tax-exempt pension scheme or appr oved per sonal pension ar r angement s as par t of t he t er minat ion package, t his is also completely free of tax. Making a t er minat ion payment t o such pension schemes, r at her t han t o t he employee dir ect ly, is ver y ef f ect ive t ax planning and is commonly used in pr act ice.

s. 408

Finally f ull exempt ion f r om t ax is given in inst ances wher e t he employee has a subst ant ial amount of f or eign ser vice. We shall look at f or eign ser vice exempt ions lat er on in t his chapt er .

s.413 s.414

D13.4 Partially taxable payments

The most impor t ant r ule as f ar as t er minat ion payment s ar e concer ned is t he £ 30,000 r ule. Sect ion 403(1) says t hat t er minat ion payment s ar e only char ged t o t ax t o t he ext ent t hey exceed £ 30,000. This means t hat t he first £30,000 of a genuine termination payment is tax free.

s. 403(1)

The £ 30,000 exempt ion only applies t o payment s which ar e t axable under Sect ion 401. This means t hat t his t ax f r ee amount only applies t o genuine ex gr at ia compensat ion payment s such as r edundancy or compensat ion f or loss of of f ice. I t does not apply wher e t he employee has a cont r act ual r ight t o r eceive t he t er minat ion payment . I f mor e t han one t er minat ion payment is made t o t he same employee, t he £ 30,000 exempt ion applies t o t he aggr egat e of all payment s. I f t er minat ion payment s ar e st agger ed so t hat t he employee r eceives t hem in dif f er ent t ax year s, t he £ 30,000 exempt ion applies t o t he ear lier payment f ir st .

s.404(4)

I f a t er minat ion payment exceeds £ 30,000 so t hat some of it will be char geable t o t ax, t hat excess must be t axed at sour ce under PAYE. I f t he t er minat ion payment is made before the employer issues the form P45, income t ax must be deduct ed f r om t he excess under PAYE using t he employee’s tax code. I f , however , t he t er minat ion payment is made after the form P45 has been

issued t o t he employee, t ax is deduct ed on t he excess over £ 30,000 at t he basic rate of 22% only.


399

I f an employer is uncer t ain as t o whet her t he £ 30,000 exempt ion applies, he can apply to the Inland Revenue for clearance. I t is ext r emely impor t ant t hat t he employer oper at es PAYE cor r ect ly as it is t he employer , and not t he employee, who is pr imar ily r esponsible f or paying any t ax which has been under deduct ed.

D13.5 Foreign service s.413 & s.414

Exempt ion f r om t ax can apply t o t er minat ion payment s wher e t he employee has f or eign ser vice. Wher e an employee has wor ked over seas and t hat employee r eceives an “ex gr at ia” t er minat ion payment , one of t wo t hings will happen. The t er minat ion payment will eit her be f ully exempt f r om t ax, or it will be par t ially exempt . The full exemption r ules ar e quit e complex. I f foreign service is at least three quarters of total service, t he t er minat ion payment is completely tax

free. Ther ef or e, if an employee has been in ser vice f or 10 year s, and has spent 8 of t hose 10 year s abr oad, f or eign ser vice compr ises mor e t han t hr ee-quar t er s of t ot al ser vice so t he t er minat ion payment is f ully exempt .

s.413(1)

I f t his r ule is not sat isf ied we move down t o t est number 2. This says t hat if total service has exceeded 10 years and the last 10 years of the employee’s

service has been spent abroad, t he whole of t he t er minat ion payment is exempt

from tax. I f neit her t est 1 nor t est 2 have been sat isf ied, we f inally move on t o t est number 3. This says t hat if total service has exceeded 20 years, any t er minat ion payment is tax free if at least half of total service has been spent abroad, including 10 of the last 20 years. These t hr ee r ules ar e dif f icult t o r emember but t hey ar e list ed in S.413(1). I f none of t he t hr ee t est s has been sat isf ied, t hen only t he f or eign ser vice par t of t he t er minat ion payment will be exempt f r om t ax.

s.414

Illustration 1

William was made r edundant in Mar ch 2007 and he r eceived an ex gr at ia t er minat ion payment of £ 150,000. William had wor ked f or t he company f or t he last 30 year s as below:

Year s Mar ch 1977 t o Mar ch 1983 London 6 Mar ch 1983 t o Mar ch 1999 Par is 16 Mar ch 1999 t o Mar ch 2007 London 8 Tot al 30

I n or der t o wor k out how much of t he t er minat ion payment is char geable t o t ax, we need t o apply t he t hr ee f or eign ser vice t est s t o see whet her t he t er minat ion payment is f ully exempt .


The f ir st t est is whet her f or eign ser vice exceeds t hr ee quar t er s of t ot al ser vice. Her e t he answer is quit e clear ly “no” because f or eign ser vice is 16 year s and t ot al ser vice is 30 year s.

The second t est says t hat t he payment will be f ully exempt if t ot al ser vice exceeded 10 year s and t he whole of t he last 10 year s was spent out side t he UK. Again, t his is quit e clear ly not t he case as t he last 8 year s of William’s ser vice was spent in London.

The t hir d t est only applies if t ot al ser vice exceeds 20 year s which is t he case her e. Ther e ar e t wo mor e condit ions t o sat isf y, t he f ir st being t hat f or eign ser vice must be at last 50% of t ot al ser vice. For eign ser vice her e is 16 year s and t ot al ser vice is 30 year s so t his 50% condit ion is sat isf ied. Finally her e, we need t o check whet her f or eign ser vice makes up 10 of t he last 20 year s. I f you look back at t he last 20 year s of William’s ser vice, you will see t hat 8 year s have been spent in t he UK and 12 year s have been spent in Par is so t his condit ion is sat isf ied.

As all three conditions in test 3 have been satisfied, f or eign ser vice is “subst ant ial” which means t hat t he whole of t he t er minat ion payment of £ 150,000 is t ax f r ee.

The impor t ant t hing her e is t he appr oach t o t he quest ion. I f you ar e asked t o deal wit h t his in pr act ice, t hen dr aw a t ime line br eaking ser vice up int o UK and over seas ser vice, t hen apply each of t he 3 t est s in or der . I f any of t he 3 t est s ar e sat isf ied, t he t er minat ion payment is fully exempt .

Illustration 2

I f we wer e t o change t he example of William ver y slight ly, it will give r ise t o a signif icant ly dif f er ent r esult . Assume William st ill has 30 year s of t ot al ser vice, but inst ead of or iginally going t o Par is in Mar ch 1983 let us now assume t hat he or iginally went in Mar ch 1985.

Year s Mar ch 1977 t o Mar ch 1985 London 8 Mar ch 1985 t o Mar ch 1999 Par is 14 Mar ch 1999 t o Mar ch 2007 London 8 Tot al 30

This will r educe his f or eign ser vice f r om 16 year s down t o 14 year s. We now need t o apply t he 3 f or eign ser vice t est s again. The f ir st t wo t est s clear ly ar e st ill not sat isf ied. For eign ser vice is clear ly not mor e t han t hr ee quar t er s of t ot al ser vice, and William has not spent t he last 10 year s out side t he UK.


401

So let us r econsider condit ion number 3. Tot al ser vice has exceeded 20 year s, however f or t est 3 t o be sat isf ied, at least 50% of t ot al ser vice must be f or eign ser vice. This is not t he case her e because f or eign ser vice is 14 year s and t ot al ser vice is 30 year s. This is less t han 50%. As such, none of t he t hr ee t est s ar e sat isf ied which means t hat t he t er minat ion payment of £ 150,000 is not f ully exempt .

I f t he t er minat ion payment is not wholly exempt , it must be par t ly t axable. When dealing wit h an ex-gr at ia t er minat ion payment , t he f ir st £ 30,000 is always t ax f r ee. This leaves a char geable amount of £ 120,000. Because par t of William’s ser vice includes f or eign ser vice, we can t ake a f or eign ser vice deduct ion f or t he t ime spent abr oad.

s.414(3)

£ Ter minat ion payment 150,000 Less: exempt ion (30,000)

120,000 Less: f or eign ser vice deduct ion:

£ 120,000 x 1430

(56,000)

Taxable £64,000

This is char geable t o t ax as specif ic employment income f or 2006/ 07.

D13.6 Statutory redundancy pay

Redundancy payment s f all int o t wo cat egor ies, being st at ut or y and non-st at ut or y. St at ut or y r edundancy is an amount which must be paid by t he employer t o t he employee under employment law and will be a f ixed amount f or each year of ser vice. Statutory redundancy pay is exempt from tax ir r espect ive of t he amount paid.

s. 309

However , if an employee r eceives st at ut or y r edundancy as par t of an over all t er minat ion package, t he amount of t he statutory redundancy pay uses up part of the £30,000 exemption. For example, assume an employee is made r edundant and r eceives st at ut or y r edundancy of £ 2,000 plus an ex gr at ia payment of £ 100,000. The st at ut or y r edundancy is exempt f r om t ax but inst ead of having an exempt ion of £ 30,000 t o set against t he ex-gr at ia awar d, t his exempt ion is r educed by £ 2,000 down t o £ 28,000.

The t ax t r eat ment of non-st at ut or y r edundancy is set out by t he Revenue in SP

1/94. Non-st at ut or y r edundancy is essent ially an ex gr at ia awar d and is t her ef or e t axed in t he nor mal way under Sect ion 401. This means t hat t he r edundancy pay is t axable but only t o t he ext ent t hat it exceeds £ 30,000.

SP1/ 94


D13.7 Employees approaching retirement age

Ter minat ion payment s will t ypically be made t o employees who ar e at or appr oaching r et ir ement age. I f an employee is r et ir ing due t o inj ur y or disabilit y and r eceives a t er minat ion payment , t hat payment is f ully exempt . However , payments made to retiring employees under nor mal cir cumst ances ar e t axable. The t ax t r eat ment is dealt wit h under SP 13/ 91.

s.394 & SP13/ 91

SP 13/ 91 t ells us t hat payment s made t o employees “on or in connect ion wit h r et ir ement ” ar e t axable in f ull. This means t hat t he £ 30,000 exempt ion will not be available. This will be t he case even wher e an employee r eceives a genuine ex gr at ia payment t hat is not wit hin his employment cont r act and is not expect ed. This r ule only applies t o employees “on or in connection with retirement”. Ther e has been much speculat ion as t o what t he Revenue mean by t he t er m “on or in connect ion wit h r et ir ement ”. The Revenue have said t hat t hey will give no “har d and f ast ” r ules as t o whet her an employee is r et ir ing and t he St at ement of Pr act ice makes no r ef er ence t o a specif ic r et ir ement age.

The Revenue has accept ed t hat a middle aged employee who moves on t o anot her f ull t ime employment is not r et ir ing. As such, if t hat middle aged employee r eceives a t er minat ion payment , t he f ir st £ 30,000 will be exempt because t he pr ovisions of SP 13/ 91 will not apply. However , when a payment is made t o an older employee, who is not moving on t o f ull t ime employment , t hat employee will be t r eat ed as r et ir ing. The payment will t her ef or e be caught by t he St at ement of Pr act ice, so t he £ 30,000 exempt ion will not be available and t he payment will be t axable in f ull. As a r ule of t humb, if you ar e dealing wit h any sor t of t er minat ion payment being made t o an employee over t he age of , say, 45 year s, t he pr ovisions of St at ement of Pr act ice 13/ 91 must be consider ed. Again, t he Revenue can be appr oached in advance f or clear ance as t o whet her t he £ 30,000 exempt ion applies or not .

D13.8 PILONS

Payment s in lieu of not ice (PI LONs) have been t he subj ect of much discussion over r ecent year s. The Revenue’s position on PILONs is summar ised in t heir Tax Bulletin number 24 issued in August 1996 and amplif ied in Tax Bulletin

Number 63 issued in February 2003.

Tax Bullet ins Nos. 24, 63

I f a payment in lieu of not ice is referred to in the employment contract, t he Revenue will r egar d it as a r ewar d f or ser vices and will tax it in full without the

£30,000 exemption. This pr inciple was est ablished in t he t ax case of EMI v Coldicot t . I n t his case, t he employment cont r act r eser ved a r ight f or t he employer t o make a PI LON on t he t er minat ion of t he employment and t his pr ovision was enough t o make t he payment f ully t axable.


403

The Revenue has always r egar ded payment s t o employees on “gar den leave” as being t axable in f ull and t his was conf ir med in Tax Bullet in 24. Gar den leave cover s sit uat ions when t he employee is not r equir ed t o wor k dur ing his not ice per iod but is inst ead sent home “t o do t he gar den” whilst st ill being paid. These payment s ar e t axable in f ull. However , wher e t he employer makes a PI LON without having any contractual right or obligation t o do so, t he payment is likely to be treated as damages

f or br each of cont r act and is taxed under Section 401 in t he nor mal way. I n Tax Bullet in Number 63, t he Revenue has said t hat even if t he employment cont r act is silent and makes no pr ovision (discr et ionar y or ot her wise) f or t he employer t o make a PI LON, a subsequent payment t o an employee in place of he/ she wor king dur ing t heir not ice per iod could st ill be held t o be t axable in f ull as an emolument of t he employment . For example, if t he making of a PI LON is an aut omat ic r esponse by t he employer t o a t er minat ion of t he employment , t he Revenue ar e likely t o r egar d t he payment as an “int egr al par t of t he employer -employee r elat ionship” and will ar gue t hat t he sour ce of t he PI LON is t he employment, t her eby making t he payment f ully t axable. I n t heir view, t he f act t hat t he cont r act may be silent on t he point is immat er ial. This is an aggr essive view and in pr act ice t he f act s and cir cumst ances of each case should be r eviewed separ at ely on t heir mer it s. I f an employer t er minat es an employment cont r act wit hout r egar d t o any cont r act ual not ice per iod, he is t r eat ed as br eaching t he cont r act . I f in r et ur n f or t hat br each of cont r act , he makes a payment in lieu of not ice t o t he employee, t hat payment is t r eat ed as a non-cont r act ual payment of damages and is not t axed in f ull. I n t hese cir cumst ances, t he f ir st £ 30,000 of t he PI LON will be f r ee of t ax. The t axat ion of PI LONs is a ver y hazar dous ar ea f or employer s and if t hey have any doubt s t hey should seek clearance bef or e making any payment s t o t heir employees. I ndeed many employer s t ake t he ver y pr udent st ep of t axing t he whole of t he payment – i.e. ignor ing t he £ 30,000 exempt ion – and leave it t o t he employee t o ar gue wit h t he Tax Of f ice as t o whet her t he exempt ion applies.

D13.9 NIC implications

Class 1 Nat ional I nsur ance Cont r ibut ions ar e paid on ear nings f r om t he employment . As f ar as t er minat ion payment s ar e concer ned, t he Nat ional I nsur ance Cont r ibut ions Of f ice have said t hat wher e a t er minat ion payment is made t o an employee under a contractual obligation, this payment will be regarded as earnings for NIC.

However , wher e an ex gr at ia payment is made – i.e. wher e t her e is no contractual obligation – t he payment will not be regarded as earnings and will not t her ef or e be char ged t o NI C. Ther ef or e as a br oad r ule, wher e a t er minat ion payment is made such t hat t he £ 30,000 exempt ion r ule applies f or income t ax, t her e will be no Nat ional I nsur ance Cont r ibut ions due.


The £ 30,000 r ule it self does not apply t o NI C. NI C is an “all or not hing” char ge – i.e. t he payment is eit her f ully char ged t o Nat ional I nsur ance or f ully exempt . Ther ef or e wher e a t er minat ion payment is t axed in f ull, NI C will be levied on t he f ull amount . Class 1 NI C is levied on bot h employees and on employer s. Employees have an upper ear nings limit f or Class 1 pr imar y cont r ibut ions which is cur r ent ly £ 33,540 per annum. This means t hat if a t er minat ion payment is made t o an employee who ear ns above t his upper ear nings limit , if t he t er minat ion payment is char geable t o NI C, t her e will only be a 1% addit ional char ge on t he employee. However , secondar y NI Cs will be levied on employer s in f ull.

D13.10 Miscellaneous points

Many t er minat ion agr eement s of t en incor por at e some sor t of r est r ict ive covenant . A t ypical r est r ict ive covenant clause is wher e t he employee pr omises not t o wor k f or a compet it or f ir m f or a cer t ain per iod of t ime af t er t he t er minat ion of his own employment .

s.225

Any such r est r ict ive covenant payment s made t o t he employee ar e t axed in f ull and t her e is no £ 30,000 exempt ion. S.225 I TEPA 2003 specif ically deals with

restrictive covenants.

A t er minat ion payment need not necessar ily be in cash. Fr om t ime t o t ime, asset s ar e t r ansf er r ed t o employees as par t of t he t er minat ion agr eement – t hese ar e most commonly company car s. Many employer s allow employees t o keep t heir company car as par t of t he t er minat ion package. For t ax pur poses we value t he company car at t he dat e of t he gif t and t o t r eat t his as a cash payment .

I t is possible f or t he ex-employee t o cont inue t o r eceive cer t ain benef it s f r om t he employment even af t er t he employment has t er minat ed. I f t his is t he case, t hese cont inuing benef it s ar e simply t axed in t he year of r eceipt and t he cash equivalent of t hose benef it s is r epor t ed t o t he Revenue on f or m P11D. Cer t ain minor benef it s ar e now excluded f r om t he s.401 char ge – t hey ar e list ed in t he legislat ion. These ar e most ly benef it s which would nor mally be t ax f r ee such as mobile phones, st af f cant een, de minimis comput er equipment et c. The employer may have cer t ain obligat ions t o r epor t t er minat ion payment s. A one of f r epor t needs t o be f iled by t he employer no lat er t han 6 J uly f ollowing t he end of t he t ax year if t he t er minat ion package exceeds £ 30,000 and includes non-cash benef it s. Finally if a t er minat ion payment is t axable under S.401 (ie, if it exceeds t he £ 30,000 t hr eshold), it is t axed on t he “t op slice” of a t axpayer ’s income. This means t hat it will be t axed after dividend income. You may t her ef or e need a 4 t h column in your t ax comput at ion.


405

Example 1

Char les is made r edundant on 30 November 2006 and r eceives t he f ollowing:

£ Ex-gr at ia cash payment 50,000 Company car (MV) 8,000 St at ut or y r edundancy pay 5,000 Employer cont r ibut ion t o pension f und 17,000 Tot al package £ 80,000

Calculat e t he amount char geable t o t ax under s.401.


Answer 1

£ Ex gr at ia payment 50,000 Car @ MV 8,000 St at ut or y r edundancy pay Exempt Pension cont r ibut ion Exempt 58,000 Less: exempt ion (net of st at ut or y r edundancy pay) £ (30,000 - 5,000) (25,000) Taxable 2006/ 07 £33,000


407

SUMMARY - TERMINATION PAYMENTS

A t er minat ion payment is f ully t axable if it is:

A r ewar d f or ser vices per f or med Cont r act ual Expect ed

A t er minat ion payment is f ully exempt if it is:

On deat h/ inj ur y/ disabilit y A payment int o an appr oved pension scheme Wher e f or eign ser vice is subst ant ial

“Ex-gr at ia” t er minat ion payment s such as r edundancy or compensat ion f or loss of of f ice ar e only t axable t o t he ext ent t hey exceed £ 30,000. PAYE will be deduct ed using t he t ax code if t he payment is bef or e t he P45, but PAYE at 22% only is deduct ed if t he payment is af t er t he P45. The t hr ee subst ant ial f or eign ser vice t est s ar e given in s.413 I TEPA 2003. I f t he f or eign ser vice is subst ant ial t he whole payment is exempt . I f it is not subst ant ial t hen only t he pr opor t ion r elat ing t o f or eign ser vice is t ax f r ee. St at ut or y r edundancy pay is t ax f r ee but uses up par t of t he £ 30,000 exempt ion. Payment s made t o employees on or in connect ion wit h r et ir ement age ar e likely t o be t r eat ed as f ully t axable wit h no £ 30,000 exempt ion (SP 13/ 91). Cont r act ual PI LONS and payment s f or gar den leave ar e f ully t axable. PI LONS made in r et ur n f or br eaching a cont r act will be t axable t o t he ext ent t hey exceed £ 30,000. NI C only applies t o cont r act ual t er minat ion payment s.

D14a: OCCUPATIONAL PENSIONS & FURBS

I n t his chapt er you will cover pension schemes including: - ways of pr oviding f unds f or r et ir ement ; - what pension f unds ar e; - how t ax r elief on cont r ibut ions t o pension schemes ar e given; - t he annual allowance; - t he lif et ime allowance.

St at ut or y r ef er ences ar e t o Finance Act 2004 unless st at ed ot her wise.

D14a.1 Introduction

Ther e ar e a number of ways in which an individual can pr ovide f unds f or his or her r et ir ement . Most UK individuals, when t hey r et ir e, will be ent it led t o some sor t of State Pension. The basic St at e Pension is cur r ent ly available t o men over t he age of 65 and women over t he age of 60. The unif icat ion of pensions at aged 65 f or all t axpayer s will be phased in bet ween 2010 and 2020. The St at e Pension is f unded f r om Nat ional I nsur ance Cont r ibut ions. NI Cs cur r ent ly being paid by employees and employer s ar e f unding t he benef it s f or t hose over r et ir ement age. Taxpayer s who r eceive t he St at e Pension r eceive it gr oss and t he income is t axable under I TEPA 2003. The St at e Pension will not be consider ed any f ur t her dur ing t his cour se.

s. 577 I TEPA 2003

I f an individual wishes t o put f unds aside t o dr aw on dur ing r et ir ement , he or she can do so via a company pension scheme. A company or occupat ional pension scheme is pr ovided by t he employer f or t he benef it of t he employees. I f t he occupat ional scheme is r egist er ed wit h t he Revenue t her e ar e t ax advant ages f or bot h employer and employee.

Anot her way of pr oviding a r et ir ement f und is via a per sonal pension scheme. Per sonal pensions ar e available t o all individuals in t he UK, be t hey employed or self -employed. Self -employed per sons cannot j oin an occupat ional pension scheme because t hey do not have an employer . As such, pr ovision f or t heir r et ir ement will be made via a per sonal pension scheme. I n Apr il 2001, t he Gover nment int r oduced St akeholder pensions. St akeholder pensions ar e modif ied ver sions of per sonal pensions designed t o encour age all individuals, especially t hose wit h low incomes, t o save f or t heir r et ir ement .

I ndividuals who wished t o make per sonal pension cont r ibut ions bef or e J uly 1988, did so via a r et ir ement annuit y scheme. Ret ir ement annuit y schemes wer e r eplaced by per sonal pension schemes in J uly 1988, alt hough member s of “old” r et ir ement annuit y schemes could cont inue t o make cont r ibut ions up unt il 2006.

Occupat ional Pensions & Fur bs

409

D14a.2 Pension Simplification

Unt il 5 Apr il 2006, t her e wer e t her ef or e 3 dif f er ent pension r egimes:

• Company/ Occupat ional schemes; • Per sonal pension schemes; • Ret ir ement annuit y schemes.

These schemes had dif f er ent r ules wit h r egar d t o cont r ibut ions t hat could be made and in r espect of benef it s t hat could be dr awn on r et ir ement . The Gover nment br ought in legislat ion in Finance Act 2004 t o abolish the

existing pension provision schemes and replace them with a single regime with

effect from 6 April 2006. The old pension r egimes will not be consider ed any f ur t her and in t his chapt er we will concent r at e on t he pension r ules as t hey apply f or t he t ax year s 2006/ 07 onwar ds.

D14a.3 Pension Funds

Bef or e we get int o t he det ailed r ules r egar ding pension schemes, it is wor t h explaining what a pension f und act ually is. A pension fund is essent ially a “money box” int o which a t axpayer makes cont r ibut ions which he or she can draw

on during retirement. The t axpayer will make cont r ibut ions t o a pension company and t he pension f und manager , on behalf of t he company, will invest t hose cont r ibut ions, of t en on wor ld st ock mar ket s.

One of t he main advant ages of r egist er ed pension f unds is t hat any growth is

completely tax-free. The pension f und will not pay any income t ax on any int er est or dividend income and it will not pay any CGT on any capit al gains. Most pension f unds ar e what ar e known as “money pur chase” schemes. This means t hat t he money invest ed by t he t axpayer is used t o pur chase unit s in t he f und and t he value of t hose unit s is ent ir ely dependent on t he under lying invest ment s made by t he f und manager . I f t he f und does well, t he t axpayer may dr aw a ver y healt hy pension however , if t he f und per f or ms badly, t he amount of money lef t in t he “box” t o dr aw on dur ing r et ir ement may not be as high as t he t axpayer had hoped. On retirement, t he t axpayer is ent it led t o dr aw a lump sum f r om t he f und and t his lump sum is completely free of tax. This pr ocess is known as “commut at ion” and t he maximum amount t hat a t axpayer can commut e by way of a lump sum is nor mally restricted to 25% of the value of the fund. The remainder of t he f und will be used t o generate an annual income f or t he t axpayer dur ing his or her r et ir ement . This pension income is t axable in t he year in which it is r eceived.

s. 571 I TEPA 2003

These money pur chase schemes ar e also known as “defined contribution” schemes because t he amount that the taxpayer can pay into his pension fund

is restricted.


Contributions to pension funds after 5 April 2006 are restricted depending

on the level of the taxpayer’s earnings. Taxpayer s wit h higher ear nings can make lar ger pension cont r ibut ions t han t axpayer s wit h lower ear nings. Ther e is no longer any age related restriction on t he level of an individual’s cont r ibut ions. The age r elat ed r est r ict ions wer e abolished wit h ef f ect f r om 6 Apr il 2006.

D14a.4 Registered pension schemes

A pension scheme will need t o be registered with the Revenue in or der t o be t ax-pr ivileged. Exist ing pension schemes t hat alr eady have Revenue appr oval will be r egist er ed aut omat ically. The scheme may be est ablished by an employer f or t he benef it of it s employees. Alt er nat ively, t he pension scheme may be est ablished by cer t ain ot her pr ovider s, such as insur ance companies and banks. Registered pension schemes will not be liable to pay tax on income and

gains.

s. 153

s.154

ss. 186, 187

D14a.5 Maximum contributions

The maximum cont r ibut ion a t axpayer can make t o a pension f und in any one t ax year is 100% of his “relevant earnings” f or t hat year . Anybody can pay up to £3,600 per year int o a pension scheme regardless of the level of his or her earnings. This is t o encour age individuals on modest incomes t o make pr ovision f or t heir r et ir ement .

s.190

Cont r ibut ions ar e not per mit t ed by t axpayer s over t he age of 75, alt hough t axpayer s who have r eached 75 will pr obably be dr awing on t heir pension r at her t han making f ur t her cont r ibut ions int o it . Cont r ibut ions can be made by t he scheme member , a t hir d par t y on t he member ’s behalf (such as a par ent on behalf of a child) or by an employer or f or mer employer .

D14a.6 “Relevant Earnings” s.189(2)

“Relevant ear nings” ar e calculat ed as f ollows

£ Employment income (including benef it s) X Tr ading income X Fur nished holiday let t ings X

Pat ent income in r elat ion t o invent ions X

Relevant ear nings X

Employment income will be r egar ded as ear nings f or pension pur poses. As well as salar y, t his will also include t he cash equivalent of any benef it s.

s.189(2)(a)


411

Wher e a t axpayer r eceives a t er minat ion payment and is t axed on t he excess over t he £ 30,000 limit , t his excess will not be r egar ded as ear nings f or pension pur poses. Pr of it s on shar e opt ions or shar e incent ives ar e not r egar ded as r elevant ear nings. The pr of it s of t he self -employed char geable as t r ading income ar e also ear nings f or pension pur poses. This includes income f r om pr of essions and vocat ions which is t axed as t r ading income. Pr of it s f r om a UK f ur nished holiday let t ing ar e r elevant ear nings. A pr oper t y is r egar ded as a f ur nished holiday let if t he pr oper t y is available f or let t ing f or 140 days in a year , is act ually let f or 70 days in t he year and is not in t he same occupat ion f or mor e t han 31 consecut ive days.

s. 325 I TTOI A 2005

D14a.7 Employer contributions

I f an employer makes a cont r ibut ion t o an employee’s pension scheme, t his is a tax-free benefit. However , employer cont r ibut ions do need t o be consider ed f or t he pur poses of t he annual allowance. This is discussed below. Employer cont r ibut ions t o a pension scheme on behalf of an employee will be deduct ible expenses f or t he pur poses of calculat ing t he t axable pr of it s f r om t he employer ’s business, as long as t he cont r ibut ions ar e “wholly and exclusively f or t he pur poses of t he t r ade”. Pension cont r ibut ions ar e deduct ible f or t he per iod in which t he payment s ar e act ually made.

D14a.8 Annual allowance

The annual allowance is t he amount by which pension savings in a r egist er ed pension scheme (t he “t ot al pension input ”) ar e allowed t o incr ease each year . “Pension input ” br oadly means employee’s plus employer’s pension contributions in t he t ax year . Pension input could be by cont r ibut ions t o a “money purchase” or “defined contribution” scheme. Such a scheme is one wher e t her e is no guarantee of the pension benefits available and t hese ar e t he most common t ype of scheme. The annual allowance also applies t o incr eases in t he capit al value of benef it s in a “defined benefits” scheme. An example of a def ined benef it s scheme is a “final salary” scheme pr ovided by an employer . I n such schemes, t he benef it s an individual can dr aw on r et ir ement ar e linked t o his r emuner at ion in t he f inal year (or year s) of employment . The annual allowance for 2006/07 is £215,000. Annual incr eases in t he capit al value of a pension over and above t his limit will be subj ect t o a t ax char ge. The annual allowance will r ise each year by amount s t o be st ipulat ed by t he Tr easur y, and will be £ 255,000 by 2010/ 20011.

s.228

s.229

s.228

Annual increases in excess of the annual allowable amount are subject to an

annual allowance charge of 40%. The char ge is payable by t he individual member and will have t o be declar ed on t he self -assessment r et ur n.

s. 227


D14a.9 Tax relief for contributions

We have seen t hat a pension f und is a ver y t ax ef f icient invest ment . Regist er ed pension f unds t hemselves ar e not char ged t o income t ax or capit al gains t ax and a member of a scheme can wit hdr aw up t o 25% of t he value of t he f und on r et ir ement complet ely t ax-f r ee. However , per haps t he main r eason t hat pension f unds ar e popular is t hat t axpayer s r eceive a measur e of tax relief every time

they make a contribution t o a r egist er ed scheme. Tax r elief is obt ained on pension cont r ibut ions in one of t hr ee ways:

1. By “Relief At Sour ce” (RAS) 2. Under “net pay ar r angement s” 3. By gr oss payment

Relief at Sour ce (RAS) s.192

Under t he Relief at Sour ce (RAS) r ules, payments to a pension scheme are

made net of 22% basic rate tax. This means t hat if a t axpayer want s £ 1,000 t o go int o his pension f und, he will act ually pay £ 780 and t he Revenue will make up t he dif f er ence of £ 220.

I f t he t axpayer pays t ax at t he higher r at e of 40%, ext r a t ax r elief is given on t hese cont r ibut ions by extending the basic rate band. This is exact ly t he same as t he way in which t ax r elief is given on donat ions t o char it y under t he Gif t Aid scheme.

Ther ef or e wher e a pension cont r ibut ion is made, t he or iginal basic r at e t hr eshold of £ 33,300 is ext ended by t he gr oss amount of t he pension cont r ibut ion – i.e. t he net cont r ibut ion mult iplied by 100/ 78. This gives us a new basic r at e t hr eshold and we use t his new f igur e t o calculat e t he t axpayer ’s t ax liabilit y.

New basic r at e t hr eshold = £ 33,300 + pension cont r ibut ion x 10078

I t is impor t ant t o not e t hat t he t axpayer ’s maximum contribution – i.e. the higher of 100% of relevant earnings or £3,600 – gives us the gross amount. So having calculat ed t he maximum cont r ibut ion in t his way, t he amount the

taxpayer will physically pay is this figure multiplied by 78%.

Net pay ar r angement s s.193

Employees making cont r ibut ions t o an employer r un scheme can obt ain t ax r elief via a net pay ar r angement . When deduct ing t ax under PAYE, t he employer will

operate PAYE on the employee’s “net pay” – i.e. gr oss pay less t he pension cont r ibut ion. Ther ef or e t he mor e an employee pays by way of a pension cont r ibut ion, t he less t ax will be deduct ed under PAYE.


413

Pension cont r ibut ions do not r eceive r elief f r om nat ional insur ance cont r ibut ions so NI Cs ar e calculat ed on gr oss salar y. When put t ing t oget her t he employee’s income t ax comput at ion, pension cont r ibut ions ar e given as a deduct ion f r om ear nings as below:

£ £ Salar y, bonus et c X Benef it s X

Taxable ear nings X Less allowable deduct ions: Employment expenses X Pension contributions X (X) NET TAXABLE EARNI NGS X

Gr oss payment s.194

Wher e t he individual has been making cont r ibut ions t o an old retirement annuity

policy, under t he new r egime t he insur ance company will cont inue t o collect cont r ibut ions on a gr oss basis. This means t hat no r elief will be obt ained at sour ce. I nst ead t ax relief will be given via the self assessment return and t he pension payment will simply be deduct ed f r om ear nings in t he income t ax comput at ion. For example: Non Savings I nt er est Dividends Employment income X Tr ading income X FHL pr of it X X Less: pension contributions (X) X Pr oper t y income X I nt er est X Dividends X For eign income X X X Tot al income T T T Less: Char ges on income (X) ___ ___ St at ut or y t ot al income STI STI STI


D14a.10 Lifetime allowance

A lif et ime limit is placed on t he t ot al value of t he pension f und t hat can benef it f r om t ax r elief . This limit is called a lifetime allowance. The lif et ime allowance has been set as £1.5m for 2006/2007. The lif et ime allowance will r ise as f ollows: 2007/ 2008 £ 1.6m 2008/ 2009 £ 1.65m 2009/ 2010 £ 1.75m 2010/ 2011 £ 1.8m

s. 218

Wher e pension f unds have been built up and t he capit al value exceeds the lifetime

allowance, a tax charge will be levied on the excess. This is called a “lifetime

allowance charge”. The char ge is t r igger ed by a “benefit crystallisation event”, f or example wher e payments are made from the retirement fund, such as t he payment of a pension or a lump sum. Ther e will be a char ge on t he amount cr yst allised t o t he ext ent t hat payment s f r om t he f und exceed t he lif et ime allowance at t he dat e of t he benef it cr yst allisat ion event . The charge is set at 25% (55% f or lump sums). The liabilit y f or t he lif et ime allowance char ge is jointly and severally on the

individual member and the scheme administrator. I n pr act ice, t he scheme administ r at or will deduct the relevant tax f r om t he f und and pay it over t o t he Revenue.

ss.214 - 226

Example 1

Huber t is self employed. He pays £ 500 per mont h int o his pension scheme. He has t axable t r ading pr of it s of £ 42,000 and r eceives bank int er est (net ) of £ 6,000 each year . Calculat e Huber t ’s t ax payable f or 2006/ 07.

Example 2

Mr Br anst on is Chief Execut ive of a small air line company. He has a salar y of £ 800,000. I n 2006/ 07, Mr Br anst on paid £ 200,000 int o t he pension f und r un by his employer . His employer also cont r ibut ed £ 200,000. Mr Br anst on has no ot her income. Calculat e Mr Br anst on’s t ax liabilit y f or 2006/ 07.


415

Answer 1

Non Savings Interest

£ £ Tr ading pr of it s 42,000 Bank int er est (x 100/ 80) 7,500 Less: Per sonal allowance (5,035) _____ Taxable I ncome £ 36,965 £ 7,500

Tax £ 2,150 @ 10% 215 34,815 @ 22% 7,659 4,027 @ 20% 805 40,992 (W) 3,473 @ 40% 1,389 Tax liabilit y 10,068 Less: t ax deduct ed on int er est (7,500 @ 20%) (1,500) Tax due £8,568

Wor king:

Basic r at e t hr eshold £ Or iginal 33,300 Add: gr oss pension cont r ibut ion £ 500 x 12 x 100/ 78 7,692 New t hr eshold £ 40,992

Answer 2

Non Savings

£ Employment income 800,000 Less: employee pension cont r ibut ions (200,000) Net t axable ear nings 600,000 Less: Per sonal allowance (5,035) Taxable I ncome £ 594,965 Tax £ 2,150 @ 10% 215 31,150 @ 22% 6,853 561,665 @ 40% 224,666 231,734 Add: annual allowance char ge

£ (400,000 – 215,000) @ 40% 74,000 Tax liabilit y £305,734


SUMMARY - PENSION SCHEMES

Up t o 5 Apr il 2006, t he main ways of pr oviding f unds f or r et ir ement wer e:

Company/ occupat ional pension scheme Per sonal pension scheme

Ret ir ement annuit y scheme Fr om Apr il 2006, t hese dif f er ent pension schemes have been abolished and r eplaced wit h one single r egime. Regist er ed pension f unds do not pay income t ax or CGT and so gr ow t ax-f r ee. At r et ir ement a limit ed t ax-f r ee lump sum (up t o 25%) is t aken and t he r est of t he f und gener at es an annual t axable income f or t he t axpayer dur ing r et ir ement . The gr oss cont r ibut ion t hat a t axpayer can make int o a pension scheme is t he higher of 100% of his r elevant ear nings f or t he t ax year or £ 3,600. “Relevant ear nings” includes employment income, t r ading income and income f r om FHLs. I f t he employer cont r ibut es t o t he scheme t his is a t ax-f r ee benef it , but must be consider ed when looking at t he annual allowance. Relief is given on amount s cont r ibut ed by t he t axpayer – basic r at e r elief is given at sour ce by t he t axpayer only paying 78% of t he cont r ibut ion. Higher r at e r elief is given by ext ending t he basic r at e band by t he gr oss cont r ibut ion. Employees can make pension payment s under “net pay ar r angement s” wher eby PAYE is applied t o salar y af t er t he pension cont r ibut ion has been deduct ed. “Tot al pension input ” f or t he year cannot exceed t he annual allowance. The annual allowance f or 2006/ 07 is £ 215,000. “Tot al pension input ” br oadly means employee’s plus employer ’s pension cont r ibut ions. I ncr eases in excess of t he annual allowance ar e subj ect t o t ax char ge of 40%. The r et ir ement f und which can be built up t o pr ovide t ax-f avour ed benef it s is subj ect t o a lif et ime allowance. The lif et ime allowance is £ 1.5m f or 2006/ 2007.

D14b: THE ENTERPRISE INVESTMENT SCHEME

I n t his chapt er you will cover t he Ent er pr ise I nvest ment Scheme including: - limit s on t he t ax r educer ; - car r y back of r elief ; - qualif ying company; - qualif ying invest or ; - clawback of r elief .

St at ut or y r ef er ences ar e t o I CTA 1988 unless st at ed ot her wise.

D14b.1 Introduction

An individual will r eceive t ax r elief in his I ncome Tax comput at ion wher e hesubscr ibes f or shar es in a qualif ying EI S company. By “subscribing for shares”we mean t hat t he company is issuing new shares to the investor.

s. 289A

I n 2005/ 06 t ax r elief is r est r ict ed t o t he lower of t he amount subscr ibed or £ 200,000 and is given by way of a t ax r educer at a f lat r at e of 20%. The maximum amount of income t ax r elief t hat an individual can r eceive in 2005/ 06 is t her ef or e:

s. 290

Maximum t ax r educer = £ 200,000 x 20% = £ 40,000

The minimum amount an individual can invest in an EI S company in a t ax year is £ 500. The t ax r educer is limit ed t o t he individual’s t ax liabilit y f or t he year – i.e. t he EI S r elief cannot cr eat e a “negat ive” f igur e f or t he t ax liabilit y. The t ax liabilit y can be r educed t o nil by EI S r elief , leaving t ax deduct ed at sour ce eit her under PAYE or f r om bank int er est , t o be r epaid t o t he t axpayer .

D14b.2 Carry back of relief

I ncome t ax r elief is usually given t o t he invest or in t he year in which t he subscr ipt ion is made. I t is, however , possible to carry back an EIS subscription

to the preceding tax year. I f an individual subscribes for shares in a qualif ying EI S company before 6 October in the tax year, t he invest or can make an election to carry back the lower of 50% of the amount subscribed

or £25,000 to the previous year. For example, if a t axpayer subscr ibes f or £ 20,000 of shar es on, say, 30 Sept ember 2005, t he t axpayer could elect f or £ 10,000 of t he subscr ipt ion t o be car r ied back and r elieved in t he 2004/ 05 t ax comput at ion.


D14b.3 Qualifying company s. 293

Tax relief will only be given if the individual subscribes for shares in a

qualifying EIS company. I t is impor t ant t her ef or e t hat we ar e comf or t able wit h exact ly what is a qualif ying company under t he EI S r ules. The company must be a t r ading company. Ther ef or e, any company which der ives it s income wholly or mainly f r om making invest ment s is not a qualif ying company f or EI S pur poses.

Ther e ar e certain prohibited or excluded trades f or EI S pur poses. Companies whose act ivit ies ar e pr imar ily financial – by t his we mean companies dealing in shar es or secur it ies or commodit ies et c. - ar e excluded, as ar e companies pr oviding legal and accountancy ser vices. Farming and market gardening ar e also excluded act ivit ies as is oper at ing or managing hotels, and property

development.

s. 297(2)

I t is possible f or t he company t o be r egist er ed out side t he UK however , t o qualif y f or r elief , t he company’s t r ade must be wholly or mainly car r ied on wit hin t he UK. Most EI S companies will be r esident in t he UK. The company must be an unquoted company. This means t hat it s shar es must not be mar ket ed t o t he gener al public by being list ed on a r ecognised St ock Exchange.

s. 293(1A)

Most companies qualif ying f or EI S r elief ar e r elat ively small t r ading companies and t he EI S r ules place a limit on t he value of t he asset s wit hin t he company. The asset s of t he company must not exceed £ 15 million bef or e t he shar e issue and must not exceed £ 16 million af t er t he shar e issue.

s. 293(6A)

Having r aised t he shar e capit al f r om it s invest or s, t he company must use t he cash r aised f or a qualif ying business act ivit y wit hin a cer t ain per iod of t ime. The company must use at least 80% of t he cash r aised f r om t he issue of EI S eligible shar es wit hin 12 mont hs and t he r emainder wit hin 24 mont hs f or a qualif ying business act ivit y. Qualif ying business act ivit y essent ially means t hat t he company must use it f or some sor t of t r ading pur pose.

s. 289(1)(c)

Finally, t her e must be no pr e-ar r anged exit s – i.e. t he company must not guar ant ee t he invest or any sor t of r et ur n on his invest ment . Only if t he invest or is t aking a bona f ide commer cial r isk, will t he Revenue of f er any f or m of t ax r elief .

S. 299B

The Ent er pr ise I nvest ment Scheme

419

D14b.4 Qualifying investor

Ther e is also one impor t ant qualif ying condit ion as f ar as t he invest or is concer ned. I n or der t o obt ain income t ax r elief , t he investor must not be

connected with the company. Br oadly speaking an invest or is connect ed wit h an EI S company if he br eaches one of t wo main condit ions.

s. 291

The invest or is connect ed wit h t he company if he is an employee of t he company. The invest or can be a dir ect or of t he company as long as he r eceives only r easonable r emuner at ion f or his ser vices.

s. 291A

The invest or is also connect ed t o t he company if he holds mor e t han 30% of t he or dinar y shar es, or he can exer cise mor e t han 30% of t he vot ing r ight s. I n consider ing whet her t he 30% limit has been br eached, t he shar eholdings of associat es must also be consider ed. The associat es her e would include spouses, and ancest or s or r elat ives such as par ent s, siblings and childr en.

s. 291B

D14b.5 Clawback of relief s. 299

Ther e ar e ant i-avoidance pr ovisions t o pr event an invest or f r om obt aining income t ax r elief on his EI S subscr ipt ion, t hen selling t he shar es shor t ly af t er war ds. I f t he investor disposes of his shares within three years of issue, there will be

a clawback of the income tax relief originally given.

The ef f ect of t his clawback is t o incr ease t he invest or ’s t ax liabilit y in t he year in which he disposes of his shar es. I f t he invest or gives away his shar es wit hin t hr ee year s, all of t he income t ax r elief or iginally obt ained will be wit hdr awn. This will not apply when t he gif t is t o t he invest or ’s spouse. The clawback of income t ax r elief is slight ly dif f er ent wher e t he shar es ar e sold t o an unconnect ed t hir d par t y. I f t he shar es ar e sold wit hin t hr ee year s, t he income t ax r elief t o be wit hdr awn is t he sale pr oceeds mult iplied by t he r at e at which t ax r elief was or iginally given. I n t he maj or it y of inst ances, t he r at e at which t ax r elief was or iginally given will be 20%.

The clawback of income t ax r elief cannot exceed t he or iginal t ax r educer . This means t hat if shar es ar e sold at a pr of it wit hin t hr ee year s of issue, an amount equal t o t he or iginal t ax r educer is added back t o t he invest or ’s t ax liabilit y in t he year of sale.

Illustration 1

I n December 2003 an invest or subscr ibes f or £ 50,000 wor t h of shar es in an EI S company. I n t his inst ance t he invest or would qualif y f or a t ax r educer of £ 10,000 in t he t ax year 2003/ 04.

The invest or disposes of t he shar es in J une 2005 – i.e. wit hin t hr ee year s of t heir issue.


I f t he disposal is by way of a gif t , all of t he t ax r elief or iginally obt ained will be wit hdr awn. This means t hat £ 10,000 will be added t o t he invest or ’s t ax liabilit y in t he t ax year 2005/ 06.

I f t he shar es wer e sold f or £ 60,000, t he I ncome Tax r elief t o be wit hdr awn would again be £ 10,000. Remember t hat when t he EI S shar es ar e sold at a pr of it wit hin t hr ee year s, all of t he or iginal income t ax r elief given will be clawed back in t he year of sale.

On t he ot her hand, if t he shar es wer e sold at a loss wit hin t hr ee year s – her e assume sale pr oceeds ar e £ 40,000 – t he income t ax r elief t o be wit hdr awn is t he sale pr oceeds, mult iplied by 20%. I n t his inst ance, £ 8,000 will be clawed back and added t o t he t ax liabilit y in t he year of sale.

Example 1

Gar y, an employee, had salar y and benef it s t ot alling £ 107,602 in 2005/ 06. He had no ot her income. I n Mar ch 2006 he subscr ibed £ 230,000 f or shar es in a qualif ying EI S company. Calculat e his t ax r educer f or 2005/ 06.

Example 2

Which of t he f ollowing t r ades is not an excluded t r ade f or EI S pur poses?

a) Resear ch and development b) Pr oper t y development c) Shar e dealing d) Mar ket gar dening

The Ent er pr ise I nvest ment Scheme

421

Answer 1

£Employment income 107,602Less: per sonal allowance (4,895)Taxable income 102,707 Tax £2,090 @ 10% 20930,310 @ 22% 6,66870,307 @ 40% 28,123 35,000Less: t ax r educer (cannot exceed liabilit y) (35,000)Tax liabilit y Nil

Gar y subscr ibed £ 230,000 f or shar es in a qualif ying EI S company. The maximum t ax r educer cannot exceed £ 200,000 x 20% = £ 40,000. However t he t ax r educer cannot exceed t he t ax liabilit y f or t he year . This means t hat t he t ax r educer f or 2005/ 06 will be £ 35,000. Remember t hat a t ax r educer can r educe a liabilit y down t o nil but cannot it self cr eat e a t ax r epayment . Not e t hat in t his quest ion no car r y back is possible as t he shar es wer e not subscr ibed f or bef or e 6 Oct ober in t he year .

Answer 2

The answer is A

Resear ch and development is per mit t ed. The ot her s ar e pr ohibit ed (s.297(2) I CTA 1988)


SUMMARY - THE ENTERPRISE INVESTMENT SCHEME

When an individual subscr ibes f or qualif ying EI S shar es, a 20% t ax r educer is given on t he lower of t he amount subscr ibed or £ 200,000. The t ax r educer is limit ed t o t he individual’s t ax liabilit y. A subscr ipt ion made bef or e 6 Oct ober can be car r ied back t o obt ain a t ax r educer in t he pr evious year but t his is limit ed t o t he lower of 50% of t he amount subscr ibed or £ 25,000. A qualif ying EI S company is an unquot ed t r ading company car r ying on it s act ivit ies wholly or mainly in t he UK. Pr ohibit ed t r ades include f inancial t r ades, f ar ming, mar ket gar dening, hot el and pr oper t y development . The company’s asset s must be less t han £ 15m bef or e and less t han £ 16m af t er t he shar e issue. 80% of t he cash r aised by t he issue of EI S shar es must be used f or t he t r ade wit hin 12 mont hs, t he r est wit hin 24 mont hs. The invest or cannot be connect ed wit h t he company, ie cannot be an employee nor hold >30% of t he shar es, t oget her wit h his associat es. The t ax r educer is wit hdr awn if t he shar es ar e disposed of wit hin 3 year s. I f t he shar es ar e given away or sold at a pr of it , t he whole t ax r educer is clawed back. I f t he shar es ar e sold at a loss t he claw back is r est r ict ed t o t he pr oceeds x 20%.

E: Value Added Tax

E1: OVERVIEW OF THE VAT SYSTEM

I n t his chapt er we will gain an under st anding of t he gener al pr inciples of VAT.

E1.1 VAT Legislation and interpretation

Value added t ax (VAT) was int r oduced in t he UK on 1 Apr il 1973 by t he Finance Act 1972. Successive Finance Act s have made amendment s t o t he law which has also been consolidat ed, f ir st by t he Value Added Tax Act 1983 (VATA 1983) and subsequent ly by t he Value Added Tax Act 1994 (VATA 1994). The Act s pr ovide t he f r amewor k of t he t ax but much of t he det ail is t o be f ound in st at ut or y inst r ument s, eit her in t he f or m of Or der s made by t he Tr easur y or Regulat ions made by HMRC.

The Gover nment have empower ed Her Maj est y’s Revenue and Cust oms (HMRC) pr eviously known as Cust oms & Excise (but her eaf t er called “Cust oms” in t his t ext ) t o manage t his t ax.

E1.2 European Community legislation

The over r iding law on VAT t hr oughout t he Eur opean Communit y (EC) is in t he EC Dir ect ives, not ably t he 6t h VAT Dir ect ive. The f or m and met hod of compliance is lef t t o individual EC count r ies but , wher e any of t he pr ovisions ar e mandat or y, EC law t akes pr ecedence if t her e ar e any inconsist encies wit h nat ional law.

E1.3 Interpretation of the law by Customs

Cust oms issue explanat or y not ices on VAT, t oget her wit h VAT not es, news r eleases and business br ief s. These explain how Cust oms int er pr et t he law. Wit h cer t ain except ions, t hese ar e not par t of t he law and t his should be bor ne in mind wher e t he manual indicat es a not ice or leaf let , et c. as sour ce mat er ial. I f a t axable per son disagr ees wit h t he int er pr et at ion, he has a r ight of appeal, in cer t ain cases, t o a VAT t r ibunal.

E1.4 General Principles of VAT

VAT is a t ax on consumer expendit ur e and is collect ed on business t r ansact ions and impor t s. The basic pr inciple is t o char ge VAT at each st age in t he supply of goods and ser vices (out put t ax). I f t he cust omer is r egist er ed f or VAT and uses t he supplies f or business pur poses, he will r eceive cr edit f or t his VAT (input t ax). The br oad ef f ect is t hat businesses ar e not af f ect ed and VAT is act ually bor ne by t he f inal consumer .


E1.5 Scope of VAT

A t r ansact ion is wit hin t he scope of UK VAT if all t he f ollowing condit ions ar e met . • I t is a supply of goods or ser vices. The t er m ‘supply’ is not def ined in t he

legislat ion but is br oadly int er pr et ed. Cer t ain t r ansact ions, alt hough supplies, ar e r egar ded as supplies of neit her goods nor ser vices and ar e out side t he scope of UK VAT.

• I t t akes place in t he UK. • I t is made by a t axable per son. A t axable per son is an individual, f ir m or

company, et c. which is r egist er ed f or VAT or which is r equir ed t o r egist er f or VAT but has f ailed t o do so.

• I t is made in t he cour se or f ur t her ance of any business car r ied on by

t hat per son. A t r ansact ion which does not meet all of t he above condit ions is out side t he scope of UK VAT.

E1.6 Place of supply

To be wit hin t he char ge t o UK VAT, a supply must be made in t he UK. Supplies made out side t he UK ar e out side t he scope of UK VAT (alt hough t hey may be liable t o VAT in anot her count r y). Separ at e r ules apply f or det er mining t he place of supply of goods and ser vices.

E1.7 Time of supply (tax point)

The t ime at which a supply of goods is t r eat ed as t aking place is called t he t ax point . VAT must nor mally be account ed f or in t he VAT per iod in which t he t ax point occur s and at t he r at e of VAT in f or ce at t hat t ime. Small businesses can, however , account f or VAT on t he basis of cash paid and r eceived. The basic t ax point f or a supply of goods is t he dat e t he goods ar e r emoved i.e. sent t o, or t aken by, t he cust omer . I f t he goods ar e not r emoved, it is t he dat e t hey ar e made available f or his use. The basic t ax point f or a supply of ser vices is t he dat e t he ser vices ar e per f or med. I n t he case of bot h goods and ser vices, wher e a VAT invoice is r aised or payment is made bef or e t he basic t ax point , t her e is an ear lier act ual t ax point at t he t ime t he invoice is issued or payment r eceived, whichever occur s f ir st .

Over view of t he VAT Syst em

425

Ther e is also gener ally an act ual t ax point wher e a VAT invoice is issued wit hin 14 days af t er t he basic t ax point . This over r ides t he basic t ax point but not t he act ual t ax point cr eat ed by t he issue of an invoice or payment bef or e t he basic t ax point . Ther e ar e also special pr ovisions f or par t icular supplies of goods and ser vices.

E1.8 Value of supply

The value of a supply is t he value on which VAT is due. The amount of VAT is t hen t he value mult iplied by t he VAT r at e. The value of a supply nor mally depends upon what is given in exchange f or t he supply, i.e. t he consider at ion. I f t his is wholly in money, t he value will be based on t hat amount . I f not , t he value is t he monet ar y equivalent of t he consider at ion. Ther e ar e special r ules r elat ing t o discount s of f er ed, t r ansact ions bet ween connect ed per sons and values expr essed in f or eign cur r encies. I mpor t s and acquisit ions f r om ot her EU count r ies also have t heir own valuat ion r ules.

E1.9 Output tax

Out put t ax is t he VAT due on t axable supplies and is nor mally t he liabilit y of t he per son making t he supply. I n addit ion t o st r aight f or war d business t r ansact ions, out put t ax may also be due on business gif t s and pr ivat e use of own goods and ser vices. A par t icular supply may be complicat ed by being a mixed supply wher e a single inclusive pr ice is char ged f or a number of separ at e supplies. Wher e t hese supplies ar e t axable at dif f er ent r at es, a f air and j ust if iable appor t ionment of t he t ot al pr ice must be made. Special schemes for retailers. Tr ader s r egist er ed f or VAT nor mally issue an invoice f or each sale made in or der t o have t he necessar y r ecor ds t o calculat e out put t ax. As t his may be dif f icult or impossible wher e goods ar e sold dir ect ly t o t he public, special schemes ar e available f or use by r et ailer s only. Second-hand goods. Ther e ar e special pr ovisions f or second-hand goods. Subj ect t o cer t ain condit ions being sat isf ied, under t he Mar gin Scheme VAT is only char geable on t he amount by which t he selling pr ice of a par t icular it em exceeds t he pr ice paid when it was obt ained. The scheme ext ends t o almost t he f ull r ange of second-hand goods. Ther e is also a Global Account ing Scheme which is a simplif ied scheme f or VAT on low value, bulk volume second-hand goods. Under t his scheme, VAT is account ed f or on t he dif f er ence bet ween t he t ot al pur chases and sales of eligible goods in each VAT per iod r at her t han on an it em by it em basis.


Flat-rate scheme for small businesses. Small businesses wit h t axable t ur nover and t ot al t ur nover below specif ied annual limit s can opt t o j oin a f lat -r at e scheme under which t hey calculat e net VAT due by applying a f lat -r at e per cent age t o t ax-inclusive t ur nover . The f lat -r at e per cent age var ies wit h t he t r ade sect or int o which a business f alls. Flat-rate scheme for farmers. Far mer s who ar e cer t if ied under t he scheme do not have t o account f or VAT on sales of goods and ser vices wit hin designat ed act ivit ies but ar e not able t o r ecover input t ax incur r ed on pur chases. To compensat e f or t his, f ar mer s in t he scheme may char ge (and r et ain) a f ixed f lat -r at e addit ion of 4% on t op of t he sale pr ice. The cust omer can r ecover t he addit ion as if it wer e VAT.

E1.10 Input tax

A t axable per son is ent it led t o r eclaim input t ax suf f er ed on goods and ser vices supplied t o him, impor t s f r om out side t he EU and acquisit ion of goods f r om ot her EU count r ies pr ovided t hat t he input t ax r elat es t o • t axable business supplies made by him; or • supplies made by him which ar e out side t he scope of UK VAT but which

would have been t axable if made in t he UK; or • cer t ain supplies by him of exempt insur ance and f inancial ser vices t o

per sons belonging out side t he EU. Taxable supplies ar e t hose char geable at t he st andar d, r educed or zer o r at e. VAT cannot be r ecover ed on goods and ser vices which ar e not used f or business pur poses (e.g. f or pr ivat e use). Wher e goods ar e used par t ly f or business and par t ly f or non-business pur poses, t he VAT incur r ed is nor mally appor t ioned. VAT incur r ed on a number of it ems is non-deduct ible. These include mot or car s (wit h cer t ain except ions), business ent er t ainment , goods sold under one of t he second-hand schemes and cer t ain ar t icles inst alled in buildings by builder s. Wher e input t ax has been claimed but t he consider at ion f or t he supply is not paid wit hin six mont hs, t he input t ax must be r epaid t o Cust oms. Special r ules also apply t o input t ax incur r ed bef or e r egist r at ion f or VAT and af t er der egist r at ion.

E1.11 VAT rates

Ther e ar e cur r ent ly t hr ee main r at es of VAT, a st andar d r at e of 17.5%, a r educed r at e of 5% and a zer o r at e. The ef f ect of a supply being zer o-r at ed is as f ollows. • The amount of VAT on t he supply is nil but it is st ill a t axable supply.


427

• As a t axable supply, it must be t aken int o account in det er mining whet her r egist r at ion is r equir ed.

• I nput t ax may be r eclaimed subj ect t o t he same r ules as f or st andar d-r at ed supplies.

• Wher e a supply could be eit her zer o-r at ed or exempt , zer o-r at ing t akes pr ior it y.

E1.12 Exempt supplies

Cer t ain supplies ar e exempt f r om VAT. This means t hat no VAT is char geable but , unlike zer o-r at ed supplies, r elat ed input t ax is not r ecover able. Wher e a per son makes bot h t axable supplies and exempt supplies, he is par t ially exempt and may or may not be able t o r ecover all his input t ax. All input t ax dir ect ly at t r ibut able t o t axable supplies can be r eclaimed but none of t he input t ax dir ect ly at t r ibut able t o exempt supplies (subj ect t o a de minimis limit ). Special r ules t hen apply t o wor k out how much input t ax can be r eclaimed on gener al over heads, et c.

E1.13 Registration

Wher e a per son is in business and making t axable supplies, t he value of t hese supplies is his t axable t ur nover . I f , at t he end of any mont h, • t axable t ur nover in t he year t hen ended has exceeded a specif ied limit ,

or • t her e ar e r easonable gr ounds f or believing t hat t he value of t axable

supplies in t he next 30 days will exceed a specif ied limit , t hat per son nor mally becomes a t axable per son and must not if y Cust oms of his liabilit y t o r egist er f or VAT. Ther e ar e f inancial penalt ies f or f ailing t o do so. Wher e, however , only zer o-r at ed supplies ar e made, Cust oms have a discr et ion t o exempt a per son f r om r egist r at ion. Even if t axable t ur nover is below t he specif ied limit , a per son who makes t axable business supplies can r equest volunt ar y r egist r at ion. A per son who is r egist er ed f or VAT ceases t o be liable t o be r egist er ed and can apply t o be der egist er ed if t he VAT-exclusive value of supplies in t he next t welve mont hs will not exceed a specif ied limit . Even wher e t her e is no liabilit y t o r egist er f or VAT in r espect of UK supplies of goods or ser vices, a liabilit y may ar ise in r espect of • ‘dist ance selling’ t o non-t axable per sons in t he UK by supplier s in ot her

EU count r ies; or • acquisit ions of goods in t he UK f r om ot her EC count r ies.


E1.14 Imports

Unless special r elief applies, VAT is char ged and payable on t he impor t at ion of goods int o t he UK f r om out side t he EU. The r at e of VAT is t he same as if t he goods had been supplied in t he UK. Unless t he goods ar e placed under Cust oms war ehousing or cer t ain Cust oms ar r angement s (e.g. f r ee zones, inwar d pr ocessing r elief or Communit y Tr ansit ar r angement s) any VAT due must nor mally eit her be paid at t he t ime of impor t at ion or def er r ed wit h any dut y if t he impor t er or his agent ar e appr oved f or def er ment . VAT paid on t he impor t at ion of goods can be claimed as input t ax, subj ect t o t he nor mal r ules.

E1.15 Exports

Pr ovided var ious condit ions ar e met , goods expor t ed out side t he EU ar e zer o-r at ed.

E1.16 Transactions with other EU countries

The concept s of ‘impor t s’ and ‘expor t s’ of goods apply only t o t r ansact ions wit h count r ies out side t he EU. For int r a-EU movement s of goods, t he t er ms ‘acquisit ions’ and ‘dispat ches’ ar e used. I t is not necessar y t o make an impor t declar at ion on an acquisit ion of goods in t he UK f r om anot her EU count r y or t o pay VAT at t he f r ont ier . Supplies of goods t o a cust omer r egist er ed f or VAT in anot her EU count r y can be zer o-r at ed pr ovided cer t ain condit ions ar e met . These include obt aining t he cust omer ’s VAT r egist r at ion number and showing it on t he VAT invoice. The cust omer t hen account s f or VAT at t he appr opr iat e r at e on t he goods in t he EU count r y of dest inat ion. I f t he condit ions cannot be met , VAT must be char ged in t he count r y of or igin at t he r at e applicable t o t he goods in t hat count r y. VAT must also be char ged on supplies of goods t o non-r egist er ed cust omer s in ot her EU count r ies. Wher e, however , t he supplier is also r esponsible f or t he deliver y of t he goods, once t he value of such ‘dist ance’ sales t o any par t icular EU count r y exceeds an annual t hr eshold set by t hat count r y, t he supplier is aut omat ically liable t o r egist er f or VAT in t hat ot her count r y. VAT on any f ur t her sales is t hen due in t he EU count r y of dest inat ion. Special r ules apply t o t r ansf er s of own goods bet ween EU count r ies, goods inst alled or assembled at t he cust omer ’s pr emises, new means of t r anspor t and goods subj ect t o excise dut y pur chased by non-t axable per sons. Ther e ar e also special r ules f or ‘t r iangulat ion’ i.e. wher e a chain of supplies of goods involves t hr ee par t ies and, inst ead of goods physically passing f r om one par t y t o t he next , t hey ar e deliver ed f r om t he f ir st par t y t o t he last par t y in t he chain.


429

E1.17 Invoices

A r egist er ed t axable per son must issue a VAT invoice wher e he makes a st andar d or r educed-r at ed supply t o anot her t axable per son in t he UK or a st andar d, r educed or zer o-r at ed supply t o a per son in anot her EU count r y.

E1.18 Returns and payment of VAT

Ever y t axable per son must keep a VAT account summar ising t he out put t ax and input t ax f or each VAT per iod. A VAT per iod is nor mally t hr ee mont hs but a one-mont h per iod is also allowed, par t icular ly wher e input t ax is likely t o exceed out put t ax on a r egular basis. The inf or mat ion in t he VAT account , plus cer t ain st at ist ical inf or mat ion, must t hen be shown on a VAT r et ur n f or t hat per iod. The r et ur n must be sent t o Cust oms any VAT due t o Cust oms paid, no lat er t han one mont h af t er t he end of t he per iod. The due dat e f or payment will be ext ended by seven days wher e payment is made by cr edit t r ansf er . Cer t ain lar ge VAT payer s must make mont hly payment s on account . Annual accounting. Smaller businesses wit h t ur nover below an annual limit may apply t o j oin t he annual account ing scheme. This allows t hem t o complet e one VAT r et ur n each year . Mont hly, or wit h t he agr eement of Cust oms, quar t er ly int er im payment s on account ar e r equir ed based on an est imat e of t he amount of VAT due. The annual VAT r et ur n must be complet ed and sent t o Cust oms, wit h any balancing payment , wit hin t wo mont hs of t he end of t he annual VAT account ing per iod.

E1.19 Records

Ever y t axable per son must keep such r ecor ds as Cust oms r equir e. Specif ically, t hese include business and account ing r ecor ds, t he VAT account , copies of all VAT invoices and cr edit not es issued and r eceived, and document at ion r elat ing t o impor t s, expor t s, acquisit ions of goods f r om ot her EC count r ies and goods dispat ched t o ot her EC count r ies. All such r ecor ds must be kept f or six year s unless Cust oms agr ee t o a shor t er per iod.

E1.20 Bad debts

VAT is nor mally due by r ef er ence t o t he t ax point . The supplier must t her ef or e account t o Cust oms f or t he VAT even if t he debt , including t he VAT, is not paid. By way of r elief , VAT can be r eclaimed wher e a debt has been wr it t en of f and six mont hs has elapsed f r om t he dat e of supply and t he dat e payment is due. The pr oblem of VAT on bad debt s can also be r emoved by using t he cash account ing syst em.


E1.21 Cash accounting

Pr ovided t ur nover is below an annual limit , a t axable per son may, subj ect t o condit ions, account f or and pay VAT on t he basis of cash or ot her consider at ion paid and r eceived. The main advant ages of t he scheme ar e aut omat ic bad debt r elief and t he def er r al of t he t ime f or payment of VAT wher e ext ended cr edit is given.

E1.22 Assessments

Cust oms ar e given power s t o r aise an assessment wher e VAT r et ur ns have not been made or it appear s t o t hem t hat r et ur ns ar e incomplet e or incor r ect . The assessment must nor mally be made wit hin t wo year s f r om t he end of t he r et ur n per iod in quest ion or , if lat er , wit hin one year of t he f act s on which t he assessment is based coming t o t heir knowledge. An assessment cannot be r aised mor e t han t hr ee year s af t er t he end of t he r et ur n per iod except in cases of f r aud when t he per iod is ext ended t o 20 year s. Wher e t he t axable per son has died, an assessment cannot be made mor e t han t hr ee year s af t er deat h or r elat e t o a per iod mor e t han t hr ee year s bef or e deat h.

E1.23 Interest and penalties

I nt er est is char geable in cer t ain cir cumst ances wher e VAT has been under declar ed or over claimed. On t he ot her hand, r epayment supplement is due wher e Cust oms do not make a r epayment on t ime and int er est can be paid t o t he t axpayer wher e VAT has been over paid or under claimed as a r esult of er r or by Cust oms. Ther e is an ext ensive r ange of cr iminal and civil penalt ies. Liabilit y f or cer t ain civil penalt ies can be avoided wher e t her e is r easonable excuse f or conduct and penalt ies can be mit igat ed by Cust oms or a VAT t r ibunal.

E1.24 Appeals

An appeal against a decision of Cust oms on cer t ain mat t er s may be made t o t he appeal body and f r om t her e, on a point of law, t o t he High Cour t (Cour t of Session in Scot land) and cont inued up t o t he House of Lor ds under nor mal pr ocedur e. The mat t er s on which an appeal may be made ar e r est r ict ed and cer t ain condit ions must be complied wit h. Not ably, unless Cust oms agr ee ot her wise, t he appellant must have made all t he r et ur ns he is r equir ed t o make and paid over t he VAT due accor ding t o t hose r et ur ns. Not ice of t he appeal must be ser ved wit hin 30 days of t he disput ed decision.


431

SUMMARY – OVERVIEW OF VAT SYSTEM Alt hough VAT is ult imat ely suf f er ed by t he f inal consumer in a chain of t r ansact ions t he way t hat t he VAT syst em wor ks is t hat VAT is collect ed piecemeal at ever y st age in t hat long chain. So, ef f ect ively, t her e is a payment on account syst em. At each point in t he chain t he supplier char ges t he appr opr iat e out put t ax t o t he next per son in t he chain and r ecover s any input t ax he paid t o t he pr evious per son in t he chain. This ser ies of out put t ax less input t ax account ing of VAT will occur r ight up unt il t he f inal sale t o t he member of t he public or t he ult imat e consumer . However , alt hough VAT is collect ed piece by piece along t he chain of t r ansact ions ult imat ely it is t he f inal consumer who bear s t he f ull cost of t he VAT being collect ed. I n ot her wor ds, t he out put t ax char ged t o t hat f inal consumer will equal all t he net VAT account ed f or dur ing t he j our ney which t ook t hose goods or ser vices t o t hat ult imat e consumer .

E2: REGISTRATION

This chapt er looks at r egist r at ion of a business f or VAT and includes: compulsor y r egist r at ion; volunt ar y r egist r at ion; de-r egist r at ion; exempt ion f r om r egist r at ion; disaggr egat ion.

E2.1 Introduction

I n t his chapt er we will look at r egist r at ion f or VAT. Not all businesses must be r egist er ed f or VAT but , if you ar e in business making t axable supplies, you will be r equir ed t o be r egist er ed by Cust oms if , at t he end of any calendar mont h, t he value of t axable supplies made in t he pr evious 12 mont hs exceeds t he annual r egist r at ion t hr eshold. Alt er nat ively, you must r egist er f or VAT if at any t ime t her e ar e r easonable gr ounds f or believing t hat t he value of t axable supplies t o be made in t he next 30 days on t heir own, will exceed t he annual r egist r at ion t hr eshold.

Sch 1 Par a 1

Ther e ar e t wo t est s and Cust oms will use t he t est which gives t he ear lier r egist r at ion dat e. Ther e ar e a f ew t er ms t o get t o gr ips wit h her e; t he f ir st one will be ‘taxable supplies’ as def ined by Cust oms. Cer t ain t r ansact ions ar e t axable i.e. VAT is char geable at a cer t ain r at e. However it is only when you exceed a cer t ain level of t axable supplies t hat you have t o r egist er and act ually account f or VAT on t hose t axable supplies. Anot her t er m used is t he ‘annual registration threshold’. This changes ever y year wit h t he Budget and t he cur r ent r at e is £ 61,000. So if , f or example, my t axable supplies f or t he 12 mont hs t o 30 Apr il 2006 wer e £ 62,000 I would have an obligat ion t o r egist er . Whilst t he above ar e compulsory registration t est s, it is possible t o voluntarily register f or VAT. Any bona f ide business whose t axable t urnover is below t he annual t hr eshold can apply t o r egist er volunt ar ily. So, f or example, I might have t axable supplies of say £ 30,000 a year , which is below t he compulsor y limit s, but I may choose t o r egist er . I might do t his f or a number of r easons, one of which is credibility. For example, if I did not char ge VAT on my invoices, t hen my cust omer s would know t hat my t ur nover is quit e small. So many businesses j ust r egist er t o add cr edibilit y or conceal t ur nover . Anot her r eason t o r egist er would be t o recover your input VAT. As we saw in Chapt er 1, when you char ge out put VAT on your supplies or your sales, you ar e ent it led t o r eclaim your input VAT, t hat is VAT which has been char ged t o you on your cost s. So t his might be quit e an impor t ant r eason f or r egist er ing f or VAT.

Regist r at ion

433

If your customers are registered businesses t hemselves, t her e would be a ver y st r ong incent ive t o r egist er because your cust omer s would not mind you char ging VAT, since t hey will claim it back as their input tax. I t is only r eally when your cust omer s ar e t he public t hat a small business must t hink quit e ser iously about whet her it should r egist er volunt ar ily or not .

E2.2 Types of Registration

I n summar y, r egist r at ion can be br oken down int o a compulsor y r egist r at ion or a volunt ar y r egist r at ion. The compulsor y r egist r at ion t est can be br oken down int o an hist or ic t est and a f ut ur e t est . For t he hist or ic t est at t he end of ever y calendar mont h, you look at t axable supplies in t he pr evious 12 mont hs and if you have exceeded t he annual t hr eshold, cur r ent ly £ 61,000, t hen you have an obligat ion t o r egist er .

Sch 1 Par a 1

I n t he f ut ur e t est you look f or war d 30 days and if t he business is expect ed t o exceed £ 61,000 of t axable supplies in t he next 30 days, t hen you would have an obligat ion t o r egist er . I t is impor t ant t o r ecognise t hat t he f ut ur e t est is a daily t est , so ever y single day you must look f or war d 30 days and see if in t he next 30 days you will exceed £ 61,000. I t makes no r ef er ence t o what went on bef or e t oday. I t is t he next 30 days on their own t hat mat t er s. For volunt ar y r egist r at ion exist ing t r ader s can r egist er even if t heir t axable supplies f all below t he limit s. Anot her f or m of volunt ar y r egist r at ion is f or int ending t r ader s. These ar e t r ader s who have not act ually commenced t r ading, but who int end t o wit hin t he f or eseeable f ut ur e. These t r ader s would apply t o Cust oms f or a VAT number well bef or e t hey commence t r ading. This might be f or a number of f act or s but t he most common is t o enable r ecover y of VAT f r om Cust oms whilst t he business is being set up. For example, it might t ake you 6 mont hs t o r ef it a shop but in t hose 6 mont hs, if you ar e r egist er ed f or VAT, you can r eclaim input t ax f r om Cust oms. These would obviously be pr ovisional r eclaims and will be dependent on t he f act t hat you do act ually commence t r ading.

Sch 1 Par a 9

Regist r at ion

Compulsor y

Volunt ar y

Hist or ic t est

Fut ur e t est

Exist ing t r ader

I nt ending t r ader


E2.3 Historic test

As we have seen, you will be r equir ed t o r egist er f or VAT if at t he end of any calendar mont h, t he value of your t axable supplies in t he last 12 mont hs exceeds £ 61,000, t he cur r ent annual t hr eshold.

Sch 1 Par a 1

I f you have exceeded t he limit t hen you must not if y Cust oms of your r equir ement t o be r egist er ed by complet ing f or m VAT 1 and submit t ing it t o Cust oms wit hin 30 days of t he mont h t hat you exceeded t he limit . The r egist r at ion will be ef f ect ive i.e. you will be r egist er ed f r om, t he f ir st day of t he second mont h f ollowing t he end of t he mont h t he £ 61,000 was exceeded.

Sch 1 Par a 11 t o 17 SI 1995/ 2518 Reg 5

For example, at t he end of J une a business exceeds t he limit s t hen it must be r egist er ed f r om t he 1st day of t he second mont h f ollowing J une. As J uly is not t he second mont h, it must be August . So t he business must be r egist er ed f r om t he 1st day of August . I t exceeded t he limit in J une, it will have J uly ef f ect ively f r ee of VAT and f r om 1 August it is r egist er ed.

Illustration 1

Let us assume we ar e a t r ader in business and we ar e checking at t he end of ever y calendar mont h t he t axable supplies in t he pr evious 12 mont hs. At t he end of Apr il 2006 my t axable supplies amount ed t o £ 55,000 f or t he pr evious 12 mont hs, so t her e is no r equir ement f or t he business t o be r egist er ed.

We t hen go t o t he end of May 2006 and, f or t he pr evious 12 mont hs t o May, t he t axable supplies amount ed t o £ 58,000; again below t he limit s. We t hen go t o t he end of J une and, if we look back 12 mont hs, t he t axable supplies amount t o £ 54,000. A f all in t he value of t axable supplies like t his is simply as a r esult of t he J une 2006 t axable supplies being lower t han t he J une 2005 t axable supplies. But , in any event , we ar e below t he £ 61,000 limit and t her e is no r equir ement t o r egist er .

We t hen go on t o t he end of J uly 2006 and f or t he pr evious 12 mont hs our t axable supplies amount t o £ 62,000. The business has exceeded t he limit s; it has a r equir ement t o r egist er .

Example 1

The business ment ioned in I llust r at ion 1 must not if y Cust oms of it s r equir ement t o r egist er f or VAT on f or m VAT 1.

By which dat e must Cust oms be not if ied?

Fr om which dat e will t his business be VAT r egist er ed?

Regist r at ion

435

Illustration 2

New Business Limit ed commenced t r ading on 1 J uly 2005. The t axable sales wer e as f ollows: £ £ 2005 J uly 4,000 2006 Mar ch 5,000 August 4,000 Apr il 5,000 Sept ember 4,000 May 5,000 Oct ober 4,000 J une 6,000 November 4,000 J uly 8,500 December 4,000 August 8,000 2006 J anuar y 4,000 Sept ember 7,000 Febr uar y 4,000 Oct ober 8,500 I shall assume t hat t his business does not want t o volunt ar ily r egist er . I need t o f ind out when t he compulsor y r egist r at ion limit of £ 61,000 is exceeded. At t he end of ever y calendar mont h I look back 12 mont hs. I f I have not got 12 mont hs t o look back t o, f or example, on a st ar t -up, I can only look back t o t he st ar t of t r ade. So at t he end of J uly 2005 I look t o see how much I have sold in t he pr evious 12 mont hs. I have sold £ 4,000; so no r equir ement t o r egist er . I t hen move on t o August 2005; t axable supplies in t he pr evious 12 mont hs, will be £ 8,000. This pr ocess will cont inue unt il I exceed t he £ 61,000 limit . We can see f r om t his example t hat when I get t o J une 2006, t axable supplies t o J une 2006 t ot al £ 53,000. Thus, r egist r at ion is not r equir ed. The 12 mont hs t o J uly 2006 amount t o £ 57,500; again not exceeding t he limit . At t he end of August 2006, in t he pr evious 12 mont hs, my cumulat ive t axable supplies amount t o £ 61,500; t hat exceeds t he limit of £ 61,000 so August 2006 is t he mont h t he limit has been exceeded and t he dat e t he business must not if y Cust oms of it s r equir ement t o be r egist er ed is 30 Sept ember 2006, t hat is 30 days af t er t he mont h t he limit was exceeded. The compulsor y r egist r at ion dat e will be 1 Oct ober 2006, t hat is t he f ir st day of t he second mont h f ollowing t he mont h t he limit was exceeded. So Sept ember has been f r ee of VAT and t he f ir st t ime t he business will have t o char ge VAT is f r om 1 Oct ober 2006.

E2.4 Future Test

This is a t est which applies at any t ime. So ever y single day, t he t r ader must ask himself whet her t her e ar e r easonable gr ounds f or believing t hat t he value of t axable supplies in t he next 30 days will exceed t he r egist r at ion limit . Not if icat ion must again be made on f or m VAT 1 and again wit hin 30 days.

Sch 1 Par as 1 and 6

The registration on t he f ut ur e t est does, however , have an immediate effect. So st r aight away you must char ge VAT even t hough you will have no VAT number at t hat point .


This f ut ur e t est is r eally t o cat ch subst ant ial or der s. So, f or example, if you ar e always below t he hist or ic t est but t oday you went int o t he of f ice and r eceived an or der f or £ 100,000 which you wer e going t o t ur n ar ound pr et t y quickly, t hen t oday you know t hat in t he next 30 days on t heir own, you would exceed £ 61,000. You have got an or der f or £ 100,000 so t her ef or e you must exceed t he limit in t he next 30 days. Consequent ly you must not if y Cust oms wit hin 30 days f r om t oday and you must be r egist er ed f or VAT f r om t oday.

Illustration 3

Let us look at an illust r at ion wher e we have a business t hat has always t r aded j ust below t he hist or ic t hr eshold. I n t he 12 mont hs t o 30 Apr il, t he t axable supplies wer e £ 58,000; t he 12 mont hs t o 31 May t he t axable supplies wer e £ 59,000; t he 12 mont hs t o 30 J une, t hey wer e £ 57,000. I n ot her wor ds t he business is always j ust below t he limit s.

Let us assume t hat t his business r eceived an or der on 10 J uly f or £ 70,000. They have got t he goods in st ock and t hey expect t o t ur n t he or der ar ound wit hin 10 days. So on 10 J uly if you look f or war d 30 days, you will exceed t he limit of £ 61,000. You have got an or der f or £ 70,000 plus what ever sales you would or dinar ily do in t hose 30 days. So t he business br eaches t he f ut ur e t est .

When must t his business not if y Cust oms of it s r equir ement s t o r egist er ? The not if icat ion dat e is 30 days f r om 10 J uly. That was t he point when you could say t hat t her e wer e r easonable gr ounds f or believing t hat t axable supplies in t he next 30 days would exceed t he limit s. So 9 August 2006 is 30 days. This business must be r egist er ed f r om what dat e? As we saw ear lier , t he dat e of r egist r at ion f or t he f ut ur e t est is immediat e so on 10 J uly t his business must be r egist er ed f or VAT, i.e. it must char ge VAT f r om 10 J uly.

E2.5 Common Misconception

J ust one point t o make about a common misconcept ion on t he hist or ic and t he f ut ur e t est s. This is best illust r at ed using an example. Let us say t axable sales in t he 11 mont hs t o 30 Sept ember 2006 wer e £ 55,000. I n Oct ober 2006 you have budget ed sales of £ 7,000. I n t his sit uat ion t he f ut ur e t est does not apply because t her e is no point at which you can say in t he next 30 days on their own, t he business will exceed t he limit s. On 1 Oct ober 2006 we ant icipat e t axable supplies f or Oct ober of £ 7,000 and £ 7,000 alone does not exceed £ 61,000 so t her ef or e t he f ut ur e t est does not apply.

The hist or ic t est will however apply when I get t o t he end of Oct ober . The t axable supplies made in t he 12 mont hs t o 31 Oct ober amount t o £ 62,000. The business has exceeded t he limit s. I t must not if y Cust oms by 30 days f r om t he mont h of excess, so 30 November 2006. The r egist r at ion dat e will be 1 December 2006 so no VAT is char ged f or t he whole of November , and t he business is r egist er ed f r om t he f ir st day of t he second mont h, so 1 December .

Regist r at ion

437

E2.6 Taxable supplies

A t axable supply is a supply of goods or ser vices made in t he UK ot her t han an exempt supply. I n det er mining whet her t he r egist r at ion limit s have been exceeded, it is t her ef or e necessar y t o t ake int o account t he VAT-exclusive value of all st andar d and zer o-r at ed supplies of goods and ser vices, including

s.4(2)

• t he value of ‘reverse charge’ ser vices r eceived f r om abr oad (Chapt er

23); and • t he value of any self-supplies (Chapt er 7). The f ollowing special r ules, however , apply. • Supplies of goods or ser vices t hat ar e capital assets of t he business in

t he cour se or f ur t her ance of which t hey ar e supplied ar e t o be disr egar ded. Specif ically, however , any st andar d-r at ed supply of an int er est in, r ight over , or licence t o occupy land is not t o be r egar ded as a capit al asset and does f or m par t of t he per son’s t axable supplies f or r egist r at ion pur poses.

Sch 1 par a 1(7)(8)

Capit al asset s may be t angible or int angible and include pr emises, plant , machiner y, of f ice machiner y, comput er s, of f ice f ur nit ur e, used company car s, pat ent r ight s which have been exploit ed and which ar e sold out r ight , and goodwill.

• Supplies can be disr egar ded if t hey ar e only t axable supplies in t he UK because an over seas business makes dist ance sales t o non-t axable per sons in t he UK and is r equir ed t o r egist er under VATA 1994, Sch 2.

Sch 1 par a 1(7)

The value of any dist ance sales wher e t he place of supply is consider ed t o be in anot her EU count r y must also be excluded when calculat ing t axable t ur nover .

• Under t he schemes f or second-hand goods, t he t axable supplies ar e t he f ull selling pr ices of t he goods. Under t he tour operators’ margin

scheme, t axable supplies ar e t he t ot al mar gin (i.e. dif f er ence bet ween buying pr ices and t he selling pr ices) on mar gin scheme supplies plus t he f ull value of any ot her t axable supplies (including all in-house supplies).

E2.7 Deregistration

Once a business is r egist er ed f or VAT, it is not always t he case t hat it will r emain r egist er ed f or VAT. I n cer t ain sit uat ions a business may be r equir ed t o der egist er or may volunt ar ily der egist er . Examples of compulsor y der egist r at ion would be:

Sch 1 Par a 11


• Sale of business - if you sold your business you ar e no longer in a posit ion t o char ge VAT so you ar e compulsor ily der egist er ed;

• Changing status – a business might change f r om a sole t r ader t o a limit ed company f or example.

• Ceasing to make taxable supplies - a business may cease t r ading f or example.

Volunt ar y der egist r at ion is available wher e a business is expect ed t o make t axable supplies in t he next 12 mont hs of less t han £ 59,000. I f t hat is t he case, and t he business no longer wishes t o r emain r egist er ed, it can inf or m Cust oms and pr oviding t hey ar e sat isf ied t hat t he business will f all below t he der egist r at ion limit of £ 59,000 it will be per mit t ed t o der egist er .

Sch 1 Par a 1(3)

However , t hat per son does not cease t o be liable t o be r egist er ed under t hese pr ovisions if Cust oms ar e sat isf ied t hat t he r eason t he value of his t axable supplies will not exceed t he above limit is t hat in t he per iod in quest ion he will cease making t axable supplies or will suspend making t hem f or a per iod of 30 days or mor e.

Sch 1 Par a 4(2)

Taxable supplies f or t he above pur poses ar e det er mined on t he basis t hat no VAT is char geable on t he supply (i.e. VAT-exclusive).

Sch 1 par as 3,4,15,16

When der egist er ing VAT must be account ed f or on t he f inal r et ur n of any ‘goods’ f or ming par t of t he business asset s which ar e on hand at t he close of business or on t he last day of r egist r at ion as if t hey wer e supplied in t he cour se or f ur t her ance of t he business unless (a) t he business is t r ansf er r ed as a going concer n t o anot her t axable per son; (b) t he t axable per son has died, become bankr upt or incapacit at ed and t he

business is car r ied on by anot her per son who under VATA 1994, s 46(4) is t r eat ed as a t axable per son; or

(c) t he VAT on t he deemed supply would not be mor e t han £ 1,000. ‘Goods’ f or t hese pur poses means t angible goods (e.g. unsold st ock, plant , f ur nit ur e, commer cial vehicles, comput er , et c.) and int angible goods such as pat ent s, copyr ight s and goodwill can be disr egar ded. I t includes goods pur chased wher e t it le has not yet passed t o t he business but wher e input t ax on t he pur chase has been allowed (e.g. goods on hir e pur chase or lease pur chase and goods subj ect t o r eser vat ion of t it le). Land f or ming par t of t he business asset s is t r eat ed as if it wer e goods.

VAT Not ice 700/ 11/ 02, par a 6.1

The pr ovisions do not apply t o any goods wher e t he t axable per son can show t o t he sat isf act ion of Cust oms t hat

Regist r at ion

439

(i) no cr edit f or input t ax has been allowed t o him in r espect of t he supply of goods, t heir acquisit ion f r om anot her EU count r y or t heir impor t at ion f r om a place out side t he EU; and

(ii) t he goods did not become his as par t of t he asset s of a business t r ansf er r ed as a going concer n f r om anot her t axable per son.

The pr ovisions also do not apply wher e a per son ceased t o be a t axable per son in consequence of being cer t if ied t o j oin t he f lat r at e scheme f or f ar mer s.

Sch 4 par as 8 & 9

The f ollowing ar e excluded f r om t he char ge t o VAT: • Goods bought f r om unr egist er ed businesses. • Mot or car s (except qualif ying car s on which input t ax has been claimed). • Goods bought under t he pr ovisions of one of t he second-hand schemes. • Goods used wholly f or business ent er t ainment . • Goods t hat have been dir ect ly at t r ibut ed t o an exempt business act ivit y

(unless t he input t ax was r eclaimable t hr ough t he par t ial exempt ion r ules).

• Goods not bought f or business pur poses. • Land or buildings which wer e pur chased under an exempt supply even

t hough

(i) t he opt ion t o t ax has been exer cised and subsequent ly st andar d-r at ed supplies have been made and/ or input t ax r ecover ed on t he r ef ur bishment of t he building; or

(ii) wit hout t he opt ion t o t ax t hey have ot her wise been used t o make

st andar d-r at ed supplies (e.g. holiday accommodat ion).

• Land or buildings which wer e pur chased under a supply on which VAT was r ecover ed (e.g. wher e a f ully t axable business buys a new commer cial pr oper t y) if at t he t ime of der egist r at ion t he sale would be exempt (because t he business has not opt ed t o t ax t he pr oper t y which is t hen over t hr ee year s old). I n such cir cumst ances, VAT due on t he supply of t he pr oper t y would be nil and so not exceed t he £ 1,000 limit .

Wher e a business has st andar d-r at ed land or buildings on hand at t he t ime of der egist r at ion on which it claimed input t ax deduct ion, t he pr oper t y is deemed t o be supplied on der egist r at ion. To avoid t he cash f low pr oblem t hat t his might cr eat e, t he business could def er t he cancellat ion of r egist r at ion unt il t he pr oper t y is sold so t hat it would t hen be r equir ed t o account f or out put t ax on t he act ual sale of t he pr oper t y. Cust oms ar e pr epar ed t o consider , if necessar y, def er r ing t he cancellat ion of r egist r at ion longer t han t he nor mal six mont hs, unt il af t er t he pr oper t y is sold.

VAT Not ice 700/ 11/ 02, Par a 6.2; Manual VI -3, Chapt er 2A par a 4.9


E2.8 Exemption from registration

Wher e a per son who makes or int ends t o make t axable supplies sat isf ies Cust oms t hat ‘any such supply’ is zer o-r at ed (or would be so if he wer e a t axable per son) t hey may, if he so r equest s and t hey t hink f it , gr ant exempt ion f r om r egist r at ion under t he above pr ovisions. On a mat er ial change in t he nat ur e of t he supplies made, t he per son exempt ed must not if y Cust oms of t he change wit hin 30 days of t he end of t he day on which it occur r ed or , if no par t icular day is so ident if iable, wit hin 30 days of t he end of t he par t icular quar t er in which it occur r ed. On a mat er ial alt er at ion in any quar t er in t he pr opor t ion of t axable supplies of such a per son t hat ar e zer o-r at ed, he must not if y Cust oms of t he alt er at ion wit hin 30 days of t he end of t hat quar t er . Exempt ion applies unt il it appear s t o Cust oms t hat t he r equest should no longer be act ed upon or t he r equest is wit hdr awn by t he t r ader .

Sch 1 par a 14

‘Any such supply’ has it s or dinar y meaning and Cust oms t her ef or e have discr et ion in applying t he pr ovisions wher e not all of t he supplies ar e zer o-r at ed. Cust oms will t her ef or e exempt a per son f r om r egist r at ion if only a small pr opor t ion of his t axable supplies is st andar d-r at ed pr ovided t hat , if r egist er ed, input t ax would nor mally exceed out put t ax. Cust oms will consider applicat ions f r om unr egist er ed per sons who have r eached t he r egist r at ion t hr eshold and f r om per sons who ar e alr eady r egist er ed. Unr egist er ed applicant s ar e st ill r equir ed t o complet e f or m VAT 1. A mat er ial alt er at ion af f ect ing exempt ion f r om r egist r at ion would ar ise wher e, if t he per son was r egist er ed, out put t ax would exceed input t ax in any t welve mont h per iod. Exempt ion saves a per son t he t r ouble and expense of having t o keep pr oper r ecor ds and account s f or VAT pur poses and r ender ing r et ur ns but it does mean t hat input t ax paid on pur chases of goods or ser vices f or t he business is not r eclaimable. Disaggr egat ion of business act ivit ies The disaggr egat ion pr ovisions ar e designed t o pr event t he maint enance or cr eat ion of any ‘ar t if icial’ separ at ion of business act ivit ies car r ied on by t wo or mor e per sons f r om r esult ing in t he avoidance of VAT. For example a builder might have a VAT r egist er ed company dealing wit h his lar ger cont r act s and an unr egist er ed par t ner ship wit h his wif e dealing wit h t he smaller maint enance wor k. I f t he par t ner ship wer e mainly dealing wit h t he public t her e would be a compet it ive and f inancial advant age f r om t r ading in t his way. I n det er mining whet her any separ at ion of business act ivit ies is ‘ar t if icial’, consider at ion must be given t o t he ext ent t o which t he dif f er ent per sons car r ying on t hose act ivit ies ar e closely bound t o one anot her by financial,

economic and organisational links.

Sch 1 par a 2(1)

Regist r at ion

441

Cust oms may make a dir ect ion under which t he per sons specif ied t her ein become t r eat ed as a single t axable per son car r ying on t he act ivit ies of a business descr ibed in t he dir ect ion. That t axable per son is t hen liable t o be r egist er ed under VATA 1994, Sch 1 wit h ef f ect f r om t he dat e of t he dir ect ion or such lat er day as is specif ied. I f , immediat ely bef or e t he dir ect ion any per son named t her ein is alr eady r egist er ed in r espect of t axable supplies made by him, he ceases t o be liable t o be r egist er ed f r om t he dat e of t he dir ect ion or , if lat er , t he dat e wit h ef f ect f r om which t he single t axable per son concer ned became liable t o be r egist er ed.

Sch 1 par a 1A Par a 2(1)(3)-(5);


Answer 1

The cor r ect not if icat ion dat e is 30 August 2006. This is 30 days f r om t he mont h in which t he limit s wer e exceeded. As t he business exceeds t he limit s at t he end of J uly 2006, t he cor r ect r egist r at ion dat e is 1 Sept ember 2006; t his is t he f ir st day of t he second mont h. Thus August was f r ee of VAT and no VAT needs t o be char ged in August . However f r om 1 Sept ember t he business will be r egist er ed and t hen must char ge VAT.

Regist r at ion

443

SUMMARY - REGISTRATION Ther e ar e t wo t ypes of r egist r at ion - compulsor y and volunt ar y r egist r at ion. For compulsor y r egist r at ion t her e ar e t wo t est s which must be consider ed – t he hist or ic t est and t he f ut ur e t est . The hist or ic t est looks at past t axable supplies but we never look back mor e t han t he pr eceding 12 mont hs. This hist or ic t est is car r ied out at t he end of ever y calendar mont h. I f t he cumulat ive t axable supplies exceeds t he VAT r egist r at ion limit t hen Cust oms must be not if ied wit hin t he next 30 days and we r egist er t he business f r om t he st ar t of t he second mont h t hat f ollows t he mont h end. The f ut ur e t est looks only at t axable supplies in t he next 30 days alone. I f t he r egist r at ion limit is exceeded t hen Cust oms must be not if ied bef or e t hat 30 day per iod expir es. The business will t hen be r egist er ed f r om t he st ar t of t he 30 day per iod. Volunt ar y r egist r at ion allows a business t o r egist er f or VAT even if it s t axable supplies does not exceed t he VAT r egist r at ion t hr eshold. Volunt ar y r egist r at ion is also available f or int ending t r ader s who have not yet commenced t o t r ade but ar e int ending t o do so in t he near f ut ur e. De-r egist r at ion allows a business t o de-r egist er f or VAT. De-r egist r at ion may be compulsor y or volunt ar y. Compulsor y de-r egist r at ion would occur wher e a business is sold or ceases t o make t axable supplies. Volunt ar y de-r egist r at ion is available wher e a business is expect ed t o make t axable supplies in t he next 12 mont hs of less t han £ 59,000. Tr ader s who make zer o r at ed supplies may r equest t o be exempt f r om r egist r at ion. Cust oms have t he power t o dir ect t hat businesses t hat have close f inancial, economic and or ganisat ional links ar e aggr egat ed f or t he pur poses of r egist r at ion. The dir ect ion will nor mally be applied wher e businesses ar e separ at ed in or der t o avoid char ging VAT on some or all of t he business t ur nover .

E3: DEFINITION OF SUPPLIES

This chapt er will look at t he f ollowing: - when a supply ar ises f or VAT pur poses; - t he def init ion of consider at ion; - t he f ive basic condit ions r equir ed t o det er mine whet her a supply should be

char ged t o VAT.

E3.1 Introduction

A supply f or VAT pur poses would gener ally ar ise wher e consider at ion is given in r et ur n f or goods or ser vices. Consider at ion is any f or m of payment , be it cash or in kind. Suppose we have a r egist er ed t r ader t hat sells goods t o a cust omer (t he supply). I n r et ur n, t he cust omer pays cash t o t he r egist er ed t r ader (consider at ion). Wher e t he consider at ion is f or t he goods pr ovided, we have a supply f or VAT pur poses.

s.5(2)

I t is not however necessar y f or cash t o pass; t he def init ion of consider at ion says payment in money or in kind, so it need not be money. For example, in r et ur n f or t he goods t he cust omer may of f er his t ime i.e. he may have an ar r angement wher e he wor ks one mor ning a week in t he r egist er ed t r ader ’s business. He would not get paid f or t hat mor ning inst ead he r eceives goods. So t he consider at ion in t his example would be t he t ime t he cust omer is giving t he r egist er ed t r ader , hence t her e will be a supply f or VAT and t he r egist er ed t r ader must det er mine whet her he should char ge VAT on t he goods supplied. This will depend on whet her t he goods supplied ar e t axable or not . Consequent ly once consider at ion is pr esent and dir ect ly linked t o a supply, we t hen need t o det er mine whet her it is a taxable supply.

E3.2 Five Conditions

Ther e ar e f ive basic condit ions t o det er mine whet her a supply mer it s a char ge t o VAT.

s.4

a) The supply must amount t o a supply of goods or services.

b) The supply must be made by a taxable person.

c) The supply must have been made in t he United Kingdom.

d) The supply must have been made in the course or furtherance of business.

e) I t must be a taxable supply by def init ion. We shall now consider each of t hese in t ur n.

Def init ion of Supplies

445

E3.3 Goods or Services

A supply of goods is def ined in t he legislat ion as t he t r ansf er of t he whole of pr oper t y in goods by way of sale, hir e pur chase, condit ional sale or similar t r ansact ion. This is ef f ect ively exclusive owner ship passing. Take car e wit h t he supply of any f or m of power , heat , r ef r iger at ion or vent ilat ion, t he gr ant , assignment or sale or sur r ender of t he f r eehold or a leasehold exceeding 21 year s - all t he above ar e deemed t o be supplies of goods.

Sch 4 Par a 1 Sch 4 Par as 3 & 4

Anyt hing done f or consider at ion which does not f all wit hin t he above is a supply of ser vices. So t her e is no r eal def init ion of ser vices. Ther e is a def init ion of goods but if your par t icular t r ansact ion does not f all wit hin t his def init ion, t hen it will be a ser vice.

s.5(2)

For example, if you ar e a r et ailer who sells a comput er t o a cust omer , t hat will be a supply of goods as exclusive owner ship is passing. I f , on t he ot her hand, t he r et ailer r et ains owner ship of t he comput er and leases it or r ent s it t o t he cust omer , t hat is a ser vice.

E3.4 Supply must be made by a Taxable Person

The second condit ion is t hat t he supply must be made by a t axable per son. A t axable per son f or VAT pur poses is any individual (i.e. a sole t r ader ), any par t ner ship, company, club or associat ion which is or is r equir ed t o be r egist er ed f or VAT. So t his is basically any per son who has exceeded t he compulsor y r egist r at ion t est s or has r egist er ed f or VAT volunt ar ily.

s.3

E3.5 UK Supply

The t hir d condit ion is t hat t he supply must be made in t he Unit ed Kingdom. Subj ect t o var ious over r ides, if t he supply of any goods does not involve t heir r emoval f r om or t o t he UK t hey shall be t r eat ed as supplied in t he UK if t hey ar e in t he UK and ot her wise shall be t r eat ed as supplied out side t he UK.

s.7(2)

Ser vices ar e deemed t o be supplied in t he count r y in which t he supplier belongs, i.e. a count r y in which he has his business est ablishment or if t her e is no such est ablishment in t he count r y in which he r esides. So, f or example, a UK lawyer will be deemed t o belong in t he UK, t her ef or e his ser vices ar e supplied in t he UK.

s.7(10)

Ther e ar e var ious over r ides t o t hese basic r ules which will be cover ed lat er in t he t ext but , f or now, we will j ust st ick wit h t hese basic pr inciples.


E3.6 In Course or Furtherance of the Business

The next condit ion is t hat t he supply must be made in t he cour se or f ur t her ance of t he business.

Despit e t he impor t ance of t he meaning of ‘business’, it is not compr ehensively def ined in UK (or EC) legislat ion. VATA 1994, s 94 gives t he f ollowing guidance as t o what t he t er m encompasses and excludes. (a) I t includes any t r ade, pr of ession or vocat ion. (b) The f ollowing (wit hout pr ej udice t o t he gener alit y of anyt hing else in

VATA 1994) ar e deemed t o be t he car r ying on of a business.

a. The pr ovision by a club, associat ion or or ganisat ion (f or a subscr ipt ion or ot her consider at ion) of t he f acilit ies or advant ages available t o it s member s (but see (c) below).

b. The admission, f or a consider at ion, of per sons t o any pr emises.

(c) Wher e a per son accept s any of f ice in t he cour se or f ur t her ance of a

t r ade, pr of ession or vocat ion, ser vices supplied by him as holder of t hat of f ice ar e t r eat ed as supplied in t he cour se or f ur t her ance of t hat t r ade, pr of ession or vocat ion.

(d) Anyt hing done in connect ion wit h t he t er minat ion or int ended t er minat ion

of a business is t r eat ed as being done in t he cour se or f ur t her ance of t hat business.

(e) The disposit ion of a business as a going concer n, or of it s asset s or

liabilit ies (whet her or not in connect ion wit h it s r eor ganisat ion or winding up) is a supply made in t he cour se or f ur t her ance of t he business.

When consider ing whet her an act ivit y is t o be t r eat ed as a business, if it is not one of t he deemed businesses above t hen t he ‘business t est ’ must be applied. This t est is der ived f r om decisions of t he VAT t r ibunals and Cour t s. The f ollowing pr inciples, as summar ised in C & E Commr s v Lor d Fisher , ar e a guide as t o whet her an act ivit y is a business alt hough t he absence of one common at t r ibut e of or dinar y businesses (e.g. t he pur suit of pr of it ) does not necessar ily mean t hat t he act ivit y is not a business and t he cr it er ia ar e not t her ef or e conclusive in ever y case. (a) By pr oviding in VATA 1994, s 94 t hat business includes any t r ade,

pr of ession or vocat ion, it is clear t hat a wide meaning of ‘business’ is int ended.

(b) I n det er mining whet her any par t icular act ivit y const it ut es a business it is

necessar y t o consider t he whole of t hat act ivit y.


447

(c) A business act ivit y can gener ally be ident if ied f r om t he answer s t o t he

f ollowing cr it er ia (as laid down in C & E Commr s v Mor r ison’s Academy Boar ding Houses Associat ion).

(i) I s t he act ivit y a ‘ser ious under t aking ear nest ly pur sued’ or a

‘ser ious occupat ion not necessar ily conf ined t o commer cial or pr of it making under t akings’?

(ii) I s t he act ivit y an occupat ion or f unct ion act ively pur sued wit h

r easonable or r ecognisable cont inuit y?

A one-of f supply or a ser ies of inf r equent , unconnect ed supplies is not nor mally a business act ivit y in it s own r ight alt hough it is impor t ant t o consider t he nat ur e of t he act ivit y. For example, occasional sales by small speculat ive builder s and pr oper t y developer s ar e business act ivit ies.

(iii) Does t he act ivit y have a cer t ain measur e of subst ance as

measur ed by t he quar t er ly or annual value of t axable supplies made?

(iv) I s t he act ivit y conduct ed in a r egular manner and on sound and

r ecognised business pr inciples? (v) I s t he act ivit y pr edominant ly concer ned wit h t he making of

t axable supplies t o consumer s f or a consider at ion? This is per haps t he most impor t ant point t o est ablish, bear ing in mind t hat ‘consider at ion’ need not necessar ily be monet ar y. I f a t r ader is car r ying on an act ivit y which does not involve t he making of any supplies f or a consider at ion and t her e is no int ent ion in t he f ut ur e of doing so, t hen t he act ivit y is unlikely t o be r egar ded as business even if all t he ot her cr it er ia ar e met .

I n C & E Commr s v The Apple and Pear Development Council, [1988]) t he Council’s pr incipal act ivit y was t o adver t ise English apples and pear s, which act ivit y was f inanced by a st at ut or y levy on gr ower s. The CJ EC r uled t hat t he levy was not consider at ion because t her e was no dir ect link bet ween t he payment s and t he benef it s of individual gr ower s on which basis t he House of Lor ds concluded t hat t he act ivit y was not ‘business’ in t he VAT sense. Wher e an act ivit y is j ust beginning and no supplies ar e being made at t he t ime but t her e is a clear int ent ion t o do so at some t ime in t he f ut ur e, t hen t he act ivit y may qualif y as a business. See Rompelman v Minist er van Financien, [1985] and Mer seyside Cablevision Lt d.


(vi) Ar e t he t axable supplies of a kind which ar e commonly made by

t hose who seek t o pr of it by t hem?

I f a per son is car r ying on an act ivit y and it is not clear whet her it amount s t o a business, it is mor e likely t o be r egar ded as such if ot her s ar e car r ying on t he same t ype of act ivit y and ar e clear ly doing so on a commer cial basis. I n Chur ch of Scient ology of Calif or nia (No 1) v C & E Commr s, [1981] cour ses in t he st udy of it s belief s pr ovided by t he Chur ch, some of which compet ed wit h t hose of f er ed by t r ained psychologist s and psychiat r ist s, wer e f ound t o be business act ivit ies.

(d) Whet her t he act ivit y is pur sued f or pr of it or some ot her pr ivat e pur pose or mot ive is not decisive in det er mining whet her t he act ivit y is a business.

(e) I f all or a suf f icient number of t he above cr it er ia ar e sat isf ied in

suf f icient measur e t o over r ide any cont r a-indicat ions which might be seen in t he f act s, t hen as a mat t er of law t he act ivit y must be held t o be a business.

The car r ying on, by a r egulat or y aut hor it y, of a st at ut or y licensing act ivit y t o pr ot ect t he public int er est is not a business act ivit y even t hough car r ied on f or a consider at ion. I n I nst it ut e of Char t er ed Account ant s in England and Wales v C & E Commr s, [1999] t he I nst it ut e’s aut hor isat ion t o issue licences t o audit or s, insolvency pr act it ioner s and per sons car r ying on invest ment business was held not t o be a business act ivit y. Business Br ief 02/ 2005 pr ovides usef ul r ef er ence t o t he business t est .

E3.7 Taxable Supply

The f inal point is whet her or not t he supply is a t axable supply. Once it has been est ablished t hat t her e is a supply we t hen need t o det er mine whet her t he supply is t axable, exempt or out side t he scope of VAT complet ely.

s.4(2)

Taxable will be at one of t hr ee r at es of VAT; t he standard rate, a lower rate

and a zero rate. The st andar d r at e is cur r ent ly 17.5%, t he lower r at e is cur r ent ly 5% and t he zer o r at e, as you would expect , is 0%. The legislat ion det ails supplies which ar e at t he lower r at e of 5%, and t he zer o r at e of 0%. The legislat ion also out lines which supplies ar e exempt supplies and, t o a cer t ain ext ent , which supplies ar e out side t he scope of VAT. I f your supply is not wit hin one of t hose specif ic def init ions, t hen t he supply is t axable at 17.5%.


449

Supply

Taxable Exempt Out side t he scope of VAT

17.5%

St andar d Rat e

5%

Lower Rat e

0%

Zer o Rat e

So t her e we have it , t he f ive condit ions. For t her e t o be a t axable supply you must meet all f ive.


SUMMARY – DEFINITION OF SUPPLIES For a supply t o be char ged t o VAT t hat supply must be a supply of goods or ser vices, made by a t axable per son, in t he UK, in t he cour se or f ur t her ance of a business. I n addit ion, t he supply must be a t axable supply and gener ally consider at ion must be pr esent . Consider at ion is not necessar ily cash. The def init ion of consider at ion is payment in money or in kind. The supply of goods is def ined as a t r ansf er of t he whole pr oper t y in goods. Anyt hing done f or consider at ion which is not a supply of goods is a supply of ser vices. A t axable per son is a per son who is or should be VAT r egist er ed. A supply made in t he UK includes supplies made in t he I sle of Man as well as England, Scot land, Wales and Nor t her n I r eland. A supply made in t he cour se or f ur t her ance of a business r equir es some sor t of economic act ivit y wit h a per son or a company car r ying on a t r ade, pr of ession or vocat ion. A pr of it mot ive is not necessar y. A t axable supply is a st andar d r at ed or zer o r at ed supply as def ined by t he VAT legislat ion.

E4: LIABILITY OF THE SUPPLY

This chapt er is going t o look at t he f ollowing: how we wor k out whet her a supply is char geable t o VAT; if it is, how much VAT we act ually char ge on t hat supply; - t he t hr ee t ypes of supply; - t he way t o cat egor ise a supply in or der t o wor k out t he cor r ect VAT t r eat ment .

E4.1 Introduction

This chapt er looks at how t o wor k out whet her a supply is char geable t o VAT and, if it is, how much VAT t o char ge on t hat supply. Ef f ect ively, it could be said t hat t her e ar e t hr ee t ypes of supply. The f ir st t ype of supply is a taxable supply which is t he sor t of supply t hat VAT will apply t o. The second t ype of supply is an exempt supply – t her e is no VAT on an exempt supply. The f inal t ype of supply is called out side t he scope, t hese supplies ar e complet ely ignor ed when looking at t he VAT legislat ion alt hough we may have t o be car ef ul if input VAT has been paid which t he business would like t o r ecover in r elat ion t o a supply t hat was out side t he scope because such input VAT cannot nor mally be r ecover ed. This will be dealt wit h in a lat er chapt er .

E4.2 Taxable supplies

Basically t her e ar e t hr ee t ypes of t axable supply. The f ir st t ype of t axable supply is called st andar d r at ed because t he st andar d r at e of VAT would apply t o t his supply – so 17.5% VAT will be charged on standard rated taxable

supplies.

The second t ype of t axable supply is a supply t axable at t he lower rate of VAT,

which is currently standing at 5%.

The f inal t ype of supply t hat is t axable is t he zer o-r at ed t axable supply which, of cour se, is t axable at t he zero rate of VAT – 0% VAT. I n t he VAT legislat ion t her e is a list of zer o-r at ed supplies in Schedule 8 of t he Value Added Tax Act (VATA) 1994. Ther e is a list of lower r at e supplies in Schedule 7A of VATA 1994. Ther e is a list of exempt supplies in Schedule 9 of VATA 1994. Ther e is some inf or mat ion in VAT Not ice 701/ 39 on VAT liabilit y law, but nowher e in t he legislat ion is t her e a def init ive list of st andar d r at ed t axable supplies.

Sch 8 Sch 9

E4.3 Method of determining liability

A business supplies widget s. How should it t r eat t hat supply of a good f or VAT pur poses? Fir st ly one looks at Schedule 8 of VATA 1994. Schedule 8 out lines all t he zero rated supplies made f or VAT legislat ion pur poses.


I f t he business cannot f ind t he supply list ed in Schedule 8 t he next st ep is t o look at Schedule 9. Schedule 9 list s all t he exempt supplies. I f t he widget is neit her zer o r at ed nor exempt , t hen st ep t hr ee is t o see if t he supply is subj ect t o VAT a t he lower r at e under Schedule 7A. Ther e ar e specif ic it ems which ar e char ged t o VAT at t he lower r at e (see below).

Sch 7A

The next st ep would be t o decide if t he widget was outside the scope of VAT. Again t her e ar e specif ic supplies t hat ar e out side t he scope of VAT, f or example, t r ansf er r ing a business as a going concer n. Thus if t he it em is not zer o r at ed, not exempt , not char ged at t he lower r at e and not out side t he scope of VAT t hen what is lef t is a st andar d r at ed t axable supply and t hat is what t he widget must be. This is t he f inal st ep. Ther e is no list of st andar d r at ed t axable supplies in t he legislat ion – basically one get s t her e by def ault . St ep 1 Schedule 8 (zer o r at ed) ↓ ↓ 2 Schedule 9 (exempt ) ↓ ↓ 3 Schedule 7A (lower r at ed) ↓ ↓ 4 Out side t he scope (specif ic supplies) ↓ ↓ 5 St andar d Rat ed Zero rating will always take priority over exempt ion by r eason of s.30(1) VATA 1994. I f an it em could f all int o bot h Schedule 8 and Schedule 9 it will always be zer o r at ed since t his t akes pr ior it y.

E4.4 Lower Rate (5%)

The lower r at e of VAT is cur r ent ly 5% and t he supplies t hat ar e subj ect t o t he lower r at e ar e out lined in Schedule 7A of VATA 1994. The main supply t hat is associat ed wit h t he lower r at e of VAT is supplies of f uel f or domest ic use f or example, gas and elect r icit y supplied t o people’s homes. Also cover ed by t he lower r at e is t he supply of ladies sanit ar y pr oduct s, t he supply of childr en’s car seat s and gr ound sour ce heat pumps.

Sch 7A Gr oups 1, 4 t o 5

Wher e dwellings ar e being r enovat ed, having been empt y f or at least t hr ee year s or mor e and t hose dwellings ar e basically a single household, t hen t he lower r at e of VAT also applies t o t he r enovat ion.

Sch 7A Gr oup 7

Also on t he list f or lower r at e VAT is t he conver sion of a r esident ial pr oper t y int o a dif f er ent number of dwellings. This would cover , f or example, t he conver sion of a house int o f lat s. By a similar t oken conver t ing a non-r esident ial pr oper t y int o a dwelling or a number of dwellings is also a r ecent addit ion t o t he list and an example of t his would be conver t ing a bar n int o a house.

Sch 7A Gr oup 6

Liabilit y of t he Supply

453

The conver sion of a dwelling int o a car e home or int o a house in mult iple occupat ion is also at t he lower r at e and conver t ing a car e home int o a single household dwelling or dwellings is also at t he 5% rat e. These ar e t he main it ems which ar e char ged t o VAT at t he lower r at e – t her e ar e a f ew ot her s cover ed in t he Schedule, f or example, t he ser vices of inst alling ener gy saving mat er ials int o homes and supplies of inst alling cent r al heat ing or secur it y equipment int o homes of t he elder ly ar e also cover ed by t he lower r at e.

Sch 7A Gr oups 2 & 3

New f or t his year is t he r educed r at e of 5% will now apply t o sale of all cont r acept ive pr oduct s including sales by r et ailer s, vending machines or via t he int er net . FA2006 int r oduced t he r educed r at e f or cont r acept ives and it will apply f r om 1 J uly 2006.

E4.5 Outside the Scope of VAT

The sor t s of it ems t hat ar e complet ely out side t he scope of VAT ar e t hings like;

• st at ut or y char ges;

• salar ies and wages;

• t ips and gr at uit ies given t o st af f ;

• f ees and honor ar ia paid t o cler gymen;

• int er -gr oup t r ansact ions if t her e is a VAT gr oup r egist r at ion in f or ce; and

• t he sale or pur chase of a business as a going concer n.

VAT Not ice 700 par a 8.14 C&E Manual V1-3 Chapt er 2B Par a .6 s.43 SI 1995/ 1268


SUMMARY – LIABILITY OF THE SUPPLY Ther e ar e t hr ee t ypes of supply: - t axable - exempt - out side of t he scope Ther e ar e t hr ee t ypes of t axable supply: - st andar d r at ed - lower r at e - zer o r at ed Schedule 8 of VATA 1994 list s t he zer o r at ed supplies. Schedule 9 of VATA 1994 list s t he exempt supplies. Supplies subj ect t o t he lower r at e of VAT ar e out lined in Schedule 7A of VATA 1994. Cer t ain supplies ar e out side t he scope of VAT, t hese include: t he sale or pur chase of a business of a going concer n int er gr oup t r ansact ions wit hin a VAT gr oup t ips and gr at uit ies salar ies and wages paid t o st af f st at ut or y char ges. Ther e is no def init ion in t he legislat ion of st andar d r at ed supplies. Ef f ect ively if a supply is not zer o r at ed, is not exempt , is not t axable at t he lower r at e, and is not out side t he scope of VAT, t hen it is by except ion a st andar d r at ed supply.

E5: SCHEDULE 8 VATA 1994 – ZERO RATING

This chapt er will look at t he t ypes of supply list ed as zer o r at ed supplies. Ther e ar e sixt een cat egor ies of zer o r at ed supplies which ar e list ed in Schedule 8 of VATA 1994.

E5.1 Introduction

Schedule 8 t o t he VAT Act 1994 is simply a list of zer o r at ed it ems. These it ems have been collat ed int o sixt een gr oups.

Sch 8

• Gr oup 1 is f ood

• Gr oup 2 is sewer age and wat er

• Gr oup 3 is books

• Gr oup 4 is t alking books f or t he blind and handicapped and wir eless set s f or t he blind

• Gr oup 5 is t he const r uct ion of buildings

• Gr oup 6 is pr ot ect ed buildings

• Gr oup 7 is int er nat ional ser vices

• Gr oup 8 is t r anspor t

• Gr oup 9 is car avans and houseboat s

• Gr oup 10 is gold

• Gr oup 11 is bank not es

• Gr oup 12 is dr ugs, medicines and aids f or t he handicapped

• Gr oup 13 is impor t s and expor t s

• Gr oup 14 is t ax f r ee shops

• Gr oup 15 is char it ies

• Gr oup 16 is clot hing and f oot wear .

I f any par t icular supply f alls wit hin one of t hese Gr oups, t hen t hat supply will be zer o r at ed. This chapt er will look at t he mor e common Gr oups.

E5.2 Group 1 - Food

Gr oup 1, Schedule 8, VATA 1994 zer o r at es t he supply of f ood. Ther e ar e however , many except ions t o t he zer o r at ing of f ood.


The main exceptions – foodstuffs

Gr oup 1 list s a number of quit e specif ic except ions wher e t he supply of t he f oodst uf f it self is st andar d r at ed. Examples ar e: • ice cr eam, ice lollies, f r ozen yoghur t et c.; • sweet s and chocolat e biscuit s, but not cakes and not “non-chocolat e”

biscuit s;

• “bever ages” ot her t han milk, t ea, cocoa and cof f ee, and “meat ext r act s” such as Bovr il;

• “snacks” which ar e made f r om pot at o, “swelled cer eals” (i.e. popcor n) and

“nut s ot her t han nut s in shell”. Ther e ar e cases about t he bor der lines of t he def init ions of t hese it ems, such as whet her a J af f a cake is a chocolat e biscuit or a cake. Catering

The bigger pr oblem t ends t o be t hat “cat er ing” is a st andar d r at ed ser vice. A “cat er er ” can t her ef or e buy in zer o r at ed ingr edient s f r om supplier s, and t ur n t hem int o a st andar d r at ed supply t o cust omer s. Whet her a supply is cat er ing depends on t he f act s of t he case, but t he f ollowing pr inciples and examples illust r at e t he bor der lines. “For consumption on the premises”

The law st at es t hat cat er ing includes “any supply [of f ood] f or consumpt ion on t he pr emises on which it is supplied”. This r aises t wo quest ions: • what ar e “t he pr emises on which it is supplied”? • is t her e an expect at ion or int ent ion t hat t he f ood will be consumed on t he

pr emises? Clear ly some supplies give no pr oblem. Meals ser ved in r est aur ant s ar e cat er ing; f ood supplied in conj unct ion wit h an event such as a wedding r ecept ion will also be cat er ing. Many ot her supplies however do cause pr oblems when t r ying t o def ine t he “pr emises”.

Schedule 8 VATA 1994 – Zer o Rat ing

457

“Food plus service”

Cat er ing is nor mally under st ood t o include a supply of “f ood wit h ser vice”, and any ser vices r ender ed in addit ion t o t he basic f ood may lead Cust oms t o ar gue t hat t he supply is st andar d r at ed.

“Hot takeaways”

The law st at es t hat cat er ing also includes hot f ood t o be eat en of f t he pr emises, wher e t he f ood “has been heat ed f or t he pur poses of enabling it t o be consumed at a t emper at ur e above t he ambient air t emper at ur e”, and it is above t hat t emper at ur e when it is supplied (see Not e 3 of Gr oup 1). The issue her e is whet her t he f ood has been heat ed f or t he pur pose of enabling t o be eat en hot , or mer ely t o make it edible (i.e. cooked, not r aw) or t o make f r esh f ood available in t he shop. This has t o be decided on t he f act s, but it depends lar gely on t he expect at ions of t he vendor . For example, whole chickens sold hot wer e unlikely t o be eat en immediat ely (Nicola Holmes t / a The Chicken Shop); but a t r ader who admit t ed t hat “f illed cr oissant s” wer e unpalat able once t hey wer e cold was held t o be cat er ing (Pr et a Manger (Eur ope) Lt d). A baker who baked pies and sold t hem shor t ly af t er war ds was held t o be cr eat ing “f r esh pies” which might be eat en hot or cold (J ohn Pimblet t & Sons Lt d v C & E); but a home deliver ed cur r y was expect ed t o be eat en hot (M A Malik v C & E). The Appeal body r ecent ly f ound in f avour of Cust oms in an appeal by Domino’s Pizza Gr oup Lt d, who had ar gued t hat t heir supplies of hot t akeaway and deliver ed pizzas should be zer o-r at ed because t heir pur pose in heat ing t he goods is t o supply a f r eshly baked pr oduct , r at her t han t o enable t heir cust omer s t o consume t he pr oduct hot . However , in t he j oined cases of Tuscan Food Lt d and Pur e At ma Lt d No. 18,716 t he Appeal body accept ed t hat “Toast y” sandwiches wer e t oast ed not so t hat t hey could be eat en hot , but so t hat t he f lavour of t he f illings wer e enhanced. The Value Added Tax (Food) Or der 2004 came int o f or ce on 1.1.05 and amends Gr oup 1 Sch 8 VATA 1994 not e (3) t o conf ir m t hat t he t ime at which t he t emper at ur e of t he f ood is r elevant f or det er mining whet her it is hot f ood is t he t ime t he f ood is pr ovided t o t he cust omer , r at her t han t he t ime of supply as det er mined under ot her pr ovisions of VATA 1994 (t he most r elevant of which f or pr esent pur poses is t he t ime at which t he supplier r eceives payment ). The pur pose of t he or der is t o r emove any possible uncer t aint y and conf ir m t hat supplies of hot t akeaway f ood ar e st andar d-r at ed ir r espect ive of t he t iming of payment . Usef ul guidance is also given in Business Brief 09/05


I n conclusion, f ood will gener ally be zer o r at ed unless t he f ood it self is except ed f r om zer o r at ing or it is supplied in t he cour se of cat er ing.

E5.3 Group 3 - Books

Under t his gr ouping zer o r at ing cover s books, br ochur es, pamphlet s, leaf let s, newspaper s, j our nals and per iodicals, childr en’s pict ur e books and paint ing books, any pr int ed music mat t er and maps. Whilst zer o r at ing cover s t he har d copies of t he above, any elect r onic t r ansmission of such books would not f all wit hin t he zer o r at ing pr ovisions. This was pr oven t o be t he case in For exia UK Limit ed and Cust oms have announced t hat t hey see no r eason f or t he VAT legislat ion t o be updat ed t o include elect r onic books. Talking books f or t he blind and handicapped and wir eless set s f or t he blind will also be zer o r at ed.

E5.4 Group 5 - Construction of Buildings

The zer o r at ing of pr oper t y is a maj or ar ea t o look at and t her e is a separ at e session on t his par t icular gr ouping lat er in t he t ext . For now, we will j ust int r oduce t he zer o r at ing pr ovision. When consider ing t he const r uct ion of a building and t he zer o r at ing of t he onwar d supply you need t wo t hings; t he r ight t ype of supply and t he r ight t ype of building. You must have bot h. I f bot h ar e pr esent t hen t he supply will be zer o r at ed. As r egar ds t he r ight t ype of supply, it must be t he f ir st gr ant of a maj or int er est in t hat building. A maj or int er est f or t hese pur poses will be a f r eehold or a lease exceeding 21 year s. So, f or example, t he builder would have t o sell t he f r eehold in a pr oper t y or gr ant a 25 year lease.

s.96(1)

As r egar ds t he r ight t ype of building, t her e ar e only t hr ee t ypes of buildings which f all wit hin t he zer o r at ing pr ovisions;

• a dwelling would f all wit hin t his cat egor y;

• a r elevant r esident ial building would also f all wit hin t he cat egor y; and,

• a r elevant char it able building.

Relevant residential buildings ar e def ined in t he legislat ion and would include dr ug r ehabilit at ion cent r es, school dor mit or ies, monast er ies, nunner ies – t her e is a def ined list of r elevant r esident ial buildings in Not e 4 of Gr oup 5. However , a char it able building is a building used by a char it y f or a charitable purpose. To summar ise t his gr ouping t hen, if a builder built a house and sold t he f r eehold of t he house he has t he r ight t ype of supply, t he f r eehold, he also has t he r ight t ype of building; he would t her ef ore zer o r at e t he f r eehold sale.


459

At t his point j ust not e t hat t his gr ouping also includes t he supply of ser vices and r elat ed mat er ials in t he const r uct ion of dwellings – but mor e on t his in a lat er chapt er . Gr oup 6 pr ovides zer o r at ing t o cer t ain aspect s of list ed buildings or protected buildings.

E5.5 Group 15 - Charities

Zer o-r at ed under t his gr oup ar e:

• Goods donat ed or hir ed t o a char it y f or sale or hir e by t he char it y.

• Sale or hir e by a char it y of goods which have been donat ed or hir ed t o t he char it y. This includes supplies int o t he char it y and t hen supplies f r om t he char it y.

• Any adver t ising supplied t o a char it y.

• Repair and maint enance of r elevant goods owned by an eligible body (Not e 4)

Relevant goods ar e list ed in t he VAT legislat ion (Not e 3) and ar e mainly connect ed wit h t he medical indust r y. Eligible bodies ar e also pr imar ily healt h based.

Char it ies ar e cover ed in det ail in Chapt er 36 of t his manual.

E5.6 Group 16 - Clothing and Footwear

Ar t icles designed as clot hing or f oot wear f or childr en and not suit able f or older per sons, will at t r act zer o r at ing. Ar t icles of clot hing will include hat s, and ot her f or ms of headgear .

Pr ot ect ive boot s and helmet s f or indust r ial use unless t he supply is made t o an employer f or his employee’s use can be zer o r at ed. These boot s and helmet s must be BSI st andar d.

Pr ot ect ive helmet s f or mot or cyclist s and pedal cyclist s again t o BSI st andar d can be zer o r at ed.

E5.7 A word of warning

When consider ing t he it ems wit hin t hese Gr oups, it is impor t ant t hat you f ully r ead all t he not es at t ached t o t he Gr oups (including t he small pr int at t he end of each Gr oup) wit hin t he legislat ion or t he VAT Not ice.


Example 1

Using t he legislat ion, or t he VAT Not ice, decide which of t he f ollowing ar e zer o r at ed.

• A child’s paint ing book

• Sandwiches sold and consumed in a caf é

• Baby’s nappies

• A packet of her bal t ea sold by a gr ocer

• Chocolat e biscuit s sold by a gr ocer

• Coach j our ney f r om London t o Edinbur gh

• Child’s sheepskin gloves


461

Answer 1

• A child’s paint ing book will be zer o r at ed by means of Schedule 8 Gr oup 3 I t em 3.

• Sandwiches sold in t he caf é will be st andar d r at ed; t hey do not f all wit hin t he zer o r at ing pr ovision of Schedule 8 Gr oup 1 because t hey ar e supplied in t he cour se of cat er ing.

• Babies’ nappies will be zer o r at ed under Schedule 8 Gr oup 16 I t em 1.

• The packet of her bal t ea sold by a gr ocer will be zer o r at ed by means of Schedule 8 Gr oup 1. Tea is f ood f it f or human consumpt ion; it is wit hin t he except ed it ems under ot her bever ages but t he it ems over r iding t he except ions, in t his case I t em 4, f ur t her down in t he legislat ion, specif ically st at e t hat her bal t ea over r ides any except ions t o t his Schedule, t her ef or e t he her bal t ea sold by a gr ocer is zer o r at ed. This is a good example of why it is so impor t ant t o r ead all of t he not es in each Gr oup.

• Chocolat e biscuit s sold by a gr ocer will not be zer o r at ed; t hey ar e deemed t o be a luxur y good i.e. not an essent ial good and ar e excluded f r om zer o r at ing by way of Schedule 8 Gr oup 1 except ed I t em 2.

• A coach j our ney f r om London t o Edinbur gh will be zer o r at ed by means of t he t r anspor t zer o r at ed gr oup at Schedule 8 Gr oup 8.

• A child’s sheepskin gloves will be zer o r at ed by means of Schedule 8 Gr oup 16 I t em 1. Not e t hat ar t icles designed as clot hing or f oot wear f or young childr en will be zer o r at ed and alt hough t her e is an except ion wher eby ar t icles ar e made of f ur skin, t his would not apply in t his inst ance, as sheepskin is not deemed t o be f ur skin under Not e 3 of Gr oup 16.


SUMMARY – SCHEDULE 8 VATA 1994 – ZERO RATING Schedule 8 of VATA 1994 list s t he t ype of supplies which f all int o zer o r at ing f or VAT pur poses. Ther e ar e ef f ect ively sixt een gr oups of such supplies which include: - f ood - books - const r uct ion of buildings - t r anspor t - clot hing and f oot wear f or childr en I t is impor t ant when looking at it ems list ed wit hin t he gr oups in Schedule 8 t hat you r ead all t he not es at t ached t o t hose gr oups because many except ions t o t he gener al r ule lie wit hin t hose not es.

E6: SCHEDULE 9 VATA 1994 - EXEMPTIONS

I n t his chapt er t he supplies which ar e exempt f or VAT will be looked at in some det ail.

E6.1 Introduction

I n t his chapt er we ar e j ust going t o have a br ief look at Schedule 9 - Exempt ion. Schedule 9 t o t he VAT Act of 1994 pr ovides a list of exempt it ems. Essent ially t hese ar e 15 gr oups and each gr oup is a specif ic exempt ion.

Sch 9

Gr oup 1 - Land

2 - I nsur ance

3 - Post al Ser vices

4 - Bet t ing, Gaming and Lot t er ies

5 - Finance

6 - Educat ion

7 - Healt h and Welf ar e

8 - Bur ial and Cr emat ion

9 - Tr ade Unions and Pr of essional Bodies

10 - Spor t , Spor t s Compet it ions and Physical Educat ion

11 - Wor ks of Ar t , et c

12 - Fund r aising event s by Char it ies and ot her qualif ying bodies

13 - Cult ur al Ser vices et c

14 - Supplies of goods wher e input t ax cannot be deduct ed

15 - I nvest ment Gold

E6.2 Group 1 - Land

The exempt ion f or land will be cover ed in det ail lat er in t he t ext . For now, we ar e going t o pr ovide an over view of t he exempt ion f or land. Schedule 9 st at es t hat any land t r ansact ion is exempt other than t he it ems act ually list ed in t he legislat ion. So t he legislat ion ef f ect ively says t hat any land t r ansact ion (e.g. lease, r ent , sale, assignment , sur r ender , r ever se sur r ender , r ever se pr emium) is exempt ot her t han t he it ems it list s which is a list of st andar d r at ed it ems (Schedule 9 it em 1 (a) t o (m)). I n t he list of st andar d r at ed it ems t he most impor t ant will be it em 1(a) which cover s t he supply of a new, f r eehold commer cial building. So a sale of a new f r eehold commer cial pr oper t y is st andar d r at ed. New is deemed t o be under 3 year s old (Schedule 9, Gr oup 1, Not e 4).


Also in t his long list ar e t hings like hot el accommodat ion, t heat r e and concer t t icket s, camping and car avan sit es and car par k char ges. Finally f or complet eness, an opt ion t o t ax is available which will change an exempt supply of land int o a t axable supply. The opt ion t o t ax can only apply t o land or commer cial pr oper t y. Remember t his is an over view of t he land exempt ions and t hese, plus t he opt ion t o t ax, will be cover ed in much mor e det ail in a lat er chapt er .

Sch 10

E6.3 Insurance

VATA 1994 Sch.9 Gr oup 2 exempt s t he pr ovision of : • it em 1: insur ance t r ansact ions and r einsur ance t r ansact ions; • it em 4: t he pr ovision by an insur ance br oker or insur ance agent of any of t he

ser vices of an insur ance int er mediar y in a case in which t hose ser vices ar e r elat ed t o an insur ance t r ansact ion or a r einsur ance t r ansact ion (whet her or not t he cont r act is act ually concluded) and t he agent or br oker is act ing in an int er mediar y capacit y.

The not es t o Gr oup 2 descr ibe in some det ail what is t o be r egar ded as “act ing in an int er mediar y capacit y”.

E6.4 Finance

VATA 1994 Sch.9 Gr oup 5 exempt s (among ot her t hings):

• it em 1: t he issue, t r ansf er or r eceipt of , or any dealing wit h, money, any secur it y f or money or any not e or or der f or t he payment of money.

• it em 2: t he making of any advance or t he gr ant ing of any cr edit . • it em 2A: t he management of cr edit by t he per son gr ant ing it . • it em 3: t he pr ovision of t he f acilit y of inst alment cr edit f inance in a

hir e-pur chase, condit ional sale or cr edit sale agr eement f or which f acilit y a separ at e char ge is made and disclosed t o t he r ecipient of t he supply of goods.

• it em 5: t he pr ovision of int er mediar y ser vices in r elat ion t o any

t r ansact ion compr ised in it em 1, 2, 3, 4 or 6 (whet her or not any such t r ansact ion is f inally concluded) by a per son act ing in an int er mediar y capacit y.

• it em 6: t he issue, t r ansf er or r eceipt of , or any dealing wit h, any secur it y

or secondar y secur it y being:

(a) shar es, st ocks, bonds, not es (ot her t han pr omissor y not es), debent ur es, debent ur e st ock or shar es in an oil r oyalt y; or

Schedule 9 VATA 1994 – Exempt ions

465

(b) any document r elat ing t o money, in any cur r ency, which has been

deposit ed wit h t he issuer or some ot her per son, being a document which r ecognises an obligat ion t o pay a st at ed amount t o bear er or t o or der , wit h or wit hout int er est , and being a document by t he deliver y of which, wit h or wit hout endor sement , t he r ight t o r eceive t hat st at ed amount , wit h or wit hout int er est , is t r ansf er able; or

(c) any bill, not e or ot her obligat ion of t he Tr easur y or of a

Gover nment in any par t of t he wor ld, being a document by t he deliver y of which, wit h or wit hout endor sement , t it le is t r ansf er able, and not being an obligat ion which is or has been legal t ender in any par t of t he wor ld; or

(d) any let t er of allot ment or r ight s, any war r ant conf er r ing an

opt ion t o acquir e a secur it y included in t his it em, any r enounceable or scr ip cer t if icat es, r ight s coupons, coupons r epr esent ing dividends or int er est on such a secur it y, bond mandat es or ot her document s conf er r ing or cont aining evidence of t it le t o or r ight s in r espect of such a secur it y; or

(e) unit s or ot her document s conf er r ing r ight s under any t r ust

est ablished f or t he pur pose, or having t he ef f ect of pr oviding, f or per sons having f unds available f or invest ment , f acilit ies f or t he par t icipat ion by t hem as benef iciar ies under t he t r ust , in any pr of it s or income ar ising f r om t he acquisit ion, holding, management or disposal of any pr oper t y what soever .

The not es t o Gr oup 5 descr ibe in some det ail what is t o be r egar ded as “int er mediar y ser vices”.

Issue of shares

Comment on Kretztechnik Cust oms have comment ed f ur t her on t he decision in Kr et zt echnik in Business Br ief 21/ 05 (expanding on t he ear lier guidance given in Business Br ief 12/ 05). Cust oms now accept t hat t he pr inciples of Kr et zt echnik apply t o issues of all t ypes of shar es, including pr ef er ence shar es, r ight s issues, bonus issues (alt hough t hey do not r aise money!) or scr ip dividends. Cust oms also accept t hat t he pr inciples of t he case apply t o issues of shar es by dif f er ent t ypes of company, and ar e not r est r ict ed t o public quot ed companies such as Kr et zt echnik it self . As long as t he company’s pur pose is t o r aise capit al, t he issue of t he shar es will be a non-supply.


This is f ur t her ext ended t o t he issue of ot her t ypes of inst r ument (e.g. bonds, debent ur es, loan not es) wher e t he pur pose is t o r aise capit al. The issue of shar es or unit s in collect ive invest ment f unds (e.g. OEI Cs) will be non-supplies f or VAT pur poses (which is not immediat ely obvious, because t he f unds ar e r aised f or invest ment pur poses r at her t han use in a t r ade; but t he invest ment pur pose is t he business of t he collect ive invest ment scheme, so t he f unds ar e r aised f or t he gener al pur poses of t he business). Cust oms also accept t hat t he non-supply t r eat ment is cor r ect wher e shar es ar e issued in ot her cir cumst ances, f or example as par t of a shar e-f or -shar e t akeover of anot her company, a mer ger , demer ger or r eor ganisat ion. Cust oms give t he usual advice about making claims f or past input VAT, subj ect t o t he t hr ee-year cap.

E6.5 Health & Welfare

Ther e ar e a f ew key issues wit hin t he healt h and welf ar e exempt ion, in par t icular : • t he scope of t he medical car e exempt ion, which was disput ed in t he case of

Dr d’Ambr umenil and is cur r ent ly t he subj ect of a consult at ion exer cise;

• t he scope of t he welf ar e exempt ion, which was disput ed in t he case of Kingscr est Associat es and which now seems t o be set t led;

• t he t r eat ment of dr ugs pr escr ibed and administ er ed by doct or s, which was consider ed by t he House of Lor ds in t he case of Dr Beynon and par t ner s.

E6.6 Other exempt items

Group 3 – postal services. Cur r ent ly only t he post al ser vices pr ovided by t he Post Of f ice ar e exempt . Businesses which char ge cust omer s post age must add on t his char ge bef or e calculat ing t he VAT due on t heir invoices. Consequent ly VAT is char ged on post age and car r iage char ges levied by or dinar y businesses. Group 4 – betting, gaming and lotteries. Alt hough bet t ing dut y has been abolished t he r evenue f r om t hose sour ces will cont inue t o be exempt f or VAT pur poses. Group 6 – education. Educat ion, r esear ch and vocat ional t r aining supplied by r ecognised bodies such as schools, colleges and univer sit ies will be exempt f r om VAT. Group 8 – burial and cremation. Ser vices pr ovided in connect ion wit h bur ial and cr emat ion, such as under t aker s’ ser vices ar e exempt f r om VAT. Group 9 – trade unions and professional bodies. Member ship subscr ipt ions t o t r ade unions and ot her pr of essional bodies ar e exempt .


467

Group 10 – sport, sports competitions and physical education. The char ge f or ent er ing compet it ions and playing member s subscr ipt ions ar e exempt f r om VAT f or non-profit making bodies. Consequent ly subscr ipt ions of non-playing member s of spor t s clubs, such as social member s ar e subj ect t o VAT at t he st andar d r at e. The House of Lor ds has r ef used t he t axpayer leave t o appeal in t he Messenger Leisur e case. This conf ir ms t he decisions of t he Tr ibunal, High Cour t and Cour t of Appeal t hat a subsidiar y company in a commer cial gr oup could not qualif y as a “not -f or -pr of it ” spor t s club simply because it s const it ut ion r est r ict ed it s abilit y t o dist r ibut e pr of it s. The Cour t of Appeal held t hat t he accumulat ion of r eser ves in t he subsidiar y was an act ual commer cial advant age t o t he gr oup, and it was also possible f or t he shar eholder s (t he commer cial holding company) t o change t he const it ut ion and allow dist r ibut ion of pr of it in t he f ut ur e. The Lor ds held t hat t her e was not hing in t he case t o war r ant an ECJ r ef er ence: t he applicat ion of EU law was so obvious t hat t her e was no r oom f or r easonable doubt . Cust oms have comment ed on t he implicat ions of t his f inal det er minat ion in a Business Br ief . They consider t hat t her e ar e numer ous ot her companies which may be af f ect ed, and t hey believe t hat t he decision conf ir ms t hat it is impossible f or a company wit hin a commer cial gr oup t o qualif y f or t he exempt ion. I t is int er est ing t hat Cust oms explicit ly comment about t he f act t hat t he evidence of t he chief t axpayer wit ness on t he mot ives of t he company was unchallenged in t his case. He said t hat he was not int er est ed in ext r act ing pr of it f r om t he subsidiar y, and Cust oms did not at t empt t o cont r adict him, because t hey did not need t o. The t axpayer ’s case was lost because of t he cor por at e st r uct ur e in any case. I f a dif f er ent st r uct ur e exist s, and t he t axpayer asser t s t hat t her e is no pr of it mot ive, Cust oms will not accept t his wit hout challenge. Group 11 – works of art et c. The sale of wor ks of ar t , ant iques and collect or s it ems, which ar e not subj ect t o a st at e dut y or inher it ance t ax, ar e exempt . Group 12 – fund raising events by charities and other qualifying bodies. The ent r ance f ees t o event s such as annual (or mor e f r equent ) f und r aising event s or ganised by char it ies f or t he benef it of t he char it y ar e exempt . Group 13 – cultural services. Ent r ance f ees t o museums, ar t galler ies, ar t exhibit ions and zoos ar e exempt .

Cult ur al ser vices can be pr ovided wit hin t he exempt ion of Sch.9 Gr oup 13 if t hey ar e supplied by a not -f or -pr of it body which is managed on an essent ially volunt ar y basis. This means t hat t hose involved in management should not have any signif icant int er est in t he act ivit ies of t he body.

I n a r ecent case a company was f or med in 2000 t o st age oper at ic per f or mances (t aking over an act ivit y which had been r un on an uncommer cial basis since 1991

Business Br ief 22/ 05


wit hin t he oper at ions of a commer cial company). I t ar gued t hat it was wit hin t he exempt ion, being limit ed by guar ant ee and managed by a boar d of t r ust ees on a non-commer cial basis. I t s memor andum of associat ion f or bade t he payment of r emuner at ion t o dir ect or s f or act ing as such, but per mit t ed t he payment of int er est on loans, r ent on pr emises or f ees f or pr of essional ser vices t o any of t he dir ect or s in appr opr iat e cir cumst ances, as well as t he r eimbur sement of out -of -pocket expenses. The Tr ibunal agr eed wit h Cust oms t hat t he exempt ion did not apply. One of t he t r ust ees was t he landlor d of t he oper a company, and also was t he sole dir ect or and maj or it y shar eholder of a commer cial company which had f inancial dealings wit h it . He had also made loans t o t he oper a company and guar ant eed it s losses. He t her ef or e had a signif icant f inancial int er est in t he act ivit ies, and he was a signif icant member of t he management . The management was t her ef or e not “essent ially volunt ar y”. The High Cour t j udge disagr eed. He held t hat t he abilit y of t he company t o cont r act wit h t he dir ect or , wher e no such cont r act was act ually ent er ed int o, did not const it ut e a f inancial int er est . Even if such a cont r act was ent er ed int o, if it was f or necessar y ser vices at t he best pr ice available, t her e would be no dilut ion of t he pr of it s of t he ent it y and t he exempt ion would not be pr ej udiced. I n summar y, t he j udge consider ed t hat “f inancial int er est ” suggest ed t hat t he per son wit h such an int er est could be enr iched by t he ar r angement , and t hat was not t he case her e. The main condit ion was a pr ohibit ion on t he dist r ibut ion of pr of it s, and t hat was sat isf ied. The f act t hat cont r act s f or supplies could be ent er ed int o did not disqualif y t he body f r om t he exempt ion; t his depended on t he t er ms of t he cont r act s, not t heir mer e possibilit y. I nt er est -f r ee loans and unenf or ceable guar ant ees also did not const it ut e a f inancial int er est . The appeal was allowed. High Cour t : Longbor ough Fest ival Oper a v HMRC

Gr oup 14 – supplies of goods wher e input t ax cannot be r ecover ed. This gr oup pr event s double t axat ion on goods wher e input t ax cannot be r ecover ed, such as t he pur chase of a car used f or bot h business and pr ivat e pur poses. Any subsequent sale in t hese cir cumst ances will be exempt . Gr oup 15 – invest ment gold. This exempt ion pr ovides a r out e f or t he cr eat ion of a st ock of invest ment gold t o be t r aded wit hin an exempt mar ket . E6.7 A wor d of war ning I t should be appr eciat ed t hat if a t r ansact ion f alls specif ically wit hin one of t he gr oups list ed in Schedule 9 t hen it will be exempt . Ther e is however , a lot of det ail in t hese gr oups wit hin t he legislat ion, and you must r ead f ully t he legislat ion and t he not es t o t he legislat ion t o det er mine whet her or not your par t icular t r ansact ion is act ually exempt . I f it does not f all wit hin t he zer o-r at ed Schedule 8 or t he exempt Schedule 9 t hen t he t r ansact ion will nor mally be st andar d r at ed.


469

SUMMARY – SCHEDULE 9 VATA 1994 - EXEMPTIONS Ther e ar e f if t een gr oups of supplies which ar e list ed in Schedule 9 of VATA 1994 as exempt supplies. Exempt supplies include: - land - insur ance - f inance - healt h and welf ar e - bur ial and cr emat ion - f undr aising event s by char it ies I t is cr ucial t hat t he legislat ion is looked at closely when det er mining if a supply is exempt or not as many except ions t o t he gener al r ule ar e out lined in t he not es t o each of t he gr oups.

E7: DEEMED SUPPLIES

This chapt er looks at deemed supplies and self -supplies. By t he end of t he chapt er you should be able t o: account f or VAT on deemed and self -supplies; be awar e of how t o t r eat a gif t of goods; under st and t he t r eat ment wher e t her e is pr ivat e use of asset s or mot or f uel is pr ovided f or pr ivat e use; out line t he t r eat ment of non-business use of ser vices supplied t o a business out line t he t r eat ment of goods held on de-r egist r at ion of a business; under st and t he t r eat ment of const r uct ion ser vices pr ovided f or own use by a business; out line t he VAT t r eat ment of mot or car s used in a business.

E7.1 Introduction

Deemed supplies and self -supplies ar e in exist ence basically as an ant i-avoidance st r at egy. This ant i-avoidance legislat ion r equir es a t r ader t o account for output tax even though there is no regular supply; in ot her wor ds, even t hough t her e is no supply f or consider at ion t o a t hir d par t y. The ant i-avoidance legislat ion ef f ect ively cover s t wo t ypes of avoidance. The f ir st t ype is wher e a t axable business buys somet hing, r ecover s t he input t ax, and t hen put s t hose it ems t o a non-business use. I f t hose it ems had been bought f or a non-business use in t he f ir st place, input t ax would not have been r ecover able. This is t he deemed

supply legislation.

The second scenar io is t o do wit h par t ially exempt and exempt businesses, so businesses t hat make exempt supplies and cannot r ecover input t ax in f ull. I t is t o pr event such businesses f r om get t ing a f ull input t ax r ecover y t hat t hey would not nor mally achieve. This is t he self-supply legislation.

E7.2 Deemed supplies

Examples of deemed supplies include goods and services bought for business purposes but then supplied free for private consumption. The input t ax or iginally claimed on t he pur chase is clawed back using an out put t ax char ge.

Sch 4 Par a 5

Wher e pet r ol or diesel f or mot or car s is pur chased by a business but t hen supplied t o t he employee of t hat business at a pr ice t hat is below cost t her e is a deemed supply and out put t ax is char ged on t he supply using a f ixed st andar d scale. We will look at t his in mor e det ail lat er .

s.56

Anot her example is wher e a business is r egist er ed f or VAT but is now going t o der egist er . Any goods held by t he business on der egist r at ion ar e t r eat ed as deemed supplies if t hose goods had input t ax r ecover ed on t heir pur chase.

Sch 4 Par a 8

Deemed Supplies

471

E7.3 Self-supplies

Self -supplies oper at e in a ver y similar way t o deemed supplies. The self -supply legislat ion basically ensur es t hat t her e is no VAT saving in a sit uat ion wher e input t ax should have been ir r ecover able. I n cer t ain cases wher e construction services ar e car r ied out in-house, a self -supply will ar ise wit h output tax charged on open market value.

SI 1989/ 472

Anot her scenar io wher e we have a self -supply is when car s ar e pur chased f or 100% business use, but used pr ivat ely. Let us say a car dealer buys br and new car s which he plans t o sell t o t he public, but lat er put s one of t hose car s t o pr ivat e use. One of t hose cars is t hus t aken out of st ock and used by an

employee. This would be a self -supply and t her e is an output tax charge on the cost of the car.

SI 1992/ 3122

Ar t 5

E7.4 How to account for deemed/self-supplies

A business t hat makes a deemed or a self -supply will have t o account f or out put t ax on t he supply, so t her e will be out put t ax t o put in box 1 of t he VAT Ret ur n. This amount will have t o be paid t o Cust oms when t he VAT Ret ur n is submit t ed.

This self-supply or deemed supply counts towards the registration limit when looking at whet her a business should r egist er f or VAT or not . Deemed supplies will only be in point if t he t r ader has r ecover ed input t ax on t he goods or ser vices in quest ion. When account ing f or out put t ax on a self supply, input t ax is available f or cr edit . This input t ax can only be r ecover ed t o t he ext ent t hat t he it em is t o be used f or making t axable supplies and is not it self subj ect t o t he blocking or der . The deemed and self -supply r ules apply t o all businesses, whet her t axable or exempt . I t is quit e possible t o have a f ully t axable business pr ovide some in-house const r uct ion ser vices. The impact of t his would be t wo ent r ies, equal and opposit e, on t he VAT r et ur n – out put t ax in t he out put t ax box equalling t he amount of input t ax in t he input t ax box. Over all t her e is a nil impact on t he business. Having said t hat , t he business cannot omit t he ent r ies f r om t he VAT r et ur n because ot her wise it will have made an incor r ect VAT r et ur n.

E7.5 Gift of goods (deemed supply)

I nput t ax is clawed back on goods t hat ar e given away by making an out put t ax char ge on t he r eplacement cost of such goods. The legislat ion says t hat out put t ax should be char ged wher e goods f or ming par t of t he asset s of a business ar e t r ansf er r ed or disposed of by or under t he dir ect ions of t he per son car r ying on t he business so as no longer t o f or m par t of t hose asset s whet her or not f or a consider at ion.

Sch 4 Par a 5


I t is impor t ant t o appr eciat e t hat t he r ules will not apply unless t he donor (or any of his pr edecessor s) has or will become ent it led t o input t ax r ecover y on t he goods. For t his pur pose, a per son is t he ‘pr edecessor ’ of t he donor wher e t he donor acquir ed t he goods f r om him under a t r ansact ion r elat ing t o t he t r ansf er of a business as a going concer n which was t r eat ed as neit her a supply of goods nor a supply or ser vices. The donor ’s pr edecessor s include t he pr edecessor s of his pr edecessor t hr ough any number of t r ansact ions. The ef f ect of t his is t hat , f or no VAT liabilit y t o ar ise, no ent it lement t o input t ax on t he goods must have ar isen t hr ough any number of such going concer n t r ansact ions.

Sch 4 Par a 5(5)(5A)

However even wher e input t ax is r ecover ed t he gif t may st ill be exempt f r om t his legislat ion. The f ir st exempt ion is wher e t her e is a gif t of goods made in t he cour se or f ur t her ance of t he business wher e t he cost to the donor is not more than £50. The exempt ion applies t o one-of f gif t s and t he cost t o t he donor could also include t he cost of pr oducing t he goods if t hey ar e pr oduced int er nally.

Sch 4 Par a 5(2)a

No out put t ax will be due on a ser ies of gif t s pr ovided t he t ot al cost of gif t s made t o t he same per son does not exceed £ 50 in any 12 mont h per iod. I f t he £ 50 is exceeded VAT will be due on all t he gif t s made in t he pr evious 12 mont hs. Those gif t s ar e t hen disr egar ded f or t he pur pose of any f ut ur e applicat ion of t he r ules. The ot her sit uat ion wher e t he r ules do not apply is wher e t her e is a gift to any person of a sample of any goods. This applies only t o t he f ir st gif t wher e a succession of ident ical samples is given t o t he same per son. Ther e is no monet ar y value on t hese sample gif t s eit her .

Sch 4 Par a 5(2)B

So t o summar ise, wit h a gif t of goods which cost £ 50 or less, t hen one needs t o look at what t he mot ive f or t he gif t was. I f t he mot ive was a business pur pose t hen t he gif t is ignor ed and does not t r igger an out put t ax char ge and any input t ax r eclaimed by t he business is allowed. I f t he gif t of goods cost s over £ 50 (can be cumulat ive) t hen input t ax will ef f ect ively be clawed back as an out put t ax char ge unless it is t he gif t of a business sample.

E7.6 Private use of business assets (deemed supply)

Consider t he scenar io of inst ead giving someone an asset f or t heir pr ivat e use, t he asset was j ust made available f or t hem t o use pr ivat ely but t he owner ship r emained wit h t he VAT r egist er ed business. The r ules on gif t s of goods do not apply wher e an asset is only made available f or pr ivat e use wit hout char ge but r emains par t of t he asset s of t he business. Or dinar ily wher e goods or ser vice ar e acquir ed wit h t he expect at ion of some non business use, t he t r ader will appor t ion t he init ial input t ax r ecover y.

S.24(5)

Sch 4 Par a 5(4)

Deemed Supplies

473

The appor t ionment pr ovisions of s.24(5) wer e quest ioned in t he case of Lennar t z. Lennar t z adopt s a dif f er ent appr oach by ensur ing a f ull input r eclaim f ollowed by an out put t ax char ge in ever y VAT quar t er in which pr ivat e use t akes place wit h t hat out put t ax char ge r ef lect ing t he cost of pr oviding t hat asset f or pr ivat e use. Thus t he Lennartz r ule allows pur chaser s of goods which ar e t o be used bot h f or business and pr ivat e (or non business pur poses) t o r ecover t he VAT in f ull on t he pur chase of t he it em and t hen char ge out put t ax on t he mar ket value of t he non business and pr ivat e use as it ar ises.

I f a car is pr ovided f or t he pr ivat e use of an employee, no supply act ually ar ises whet her or not t he employee makes an act ual payment f or t he pr ivat e use. This seems a ver y odd r ule but t his r ule has come about because some or all of t he input t ax on t he car has been blocked in t he employer ’s hands.

SI 1992/ 3222 Par a 7(1)

I f a mobile phone is pr ovided t her e ar e some ver y complex r ules which ar e out lined in Business Br ief 14/99. Ef f ect ively a business can deduct all t he input t ax on t he init ial pr ovision of t he mobile phone pr oviding t he payment s cont ain no element f or calls which might be used f or pr ivat e pur poses and obviously as long as t her e is some business use. I f t he business pr ohibit s pr ivat e use of t he phone t hen all t he input t ax will be deduct ible. I f t he business char ges employees f or pr ivat e calls made t hen again all input t ax is deduct ible but t he business must account f or out put t ax on t he char ges. I f t he business allows employees t o make pr ivat e calls wit hout char ge, t hen t he business has got t o appor t ion t he input t ax on t he call char ges and only claim t he business pr opor t ion.

Illustration 1

ABC Limit ed own a hor se used f or business pur poses 40 days per quar t er and f or pr ivat e pur poses by t he company employees 30 days per quar t er . Cost s associat ed wit h keeping t he hor se ar e:

St able f ees per annum £ 5,000 Vet s bills, liver y f ees et c per annum £ 1,000 Use of t r ekking f acilit ies in quar t er :

- business days - pr ivat e days

£ 400 £ 300


We have t o wor k out t he pr ivat e cost of keeping t he hor se. That will be our deemed supply f or one quar t er .

Deemed supply f or one quar t er : £ St able f ees £ 5,000 x ¼ x 30/ 70

536.00 Vet et c f ees £ 1,000 x ¼ x 30/ 70

107.00

Tr ekking f ees – pr ivat e days 300.00

Cost of pr ivat e use 943.00

VAT = 17.5% x £ 943.00

£ 165.03

E7.7 Non-business use of services supplied to a business (deemed supply)

Wher e a per son car r ying on a business put s ser vices supplied to him t o any pr ivat e or non-business use, he is t r eat ed as having supplied t hose ser vices in t he cour se or f ur t her ance of t he business. The value of t he supply is t hat par t of t he value of t he supply of t he ser vices t o him as r easonably r epr esent s t he cost t o him of pr oviding t he ser vices. Wher e t he ser vices ar e put t o a pr ivat e or non-business use on mor e t han one occasion, t he t ot al VAT liabilit y under t hese pr ovisions cannot exceed t he input t ax claimed when t he ser vices wer e obt ained.

SI 1993/ 1507

This r ule does not apply t o ser vices gener at ed int er nally, e.g. a solicit or s pr act ice under t aking conveyancing f or an employee f r ee of char ge. Ther e ar e no input t ax deduct ions, t her ef or e t he deemed supply r ules ar e not in point .

E7.8 Motor fuel provided for private use (deemed supply)

I f a business buys pet r ol or diesel and allows pr ivat e use of it by an employee or t he owner of t he business, t he par t ner or sole t r ader , t hen ef f ect ively t he business has t hr ee choices as t o what it will do f r om a VAT point of view. The f ir st choice is t hat it could claim all input tax incur r ed on all f uel pur chased and t hen, using t he scale charges set by Cust oms, calculat e t he appr opr iat e out put t ax. The f uel scale r at es ar e dependent on engine size and whet her t he f uel is pet r ol or diesel. The scale r at es ar e VAT inclusive so you mult iply t hem by 7 over 47 t o f ind t he out put t ax due.

s.56

s.57

The second choice is t o claim absolutely no input tax on all f uel pur chased. As t her e ar e no input t ax issues t her e is no need f or any out put t ax calculat ions.

Not ice 748 ESC 3.1

Deemed Supplies

475

The f inal choice is f or a business t o keep very detailed mileage records so t hat t hey can pr ove t hat t he f uel t hat t hey have bought is only used f or business pur poses and ef f ect ively t he business t her ef or e does not pay anyt hing t owar ds t he cost of f uel used f or pr ivat e pur poses. I n such a case input t ax can be r ecover ed and t her e is no out put t ax char ge. Example 1

J onas Limit ed pur chases pet r ol in t he quar t er ended 30 Sept ember f or £ 302.50. The pet r ol was f or J onas’s car in which he t r avels 1,000 business miles and 1,000 pr ivat e miles. The appr opr iat e quar t er ly f uel scale char ge is, say, £ 500. What is t he net VAT payable or (r ecover able) f or t he business f or t his quar t er if it wishes t o r ecover t he input t ax on t he f uel?

E7.9 Goods held on deregistration (deemed supply)

When a business der egist er s f or VAT t his will mean t hat t he asset s cont ained in t he business, when event ually sold, will not have VAT char ged on t heir sale. I n t his sit uat ion we have a special r ule which says t hat when a business der egist er s f or VAT t her e is a deemed supply at t he dat e of der egist r at ion on all t he asset s t hat wer e held on t he dat e t he business der egist er ed. The out put t ax is char ged on r eplacement cost of t he asset s. Replacement cost is t he cost of an asset in exact ly t he same condit ion. This r ule only applies t o asset s on which input t ax was claimed or iginally. For example if t her e is a car in t he business when it der egist er s, and t her e was no init ial input t ax r ecover y on t hat car , out put t ax is not char ged.

Sch 4 Par a 8

Sch 6 Par a 6

Ther e is also no charge if t he output tax t hat is due comes t o £1,000 or less.

The following are excluded from the charge to VAT:

• Goods bought f r om unr egist er ed businesses. • Mot or car s (except qualif ying car s on which input t ax has been claimed). • Goods bought under t he pr ovisions of one of t he second-hand schemes. • Goods used wholly f or business ent er t ainment . • Goods t hat have been dir ect ly at t r ibut ed t o an exempt business act ivit y

(unless t he input t ax was r eclaimable t hr ough t he par t ial exempt ion r ules).

• Goods not bought f or business pur poses. • Land or buildings which wer e pur chased under an exempt supply even

t hough (i) t he opt ion t o t ax has been exer cised and subsequent ly st andar d-

r at ed supplies have been made and/ or input t ax r ecover ed on t he r ef ur bishment of t he building; or

(ii) wit hout t he opt ion t o t ax t hey have ot her wise been used t o make st andar d-r at ed supplies (e.g. holiday accommodat ion).


• Land or buildings which wer e pur chased under a supply on which VAT was r ecover ed (e.g. wher e a f ully t axable business buys a new commer cial pr oper t y) if at t he t ime of der egist r at ion t he sale would be exempt (because t he business has not opt ed t o t ax t he pr oper t y which is t hen over t hr ee year s old). I n such cir cumst ances, VAT due on t he supply of t he pr oper t y would be nil and so not exceed t he £ 1,000 limit .

Wher e a business has st andar d-r at ed land or buildings on hand at t he t ime of der egist r at ion on which it claimed input t ax deduct ion, t he pr oper t y is deemed t o be supplied on der egist r at ion. To avoid t he cash f low pr oblem t hat t his might creat e, t he business could def er t he cancellat ion of r egist r at ion unt il t he pr oper t y is sold so t hat it would t hen be r equir ed t o account f or out put t ax on t he act ual sale of t he pr oper t y. Cust oms ar e pr epar ed t o consider , if necessar y, def er r ing t he cancellat ion of r egist r at ion longer t han t he nor mal six mont hs, unt il af t er t he pr oper t y is sold.

VAT Not ice 700/ 11/ 02

Par a 6.2

E7.10 Construction services (self supply)

The self supply of const r uct ion ser vices r ule applies t o pr event exempt or par t ially exempt businesses f r om employing t heir own people t o car r y out const r uct ion ser vices r at her t han using a t hir d par t y cont r act or t o car r y out t he const r uct ion ser vices f or t hem who, of cour se, will char ge t hem VAT, which t hey pr obably could not r ecover in f ull.

SI 1989/ 472

The self -supply r ule applies wher e t her e is a construction of a building or an extension to an existing building – t he ext ension increasing floor space by at least 10%.

The value of t he const r uct ion ser vices must be over £100,000 in a year f or t his self -supply r ule t o apply. The self -supply r ule basically calculat es out put t ax on t he open mar ket value of t he const r uct ion ser vices and so t his out put t ax has t o be account ed f or by t he business on t he VAT Ret ur n.

By t he same t oken, t his out put t ax f or ms input t ax which t he business can r ecover in t he nor mal way so, if it uses t he building t o make t axable supplies in any way, t hen t hat pr opor t ion of input t ax can be r ecover ed. I nput t ax act ually incur r ed on goods and ser vices f or such building wor ks ar e t r eat ed as r elat ing t o t he t axable self -supply and can be deduct ed in f ull (subj ect t o t he nor mal r ules). Ther e ar e pr oposals in t he FA2006 t o r epeal t he pr ovisions r elat ing t o t he developer ’s self supply char ge in Schedule 10 when Schedule 10 is r ewr it t en – a pr ocess which is under way.

Deemed Supplies

477

E7.11 Motor cars (self supply)

The self -supply char ge on mot or car s applies wher e a car dealer pur chases a car f r om a manuf act ur er t o put int o st ock. Because t he car is par t of his st ock, he is allowed t o r ecover input t ax in f ull on t hat car (new and f or r esale). Then t he car dealer t akes t he car out of st ock f or pr ivat e use. Nor mally t he pur chase of a car f or pr ivat e use is subj ect t o a blocking or der on t he input VAT which basically means input VAT on a mot or car cannot be r ecover ed. The self supply legislat ion aims to stop a car dealer being able to get a car into private use

and yet still recover input tax.

SI 1992/ 3122

Ar t 5

The self -supply char ge claws back t he VAT t hat was r ecover ed when t he mot or car was pur chased as st ock. I t is calculat ed on t he cost of t he car and not on t he selling pr ice of t he car . The t r ader will have t o account f or out put t ax on t he self supply. Ther e will be no r elat ed input t ax claim as t he car is not wholly f or a business pur pose – it is blocked under SI 1992/ 3122 Ar t 5. VAT on t he pur chase of demonst r at or car s pr ovided by mot or dealer s and manuf act ur er s is excluded f r om t he blocking or der which gener ally pr event s VAT r ecover y on t he pur chase of mot or car s. I nst ead, VAT is due on t he pr ivat e use of such car s. Cer t ain businesses have sought t o minimise t he VAT due on pr ivat e usage by char ging employees a nominal sum f or t he use of t he car . Following FA2004, f r om a dat e t o be announced, t he Commissioner s will be able t o dir ect t hat VAT is t o be account ed f or on t he open mar ket value of demonst r at or car s supplied t o employees. This measur e r equir es a der ogat ion f r om Eur opean Communit y legislat ion; such a der ogat ion has been applied f or .

Ther e ar e some ot her self -supply r ules in t he VAT legislat ion but t his chapt er has cover ed t he main ones t hat you ar e likely t o see in pr act ice.

Example 2

Dr aw a line bet ween t he supply and t he cor r ect t it le box.

Goods and ser vices bought f or business

use and supplied f r ee f or pr ivat e use

Car s bought f or business use and t r ansf er r ed t o

pr ivat e use

Mot or f uel pur chased by business f or pr ivat e use

I n-house const r uct ion

ser vices

Goods held on der egist r at ion

DEEMED SUPPLY

SELF-SUPPLY


Answer 1

The business bear s t he cost of pr ivat e f uel and so t he choice it has made is t o r ecover input t ax in f ull but t hen t o char ge out put t ax using t he scale char ge. The business mileage act ually t r avelled by t he car is ir r elevant except t hat we need t o know t hat it does act ually do some pr ivat e mileage. We t ake our scale char ge of £ 500 which is VAT inclusive, mult iply it by 7 over 47 t o get our out put t ax. We t hen t ake t he cost of t he pet r ol £ 302.50, which again is VAT inclusive, mult iply it by 7 over 47 t o get our input t ax and t his leaves us wit h net VAT payable of £ 29.42 by t he company.

The business bear s t he cost of pr ivat e f uel.

Out put t ax £ 500 x 7/ 47

£ 74.47

I nput t ax £ 302.50 x 7/ 47

(45.05)

Net VAT payable 29.42

I n t his example J onas Limit ed should be advised t o claim no input t ax on f uel. I f t his wer e t he case, t he f uel scale char ge need not be account ed f or and t he business would save £ 29.42 t his quar t er .

Deemed Supplies

479

Answer 2

Goods and ser vices bought f or business

use and supplied f r ee f or pr ivat e use

Car s bought f or business use and t r ansf er r ed t o

pr ivat e use

Mot or f uel pur chased by business f or pr ivat e use

I n-house const r uct ion

ser vices

Goods held on der egist r at ion

DEEMED SUPPLY

SELF-SUPPLY


SUMMARY – DEEMED SUPPLIES AND SELF-SUPPLIES

This chapt er has looked at t wo t ypes of supply – deemed supplies and self supplies. The r ules t hat apply t o bot h of t hese supplies ar e ver y similar and t hey ar e mainly t o pr event a loss of VAT and a dist or t ion of compet it ion. However , it is impor t ant t o cat egor ise t he supplies separ at ely because a self supply is wher e we char ge VAT on an it em t o our selves. Thus t her e is an out put t ax char ge and an equal and opposit e input t ax cr edit on a self supply. I nvar iably f ull r ecover y of input t ax is not achieved and t he self supply achieves it s obj ect ive. The t r eat ment of a deemed supply is an out put t ax char ge due t o t he f act t hat input t ax has alr eady been claimed. This will nor mally be in ef f ect wher e t he onwar d supply (if any) is not subj ect t o VAT. On a gif t of goods input t ax is clawed back on t hose goods wher e t hey ar e gif t ed f or non business use. The way t o do t his is t o make an out put t ax char ge on t he r eplacement cost of such goods. Wher e a business asset is used pr ivat ely, and t he Lennar t z appr oach is adopt ed, t hen t her e is an out put t ax char ge in ever y VAT quar t er in which pr ivat e use t akes place. The out put t ax char ge r ef lect s t he cost of pr oviding t he asset f or pr ivat e use. I n t he absence of Lennar t z t he nor mal appor t ionment pr ovisions under s.24(5) will apply. Tr ader s must account f or out put t ax on t he deemed supply of bought in ser vices wher e t hey ar e put t o a non business use. Wher e a business pur chases f uel f or pr ivat e use by an employee or t he owner of a business t hen wher e input t ax is r ecover ed on t hat pur chase, out put t ax must be account ed f or using t he scale char ges set by Cust oms. Any asset s held by a business when it de-r egist er s f or VAT must have out put t ax account ed f or based on t heir r eplacement cost . However , if t he out put t ax due comes t o £ 1,000 or less Cust oms waive t he r equir ement t o pay over t he out put t ax. The self supply r ule applies wher e const r uct ion ser vices ar e pr ovided by an exempt or par t ially exempt business t o it self . A self supply char ge occur s wher e mot or car s ar e t aken out of st ock f or use by an employee or owner of a business.

E8: VALUE OF THE SUPPLY

I n t his chapt er we shall look at how you value a supply. The chapt er will cover : - t he def init ion of consider at ion; - special r ules f or valuing supplies in cer t ain sit uat ions; - pr ompt payment discount ; - mixed and composit e supplies.

E8.1 Introduction

The gener al r ules f or det er mining t he value of a supply of goods or ser vices ar e t o be f ound in • VATA 1994, s 19(2) wher e t he consider at ion f or t he supply is wholly in

money; and • VATA 1994, s 19(3) wher e t he consider at ion is not wholly in money. These gener al r ules ar e, however , subj ect t o any special valuat ion r ules made by or under VATA 1994. These special r ules ar e consider ed in 8.4 below.

VATA 1994 S 19(1)

E8.2 Consideration wholly in money

The gr oss value of t he supply is t he value of t he consider at ion t hat is given f or it . Ther ef or e t he st ar t ing point f or VAT is what a t r ader r eceives f or a supply r at her t han what t he t r ader act ually supplies.

s.19 (2)

Consider at ion = Pr ice of t he it em + t he VAT

Ther ef or e t he nor mal calculat ion is t hat 40/47ths of t he consider at ion is the net price and 7/47ths is the VAT. Tr ade pr ices and cont r act s usually st at e t hat t he pr ice is VAT exclusive so t his would mean t hat t he pr ice being quot ed is t he value of t he supply and t hat VAT will be added on t op of t his pr ice at 17.5%. (Host git t Lt d v Megahar t Lt d) However , in pr act ice, t his pr ocedur e is act ually t he opposit e of t he VAT r ules because t he VAT r ules say t hat wher e a cont r act says not hing about VAT t hen t he st ar t ing point is t he consider at ion so, in ot her wor ds, if you ar e quot ed a cer t ain pr ice and VAT is not ment ioned, t hat pr ice is VAT inclusive and hence is t he consider at ion. This is what happens when people go shopping in super mar ket s and shops, t he pr ice t hey see, which never ment ions VAT, is t he pr ice including VAT.


Example 1

Out lined below ar e t hr ee it ems or ser vices being sold; you have t o calculat e t he t ax t o t he near est penny.

a) Mar ks & Spencer sell a ladies coat at £ 99.00 VAT due is £

b) A plumber char ges £ 250 plus VAT t o r epair a leaky t ap VAT due is £

c) A book cost s £ 12.00 in Wat er st one’s Book Shop VAT due is £

However , r at her unusually, wit h ef f ect f r om 17 Mar ch 2005, t he consider at ion payable t o an over seas supplier of nat ur al gas and elect r icit y is t he value on which VAT is t o be account ed f or . This f ollows t he changes in t he place of supply r ules r elat ing t o t hese ser vices which wer e int r oduced f r om 1 J anuar y 2005.

E8.3 Consideration not wholly in money

I f a supply is f or a consider at ion not consist ing, or not wholly consist ing, of money, subj ect t o t he special valuat ion r ules in 8.4 below, it s value is t o be t aken t o be such amount in money as, wit h addit ion of t he VAT char geable, is equivalent t o t he consider at ion. I n ot her wor ds, it is necessar y t o

VATA 1994 S 19(3)

• det er mine t he amount t hat would have been given in money f or t he supply

if goods or ser vices had not inst ead been used f or all or par t of t he payment ; and t hen

• mult iply t hat amount by t he VAT f r act ion t o est ablish how much VAT is due.

It is important to distinguish between non-monetary consideration and no

consideration. Non-monet ar y consider at ion exist s when a supply is made in r et ur n f or payment in t he f or m of goods or ser vices. Wher e t her e is only non-monet ar y consider at ion, a bar t er t r ansact ion t akes place. I n some cases t her e may be bot h a monet ar y consider at ion and a non-monet ar y consider at ion. When goods or ser vices ar e pr ovided f or no payment in any f or m (monet ar y or non-monet ar y), t her e has been no consider at ion. I t is t hen only necessar y t o value such a pr ovision of goods or ser vices wher e VATA 1994 deems a t axable supply t o have t aken place. The commonest cases ar e • pr ivat e or non-business use of business asset s f or no consider at ion; • pr ivat e or non-business use of ser vices supplied t o t he business; • supplies of business goods/ asset s f or no consider at ion; and • deemed supplies of business goods/ asset s on hand at t he t ime of

der egist r at ion. These wer e cover ed in det ail in Chapt er 7.

Value of t he Supply

483

E8.4 Special Rules

Schedule 6 of VATA 1994 cont ains special r ules f or valuing supplies in cer t ain sit uat ions. Cust oms can dir ect t hat an open mar ket value is used f or supplies bet ween cer t ain connect ed per sons. This will nor mally apply wher e t he pur chaser cannot r ecover all of t he input t ax being char ged (f or example, an exempt or a par t ially exempt t r ader ). For t he r ule t o apply t he consider at ion must be wholly in money f or less t han open mar ket value. Ther e must t her ef or e be some consider at ion f or t he open mar ket value t o be applied bet ween connect ed per sons. I f t her e is no consider at ion, f or example, it is some sor t of bar t er t r ansact ion, t his r ule cannot be applied.

Sch 6 Par a 1

I f a mail or der company sells goods using unr egist er ed agent s, t hen t hat mail or der company can be f or ced by Cust oms t o account f or VAT on t he f ull r et ail pr ice of t hose goods. I f t his was not t he case, t hen t he mar gin of pr of it given t o t he agent would escape a char ge of VAT and, t he VAT being paid would not be 7/ 47t hs of t he act ual amount paid by t he cust omer .

Sch 6 Par a 2

Wher e t her e is a supply of goods by vir t ue of • a Tr easur y or der under VATA 1994, s 5(5) (self -supply of goods,), • VATA 1994, Sch 4 par a 5(1) (gif t s of business asset s), • VATA 1994, Sch 4 par a 6 (r emoval of business asset s f r om one EC

count r y t o anot her ), or • VATA 1994, Sch 4 par a 8 (deemed supply on der egist r at ion and

t er minat ion of business), t hen, (subj ect t o except ion in Sch 6 par a 10) t he value of t he supply is (a) such consider at ion in money (excluding any VAT) as would be payable by

t he per son making t he supply if he wer e, at t he t ime of t he supply, t o pur chase goods ident ical in ever y r espect (including age and condit ion) t o t he goods concer ned;

(b) wher e t he value cannot be det er mined as under (a) above, such consider at ion in money (excluding any VAT) as would be payable by t hat per son if he wer e, at t hat t ime, t o pur chase goods similar t o, and of t he same age and condit ion as, t he goods concer ned; and

(c) Wher e t he value cannot be det er mined as under (a) or (b) above, t he cost of pr oducing t he goods concer ned if t hey wer e pr oduced at t hat t ime.

VATA 1994 Sch 6, par a 6

Wher e an employer makes a supply of goods or ser vices t o his employees consist ing of • f ood or bever ages supplied in t he cour se of cat er ing, or • accommodat ion in a hot el, inn, boar ding house or similar est ablishment ,

t he value of t hat supply is t o be t aken t o be t he monet ar y consider at ion, if any, paid by t he employee (i.e. t he consider at ion is nil wher e t her e is no consider at ion or any consider at ion ot her t han money).

VATA 1994 Sch 6 Par a 10


Wher e accommodat ion in a hot el, inn, boar ding house or similar est ablishment is • pr ovided t o an individual f or a per iod exceeding f our weeks, and • t hr oughout t hat per iod t he accommodat ion is pr ovided f or t he use of t he

individual eit her alone or t oget her wit h one or mor e per sons who occupy t he accommodat ion wit h him ot her wise t han at t heir own expense,

af t er t he init ial f our weeks t he value of t he supply is r educed t o t hat par t at t r ibut able t o f acilit ies ot her t han t he r ight t o occupy t he accommodat ion (subj ect t o a minimum of 20%).

VATA 1994 Sch 6 Par a 9

I f a supply is invoiced in a f or eign cur r ency, t hen t hat supply is valued at t he appr opr iat e exchange r at e in f or ce on t he day t he supply is made.

Sch 6 Par a 11

E8.5 Prompt Payment Discount

Some t r ader s of f er a pr ompt payment discount t o encour age cust omer s t o pay on a t imely basis. When valuing goods f or VAT always assume t hat if a pr ompt payment discount is of f er ed, t he discount will be t aken up by t he cust omer . Thus t he VAT is always char ged on t he discount ed pr ice whet her or not t he discount was act ually t aken.

Sch 6 Par a 4

Illustration 1

Let us say t hat a t r ader sells goods f or £ 500 exclusive of VAT. This t r ader of f er s a 10% discount if payment is made wit hin 7 days. The goods ar e £ 500 if you pay lat e, or £ 500 less a 10% discount , so £ 450, if you pay ear ly.

Because a pr ompt payment discount is of f er ed, whet her it is t aken or not , VAT is calculat ed on t he discount ed amount . Thus t he VAT is calculat ed on t he £ 450 value of goods, which at 17.5% gives £ 78.75 of VAT. This is added on t o £ 500 wor t h of goods if t he goods ar e paid f or af t er 7 days, (£ 578.75) or it is added on t o t he £ 450 wor t h of goods if t he goods ar e paid f or wit hin 7 days (£ 528.75).

Example 2

J oe sells goods f or £ 1,000 exclusive of VAT t o ABC Limit ed. J oe of f er s a 2% discount f or payment wit hin 10 days. Calculat e t he VAT due if ABC Limit ed pays 30 days lat er .

E8.6 Further points

The next it em t o consider is a gif t . A gif t is wher e goods ar e given over t o one per son but no consider at ion is given back f or t he goods. For VAT you must value t he goods and you value t hem at t heir r eplacement cost . VAT is t hen char ged on a consider at ion which equals t he r eplacement cost of t hose goods.

Sch 6 Par a 6(1)


485

For a bar t er t r ansact ion, (i.e. I give you goods and in r et ur n you give me somet hing back, but not money), we ar e ef f ect ively looking at non-monet ar y consider at ion. The legislat ion st at es t hat t his non-monet ar y consider at ion must be valued and t his value is what t he out put t ax is calculat ed in r espect of .

s.19(3)

E8.7 Mixed and Composite Supplies

Ther e ar e t wo dif f er ent t ypes of supply. The mixed (or mult iple) supply and t he composite (or compound) supply. A mixed supply is wher e t her e ar e individual elements wit hin t he supply t hat ar e treated separately for VAT. An example of t his would be wher e a st udent goes on a cour se and has t o pur chase some books as par t of t he cour se. A cour se is st andar d r at ed and books ar e zer o-r at ed. They ar e ef f ect ively t r eat ed as separ at e supplies, even t hough t he st udent might pur chase t hem t oget her . The individual element s ar e being t r eat ed separ at ely f or VAT. This is cont r ast ed t o t he composite supply wher e t her e is j ust a single supply alt hough it might be made up of lot s of dif f er ent t hings. A compound supply is a single supply wit h a single VAT liability. An example of t his is a plane t icket t o f ly t o New Yor k. The t r aveller will also pr obably be pr ovided wit h a meal on t he f light . Air t r anspor t is zer o-r at ed and cat er ing is st andar d r at ed. However t he t r aveller is buying a complet e package and it is dif f icult t o separ at e t he t wo element s plus, of cour se, t he meal is j ust a small insignif icant piece of t he over all f light t o New Yor k. I n such a case, t his composit e supply would j ust be t r eat ed as a single zer o-r at ed supply of a plane t icket t o New Yor k. Wit h a mixed supply, t her e is t he need t o per f or m an appor t ionment calculat ion t o split t he individual element s of t he supply in or der t o calculat e t he VAT due. Wit h a compound supply only a single r at e of VAT applies t o t he whole supply.

s.19(4)

The case of Car d Pr ot ect ion Plan conf ir med t hat t he pur chaser ’s per cept ion of what t hey ar e buying is t he key f act or in det er mining whet her a supply is a mixed or composit e supply. When you buy a plane t icket , t he in f light meal is ancillar y t o t he plane t icket and t her ef or e t he supply is a composit e supply of air t r avel. I f t he pur chaser believes t he t wo element s of a supply ar e of equal impor t ance t he supply will gener ally be mixed and subj ect t o an appor t ionment calculat ion.

Illustration 3

A t r aining company of f er s a lect ur e cour se and st udy mat er ials f or £ 2,000 plus VAT. The cost t o t he t r aining company f or t he manuals is £ 100 and t he cost of t he cour se is £ 500. The manuals ar e a zer o-r at ed supply of pr int ed mat t er and t he cour se a st andar d –r at ed supply. This is a mixed supply.


Not ice 700 published by HMRC suggest s using eit her t he cost of each element or t he selling pr ice of each element t o appor t ion t ot al consider at ion. I n our illust r at ion we shall use cost t o appor t ion t his mixed supply. The t ot al cost of £ 500 and £ 100 is £ 600.

Not ice 700

100600

X £ 2,000 = zer o r at ed out put = £ 333

500600

X £ 2,000 = st andar d r at ed out put = £ 1,667

£ 2,000

VAT due:

£ 333 @ 0% £ nil

£ 1,667 @ 17.5% 291.73

Tot al VAT Due: £ 291.73

Example 3

For each of t hese supplies decide whet her t her e is a mixed / mult iple supply or a compound / composit e supply. Mixed/ Compound/ Mult iple Composit e Supply Supply a) A box of Ear l Gr ey Tea comes wit h a china t eapot

as a special Chr ist mas pr omot ion

b) A language school sells cour ses and books

f or a t ot al f ee of £ 500.

c) Ticket t o f ly t o Rome includes a

st andar d lunch


487

Answer 1

a) £ 14.74

The f ir st it em is f or sale in Mar ks & Spencer and t he pr ice shown will be t he consider at ion, i.e. t he VAT inclusive pr ice. Thus 7/ 47 of £ 99 gives us £ 14.74.

b) £ 43.75 The second it em is a plumber char ging £ 250 plus VAT f or ser vices, so t he pr ice being shown is not t he consider at ion because t he VAT is not included and has t o be added on t op t o get t o consider at ion. To wor k out t he VAT we char ge 17.5% of £ 250 and get £ 43.75.

c) Nil

The t hir d it em is a book being sold f or £ 12. I t is a shop, j ust like t he Mar ks & Spencer example, so t he pr ice being shown is t he consider at ion. Nor mally we would t ake 7/ 47 f or t he VAT except books ar e zer o-r at ed supplies so it is act ually 0% VAT added on t o t his pr ice paid t o give us bot h a pr ice paid and a consider at ion of £ 12 and zer o VAT.

Answer 2

The cor r ect answer calculat es VAT on t he discount ed amount even t hough t he discount was not t aken because t he company paid lat e. £ 1,000 less 2% discount is £ 980, which at 17.5%, gives us £ 171.50 of VAT. The company will pay £ 1,000 plus £ 171.50 of VAT (i.e. £ 1,171.50).

Answer 3

A box of Ear l Gr ey t ea is t he main supply her e. The china t eapot , which pr obably cost s a lot mor e t han t he t ea, is j ust a promot ional incident al supply. This is ver y similar t o t he case wit h t he biscuit t in in Unit ed Biscuit s Limit ed. This is a single supply, a compound / composit e supply, of Ear l Gr ey t ea which will be zer o-r at ed. A language school selling a cour se and books will pr obably be making a mixed / mult iple supply because you will be able t o appor t ion VAT bet ween t he t wo element s pr ovided, i.e. t he cour se and t he books. I f you buy a t icket t o f ly somewher e and t hey pr ovide a meal, t he meal is gener ally j ust an incident al par t of t he main supply. So t his would be a zer o-r at ed single compound supply of air t r anspor t ser vices, wit h t he st andar d r at ed cat er ing meal being incident al t he main supply, and hence ignor ed.


SUMMARY – VALUE OF THE SUPPLY

VAT is 7/ 47t hs of t he consider at ion. Consider at ion not wholly in money is valued f r om t he point of view of t he per son r eceiving t he consider at ion wher e t hey ar e awar e of t he r et ail pr ice of t he goods or ser vices r eceived (Nat ur ally Your s). Wher e t hey ar e unawar e of t he r et ail value, consider at ion is valued at cost t o t he supplier of t he goods (Empir e St or es). I f t her e was a pr ompt payment discount of f er ed always deduct it when calculat ing VAT even if t he discount is not act ually t aken up by t he cust omer . A gif t needs t o have a value f or consider at ion in or der t o wor k out VAT and we would use r eplacement value in such a case. I f we ar e looking at a bar t er t r ansact ion t hen t he value of consider at ion is t he value of t he non-monet ar y consider at ion we ar e r eceiving. A mixed/ mult iple supply is a supply t hat you can appor t ion int o it s individual element s and t hen char ge VAT upon each element accor dingly. A composit e/ compound supply is r eally j ust a single supply wit h a single VAT liabilit y. I f t her e ar e separ at e element s t hen t her e must be a main supply wit h t he ot her element or element s j ust being incident al t o t hat main supply.

E9: TIME OF SUPPLY

I n t his chapt er we will have a look at t he f ollowing: - how t he t ime of a supply is calculat ed; - t he sit uat ions when a basic t ime of supply (t ax point ) can be over r idden and

changed t o a dif f er ent dat e; - t he t ime of supply wher e deposit s ar e paid f or a supply; - special r ules which f ix t ax point s f or unusual sit uat ions t hat t he t r ader may incur .

E9.1 Introduction

The t ime of supply is a ver y impor t ant piece of t he VAT legislat ion because t he t ime of supply basically gives you a dat e on which an it em is pur chased or an it em is sold. That dat e is cr ucial because it will det er mine which VAT Ret ur n you account f or t he out put t ax on a sale or you r ecover t he input t ax on a pur chase. The dat e is also cr ucial in case t her e was a change in t he r at e of VAT because t he dat e will det er mine which r at e of VAT t o char ge – t he old or t he new r at e. I t is also cr ucial if t her e was a change in t he law because t he dat e will f ix when t he supply occur s and whet her it happens under t he old law or t he new law. The t ime of supply is ver y impor t ant especially when pr epar ing your VAT Ret ur n since it det er mines which it ems t o put on a par t icular VAT Ret ur n. I f a business put s a t r ansact ion in t he wr ong VAT Ret ur n t he business opens it self up t o penalt ies.

s.1(2)

The main r ule is t hat t her e is a basic tax point f or all goods and all ser vices supplied.

E9.2 Basic tax point

For goods t he basic t ax point is t he dat e t he goods are removed f r om t he supplier t o t he pur chaser so, f or example, if a cust omer goes int o a shop and pur chases a sandwich, he is r emoving t he sandwich f r om t he supplier on t he dat e t hat he buys t hat sandwich. I f , as anot her example, he or der s some widget s – it is t he dat e t hose widget s leave t he f act or y wher e t hey ar e being manuf act ur ed in or der t o come t o t he cust omer t hat det er mines t he basic t ax point – t he dat e of supply.

s.6(2)

For ser vices, t he dat e of supply is when the services are performed. For ‘per f or med’ t hink of ‘complet ed’. I f a plumber comes t o your house t o inst all cent r al heat ing, t hen it is t he dat e he f inishes t he inst allat ion – t he dat e t he ser vices ar e r eally per f or med and f inished – t hat is t he basic t ax point .

s.6(3)


E9.3 Basic tax point overridden

The basic t ax point can act ually be over r idden by a dif f er ent dat e in t wo sit uat ions. One sit uat ion act ually makes t he act ual t ax point we use ear lier t han t he basic t ax point dat e. This will occur wher e t her e is a receipt of a payment on a dat e bef or e t he basic t ax point dat e or when t he tax invoice is issued on a dat e bef or e t he basic t ax point dat e. I n t hese cases, t he earlier date becomes

the actual tax point date t hat we will use.

s.6(4)

The second scenar io gives us a lat er t ax point dat e t han our basic t ax point . The lat er t ax point will only apply if we have not had an ear lier t ax point imposed on us. So our st ar t ing point is our basic t ax point dat e. I f a tax invoice is issued in the 14 day period after the basic tax point date t he t ax invoice issue dat e, i.e. t he lat er dat e, becomes t he act ual t ax point t hat we will use. The t r ader can waive t his 14 day r ule if he does not want t o have t his lat er dat e as his t ax point . He can chose t o st ick wit h t he basic t ax point dat e. Cust oms have t he power t o ext end t he 14 day per iod and, in many cases, t hey will ext end it up t o 30 days. A 30 day ext ension would help businesses t hat only have one invoice r un – usually at t he end of ever y mont h. This allows t hose businesses t o use t he invoice dat e as t heir act ual t ax point f or all supplies made in t hat mont h.

s.6(5)

Illustration 1

Anne or der s a wedding dr ess f r om Dr esses Limit ed on 1 November 2006. The company makes t he dr ess in November and Anne collect s t he dr ess on 1 December 2006. The company issues an invoice on 9 December 2006, which Anne pays on 20 December 2006.

Basic t ax point - 1.12.2006

Ear lier t ax point - Not applicable

Lat er t ax point - 9.12.2006

Act ual t ax point used = 9.12.2006

The basic t ax point is t he dat e t hat t he goods, t he wedding dr ess, is r emoved f r om t he supplier t o t he pur chaser – so t his will be t he dat e t hat Ann collect s t he dr ess and hence will be 1 December 2006. I f t her e was a payment made bef or e t his dat e or t he t ax invoice was issued bef or e t his dat e t hen an ear lier t ax point would apply. That is not what happens in t his example.

I f t he t ax invoice is issued wit hin 14 days of t he basic t ax point , t hen t he lat er dat e becomes t he act ual t ax point we use. The invoice was issued on 9 December 2006 – t his is wit hin 14 days of our basic t ax point on 1 December 2006 hence t he lat er t ax point is t he act ual t ax point t hat we will use f or t his supply, unless t he company waives t he r ight t o use t he lat er dat e which is not ver y of t en t he case in pr act ice.

Time of Supply

491

Example 1

Same as I llust r at ion 1 except Anne or der s t he dr ess on 1.11.2006, pays f or t he dr ess on 1.12.2006, collect s t he dr ess 5.12.2006 and t he invoice is issued on 9.12.2006.

Which of t he f ollowing is t he t ax point f or t he supply?

a) 1.11.2006

b) 1.12.2006

c) 5.12.2006

d) 9.12.2006

E9.4 Deposits

I t is possible t o have mor e t han one t ax point f or t he same supply – an example of t his would be wher e a deposit is paid upf r ont and t hen, when t he goods ar e deliver ed at a lat er dat e, t he balance is paid.

Illustration 2

Let us have a look at how a deposit would af f ect t he example wit h Anne. Anne or der s a dr ess on 1 November and pays her £ 500 deposit when she or der s t he dr ess on 1 November . She t hen collect s t he dr ess on 1 December . The company t hen invoices Anne f or t he balance due on 9 December and Anne pays t he balance on 20 December .

St ar t ing wit h t he deposit . The basic t ax point f or t his supply is t he dat e t hat t he dr ess is collect ed on 1 December 2006. The deposit was paid ear lier t han t he basic t ax point – it was paid on 1 November and t he nor mal t ax point r ules would say t hat t he ear lier dat e is t he dat e used as t he t ax point .

Thus 1 November becomes t he act ual t ax point f or t he deposit because it was ear lier t han t he basic t ax point f or t he supply.

When consider ing t he balance of t he payment , once again t he basic t ax point is t he dat e t he dr ess is collect ed on 1 December . The company t hen issue an invoice f or t he balance t hat is due on 9 December . This is wit hin 14 days of t he basic t ax point f or t hat balance and hence t he lat er dat e is t he t ax point f or t he balance. So 9 December is t he t ax point f or t he balance. Ther e ar e t wo t ax point s f or t his supply – 1 November is t he t ax point f or t he deposit , 9 December is t he t ax point f or t he balance.


Anne:

Or der s dr ess 1.11.2006

Pays £ 500 deposit 1.11.2006 Tax point f or deposit

Collect s dr ess 1.12.2006 Basic t ax point

I nvoice f or balance 9.12.2006 Tax point f or balance

Pays balance 20.12.2006

E9.5 Special rules

I t is only possible t o issue a t ax invoice showing VAT payable f or a st andar d r at ed t axable supply by a r egist er ed per son. When you ar e looking at t he tax point of an exempt supply or a zero-rated supply, or a supply by an

unregistered person (which could be impor t ant f or r egist r at ion liabilit y calculat ions), t hen one does not consider the issue of a tax invoice. Thus when looking at t he t ax point r ules, one only looks at payment or basic t ax point s f or supplies t hat ar e not st andar d r at ed supplies.

Somet imes wit h ser vices t he ser vice can be supplied cont inuously and never act ually f inish or , as t he legislat ion put s it ‘per f or med’. An example of t his would be r ent – a business is const ant ly being pr ovided wit h t he pr oper t y f or which it pays r ent . Anot her example is consult ancy wor k, which can const ant ly be on going but never r eally complet ed. For a continuous supply of services one does not consider basic t ax point because t her e is not one - t he ser vice is never per f or med so it is never complet ed. Wit h a cont inuous supply of ser vices t her e is only payment and invoice – so t he ear lier of t he t wo will det er mine t he t ax point .

SI 1995/ 2518

r eg 90

Thus supplies which ar e subj ect t o t he cont inuous supply r ule gener at e a t ax point only by t he issue of a t ax invoice, or payment passing. When t hese supplies ar e bet ween connect ed par t ies, f or example gr oup companies, t he char ges ar e f r equent ly passed bet ween companies f or account ing pur poses, but no invoices ar e issued. I n such a case, out put t ax is not declar ed nor is input t ax r ecover able.

SI 1997/ 2887 r eg 2

However , wher e t he input t ax would not be r ecover able, f or example because t he r ecipient is wholly or par t ially exempt , t his causes a loss of r evenue t o Cust oms. A r ule int r oduced by FA2003 imposes a per iodic t ax point on cont inuous supplies bet ween connect ed par t ies, gener ally leading t o an annual VAT out put t ax char ge. The t ype of supplies af f ect ed by t his new r ule ar e t hose f or management char ges, t elephone, elect r icit y, piped gas and wat er and leasing of pr oper t y and equipment .

Time of Supply

493

The t ax point f or supplies in t he construction industry depend upon t he t er ms of payment under t he cont r act f or t he supply. (a) Wher e t he cont r act pr ovides f or per iodic payment s t o t he supplier

(of t en r ef er r ed t o as st age payment s or int er im payment s) a t ax point ar ises at t he ear liest of t he f ollowing dat es.

(i) The dat e a payment is r eceived f r om t he supplier . (ii) The dat e t he supplier issues a VAT invoice. (iii) For const r uct ion ser vices wher e, br oadly, t he building in quest ion

is occupied by a per son who cannot r ecover VAT and t he const r uct ion cont r act or is connect ed wit h t he occupier or has been f inanced by t he occupier t o car r y out t he const r uct ion wor k. • if t he ser vices wer e per f or med af t er 8 December 1997 and

bef or e 9 J une 1999, 18 mont hs af t er t he dat e on which t he ser vices wer e per f or med; and

• if t he ser vices ar e per f or med af t er 8 J une 1999 t he dat e on

which t he ser vices ar e per f or med.

(b) Single payment cont r act s (even if payment of par t of t he pr ice is t o be delayed under a r et ent ion clause) ar e subj ect t o t he nor mal t ax point r ules.

Wher e a cont r act wit hin (b) above includes a r et ent ion clause, t he t ax point of t he r et ained element is t he ear liest of t he t ime when a payment is r eceived in r espect of t he r et ent ion and t he dat e t he supplier issues an invoice r elat ing t o it . When supplies ar e deemed t o be made under t he r ever se char ge r ules, t hen t he t ax point is only det er mined by payment . I n ot her wor ds, it is only det er mined by t he dat e t he ser vices ar e paid f or . When t he ser vices ar e act ually per f or med, or when an invoice is issued is ir r elevant under t he reverse charge r ules.

SI 1995/

2518 r eg 82

Example 2

Kar en or der s a t oy over t he t elephone f r om a mail or der supplier quot ing her debit car d number on 12 November 2006. On 14 November 2006 t he supplier sends t he t oy t o Kar en. On 16 November 2006 an invoice is issued showing f ull payment has been made. Which of t he f ollowing is t he t ax point f or t he supply?

a) 12.11.2006

b) 14.11.2006

c) 16.11.2006

d) 1.12.2006

SI 1995/ 2518 Reg 93; SI 1997/ 2887, Reg. 5; SI 1999/ 1374 SI 1995/ 2518 Reg 89


Answer 1

The cor r ect answer is B

The basic t ax point is t he dat e t he dr ess was collect ed which is 5 December .

However if a payment was made bef or e t his basic t ax point or if an invoice was issued bef or e t his t ax point , t hen we use t he ear lier dat e.

I n t his example a payment was made on 1 December and so t hat dat e becomes t he act ual t ax point t hat we would use f or t his supply.

Answer 2

The cor r ect answer is A

The basic t ax point is t he dat e t he goods wer e supplied or lef t t he pr emises of t he supplier ; so t hat would be 14 November .

Because a payment was made ear lier t han t his basic t ax point dat e, on 12 November 2006, we use t he ear lier dat e as t he t ax point dat e f or t hese supplies. The act ual t ax point used is t her ef or e 12 November 2006.

Time of Supply

495

SUMMARY – TIME OF SUPPLY The basic t ax point f or goods is t he dat e t he goods ar e r emoved f r om t he supplier . The basic t ax point f or ser vices is t he dat e t he ser vice is per f or med. The basic t ax point is over r idden in t wo sit uat ions. I f t her e is r eceipt of a payment or a t ax invoice is issued on a dat e bef or e t he basic t ax point dat e t hen t he ear lier dat e becomes t he act ual t ax point dat e used. I f an ear lier t ax point does not apply and an invoice is issued wit hin 14 days af t er t he basic t ax point t hen t he invoice issue dat e becomes t he t ax point dat e used ,i.e. t he lat er dat e is t he t ax point used by t he business. When consider ing deposit s, t he deposit and t he balance paid ar e consider ed separ at ely; each will have t heir own t ax point s calculat ed in t he nor mal way which mor e of t en or not ar e complet ely dif f er ent dat es f r om each ot her . I f ser vices ar e supplied cont inuously, t hen t he t ax point becomes t he dat e money is paid or an invoice is issued. A special r ule exist s f or cont inuous supplies bet ween connect ed par t ies. Supplies deemed t o be made under t he r ever se char ge r ules have a t ax point det er mined by t he dat e of payment .

E10a: INPUT TAX: WHEN TO RECOVER

I n t his chapt er we will look at when t o r ecover input t ax including: t he numer ous condit ions which must be sat isf ied bef or e input t ax can be r eclaimed by a business; - t he def init ion of a supply of goods or ser vices; - t he def init ion of t axable per sons; - t he def init ion of business pur poses; t he r equir ed evidence t o show t hat input t ax was cor r ect ly char ged; how we det er mine a dir ect and immediat e link wit h a t axable t r ansact ion; t he sit uat ions when input t ax r ecover y is not available.

E10a.1 Introduction

As a gener al r ule, when input VAT is incur r ed by a t axable per son it is available f or cr edit (which basically means it is included as input VAT on t he VAT Ret ur n) f or t he per iod in which it ar ises. I t is deduct ed f r om out put t ax and hence r ecover ed f r om Cust oms. I f t he input t ax on a VAT Ret ur n exceeds t he out put t ax, t hen Cust oms act ually make a r epayment of t he net amount . This chapt er is going t o look at t he conditions which have t o be met bef or e input t ax is available f or cr edit .

s.24 & s.26 SI 1995/ 2518

Reg 29

The condit ions ar e numer ous and can be summar ised as f ollows:

• A supply of goods or services is being made;

• This supply must be made to the taxable person and t he t r ader is a t axable per son at t he t ime t he supply was made;

• The supply of goods or ser vices must have been made f or a business

purpose;

• The claimant must hold t he r equir ed evidence of t heir pur chase;

• I nput t ax on t he supply must have been correctly charged; and

• The goods or ser vices being supplied must have a direct and immediate link wit h a t axable t r ansact ion.

I n addit ion t o t hese condit ions t he input t ax must not be specif ically blocked f r om cr edit .

E10a.2 A supply of goods or services has been made

The f ir st condit ion is t hat a supply of goods or ser vices has been made. The supply must have act ually t aken place. I f a supply does not t ake place f or what ever r eason, t hen t he VAT element of anyt hing t hat has been paid is not r ecover able.

I nput Tax: When t o Recover

497

I f somet hing was paid, t hen it is f or t he cust omer t o go back t o t he seller and t r y t o get a r ef und. A r ef und cannot be obt ained f r om Cust oms because any payment made is not r egar ded as input t ax. A classic example of t his is t he t r ansf er of a business as a going concer n (TOGC) because t his is not consider ed t o be a supply f or VAT. Hence, because no supply is being made, if any VAT has been char ged in r espect of such a t r ansact ion, it cannot be r ecover ed, f r om Cust oms.

E10a.3 Supply made to the taxable person

The second condit ion is t hat t he supply has been made t o t he t axable per son. I t is not accept able f or a supply t o be made t o somebody else but t he t axable per son r ecover s t he input VAT on t hat supply. Ther e is a case t hat looks at t his condit ion which is CCE v Redr ow Gr oup Plc (1999).

s.24

Redr ow designed and oper at ed a sales incent ive scheme wher eby it would pay t he Est at e Agency f ees incur r ed by per sons selling t heir homes and pur chasing new Redr ow homes. The sum concer ned was paid on t he complet ion of t he pur chase. Redr ow submit t ed a claim t o r ecover t he input t ax on t he Est at e Agent s’ f ees. Cust oms ar gued t hat t he Est at e Agent ’s ser vices wer e not supplied t o Redr ow but r at her wer e supplied t o t he pur chaser s of t he new house. The case went f r om Tr ibunal t o High Cour t t o Cour t of Appeal and f inally, t o t he House of Lor ds. The House of Lor ds f elt t hat t he quest ion in t his case was whet her t her e was input t ax in Redr ow’s hands which, in t ur n, depended on whet her Redr ow had r eceived t axable supplies f or t he pur pose of it s business. The House of Lor ds st at ed t hat Redr ow did not mer ely der ive a benef it f r om t he ser vices r ender ed t o t he pur chaser s of t he houses, but t hey had act ually select ed and inst r uct ed t he Agent s. The Cour t t her ef or e concluded t hat Redr ow r eceived supplies of ser vices f r om t he Agent in r et ur n f or t he consider at ion paid. Consequent ly, t he t ax paid was input t ax in t he hands of Redr ow. I n t he case of Mono Global Lt d t wo shar eholder s acquir ed a company wit h t he int ent ion of using it t o make supplies in t he t elecommunicat ions sect or . They sought out side invest or s, and t he company paid f or r epor t s on it s likely pr of it abilit y by t wo f ir ms of account ant s and t wo f ir ms of consult ant s. The company r eclaimed t he input t ax on t hese r epor t s, and Cust oms r ef used it , ar guing t hat t he supplies of t he r epor t s had r eally been made t o t he out side invest or s. The Tr ibunal allowed t he company’s appeal in line wit h t he decision of t he House of Lor ds in Redr ow Gr oup plc. Ther e was some benef it t o t he out side invest or s, but t he company was undoubt edly t he main r ecipient of t he supplies.


The Tr ibunal held t hat “t he exact cont r act ual r elat ionship concluded by t he pr of essional adviser s does not necessar ily det er mine t he ident it y of t he par t y t o whom t he supply is made”. This indicat es t hat t he out side shar eholder – 3i – was ent er ed on t he let t er s of engagement along wit h t he “shell” company t hat became liable t o pay t he f ees at a lat er dat e. Cust oms t hought t hat t his was enough t o dist inguish t his case f r om Redr ow, but t he Tr ibunal disagr eed. The main benef it was always going t o be t o t he shell company, even if it did not have a name when t he cont r act s wer e ent er ed int o, and t he benef it s t o 3i wer e always incident al. Employee expenses St r ict ly, t he condit ion t hat t he supply must have been made t o t he t axable per son, means t hat if any input t ax is incur r ed on employee’s expenses which ar e t hen r eimbur sed by t he employer , t his input t ax is ir r ecover able. Thus if an employee is sent away t o wor k and has t o st ay in a hot el over night , and t he company r eimbur ses his hot el bill, in t he st r ict r eading of t he law, input t ax on t hat hot el bill cannot be r ecover ed because t he bill is made out t o t he employee; t he employee was pr ovided wit h t he ser vice not t he employer . The case of Co-oper at ive I nsur ance Societ y Lt d had t he input t ax being disallowed on hot el accommodat ion r eser ved by employees and only deduct ible if r eser ved by t he company. However , in pr act ice, Cust oms give cr edit in r espect of expenses t hat ar e specif ically r eimbur sed. Cust oms do not allow r elief f or r ound sum expense allowances, even if t he employee account s f or expendit ur e act ually incur r ed.

Not ice 700 Par a 12.1

Similar pr ovisions apply t o employee mileage claims. Employees ar e nor mally r eimbur sed at 40p per mile f or each business mile t hey t r avel in t heir own car . The employer can r ecover 7/ 47 of t he petrol element of such claims. The aut hor it ies have published an appr oved list of r at es f or such claims. Fr om 1 J uly 2006 t hey ar e:

Engine size Rat e (f uel only/ f uel element ) Pet r ol: up t o 1400cc 11p per mile Pet r ol: 1401cc – 2000cc 13p per mile Pet r ol: over 2000cc 18p per mile Diesel: up t o 2000cc 10p per mile Diesel: over 2000cc 14p per mile

These r at es ar e also used f or mileage claims made on company car s.


499

Changes to VAT recovery on employee mileage claims

Business Br ief 22/ 05 explains t he new ar r angement s f or r ecover y of VAT on r oad f uel pur chased by employees. They wer e int r oduced as a r esult of t he j udgment of t he Eur opean Cour t (Case-33/ 03) in t he inf r act ion pr oceedings against t he Unit ed Kingdom, which was issued in Mar ch 2005. The new r ules came int o ef f ect f r om t he 1st January 2006.

The Gover nment has now int r oduced secondar y legislat ion t o comply wit h t he j udgment by r epealing t he Value Added Tax (I nput Tax) (Per son Supplied) Or der 1991 and r eplacing it wit h a new Or der t o be known as t he Value Added Tax (I nput Tax) (Road Fuel Pur chased By Employees) (Or der ) 2005. Under t he new Or der , employer s will be able t o cont inue t o t r eat as input t ax t he VAT incur r ed by t heir employees on f uel cost s t hat ar e subsequent ly r eimbur sed by t he employer , eit her on t he basis of t he act ual cost of t he f uel or by means of a mileage allowance. Unlike t he old Or der , which t he ECJ f ound t o be incompat ible wit h t he Dir ect ive, t he new Or der makes it explicit t hat employer s can r ecover only t hat VAT on f uel which is f or use in t heir businesses in making t axable supplies and must hold a VAT invoice in suppor t of t heir claim. This means t hat t he old ar r angement s in pr act ice f or businesses t o r ecover VAT on f uel pur chased by employees ar e unchanged, except t hat businesses must now

retain VAT invoices to support their claims. The invoice can be a f ull VAT invoice or a less det ailed VAT invoice, as appr opr iat e. The only pr act ical change t o t he old syst em is t hat an invoice must be r et ained in suppor t of a claim f or VAT r ecover y - in t he vast maj or it y of cases, t his will be a less det ailed t ax invoice. The change comes in f r om 1 J anuar y 2006 r egar dless of t he VAT r et ur n per iod end dat e. Fr om t hat dat e, employer s should r et ain VAT invoices, including less det ailed VAT invoices, t hat t heir employees obt ain f r om t he f uel supplier as pr oof of pur chase. However , HMRC acknowledge t hat businesses will need a lit t le t ime t o make t he necessar y changes t o t heir ar r angement s in or der t o hold VAT invoices in suppor t of t heir claims. Ther ef or e, HMRC will be administ er ing t he change wit h a light t ouch unt il such t ime as businesses have had a r easonable per iod t o adj ust t o t he new r equir ement . As wit h t he old syst em, input t ax may only be claimed on t he cost of f uel f or business use. As such, invoices only need t o cover t his amount . HMRC accept t hat t he amount of t he invoice in many cases will not mat ch t he input t ax claim in r espect of business f uel in any one claim per iod and invoices may cover mor e t han one per iod, par t icular ly wher e f uel is pur chased t owar ds t he end of a per iod.


Clear ly, a claim cannot be suppor t ed by a VAT invoice which is dat ed af t er t he dat es cover ed by t he claim. This means, in pr act ice, t hat it may be advisable f or employer s t o ar r ange f or t heir employees who use, or may use, t heir car s f or business pur poses t o r et ain all f uel invoices. This will ensur e t hat , at t he end of t he claim per iod, t he value of business f uel is cover ed by an invoice. Illustration

Max wor ks f or Canmor e Limit ed. On a r ecent business t r ip Max dr ove 300 miles in his own Mer cedes E280 CDI . I n line wit h company guidelines he submit s a mileage claim f or £ 120 (300 miles at 40p). The f uel element of t he claim amount s t o £ 42. This is 300 miles at t he diesel r at e of 14p f or t his 2,800 cc car . I n or der f or t he company t o r ecover 7/ 47 of £ 42, Max must ensur e t hat a pet r ol r eceipt f or at least £ 42 accompanies t he mileage claim he submit t ed t o his employer . The pet r ol r eceipt must pr e-dat e t he business t r ip and can be a nor mal r et ailer s invoice f r om a gar age.

Pr e r egist r at ion input t ax The condit ion says t hat t he supply must be made t o t he t axable per son who was a t axable per son at t he t ime of t he supply. However t her e is an except ion t o t his r ule t o enable pre-registration input tax t o be r ecover ed on a t r ader ’s f ir st VAT Ret ur n. The legislat ion st at es t hat f or goods acquired f or t he business and still owned at the date of registration and f or services supplied for the purpose of the business in the six months prior to registration, input t ax on bot h of t hose it ems can be recovered on a trader’s very first VAT return once he has r egist er ed f or VAT. A similar r ule applies t o input t ax on goods and ser vices used f or business pur poses by a company pr ior t o it s incor por at ion pr ovided t he per son who incur r ed t he expendit ur e becomes an of f icer or employee of t hat company and is f ully r eimbur sed by t he company f or t he expendit ur e. This is called pr e-incor por at ion input t ax.

SI 1995/ 2518 Reg. 111

Wher e t he t ax point on pur chase ar ises post r egist r at ion but t he goods ar e consumed or sold on pr e r egist r at ion t he t r ader will not have a valid input r eclaim. To be ‘input t ax’ t he goods must be consumed or supplied at a t ime when t he t r ader is a t axable per son (Schemepanel Tr ading Co. Lt d). The pr e-r egist r at ion r ules would not be in point as t he t ax point ar ose post r egist r at ion. Hence Schemepanel is r equir ed t o r est r ict input r ecover y in t his inst ance.

Anot her special r ule says t hat cr edit f or input t ax may be available in r espect of cer t ain post -der egist r at ion supplies. So wher e ser vices ar e supplied af t er t he dat e of der egist r at ion, but t hose ser vices r elat e t o t axable supplies t hat wer e made when t he t r ader was st ill VAT r egist er ed, t he input t ax on t hose ser vices is r ecover able if a claim is made.

SI 1995/ 2518 Reg. 111


501

E10a.4 Supply for Business purposes

Ther e is no def init ion of whet her goods or ser vices have been supplied f or t he “pur pose of t he business”. Wher e t he connect ion bet ween t he expendit ur e and t he business is not clear , t he f ollowing t est s can be applied:

a) Det er mine t he int ent ion of t he per son at t he t ime of incur r ing t he expendit ur e. This is a subj ect ive t est and wher e t her e is no obvious associat ion bet ween t he business and t he expendit ur e concer ned, t he cour t should appr oach any asser t ion t hat it is f or t he business wit h cir cumspect ion and car e, I an Flockt on Development s 1987.

b) Est ablish whet her or not t her e is a clear connect ion bet ween t he act ual

or int ended use of t he goods or ser vices and t he act ivit ies business. This is an obj ect ive t est of t he use t o which t he goods ar e put

Expendit ur e, even if f or t he benef it of t he business is not necessar ily f or t he pur pose of t he business. I n t he case of Rosner (1993), VAT on legal cost s incur r ed in def ending a sole t r ader against cr iminal char ges was held t o be non-deduct ible under t his pr inciple. The same decision was r eached wher e a dir ect or was being def ended in t he case of Wallman Foods Limit ed. I n t he case of P&O Eur opean Fer r ies (Dover ) Lt d, VAT on legal cost s in def ending t he company and cer t ain of it s employees char ged wit h manslaught er f ollowing t he sinking of a f er r y was held t o be deduct ible. I t had clear ly been incur r ed f or t he pur pose of t he business even t hough it also had t he ef f ect of benef it ing individual employees.

s. 24(1)

I f a supply is pur chased which is used par t ly f or business pur poses and par t ly f or non-business pur poses, t hen t he input t ax on t he supply has t o be appor t ioned and only t he input t ax which r elat es t o t he business pur pose is available f or cr edit . For example, you might have t o appor t ion input t ax on t elephone bills, wher e t he t elephone is used bot h f or business and f or pr ivat e use.

s. 24(5)

The appor t ionment pr ovisions of VATA 1994, s 24(5) wer e called int o quest ion by t he r uling in Lennar t z v Finanzamt Munchen I I I . The Cour t r uled t hat wher e goods ar e acquir ed solely f or a pr ivat e or non-business pur pose, VAT incur r ed is not r ecover able, even if t he goods in quest ion ar e lat er put t o a deduct ible business use (because t he r ight t o deduct VAT ar ises, and is exer cisable, at t he t ime when t he VAT is incur r ed). I f , however , a t axable per son acquir es goods and used t hem par t ly f or business pur poses and par t ly f or pr ivat e or non-business pur poses, he has a r ight t o t ot al and immediat e input t ax deduct ion (unless t he goods ar e subj ect t o input t ax r est r ict ion). Wher e t he goods ar e lat er used f or pr ivat e or non-business pur poses, t hat use is t o be t r eat ed as a t axable supply of ser vices and VAT must be account ed f or under VATA 1994, Sch 4 par a 5(4) in each VAT per iod in which pr ivat e or non-business use of t he asset occur s. Recor ds must be kept showing how t he r elevant asset has been used. Typically t hese pr ovisions might apply t o yacht s, helicopt er s or aer oplanes bought by t he business.


E10a.5 Claimant holds required evidence

This condit ion st at es t hat input t ax is available f or cr edit if t he r equir ed evidence is available. The r equir ed evidence t akes sever al f or ms. The most common f or m is a tax invoice f or t he supplies t hat have been pur chased f r om anot her t axable per son and a t ax invoice has t o sat isf y cer t ain condit ions (cover ed in t he chapt er on VAT r ecor ds).

s. 24(6)

SI 1995/ 2518

Reg 29

An invoice is required from a foreign supplier f or t he ser vices t hat ar e r eceived f r om over seas. These ar e t he sor t s of ser vices t o which t he r ever se char ge under s.8 VATA 1994 applies. For imported goods a certificate C79, which is issued mont hly by Cust oms t o all VAT r egist er ed impor t er s, will be t he necessar y evidence r equir ed.

I f goods have been acquired from an EC member state t hen t he evidence r equir ed is what ever r elevant document is r equir ed by t hat EC st at e. I n t he UK t he r elevant document is t he tax invoice. The r elevant document f r om t he EC st at e should show the claimant and the supplier’s VAT numbers, t he consideration excluding VAT t hat was paid f or t he goods and a description of the goods.

Cust oms can accept ot her document ar y evidence as t he r equir ed evidence but t his is at t heir discr et ion.

Ther e is an except ion f r om t he main r ule in cer t ain cir cumst ances. A t ax invoice is not r equir ed as evidence when claiming a cr edit f or input t ax if t he expendit ur e was below £ 25 on:

• t elephone calls f r om public and pr ivat e t elephones;

• pur chases t hr ough coin-oper at ed machines;

• car par k char ges. I n cer t ain sect or s t r ader s will be r equir ed t o pr ovide a higher st andar d of pr oof ; evidence will also be r equir ed t hat t he t r ansact ion is bona f ide, bef or e input t ax incur r ed can be r ecover ed.

The r ule af f ect s t he f ollowing sect or s:

• Comput er s and r elat ed equipment ; • Telephones and r elat ed equipment ; • Alcohol pr oduct s, and • Oils held out as r oad f uel.

Essent ially, t he measur e will ensur e t hat any supply made on or af t er 16 Apr il 2003 will have t he input t ax disallowed if t he VAT invoice pr oves t o be invalid, and t he f ur t her evidence of bona f ides is not available.


503

Example 1

Dr aw a line t o mat ch t he pur chase t o t he “r equir ed evidence”

A pur chase of 100 pens f r om a UK st at ioner

Cer t if icat e C79

The ser vices of an account ant based in J er sey

Fr ench T.V.A invoice

I mpor t ed boxes f r om t he USA

Tax invoice

Pur chase of 1,000 pencils f r om Fr ench supplier

Fee invoice

E10a.6 Input tax was correctly charged

Cr edit f or input t ax is r est r ict ed t o t he amount pr oper ly char geable on a supply. I f VAT was incor r ect ly char ged on a supply t hat VAT cannot be r ecover ed as input t ax. The classic example is wher e a business is t r ansf er r ed as a going concer n (TOGC). A TOGC is a supply which is out side t he scope of VAT – so it is not a VAT supply. Hence, if VAT was mist akenly char ged on such a supply it would gener ally not be possible t o r ecover t his VAT as input t ax.

s. 24(1) and (2)

One can only r ecover t he cor r ect amount of t ax t hat should have been char ged so if t he t ax char ged was over st at ed, t he cr edit f or input t ax is r est r ict ed t o t he amount t hat should have been char ged. I nput t ax can only be r ecover ed at t he cor r ect amount on a cor r ect t ype of supply.

E10a.7 Direct and immediate link with a taxable transaction

The f inal condit ion is t hat t he goods or t he ser vices pur chased must have a dir ect and immediat e link wit h a t axable t r ansact ion.

The Eur opean Cour t of J ust ice gave an impor t ant r uling on t his linking pr inciple in t he case CCE v Midland Bank Plc (2000). The issue in t his case was whet her one of t he Bank’s subsidiar ies could r ecover input t ax char ged on legal ser vices incur r ed when it was def ending it self against a legal act ion ar ising f r om an earlier t axable t r ansact ion. Cust oms did not disput e t hat t he VAT incur r ed was input t ax f or t he Bank but ar gued t hat t he Bank should t r eat t he input t ax as r elat ing t o a gener al over head and, hence, t her e would be some r est r ict ion in t he input t ax r ecover y because t he Bank as a whole was par t ially exempt .


The Eur opean Cour t of J ust ice made it s j udgement in f avour of Cust oms. VAT paid on legal ser vices supplied t o a Bank, which was making bot h t axable and exempt supplies, in connect ion wit h a claim f or damages ar ising out of an earlier t axable t r ansact ion, did not have t he necessar y dir ect and immediat e link wit h t hat t axable t r ansact ion. Hence, input t ax could not be r ecover ed in f ull.

To be dir ect ly at t r ibut able t o making a supply an input has t o be a cost component of t hat supply at the time it is made.

The Eur opean Cour t of J ust ice’s decision in t he BLP Gr oup plc v CCE (1995) case also looked at t his condit ion in some det ail. I n t his case, input t ax t hat was dir ect ly linked t o making an exempt supply (sale of shar es) had t o be at t r ibut ed t o t hat exempt supply and hence was ir r ecover able input t ax even t hough t he wider pur pose of an exempt shar e sale was t o benef it t he r est of a wholly t axable business. I nput t ax has t o at t ach t o t he immediat e supply and not t o t he wider pur pose.

E10a.8 Blocked input tax

I n cer t ain cases input t ax is specif ically ir r ecover able. The blocking or der includes input t ax on business entertaining and motor cars – input t ax can never be r ecover ed on t hese it ems even if t he t r ader meet s all t he condit ions out lined in t his chapt er .

SI

1992/ 3222

‘Business ent er t ainment ’ means ent er t ainment (including hospit alit y of any kind) pr ovided by a t axable per son in connect ion wit h a business car r ied on by him, but does not include t he pr ovision of any such ent er t ainment f or eit her or bot h • employees of t he t axable per son; or • if t he t axable per son is a company, it s dir ect or s or per sons engaged in

t he management of t he company unless t he pr ovision of ent er t ainment f or such per sons is incident al t o it s pr ovision f or ot her s.

SI 1992/ 3222 Ar t 5(3)

Cust oms r egar d business ent er t ainment as including • pr ovision of f ood and dr ink; • pr ovision of accommodat ion (hot els, et c.); • pr ovision of t heat r e and concer t t icket s; • ent r y t o spor t ing event s and f acilit ies; • ent r y t o clubs, night clubs, et c; and • use of capit al goods such as yacht s and air cr af t f or t he pur pose of

ent er t aining. Wher e t he cost of pr oviding hospit alit y is passed on as par t of t he over all char ge f or a t axable supply, VAT incur r ed in pr oviding t he hospit alit y cannot be r eclaimed.


505

For business ent er t ainment pur poses, Cust oms r egar d ‘employee’ as including • dir ect or s or anyone engaged in t he management of t he business (including

par t ner s); • self -employed per sons (subsist ence expenses only) t r eat ed by t he

employer in t he same way f or subsist ence pur poses as an employee; and • helper s, st ewar ds and ot her people essent ial t o t he r unning of spor t ing or

similar event s but not as including pensioner s and f or mer employees, j ob applicant s and int er viewees, and shar eholder s (who ar e not also employees).

VAT Not ice 700/ 65/ 02

par as 2.3, 2.4

Staff entertainment. Following t he decision in Er nst & Young, Cust oms accept t hat wher e an employer pr ovides ent er t ainment f or t he benef it of it s employees (e.g. t o r ewar d t hem f or good wor k or t o maint ain and impr ove st af f mor ale), it does so wholly f or business pur poses. Thus, t he VAT incur r ed on ent er t ainment of employees (e.g. st af f par t ies, t eam building exer cises, st af f out ings and similar event s) is input t ax and is not blocked f r om r ecover y under t he business ent er t ainment r ules. Ther e ar e t wo except ions t o t his gener al r ule. • Wher e ent er t ainment is pr ovided only f or dir ect or s, par t ner s or sole

pr opr iet or s of a business, t he VAT incur r ed is not input t ax as t he goods or ser vices ar e not used f or a business pur pose. But wher e dir ect or s, et c. at t end st af f par t ies t oget her wit h ot her employees, Cust oms accept t hat t he VAT incur r ed is input t ax and is not blocked f r om r ecover y.

• Wher e employees act as host s t o non-employees, t he cost s ar e incur r ed

solely f or t he pur pose of ent er t aining t he non-employees and t he input t ax is blocked under t he business ent er t ainment r ules.

VAT Not ice 700/ 65/ 02

par as 3.1-3.3

Subsistence expenses. Wher e meals et c. ar e pr ovided away f r om t he place of wor k on a business t r ip, t he VAT incur r ed on t he employee’s meal can be claimed as input t ax under t he subsist ence r ules.

VAT Not ice 700/ 65/ 02 par as 2.5

Staff parties with guests, etc. Wher e a business ent er t ains bot h employees and non-employees, it can only r ecover as input t ax t he VAT it incur s on ent er t aining it s employees. The por t ion of t he input t ax incur r ed in ent er t aining ot her s is blocked under t he business ent er t ainment r ules. I n KPMG (No 2) an account ancy f ir m or ganised dinner dances f or it s employees, each of whom was ent it led t o br ing one guest . I t was held t hat t he r elat ed input t ax should be appor t ioned on t he basis t hat t he pr opor t ion of t he expendit ur e at t r ibut able t o t he guest s const it ut ed business ent er t ainment . The ent er t ainment of t he non-employees could not be t r eat ed as incident al t o t he ent er t ainment of t he employees. This decision came af t er t he decision in Thor n EMI plc v C & E Commr s, CA [1995] t hat input t ax r elat ing t o business ent er t ainment can be appor t ioned. The decision in KPMG (No 2) was dist inguished in Er nst & Young wher e a char ge of £ 15 per head was made f or guest s. The t r ibunal held t hat t he cr ucial char act er ist ic of ‘ent er t ainment ’ in t he phr ase ‘business ent er t ainment ’ was t hat it was pr ovided f r ee of char ge. Alt hough t he £ 15 char ge was



consider ably less t han t he cost of t he par t y, it was not so small as t o say t he meal was pr ovided f r ee of char ge. Hence Er nst & Young account ed f or out put VAT on t he £ 15 and had f ull r ecover y of r elat ed input t ax. I n Thor n EMI plc v C & E Commr s, [1995] , Cust oms sought t o exclude cr edit f or all input t ax on hospit alit y chalet s const r uct ed t o r eceive cust omer s at shows alt hough accept ing t hat t he chalet s wer e used par t ly f or business pur poses. I t was held, t hat Cust om’s appr oach was unr easonable. Applying t he gener al pr inciple in EC 6t h Dir ect ive, Ar t 17, appor t ionment should be allowed. Cust oms now accept t his.


I n 2005 t he boxing pr omot or , Fr ank War r en, won a case which enabled him t o r ecover 25% of t he input t ax on a hospit alit y box on t he basis t hat t his element was pr omot ional.

Motor cars. Apar t f r om one or t wo except ions, VAT cannot be r ecover ed on t he pur chase of a mot or car . One of t he except ions is on t he pur chase of a mot or car wher e exclusive business use is intended. This condit ion will not be sat isf ied wher e t he t axable per son int ends t o make t he car available t o any per son f or private use. Cust oms r egar d a car as being used exclusively f or a business pur pose if it is used only f or business j our neys and it is not available f or pr ivat e use. I n Upt on (t / a Fagomat ic) v C & E Commr s (2002) a t r ader r eclaimed input t ax on t he pur chase of a Lambor ghini. The t r ibunal allowed t he t r ader ’s appeal, as all t he shops which t he t r ader visit ed wer e wit hin walking dist ance of his home and he always used t axis t o at t end social engagement s. The High Cour t , however , r ever sed t he decision holding t hat , on t he evidence, t he t r ader had made t he car available for private use. The f act t hat t he t r ibunal had accept ed t he t r ader ’s evidence t hat he did not need t o use t he car pr ivat ely was not conclusive. The Cour t of Appeal upheld t his decision. The “int ent ion t o use” is not synonymous wit h t he “int ent ion t o make available”. Wher e an individual t r ader acquir es a car , t he ver y f act of his deliber at e acquisit ion of t he car , wher eby he makes himself t he owner of t he car and cont r oller of it , means t hat he must int end t o make it available t o himself f or pr ivat e use, even if he never int ends t o use it pr ivat ely. Fagomat ic is of t en r ef er r ed t o when consider ing t he r ecover abilit y of input t ax on car s. Her e is a select ion of r elevant cases.

A couple owned and oper at ed a hot el. The husband bought a Toyot a Pr evia and r eclaimed t he input t ax. Cust oms disallowed it , on t he gr ounds t hat Ar t 7(2G) SI 1992/ 3222 r uled out t he assumpt ion of 100% business use. The Tr ibunal held t hat , on t he evidence, t he t r ader had shown t hat he had no int ent ion of using t he car pr ivat ely or of making it available f or pr ivat e use.


507

The High Cour t has over r uled t his decision, holding t hat t he Tr ibunal chair man had er r ed in law. The Cour t of Appeal’s decision in Fagomat ic est ablished t hat t he t est of “int ent ion t o use” was subj ect t o t he f ur t her condit ion t hat “t her e must be no int ent ion t o make available f or pr ivat e use”. I f t he t r ader has placed no physical or legal r est r ict ion on t he possibilit y of making pr ivat e use of t he car , t her e was assumed t o be an int ent ion t o make it available f or pr ivat e use, even if t her e was no int ent ion t o t ake advant age of t hat availabilit y, C & E v PJ Robbins. The Tr ibunal has conf ir med in anot her case t hat a t r ader could not r ecover t he input t ax on a car , in spit e of accept ing t hat he made no pr ivat e use of it (having anot her car f or all pr ivat e mot or ing). The Tr ibunal applied t he r ulings of t he Cour t of Appeal in Fagomot ic, Robbins, J Williams (t / a Radmor e Coaches) Anot her r ecent case shows how har d it is f or t he t axpayer t o convince t he Tr ibunal t hat a car is not available f or pr ivat e use. The t r ader bought an I suzu Tr ooper est at e car t o t ow a t r ailer (which t r anspor t ed high-value car s). The mileage was 180,000 on business over t wo year s. The Tr ooper was usually kept at a f ar m 8 miles f r om t he t r ader ’s house, but it occasionally spent t he night at t he house (wit h t he t r ailer at t ached) if t he t r ader was due t o t r avel in t he ot her dir ect ion ear ly in t he mor ning. Somet imes it was dr iven by sub-cont r act or s, in which case it was always r et ur ned t o t he f ar m. The insur ance policy was t he st andar d one which allows pr ivat e as well as business use. Alt hough t he keys t o t he vehicle wer e kept at t he f ar m, t he t r ader had a spar e set at home. The t r ader had a dif f er ent car (and his wif e a t hir d) f or pr ivat e mileage of about 15,000 miles a year . The Tr ibunal held t hat t he t r ader had f ailed t o sat isf y t he ext r emely st r ingent t est s laid down by t he Cour t of Appeal in Fagomat ic. The car was act ually available f or pr ivat e use, and he was deemed t o have int ended t hat ; t hat was enough t o block t he input t ax, DC Humphr eys An account ant r eclaimed input t ax on t he pur chase of six car s bet ween Mar ch 1997 and Sept ember 1998. Thr ee of t he car s wer e sold in t he same per iod, and he account ed f or out put t ax on t he sales. He ar gued t hat he had ot her car s f or his pr ivat e use, and t hese car s wer e solely int ended f or business use. The Tr ibunal held t hat t he Fagomat ic pr inciple applied – t he car s wer e act ually available f or pr ivat e use, and t his was enough t o deny t he input t ax cr edit , HAS Thompson (t / a HAS Thompson & Co)

On t he ot her hand, a company has succeeded bef or e t he Tr ibunal wit h t he ar gument t hat t he company’s boar d of dir ect or s had passed a r esolut ion f or bidding pr ivat e use of t he car . The car was f or t he business use of t he managing dir ect or , who was not a shar eholder (alt hough par t of t he cont r olling f amily). He lived only 50 yar ds f r om t he business pr emises, Elm Milk Lt d. This decision was conf ir med in t he Cour t of Appeal in 2006.


Anot her company has also succeeded on t he basis of an int ent ion f or car s only t o be available f or business use. Secur it y guar ds t ook t he car s home, but t hey wer e st ill on dut y, and t he car s could be collect ed by t he company at any t ime. The employees all had t heir own car s which wer e used f or pr ivat e mot or ing. Cust oms r elied on a t er m in t he employees’ cont r act s which st at ed t hat pr ivat e use of t he car s r equir ed special per mission – implying t hat pr ivat e use was cont emplat ed – but t he Tr ibunal did not believe t hat t his accur at ely r ef lect ed t he int ent ions of t he t axpayer . The cont r act s wer e st andar d f or ms which had been pur chased f r om t he local Chamber of Commer ce, and t he t axpayer had not consider ed t he ef f ect of t his t er m on VAT r ecover y. The Tr ibunal allowed t he input t ax, Mast er guar d Secur it y Ser vices Lt d I t is not able t hat t he cases wher e t he t r ader has been successf ul involve companies. I t is f ar easier t o r est r ict int ended usage t hr ough a company as it is a separ at e legal ent it y t o t he owner / manager of t he business.

Example 2

Fill in t he missing wor ds:

The condit ions t o be sat isf ied f or an input t ax claim ar e:

1. A supply of ………….. or ser vices has been made.

2. A supply was made t o t he …………… ……………….

3. The supply was f or a ……………… pur pose.

4. The claimant holds t he r equir ed ……………….

5. …………… t ax has been cor r ect ly char ged.

6. Goods/ ser vices have a ……………… and ………………… link wit h a t axable t r ansact ion.


509

Answer 1

A pur chase of 100 pens f r om a UK st at ioner

Cer t if icat e C79

The ser vices of an account ant based in J er sey

Fr ench T.V.A invoice

I mpor t ed boxes f r om t he USA

Tax invoice

Pur chase of 1,000 pencils f r om Fr ench supplier

Fee invoice

Answer 2

The condit ions t o be sat isf ied f or an input t ax claim ar e:

1. A supply of goods or ser vices has been made.

2. A supply was made t o t he t axable per son.

3. The supply was f or a business pur pose.

4. The claimant holds t he r equir ed evidence.

5. I nput t ax has been cor r ect ly char ged. 6. Goods/ ser vices have a dir ect and immediat e link wit h a t axable t r ansact ion.


SUMMARY – INPUT TAX: WHEN TO RECOVER Ther e ar e numer ous condit ions which have t o be sat isf ied bef or e input t ax is available f or cr edit . Fir st ly a supply of goods or ser vices must have act ually t aken place. Secondly t hat supply must have been made t o a t axable per son. That t axable per son must have been a t axable per son at t he t ime of t he supply. Ther e ar e however some except ions t o t his r ule including pr e-r egist r at ion input t ax and pr e-incor por at ion input t ax. The goods and ser vices must be used f or a business pur poses if input t ax cr edit is t o be allowed. The claimant must hold t he r equir ed evidence t hat input t ax has been incur r ed. The most common evidence a business will hold is a VAT invoice pr ovided by t he supplier of t he goods or ser vices. Cr edit f or input t ax is r est r ict ed t o t he amount pr oper ly char geable on a supply. I f VAT was incor r ect ly char ged on t he supply t hen t hat VAT cannot be r ecover ed as input t ax. The f inal condit ion r equir ed t o be sat isf ied is t hat t he goods or t he ser vices pur chased must have a dir ect and immediat e link wit h a t axable t r ansact ion. All t he above ar e subj ect t o t he except ions det ailed in t he gener al blocking pr ovisions in SI 1992/ 3222.

E10b: PARTIAL EXEMPTION

I n t his chapt er you will look at : par t ial exempt ion, wher e a business makes bot h t axable and exempt supplies; det er mining t he amount of input t ax t hat t he business can r ecover ; t he appor t ionment of input VAT; t he de minimis input VAT limit s; t he annual adj ust ment r equir ed by par t ially exempt businesses; input t ax at t r ibut ion; adj ust ment s t o input r ecover y f or changes in int ended supplies; t he special met hods of appor t ionment available t o businesses.

10b.1 Introduction

A par t ially exempt business is simply a business which supplies t axable and exempt sales, i.e. par t of it s business is t axable and par t of it is exempt . This could be a f ir m of business adviser s. Par t of what t hey do is consult ancy ser vices and t hey may also pr ovide insur ance ser vices. The consult ancy ser vices will be t axable, t he insur ance ser vices exempt . The issue wit h par t ially exempt businesses is how much input t ax t hey can r eclaim. The amount of allowable input t ax f or which a t axable per son is ent it led t o claim at t he end of any per iod is so much of t he input t ax on supplies, acquisit ions and impor t at ions in t he per iod as is allowable as being at t r ibut able t o t he f ollowing supplies made, or t o be made, by t he t axable per son in t he cour se or f ur t her ance of his business. (a) ‘Taxable supplies’, i.e. supplies of goods and ser vices made in t he UK

ot her t han exempt supplies. (b) Supplies out side t he UK which would be t axable supplies if made in t he

UK. (c) Supplies of ser vices which

(i) ar e supplied t o a per son who belongs out side t he EC, or (ii) ar e dir ect ly linked t o t he expor t of goods t o a place out side t he

EC, or (iii) consist of t he pr ovision of int er mediar y ser vices in r elat ion t o any

t r ansact ion wit hin (i) or (ii) above pr ovided t hat t he supply is exempt (or would have been exempt if made in t he UK) by vir t ue of VATA 1994, Sch 9 Gr oup 2 (insur ance) or VATA 1994, Sch 9 Gr oup 5 I t ems 1–8 (f inance).

(d) Supplies made eit her in or out side t he UK which f all, or would f all, wit hin

VATA 1994, Sch 9 Gr oup 15 it em 1 or 2 (invest ment gold).

SI 1995/ 2518 Reg 101(1) SI 1995/ 2518 Reg 103(1)a SI 1995/ 2518


Cust oms must make r egulat ions f or secur ing a f air and r easonable at t r ibut ion of input t ax t o t he supplies wit hin (a) t o (c) above.

s 4(2), 26

Illustration 1

ABC Limit ed is par t ially exempt , i.e. some of t he company’s t ur nover is st andar d r at ed and some is exempt . Taxable t ur nover £ 100,000

Exempt t ur nover £ 20,000

Input tax

£ 15,000 £ 5,000 £ 3,000

X ? X

The input t ax r elat ing t o t he t axable business of £ 15,000 is f ully r ecover able. £ 3,000 of input t ax r elat ing t o t he exempt business would not be r ecover able. This could be input t ax incur r ed on t elephone bills, account ancy f ees, legal f ees, and r epair s t o t hat par t of t he pr oper t y f or example. Ther e is also input t ax which r elat es t o bot h t he t axable and exempt business. This £ 5,000 is ef f ect ively at t r ibut able t o bot h. The business will need t o appor t ion t he £ 5,000 bet ween t he t axable and exempt supplies t o det er mine r ecover abilit y of t he £ 5,000. To summar ise, input t ax is r ecover able t o t he ext ent t hat it r elat es t o t axable supplies. The £ 15,000 is r ecover able, t he £ 3,000 is not r ecover able, t he £ 5,000, which r elat es t o bot h, is par t ly r ecover able. This £ 5,000 is of t en r ef er r ed t o as r esidual or indir ect or non-at t r ibut able or over head input t ax. All of t hese descr ipt ions ar e simply saying it is not dir ect ly at t r ibut able t o one par t icular par t of t he business and consequent ly an appor t ionment must be made.

10b.2 Apportionment

The st andar d met hod of appor t ionment is as f ollows.

Taxable supplies (excluding VAT)

Total supplies (excluding VAT)

This f r act ion is t hen expressed as a percentage. For cer t ain businesses t his f r act ion is rounded up t o t he next whole number . I f it came out t o 83.0001 it would become 84%. The benef it of r ounding up in t he st andar d met hod will only be available t o businesses whose r esidual input t ax is less t han £ 400,000 a mont h. This new r ule was int r oduced f r om 1 Apr il 2005. Pr ior t o t his dat e r ounding was available t o all businesses r egar dless of size.

SI

1995/ 2518 Reg 101 (2)

SI 1995/ 2518 Reg 101 (4)

Par t ial Exempt ion

513

This per cent age is applied t o t he r esidual input t ax, i.e. t o t he £ 5,000 in t he pr evious illust r at ion.

I n making t he calculat ion, t he value of all t he f ollowing supplies must be excluded.

SI 1995/ 2518 Reg 101(3)

(a) Any sum r eceivable in r espect of a supply of capital goods used f or t he pur poses of t he business. Ther e is no st at ut or y def init ion of capit al goods but t he t er m is wider t han simply goods wit hin t he capit al goods scheme. I n C & E Commr s v J DL Lt d, [2002] mot or car s wer e held t o be capit al goods as t hey wer e of subst ant ial dur abilit y and value as compar ed t o ot her ar t icles used in t he management and day-t o-day r unning of t he business.

(b) Any sum r eceivable in r espect of any of t he f ollowing descr ipt ions of

supplies made wher e such supplies ar e incidental t o one or mor e of t he business act ivit ies.

• Any supply f alling wit hin VATA 1994, Sch 8 Gr oup 5 I t em 1 or

Gr oup 6 I t em 1. • Any exempt gr ant which f alls wit hin VATA 1994, Sch 9 Gr oup 1

I t em 1. • Any st andar d-r at ed gr ant which f alls wit hin VATA 1994, Sch 9

Gr oup 1 I t em 1(a). • Any gr ant which would be an exempt gr ant but f or an elect ion

having been made t o opt t o t ax under VATA 1994, Sch 10 par a 2. • Any supply which f alls wit hin VATA 1994, Sch 9 Gr oup 5 (f inance).

What const it ut es an ‘incident al’ supply can be viewed in t wo ways. Fir st , it can be a one-of f sit uat ion (e.g. t he sale of a f act or y by a f ully t axable manuf act ur ing company) wher e t her e is act ivit y but not suf f icient t o be r egar ded as a business. Secondly, it could be r egular income (e.g. int er est f r om bank deposit s which ar e r eceived passively, incur r ing no r elat ed input t ax) wher e, in r ealit y, t her e is no act ivit y at all. I n C H Beazer (Holdings) plc t he t r ibunal consider ed incident al t o mean ‘occur r ing or liable t o occur in f or t uit ous or subor dinat e conj unct ion wit h’. Cust oms policy is t o ident if y all t he business act ivit ies and t hen consider whet her t he supply in quest ion is incident al t o any of t hese business act ivit ies (not j ust t he main act ivit ies). I t is possible t hat a supply might be dist or t ive but not incident al. I n such a case, it is open t o t he t r ader t o apply f or , or Cust oms t o dir ect , a special met hod.

(c) That par t of t he value of any supply of goods on which out put t ax is not

char geable by vir t ue of a Tr easur y or der under VATA 1994, s 25(7) unless t he business has impor t ed, acquir ed or been supplied wit h t he goods f or t he pur pose of selling t hem.


(d) The value of any supply which, under or by vir t ue of any pr ovision of VATA 1994, t he business makes t o it self (self supplies).

(e) The value of any goods or ser vices pr ovided as a business t r ansact ion

which is neit her a t axable nor an exempt supply (e.g. t he t r ansf er of a business as a going concer n).

(f ) The value of cer t ain impor t ed ser vices specif ied in VATA 1994, Sch 5 subj ect t o t he r ever se char ge under VATA 1994, s 8(1).

Illustration 2

Taxable t ur nover

£ 100,000 Exempt t ur nover

£ 20,000

I nput t ax

£ 15,000 £ 5,000 £ 3,000 Taxable supplies

Residual Exempt supplies

Round up f r om 83.33%

100,000

100,000 + 20,000 X 100 = 84%

Applying t he f or mula t o t he illust r at ion, £ 100,000 over £ 120,000 x 100 which equals 84%. 84% has been r ounded up f r om 83.33%. Consequent ly 84% of t he £ 5,000 r elat es t o t he t axable business and 16% r elat es t o t he exempt business. This equat es t o £ 4,200 on t he t axable side and £ 800 on t he exempt side. The input t ax t hat r elat es t o t he t axable supplies, is r ecover able, and t he input t ax r elat ing t o t he exempt business is ir r ecover able.

Taxable t ur nover £ 100,000

Exempt t ur nover £ 20,000

I nput t ax £ 15,000 £ 5,000 £ 3,000

X 84% 16% X = £ 4,200 = £ 800 X X

Consequent ly in t his quar t er t he business will r ecover £ 19,200 (£ 15,000 + £ 4,200) of input t ax.


515

Example 1

I n t he quar t er t o 31 Mar ch, Zap Limit ed had t he f ollowing: £ Taxable supplies (excluding VAT) 292,000 Exempt supplies 40,000 I nput t ax: Dir ect ly at t r ibut able t o t axable supplies

7,000

Dir ect ly at t r ibut able t o exempt supplies 4,000 Residual 14,000 Taxable supplies include £ 12,000 (excluding VAT) f or t he sale of equipment dur ing t he quar t er . You ar e r equir ed t o calculat e t he r ecover able input t ax.

10b.3 De Minimis Input VAT

One of t he mor e impor t ant point s is t he de minimis input t ax limit s. I t is possible t o r eclaim t he input VAT r elat ing t o exempt supplies if t he amount s involved ar e below a cer t ain limit . Such input t ax is nor mally ir r ecover able, but Cust oms st at e t hat if t he amount s ar e low enough t hey will allow t he t r ader t o r eclaim t he input t ax even t hough it r elat es t o making exempt supplies.

SI 1995/ 2518 Reg 106(1)

To be de minimis t he total exempt input tax must be less than or equal to £625 per month on average and less than 50% of total input tax. This is a ver y impor t ant t est and t he t r ader must sat isf y bot h condit ions.

Tot al exempt input t ax is t he input t ax dir ect ly at t r ibut able t o exempt supplies plus t he exempt pr opor t ion of t he r esidual input t ax. The £ 625 per mont h on aver age equat es t o £ 1,875 per quar t er , or £ 7,500 per annum.

Illustration 3

Quar t er t o 31 December Taxable supplies £ 60,000 Exempt supplies £ 9,000 I nput t ax: Dir ect ly at t r ibut able t o t axable supplies £ 5,000 Dir ect ly at t r ibut able t o exempt supplies £ 1,600 Residual input t ax £ 1,200


The r ecover able input t ax f or t he quar t er is calculat ed as f ollows: Quar t er t o 31 December Taxable supplies £ 60,000 Exempt £ 9,000 60/ 69 x 100 = 87% I nput t ax Tot al Taxable Exempt Dir ect ly at t r ibut able t o t axable supplies £ 5,000 £ 5,000 Dir ect ly at t r ibut able t o exempt supplies £ 1,600 £ 1,600 Residual input t ax £ 1,200 £ 1,044 £ 156

£ 7,800 £ 6,044 £ 1,756

De-minimis

The r ecover able input t ax is £ 7,800. The dir ect t axable input t ax of £ 5,000 would go int o t he t axable column. The dir ect exempt input t ax of £ 1,600 would go int o t he exempt column. The r esidual (or indir ect ) input t ax would have t o be appor t ioned. Appor t ioning t he r esidual we get £ 1,200 t imes 87% = £ 1,044 int o t he t axable column. This leaves £ 156 in t he exempt column. Ther ef or e t he t ot al f igur es ar e £ 7,800 f or t ot al input t ax, £ 6,044 f or t axable input t ax and £ 1,756 f or input t ax which r elat es t o exempt supplies. The t ot al exempt input t ax of £ 1,756 is below t he de minimis limit s of £ 625 per mont h on aver age or £ 1,875 per quar t er ; and is less t han half of t he t ot al input t ax. Half t he t ot al input t ax is £ 3,900 (£ 7,800 x 50%), so £ 1,756 is below t his limit . Thus in t his par t icular quar t er t he t r ader can claim all of his input t ax back, i.e. £ 7,800.

Example 2

I n t he quar t er t o 30 J une, Zap Limit ed had t he f ollowing: £ Taxable supplies (excluding VAT) 300,000 Exempt supplies 50,000 I nput t ax: Dir ect ly at t r ibut able t o t axable supplies

9,000

Dir ect ly at t r ibut able t o exempt supplies 1,000 Residual 4,000 Taxable supplies include £ 5,000 (excluding VAT) f or t he sale of equipment dur ing t he quar t er . You ar e r equir ed t o calculat e t he r ecover able input t ax.


517

10b.4 Annual Adjustment

The calculat ions ar e made on a quar t er ly basis and input t ax is r ecover ed ever y quar t er . These calculat ions ar e however not f inal. At t he end of t he t r ader ’s VAT year he must per f or m an annual calculat ion. Ef f ect ively it is t he same calculat ion again, but t his t ime using annual supplies and annual input t ax f igur es. When consider ing t he de minimis limit s t he annual de minimis limit is applied which is less t han £ 7,500 (t hat is £ 625 t imes 12 mont hs) and 50% of t ot al input t ax.

SI 1995/ 2518

Reg 107

The t r ader should calculat e t he cor r ect r eclaim f or t he year based on t hese annual f igur es. The t r ader t hen compar es t he quar t er ly r eclaims t o t he cor r ect annual claim. The dif f er ence is known as t he annual adj ust ment . The annual adj ust ment is accounted for on the first VAT return of the new

VAT year. A VAT year will depend on t he t r ader s VAT St agger Gr oup. I t will eit her be t he year ended 31 Mar ch (St agger 1), 30 Apr il (St agger 2) or 31 May (St agger 3). Consequent ly a t r ader ’s annual adj ust ment f or t he VAT year t o 31 Mar ch, if t hat is t heir st agger , will be made in t he quar t er t o 30 J une, i.e. t he quar t er f ollowing t he VAT year end.

Illustration 4

A t r ader wit h f our quar t er s r esult s. The t axable supplies ar e st at ed exclusive of VAT. Qt r t o Qt r t o Qt r t o Qt r t o Year t o 31.7.06 31.10.06 31.1.07 30.4.07 30.4.07 Supplies: £ £ £ £ £ Taxable 80,000 71,000 77,000 81,000 309,000 Exempt 10,000 14,000 8,000 15,000 47,000

Tot al 90,000 85,000 85,000 96,000 356,000

% 89 84 91 85 87

The cor r ect per cent ages ar e calculat ed as f ollows; • 89% f or quar t er 1 i.e. £ 80,000 over £ 90,000 t imes 100 r ounded up t o

89%. • Quar t er 2 is 84%, i.e. £ 71,000 divided by £ 85,000 t imes 100 and t hat is

t hen r ounded up t o 84%. • Quar t er 3 is £ 77,000 divided by £ 85,000 t imes 100 which equals 91%. • Quar t er 4 is £ 81,000 divided by £ 96,000 t imes 100 which r ounds up t o

85%. • To calculat e t he annual per cent age apply t he same met hod. £ 309,000

divided by £ 356,000 t imes 100, r ounded up equals 87%.


Now we have our per cent ages we can move on t o t he input t ax r eclaims. Qt r t o Qt r t o Qt r t o Qt r t o Year t o

31.7.06 31.10.06 31.1.07 30.4.07 30.4.07 I nput t ax: £ £ £ £ £ Dir ect Taxable

6,000 7,500 7,000 6,750 27,250

Dir ect Exempt

2,000 1,500 1,700 1,800 7,000

Residual 1,500 1,800 1,650 700 5,650 Taxable 1,335 1,512 1,502 595 4,916 Exempt 165 288 148 105 734

Tot al t axable

7,335 9,012 8,502 7,345 32,166

Tot al exempt

2,165 1,788 1,848 1,905 7,734

Claim 7,335 10,800 10,350 7,345 32,166

I n t he f ir st quar t er mult iply t he r esidual of £ 1,500 by t he per cent age f or t hat quar t er . £ 1,500 t imes 89% equals £ 1,335. The r emainder of t he r esidual is exempt , i.e. £ 165. Similar calculat ions ar e per f or med t o calculat e t he amount s f or quar t er s 2, 3 and 4.

I n quar t er 2 t he £ 1,800 r esidual get s appor t ioned 84% t o t axable supplies (£ 1,512), t he balance t o exempt (£ 288). I n quar t er 3, £ 1,650 t imes 91% is £ 1,502, t he balance is exempt t ax of £ 148. I n quar t er 4 £ 700 t imes 85% which gives £ 595 wit h t he balance going t o exempt t ax of £ 105. At t his point t her e is a gr eat t empt at ion t o add r ight t he way acr oss t o f ind t he annual f igur es, but t hat would be incor r ect . For t he annual calculat ion use t he annual percentage of 87% and apply t hat t o t he annual r esidual, £ 5,650. That gives annual t axable wit hin t he r esidual box of £ 4,916 wit h t he balance of £ 734 being allocat ed t o exempt input t ax.

Re: t he t ot al f igur es. I n quar t er 1 £ 7,335 is t he £ 6,000 dir ect t axable plus t he r esidual allocat ed t axable of £ 1,335. The t ot al exempt f or quar t er 1 is the dir ect exempt of £ 2,000 plus t he allocat ed r esidual exempt of £ 165, £ 2,165. The same met hod is used f or t he next t hr ee quar t er s.


519

On t he annual calculat ion adopt t he same met hod - do not add acr oss. To get £ 32,166 as t he t ot al t axable f or t he year add t he £ 27,250 t o t he allocat ed r esidual f or t he year of £ 4,916. The £ 7,734 is t he £ 7,000 f or t he year of dir ect exempt plus t he r esidual allocat ion of £ 734.

The f inal line is t he claim f igur e. I n quar t er 1 t he t ot al exempt is £ 2,165. This is not de minimis since exceeds £ 1,875. Consequent ly t he claim is only t he t axable amount , t he £ 7,335. I n quar t er 2 t he £ 1,788 is de minimis. I t is less t han £ 1,875 and it is less t han 50% of t ot al input t ax - in t his case 50% of £ 10,800. Consequent ly t he claim is f or t he t ot al input t ax, t hat is £ 10,800. I n quar t er 3 t he £ 1,848 is de minimis. I t is less t han £ 1,875 and it is less t han 50% of t he t ot al input t ax - in t his par t icular quar t er t hat is 50% of £ 10,350. Consequent ly t he claim is t he t ot al input t ax, i.e. £ 10,350. I n quar t er 4 t he exempt input t ax of £ 1,905 is not de minimis. I t is gr eat er t han £ 1,875. Ther ef or e t he claim f or quar t er 4 is t he £ 7,345 t ot al t axable input t ax. Finally, on t he annual adj ust ment consider whet her t he £ 7,734 is r ecover able. The annual limit is £ 7,500. Ther ef or e £ 7,734 is not de minimis, since it is gr eat er t han t he annual amount . Consequent ly t he claim amount is only £ 32,166. The t ot al claimed in t he year is simply t he 4 quar t er ’s amount s which t ot al £ 35,830. These would have been claims made each quar t er . The annual claim is, however , r est r ict ed t o £ 32,166. This leaves an annual adj ust ment of £ 3,664. That will be a negat ive input t ax in t he quar t er t o 31 J uly 2007. Ef f ect ively t he t r ader owes anot her £ 3,664 t o Cust oms in t he f ir st quar t er af t er t he VAT year . That is called t he annual adj ust ment .


Example 3

Qt r t o Qt r t o Qt r t o Qt r t o Year t o 31.8.06 30.11.06 28.2.07 31.5.07 31.5.07 Supplies: £ £ £ £ £ Taxable 60,000 63,000 61,000 70,000 254,000 Exempt 9,000 7,000 14,000 10,000 40,000

Tot al 69,000 70,000 75,000 80,000 294,000

%

I nput t ax: Dir ect Taxable

4,000 3,000 500 3,500 11,000

Dir ect Exempt

1,500 1,200 1,500 2,000 6,200

Residual 2,700 2,500 1,000 1,900 8,100 Taxable

Exempt

Tot al t axable

Tot al exempt

Claim

Not e: The t axable supplies ar e exclusive of VAT. You ar e r equir ed t o f ill in t he missing f igur es in t he above example.

10b.5 Special Methods

Gener ally t he st andar d met hod applies by def ault . I f a t r ader is par t ially exempt t hey should apply t he st andar d met hod, unless a special met hod is agr eed wit h Cust oms. A special met hod is usually opt ed f or wher e it pr oduces a f air er appor t ionment of t he r esidual input VAT. I t may be t hat t he st andar d met hod of appor t ionment does not give a f air f r act ion, so t her ef or e a special met hod is agr eed. I t is f air t o say t hat t he maj or it y of par t ially exempt t r ader s in pr act ice will be using a special met hod - a met hod which is ver y dist inct t o t heir business.

SI 1995/ 2518

Reg 102


521

Special met hods can be based on the number of transactions, f or example, t he number of t axable t r ansact ions in a quar t er over t ot al number of t r ansact ions in t he quar t er . I t could be based on floor area, t hat is t he f loor ar ea used t o make t axable supplies and t he f loor ar ea used t o make exempt supplies. I t could even be on staff numbers, t hat is t he t ot al st af f employed on t he t axable business compar ed t o t he st af f number s used in t he exempt business.

These ar e obviously ver y simplist ic examples, but t hey j ust give you an idea of what can be agr eed wit h Cust oms. I n pr act ice special met hods can be quit e complicat ed; ever y business is dif f er ent and t hey have t heir own idiosyncr asies. A business using a special met hod approved or dir ect ed by Cust oms must cont inue t o use it unt il Cust oms appr ove or dir ect t he t er minat ion of it s use. Any dir ect ion f or t he use, or t er minat ion of use, of a special met hod t akes ef f ect f r om t he dat e of t he dir ect ion or such lat er dat e as Cust oms specif y. Ret r ospect ive changes of met hod ar e not allowed. However , Cust oms may appr ove a change of met hod wit h ef f ect f r om t he st ar t of t he t ax year in which t he wr it t en applicat ion is r eceived A business may apply t o Cust oms t o use a special met hod if it consider s t hat t he st andar d met hod does not pr ovide a f air and r easonable r esult . Cust oms r equir e pr ecise det ails of how t he pr oposed met hod will wor k in pr act ice and ar e pr epar ed t o discuss pr oposals bef or e a f or mal applicat ion is submit t ed. Cust oms will nor mally appr ove a special met hod pr ovided it is f air and r easonable. Wr it t en appr oval f r om Cust oms is r equir ed bef or e st ar t ing t o use a special scheme. Any specif ic condit ions will be set out in t he let t er of appr oval.


Answer 1

Tot al Taxable Exempt £ £ £

I nput s:

Dir ect t axable 7,000 7,000

Dir ect exempt 4,000 4,000Residual 14,000 12,320 1,680

25,000 19,320 5,680

Taxable supplies - exclude Capit al I t ems i.e. equipment £ 292,000 - £ 12,000 = £ 280,000 Fr act ion Taxable supplies x 100 = ? Tot al supplies £ 280,000 x 100 = 88% (r ounded up f r om 87.5) £ 280,000 + £ 40,000 88% x 14,000 = £ 12,320

The dir ect t axable input t ax, i.e. t he input t ax r elat ing dir ect ly t o t he t axable sales wer e £ 7,000 - £ 7,000 goes int o t he t axable column. The dir ect exempt input t ax was £ 4,000 - £ 4,000 goes int o t he exempt column. The r esidual is £ 14,000. This is t he amount which must be appor t ioned bet ween t axable and exempt supplies. This is done using t he st andar d met hod. The st ar t ing point is t axable supplies, r emember ing t o exclude capit al it ems, which in t his case would be t he sale of t he equipment . Thus £ 292,000 minus t he capit al equipment of £ 12,000 which gives £ 280,000. The f r act ion is t axable supplies over t ot al supplies t imes 100, which equals 88%. This is r ounded up f r om £ 87.5%. This per cent age is t hen applied t o t he r esidual input t ax. The r esidual input t ax which r elat es t o t axable sales t hus amount s t o £ 12,320. (i.e. 88% t imes t he £ 14,000) The balance of r esidual input t ax is exempt , i.e. £ 1,680. The t ot al f igur es f or t he quar t er ar e t her ef or e £ 25,000 wor t h of t ot al input t ax, £ 19,320 of t axable input t ax and £ 5,680 of exempt input t ax. The t r ader will be able t o claim £ 19,320 of input t ax. The £ 5,680 is ir r ecover able as it r elat es t o exempt sales.


523

Answer 2

Tot al Taxable Exempt £ £ £

I nput s:

Dir ect t axable 9,000 9,000

Dir ect exempt 1,000 1,000Residual 4,000 3,440 560

14,000 12,440 1,560

Taxable supplies exclude £ 5,000 capit al it ems £ 300,000 - £ 5,000 = £ 295,000 Fr act ion £ 295,000 x 100 = 85.5% (i.e. 86%) £ 295,000 + £ 50,000

£ 4,000 x 86% = £ 3,440.

The input t ax dir ect ly at t r ibut able is £ 9,000 t o t axable and £ 1,000 t o exempt supplies. The r esidual of £ 4,000 needs t o be appor t ioned. To appor t ion use t axable supplies, which exclude capit al it ems, i.e. exclude t he sale of equipment . Consequent ly t he t axable supplies f or t he f r act ion ar e £ 300,000 minus £ 5,000 which equals £ 295,000. The f r act ion is t axable supplies over t ot al supplies t imes 100 r ounded up which equals 86%. This is r ounded up f r om 85.5%. Applying t he 86% t o t he £ 4,000 = £ 3,440 in r elat ion t o t axable supplies. The balance of r esidual input t ax of £ 560 r elat es t o t he exempt sales. This gives t ot als of £ 14,000 f or t he t ot al input t ax in t he quar t er , £ 12,440 of input t ax r elat ing t o t axable supplies, £ 1,560 of input t ax r elat ing t o exempt supplies. The quest ion is whet her t he exempt input amount is de minimis? I t is less t han £ 1,875 and it is also less t han 50% of £ 14,000 t he t ot al input t ax. Consequent ly in t he quar t er t he t r ader can r eclaim t he whole of t he input t ax, t he £ 14,000.


Answer 3

Qt r t o Qt r t o Qt r t o Qt r t o Year t o 31.8.06 30.11.06 28.2.07 31.5.07 31.5.07 Supplies: £ £ £ £ £ Taxable 60,000 63,000 61,000 70,000 254,000 Exempt 9,000 7,000 14,000 10,000 40,000

Tot al 69,000 70,000 75,000 80,000 294,000

% 87 90 82 88 87

I nput t ax: Dir ect Taxable

4,000 3,000 500 3,500 11,000

Dir ect Exempt

1,500 1,200 1,500 2,000 6,200

Residual 2,700 2,500 1,000 1,900 8,100 Taxable 2,349 2,250 820 1,672 7,047 Exempt 351 250 180 228 1,053

Tot al t axable

6,349 5,250 1,320 5,172 18,047

Tot al exempt

1,851 1,450 1,680 2,228 7,253

Claim 8,200 6,700 1,320 5,172 25,300

Claimed in year £ 21,392

Annual Adj ust ment £ 3,908 – Qt r t o 31.8.07 The cor r ect per cent ages ar e 87, 90, 82, 88 and 87. The calculat ion each quar t er is t axable over t ot al t imes 100 r ounded up. For example, in quar t er 1, 60,000 over 69,000 t imes 100 r ounded up t o 87%. I n quar t er 1, t he t axable appor t ionment of r esidual is £ 2,349, i.e. £ 2,700 t imes 87%. The balance of r esidual of £ 351 is t r eat ed as t he exempt pr opor t ion. This gives a t ot al t axable f or t he quar t er of £ 6,349, i.e. £ 4,000 plus £ 2,349. The t ot al exempt is £ 1,500 f or t he quar t er plus t he £ 351. When consider ing t he claim f or t he quar t er consider whet her t he £ 1,851 is de minimis. I n t his case it is de minimis as it is less t han £ 1,875. The t ot al claim f or quar t er 1 is £ 8,200. Similar calculat ions have been per f or med f or quar t er s 2, 3 and 4.

The claim in quar t er 2 is simply t he whole input t ax f or t he quar t er . The £ 1,450 of input s r elat ing t o t he exempt supplies is de minimis, t her ef or e f ull r eclaim.


525

I n quar t er 3 t her e is £ 1,680 of input t ax r elat ing t o exempt supplies. This does pass t he f ir st de minimis t est . I t is less t han £ 1,875, but it is not less t han 50% of t ot al input t ax, t hat is 50% of £ 3,000. Consequent ly it is not de minimis. The r eclaim is r est r ict ed t o t he input t ax r elat ing t o t axable supplies in t hat quar t er , t hat is £ 1,320. I n quar t er 4 t he input t ax r elat ing t o exempt supplies of £ 2,228 is not de minimis as it exceeds £ 1,875.

Finally, t he annual f igur es: Calculat e t he annual appor t ionment of £ 7,047 by mult iplying t he r esidual f or t he year of £ 8,100 by 87%. Next consider t he t ot al f igur es f or t he year . The £ 18,047 is £ 11,000 plus t he appor t ioned r esidual of £ 7,047. This same pr inciple applies f or t he t ot al exempt - £ 6,200 plus t he £ 1,053, giving £ 7,253. Consider whet her t he £ 7,253 is de minimis. I t is less t han £ 7,500, (£ 625 x 12) and it is less t han 50% of t ot al input t ax. Consequent ly t he claim f or t he year should be £ 25,300. The business act ually claimed in t he year £ 21,392. This leaves an annual adj ust ment of £ 3,908 of addit ional input t ax t o r eclaim on t he quar t er t o 31 August 2007. That is t he f ir st quar t er af t er t he VAT year -end.


SUMMARY – PARTIAL EXEMPTION

Par t ial exempt ion is all about r ecover ing input t ax. Gener ally, input t ax is r ecover able if it r elat es t o a t axable supply. I f a t r ader is not sur e what t he input t ax r elat es t o t hen he must appor t ion it . Ther e is a st andar d met hod of appor t ionment and a special met hod of appor t ionment , a t r ader can use eit her , but special met hods must be by explicit agr eement . The t r ader claims input t ax t hr ough t he quar t er s, but t hese ar e only int er im calculat ions. The cor r ect calculat ion is done at t he end of t he VAT year . This may r esult in annual adj ust ment , which is account ed f or on t he f ir st r et ur n of t he next VAT year .

E11: VAT RECORDS AND RETURNS

I n t his chapt er we will look at t he r ecor ds which must be kept by a VAT r egist er ed t r ader including: t he VAT account and t he t ime limit f or r et ent ion; special r ecor d-keeping r equir ement s f or special schemes; t he VAT invoice; when a less det ailed VAT invoice may be used; elect r onic invoicing; self billing; VAT r et ur ns.

E11.1 Introduction

This chapt er looks at how impor t ant r ecor ds and r et ur ns ar e in t he VAT syst em. Because VAT is collect ed at ever y level along a chain of a supply, it is impor t ant t hat r ecor ds should exist of all t r ansact ions made and r eceived by a business. The impor t ance of r ecor ds is par amount when t he business want s t o claim a r ef und of input t ax because t hey will need t o be able t o pr ove t hat t he t ax t hey ar e r eclaiming was, in t he f ir st place, paid by t he business. The best pr oof of t his is t he r ecor ds t hat t he business keeps.

E11.2 Records

Cust oms have a gener al power t o r equir e t r ader s t o keep such r ecor ds as t hey r equir e and t hese gener al r equir ement s ar e set out in t he VAT Regulat ions 1995 in Regulat ion 31. Each t axable per son has an obligat ion t o keep and t o pr eser ve;

Sch 11 Par a 6(1)

• his business accounting records;

• copies of all VAT invoices which have been issued by t he business;

• all VAT invoices which have been received by t he business;

• documentation r elat ing t o all imports and exports, and document at ion r elat ing t o all EC acquisitions of goods and dispatches of goods;

• credit notes, debit notes and similar document s which evidence changes in t he consider at ion f or supplies made or r eceived and t hat includes document at ion bot h issued by t he business and r eceived by t he business; and

• a VAT account.

Business r ecor ds must be kept f or a minimum of 6 years unless an agr eement is r eached wit h Cust oms f or a shor t er r et ent ion per iod.

Sch 11 Par a 6(3)

I t is possible f or a t r ader , inst ead of keeping or iginal paper r ecor ds, t o keep copies on micr of ilm or micr of iche. This will be allowed if t he copies can be pr oduced f or Cust oms t o view and t hat t her e ar e adequat e f acilit ies f or Cust oms

Sch 11 Par a 6(4)

SI 1995/ 2518

Reg 31


Of f icer s t o view t hem. The t r ader must seek t he per mission of Cust oms if he wishes t o r et ain r ecor ds on micr of ilm or micr of iche.

I n a similar way, if a t r ader wishes t o keep r ecor ds on comput er t hen he must get appr oval of t he syst em he is going t o use f r om Cust oms. Appr oval will not be needed if t he r ecor ds ar e going t o be pr oduced by comput er but t hen st or ed on paper .


E11.3 The VAT Account

The r equir ed cont ent s of t he VAT account ar e specif ied in t he VAT Regulat ions 1995 in Regulat ion 32. The VAT account must be divided int o separ at e par t s f or t he dif f er ent pr escr ibed account ing per iods f or which t he business makes VAT r et ur ns. Then each par t must be sub-divided int o a VAT payable por t ion and a VAT allowable por t ion.

SI 1995/ 2518

Reg 32

I n t he VAT payable por t ion, f or each VAT r et ur n per iod, it should show:

• The out put t ax due on all t he sales made in t hat per iod;

• The out put t ax due on all t he acquisit ion of goods f r om ot her EU member st at es in t he per iod;

• Any ear lier out put t ax er r or s t hat have been discover ed dur ing t his per iod wher e adj ust ment is allowed in t he cur r ent per iod;

• Any incr eases or decr eases in out put t ax which have ar isen dur ing t he per iod f r om changes in t he consider at ion f or supplies. An example of t his would be a pr ice adj ust ment or some sor t of disput e t hat has r esult ed in a change in out put t ax; and

• Finally, any ot her adj ust ment s t o out put t ax which ar e r equir ed or allowed under t he VAT legislat ion.

I n t he VAT allowable por t ion f or each r et ur n per iod, you have t o show:

• The input t ax allowable f or t he per iod on all supplies made t o t he business in t he VAT per iod;

• The input t ax allowable f or t he per iod on int r a-EU acquisit ions;

• I f any ear lier input t ax er r or s wer e discover ed dur ing t he per iod, t hen any adj ust ment s being made in t he cur r ent per iod must also be shown;

• Any incr eases or decr eases in input t ax ar ising dur ing t he per iod f r om changes in t he consider at ion f or supplies r eceived. So once again pr ice adj ust ment s, disput es and so on; and

• Finally, any ot her adj ust ment s t o input t ax which ar e r equir ed or allowed under t he VAT legislat ion.

VAT Recor ds and Ret ur ns

529

Examples of adj ust ment s r equir ed or allowed under t he VAT legislat ion include a par t ial exempt ion annual adj ust ment , a capit al goods scheme adj ust ment or a bad debt r elief claim. Such adj ust ment s could be seen in bot h t he VAT payable and t he VAT allowable por t ion of t he VAT account .

E11.4 Special Record Keeping Requirements

Apar t f r om t he r ecor ds needed by all t r ader s, if a t r ader oper at es a special scheme t hen he is usually subj ect t o addit ional r ecor d keeping r equir ement s. These r equir ement s will be specif ied by Cust oms usually in not ices which have t he f or ce of law f or t his pur pose. Special r ecor d keeping r equir ement s ar ise f or r et ail schemes, mar gin schemes (f or example t he second-hand good schemes), f or bad debt r elief claims and f or t r ader s using t he cash account ing scheme.

E11.5 VAT Invoices

The VAT invoice is pr obably t he most impor t ant document f or VAT pur poses. The r equir ement s wer e amended f r om 1 J anuar y 2004 (see Business Br ief 23/ 2003), in or der t o implement t he EC I nvoicing Dir ect ive (2001/ 115/ EC). I n or der t o be a valid VAT invoice it must show all of t he f ollowing inf or mat ion as list ed in SI 1995/ 2518 r eg 14:

SI 1995/ 2518

Reg 14

• An ident if ying invoice number;

• The date of t he supply;

• The dat e when t his VAT invoice is being issued;

• The supplier’s name and address and t he supplier ’s VAT registration number. I f a supply has been made t o a cust omer in anot her EU member st at e t hen t he VAT r egist r at ion number must be pr ef ixed by t he let t er s GB;

• I t must show t he recipient’s name and address and if t he r ecipient is in anot her EU member st at e, t hen it must show t he r ecipient ’s VAT

registration number in t hat member st at e;

• Ther e is a r equir ement t o include unit pr ice on an invoice as it applies t o count able goods or ser vices. For ser vices t he count able element might be, f or example, an hour ly r at e or a pr ice f or st andar d ser vices.

I f t he supply cannot be br oken down int o count able element s, t hen t he t ot al t ax exclusive pr ice will be t he unit pr ice. Addit ionally, t he ‘unit pr ice’ may not need t o be shown at all if it is not nor mally pr ovided in a par t icular business sect or and is not r equir ed by t he cust omer . I t is no longer a r equir ement t o show t he type of supply (whet her t he supply is a supply by sale, by hir e pur chase, by loan, by exchange, by hir e, lease or r ent al, a supply of pr oducing goods f r om t he cust omer ’s mat er ials, a supply by sale on commission or a supply on sale or r et ur n or similar t er ms) alt hough businesses may cont inue t o give t his inf or mat ion on invoices;


• Ther e must also be a description suf f icient t o ident if y t he goods or ser vices being supplied;

• The invoice must also f or each descr ipt ion on t hat invoice show t he quantity of goods or t he ext ent of ser vices supplied, show t he rate of VAT applicable and t he amount t hat is being charged, which is net of VAT. Pr ior t o 1 J anuar y 2004 t he VAT exclusive amount s had t o be shown in st er ling. Now t hey an be shown in any cur r ency;

• The invoice must also show t he total amount being charged, again net of VAT;

• I f a cash discount is of f er ed t he invoice must show t he rate of

discount;

• Fr om 1 J anuar y 2004 it is no longer a r equir ement f or t he invoice t o show t he amount of t ax t hat is char geable at each r at e,; and

• Finally t he invoice must show t he t ot al amount of t ax char geable expr essed in st er ling.

Wher e a VAT invoice is r equir ed t he t r ader has an obligat ion t o issue t he t ax invoice wit hin 30 days af t er t he t ax point .

Ef f ect ively t he EC I nvoicing Dir ect ive r equir es one ext r a it em t o be added t o VAT invoices (t he ‘unit pr ice’) and businesses can st ill choose t o show t hose it ems t hat ar e no longer mandat or y if t hey wish t o. Ther e should t her ef or e be no need f or pr e-pr int ed VAT invoice f or ms t o be wast ed. A 12 mont h t r ansit ional per iod will enable businesses t o use up old st ocks and build in any changes t o t heir new invoices. The UK has not t aken up t he opt ion available in t he Dir ect ive f or Member St at es t o r equir e invoices f or supplies in t heir t er r it or y t o show t he cust omer ’s VAT r egist r at ion number . The cust omer ’s VAT r egist r at ion number will only be r equir ed on invoices pr ovided t o per sons in ot her Member St at es as per Regulat ions 14(2)(c). SI 1995/ 2518. I nvoices do not cur r ent ly have t o be issued f or zer o-r at e and exempt t r ansact ions when supplied in t he UK and t his will not change. I f such supplies ar e included on invoices wit h t axable supplies, t hose it ems must show clear ly t hat t her e is no VAT payable and t heir values must be t ot alled separ at ely (par agr aph 16.5, of Not ice 700 The VAT Guide). However , UK businesses may st ill have t o issue VAT invoices f or zer o r at e or exempt supplies made t o cust omer s in ot her Member St at es if t hose ot her Member St at es r equir e t hem. These invoices should eit her : • I ndicat e t hat t he supply is exempt ; or • Ref er t o t he r elevant pr ovision in EU or UK law.


531

This means t hat inf or mat ion such as t he descr ipt ion of t he goods (e.g. medical supplies) or t he cust omer (e.g. healt h ser vice) will be enough t o indicat e t hat a supply is exempt f or invoicing pur poses

E11.6 Less Detailed VAT Invoices

Cust oms allow t he issue of a less det ailed invoice in cer t ain cir cumst ances. Ef f ect ively t wo condit ions must be sat isf ied f or a less det ailed invoice t o be allowable. Fir st of all, t he supplier must be a r et ailer , so must be selling dir ect ly t o t he public, and secondly, t he value of t he supply, and t his is including VAT, must be less than £250.

SI 1995./ 2518

Reg 16

I f bot h condit ions ar e sat isf ied a less det ailed invoice can be issued which will compr ise of t he f ollowing:

• The name, addr ess and VAT r egist r at ion number of t he supplier ;

• The dat e of t he supply;

• A descr ipt ion suf f icient t o ident if y t he goods or t he ser vices supplied;

• The t ot al payable which is including VAT; and

• The r at e of t ax applicable.

A cr edit car d voucher can be used as a less det ailed t ax invoice pr ovided t hat t he r et ailer adapt s it t o show t he inf or mat ion r equir ed. A r et ailer can also issue a t ax invoice in a modif ied f or m if t he cust omer agr ees. The modif icat ion would be t o show separ at e supplies and t ax inclusive values and t he t ot al VAT, as well as t he t ot al of t he VAT inclusive and exclusive values of supplies at dif f er ent r at es. A VAT invoice f or pet r ol may be issued as a less det ailed invoice if t he value of t he supply is below £ 250. I f t he value, however , is £ 250 or mor e, t hen t he t r ader is allowed t o show t he vehicle r egist r at ion number inst ead of t he cust omer ’s name and addr ess and omit det ails of t he quant it y of supplies.

A cash and car r y wholesaler is also allowed t o use t ill slips as t ax invoices pr ovided t hat he maint ains pr oduct code list s and can pr ovide up-t o-dat e copies of t hese code list s t o all VAT r egist er ed cust omer s.


Example 1

Look at t his VAT invoice car ef ully and decide if t her e is anyt hing wr ong wit h it .

The Lit t le Car d Shop 22 High St r eet , Didsbur y, Cheshir e M2 OBD

t el: 0161 445 2222 / email: t 1cs.com

I N V O I C E

Vat Reg.No: 232 4572 81 Dat ed: 24.12.2005 £ Glor ious Sant a Chr ist mas Car ds x 1 15.18 Gif t wr apping x 1 4.46

19.64

Tot al including VAT 23.08

E11.7 Electronic Invoices

The I nvoicing Dir ect ive allows f or elect r onic invoicing using an advanced elect r onic signat ur e, or Elect r onic Dat a I nt er change (EDI ). All Member St at es must accept t hese t wo met hods. Member St at es can also accept ot her means of e-invoicing f or supplies on t heir t er r it or y.

SI 1995./ 2518

Reg 13A

Elect r onic signat ur es ar e linked t o t he dat a t o which t hey r elat e in such a way as t o allow someone r eceiving t he dat a over an elect r onic net wor k t o det er mine t he aut hent icit y of t he or igin of t he dat a, and t o check t hat t he dat a has not been alt er ed or cor r upt ed dur ing t r ansmission. EDI is a comput er -t o-comput er exchange of st r uct ur ed dat a t hat per mit s aut omat ic pr ocessing by t he r ecipient . I t is mor e commonly used f or high volume dat a t r ansf er s bet ween businesses, using agr eed st andar ds (f or example, UN/ EDI FACT) t o st r uct ur e t he dat a. Cust oms do not publish a def init ive list of accept able syst ems since new t echnologies ar e const ant ly emer ging. Cust oms ar e keen t o f acilit at e t he development of elect r onic invoicing syst ems and cr it er ia f or e-invoicing will be set out in new Not ice – 700/ 63 Elect r onic invoicing. Pr oviding t hat a par t icular invoicing syst em meet s t hese cr it er ia it can be used t o t r ansmit VAT invoices. A t r ader will have t o not if y Cust oms wit hin 30 days f or m t he dat e t hat he st ar t s t o invoice elect r onically.


533

However , if Cust oms have alr eady given appr oval f or t he t r ader t o invoice elect r onically, he does not need t o not if y Cust oms again. I t will be f or businesses t o decide whet her t o invoice by t r adit ional paper met hods or elect r onically. I ndeed some businesses may use bot h met hods f or separ at e supplies/ supplier s. I f a business is not e-enabled it may not be able t o r eceive e-invoices. Whet her E-invoicing is appr opr iat e is a commer cial mat t er and cust oms cannot oblige a business t o e-invoice or make cust omer s accept it if t hey don’t want t o. Rules on e-st or age ar e in keeping wit h exist ing r ules on r ecor d keeping and pr oduct ion i.e. r ecor ds must be pr oduced wit hin a r easonable per iod of t ime eit her at t he pr incipal place of business or anot her r easonable place. Compr ession of dat a will be per mit t ed, t o allow f ar mor e ef f icient st or age, pr oviding t hat int egr it y and aut hent icit y of t he dat a can be maint ained. The r et ent ion per iod f or invoices r emains at 6 year s unless Cust oms agr ee a shor t er r et ent ion per iod. (par agr aph 19.2.3 of Not ice 700 The VAT Guide)

E11.8 Self-Billing

Self -billing is an est ablished pr act ice wher e t he cust omer pr epar es a VAT invoice in t he name of , and on behalf of , t he supplier and t hen sends it t o t he supplier , usually wit h t he payment . Pr ior t o 1 J anuar y 2004 UK businesses t hat wished t o self -bill had t o apply t o Cust oms who would issue an appr oval let t er set t ing out t he condit ions which had t o be met . Fr om 1 J anuar y 2004 businesses no longer have t o obt ain appr oval t o self -bill and self -billing will not be r est r ict ed t o supplies wit hin t he UK. However , businesses who wish t o st ar t t o self -bill or cont inue wit h self -billing, will need t o meet condit ions set out in Regulat ion 13(3) SI 1995/ 2518 and in Not ice – 700/ 62 “Self -billing”. These condit ions ar e based on t hose r equir ed by t he Dir ect ive and ar e similar t o t he ones set out in t he old Cust oms appr oval let t er s.

Reg 13(3) SI 1995/ 2518

Not ice 700/ 62

The main condit ions ar e:

• Ther e must be an agr eement in place at t he out set bet ween t he supplier and t he cust omer (a “self -billing agr eement ”).

• The self -billed invoice must cont ain t he nor mal invoice par t icular s r equir ed under r egulat ion 14(1) or (2), SI 1995/ 2518.

• The self -billed invoice must r elat e t o a supply or supplies made by a supplier who is a t axable per son. I f not , any amount claimed as input t ax will be disallowed, MJ Gleeson Gr oup plc.


• The self -biller must show t he legend “THE VAT SHOWN I S YOUR OUTPUT

TAX DUE TO HM REVENUE & CUSTOMS” (pr eviously Cust oms & Excise) on t he self -bills.

• The self -biller must keep and maint ain an up t o dat e list of t he names, addr esses and VAT r egist r at ion number s of supplier s who have agr eed t o self -billing and t his list must be made available t o Cust oms on r equest .

• The cust omer must r aise self -billed invoices f or all t r ansact ions wit h t he supplier dur ing t he t er m of t he agr eement .

I f all t he condit ions ar e not met , any self -billed invoices issued ar e not pr oper VAT invoices. As such, t hey cannot be used as evidence of ent it lement t o input t ax r ecover y and t he supplier will have t o issue his own invoice. The r equir ed cont ent s of a self -billing agr eement can be f ound in Regulat ion 13(3B) SI 1995/ 2518.

Reg 13(3B) SI 1995/ 2518

Ther e ar e no changes in t he way t he exist ing t ax point r ules apply t o self -billed invoices. The issue of a self -billed invoice does not cr eat e a t ax point in t he same way t hat a VAT invoice would if t he supplier had issued it – but t her e is one except ion. This is wher e a t r ader issues a self -billed invoice wit hin 14 days of t he basic t ax point . This will cont inue t o cr eat e a t ax point in t he same way as a nor mal VAT invoice would.

E11.9 VAT returns

A t axable per son must f ur nish a VAT r et ur n, (f or m VAT 100) in r espect of each pr escr ibed account ing per iod. A pr escr ibed account ing per iod is usually a t hr ee-mont h per iod alt hough t r ader s can r equest t o have mont hly pr escr ibed account ing per iods. Pr escr ibed account ing per iods ar e st agger ed f or administ r at ive convenience and can be t he quar t er s ended 31 Mar ch, 30 J une, 30 Sept ember , and 31 December f or st agger gr oup 1. 30 Apr il, 31 J uly, 31 Oct ober and 31 J anuar y f or st agger gr oup 2. 31 May, 31 August , 30 November and t he end of Febr uar y f or st agger gr oup 3.

SI 1995./ 2518

Reg 25

For each of t hose t hr ee st agger gr oups, t he VAT year end will end on eit her t he 31 March, 30 April or the 31 May as appr opr iat e.

Not ice 700 par a 20.5

The st agger gr oups ar e allocat ed t o t r ader s when t hey r egist er f or VAT. Tr ader s can r equest cer t ain account ing dat es f or t heir convenience (f or example t o coincide wit h t heir f inancial year end) but t he allocat ion is ent ir ely at Cust oms discr et ion.

The VAT r et ur n deals wit h all UK t r ansact ions t hat f all wit hin VAT and also will include ent r ies f or int r a-EU t r ade as well as t ax on impor t ed goods which have t o be dealt wit h on t he VAT r et ur n.


535

A copy of t he VAT r et ur n can be f ound at Schedule 1 of SI 1995/ 2518. The VAT r et ur n is complet ed as f ollows:

Box 1 shows t he output tax due on supplies and deemed supplies made by t he t axable per son. Box 2 shows t he VAT due on acquisit ions f r om ot her EU count r ies. Box 3 shows t he t ot al of Boxes 1 and 2, i.e. t he t ot al VAT due on sales and on EU acquisit ions.

Box 4 shows t he input tax available f or cr edit on all pur chases. So t hat will include impor t s and EU acquisit ions.

Box 5 is ef f ect ively t he net figure, so Box 3 minus Box 4 and t hus will show t he VAT payable t o or by t he Commissioner s.

The r emainder of t he VAT r et ur n is ef f ect ively t o collect st at ist ical inf or mat ion par t ly f or checking t he r easonableness of t he input and out put t ax f igur es but also in r espect of inf or mat ion on t r ade wit h ot her EU member st at es. Box 6 shows t he total value of sales and all other outputs (but t his excludes VAT) made dur ing t he per iod and will include t he amount shown in Box 8. Box 7 shows t he total value of purchases and all other inputs, again excluding VAT, r eceived dur ing t he per iod and t his includes t he amount shown in Box 9. Box 8 shows t he total value of all supplies of goods and r elat ed ser vices excluding VAT to other EU member states. Box 9 shows t he value of all acquisitions of goods and r elat ed ser vices, excluding any VAT, from all other EU member states. Alt hough all nine boxes should be complet ed, if a business has not hing t o put in a box it should wr it e “None”. Most t r ader s who do not have any t r ansact ions wit h ot her EU count r ies will only act ually be ent er ing f igur es in Boxes 1, 3, 4, 5, 6 and 7. Any negat ive f igur es f or out put t ax and input t ax should st ill be put in t he cor r ect box – i.e. boxes 1 & 3 f or out put t ax, and box 4 f or input t ax – but should be enclosed in br acket s. Cer t ain it ems should not be included in boxes 6 and 7 of a cur r ent VAT r et ur n: Wages & salar ies; PAYE & Nat ional I nsur ance Cont r ibut ions; Money put int o or t aken out of t he business; Loans, dividends and gif t s of money;


I nsur ance claims; St ock exchange dealings (unless t he business is a f inancial inst it ut ion); MOT Cer t if icat es; Mot or vehicle licence dut y; Local Aut hor it y r at es; Any income which is out side t he scope of VAT because it is not consider at ion f or a supply.

The VAT r et ur n has t o be signed by a relevant person and submit t ed wit h a cheque f or payment of any VAT due within one month of t he end of t he pr escr ibed account ing per iod f or which t he r et ur n is made.

SI 1995/ 2518 Reg. 25(1)

For a business which makes use of elect r onic means of payment , bot h t he due dat e f or t he r et ur n and t he dat e by which Cust oms must r eceive t he payment (int o t heir bank account ) ar e ext ended by 7 days. I f t he ext ended dat e is a weekend, or on a bank holiday, t hen t he due dat e will be t he closest wor king dat e immediat ely pr ior t o t he 7t h day. I f t he r et ur n is a r epayment r et ur n, t he 7-day ext ension on t he submission of t he r et ur n does not apply, and t he or dinar y submission dat e applies. Businesses in t he payment s on account scheme and on annual account ing schemes, ar e excluded f r om t he 7 day ext ension.

Example 2

J J Limit ed has an account ing year -end of 31 J anuar y 2007. The company is in VAT st agger gr oup 2. VAT r et ur ns t o which quar t er s wer e made based on t he year ’s r esult s?

a) 30.4.2006 31.7.2006 31.10.2006 31.1.2007

b) 31.3.2006 30.6.2006 30.9.2006 31.12.2006

c) 31.3.2006 30.6.2006 30.9.2006 31.1.2007


537

Answer 1

I hope you r ealised t hat t he invoice shown was a less det ailed VAT invoice. The Lit t le Car d Shop is a r et ailer and t he value of t he supply, including VAT, is less t han £ 250, so t his t r ader may issue a less det ailed VAT invoice. Name of supplier X

Addr ess of supplier X

VAT Reg Number of supplier X

Dat e of supply X

Descr ipt ion X

Tot al payable including VAT X

Rat e of t ax applicable X A less det ailed VAT invoice shows t he name, addr ess and VAT r egist r at ion number of t he supplier .

Also needed: t he dat e of t he supply.

Also needed: a descr ipt ion suf f icient t o ident if y t he goods or ser vices supplied. The quest ion st at es t hat t her e ar e var ious Glor ious Sant a Chr ist mas Car ds and some gif t wr apping, which is a suf f icient descr ipt ion f or VAT.

A less det ailed invoice needs t o show t he t ot al including VAT.

And f inally a less det ailed invoice has t o show t he r at e of t ax applicable and t hat is wher e t his VAT invoice f alls down. Nowher e is t he r at e of VAT applicable t o t he it em shown. Hence it is not a valid t ax invoice. To conclude t her e is j ust one it em t hat is incor r ect in r espect of t his less det ailed VAT invoice.

Answer 2

The cor r ect answer is A These ar e t he quar t er ly VAT r et ur ns a t r ader would have t o make if you wer e allocat ed int o st agger gr oup 2.


SUMMARY – VAT RECORDS AND RETURNS Cust oms have a gener al power t o r equir e t r ader s t o keep such r ecor ds as t hey r equir e. As well as t he business’s account ing r ecor ds copies of all VAT invoices issued and r eceived must be r et ained by t he business in addit ion t o cr edit and debit not es. Each business must maint ain a VAT account which shows all out put t ax and input t ax movement s dur ing t he VAT per iod. Recor ds must be kept f or a minimum of six year s. I f a VAT r egist er ed t r ader oper at es a special scheme t hen he will be subj ect t o addit ional r ecor d-keeping r equir ement s. The VAT invoice is a cr ucial document and must meet all t he condit ions specif ied by Cust oms if input t ax is t o be r ecover ed by a pur chaser . Cust oms allow t he issue of less det ailed VAT invoices in cer t ain cir cumst ances – basically wher e t he supplier is a r et ailer and t he value of t he supply including VAT is less t han £ 250. Tr ader s ar e per mit t ed t o use elect r onic invoices. I n or der t o f acilit at e input t ax r ecover y t r ader s may issue self bill invoices when r eceiving goods or ser vices f r om a t axable per son. A VAT Ret ur n is submit t ed per iodically (usually quar t er ly) by VAT r egist er ed businesses out lining out put VAT, input VAT and net VAT payable or r epayable f or t he per iod.

`

E12: ACCOUNTING FOR VAT

This chapt er looks at t he payment and r epayment of VAT dealing wit h t he f ollowing: when VAT should be paid; in which cir cumst ances VAT will be r epaid.; t he annual account ing scheme which allows businesses t o submit VAT r et ur ns on an annual basis; t he cash account ing scheme which allows businesses t o account f or VAT ignor ing t he nor mal t ax point r ules but inst ead looking at t r ansact ions passing t hr ough t he cash book.

E12.1 Introduction

This chapt er looks at f our dif f er ent but r elat ed t opics which would all come under t he umbr ella of account ing f or VAT. Fir st t he payment or r epayment of VAT; t hen mont hly payment s on account of t he VAT liabilit y; and f inally t wo dif f er ent schemes which have t he aim of simplif ying account ing f or VAT f or t he smaller t r ader - t he annual account ing scheme and t he cash account ing scheme.

E12.2 Payment and Repayment of VAT

VAT r et ur ns must be submitted t o Cust oms not lat er t han one calendar month

after the end of the VAT return period in quest ion. When a r et ur n is sent t o Cust oms any VAT t hat is due f or payment , as shown on t he VAT r et ur n, should be sent t o Cust oms at t he same t ime. So ever y VAT r et ur n going t o Cust oms showing VAT payable will also have a cheque being sent t o Cust oms at t he same t ime and wit hin t he same t ime limit . Late returns and late payments of VAT

due can result in penalties.

SI 1995/ 2518 Reg 25 & 40

I f t he VAT r et ur n shows input t ax exceeding out put t ax f or t he r et ur n per iod t hen Cust oms will owe t he business some money. I n t his case when Cust oms r eceive t he VAT r et ur n t hey will send money back t o t he business. Wher e possible Cust oms like t o make r epayment s of VAT t hough t he Banker s Aut omat ed Clear ing Syst em (BACS). Nor mally a VAT r et ur n will only show t he VAT due f r om t hat t r ader . Thus a t r ader is only liable f or his own VAT due t o Cust oms shown on his VAT r et ur n.

However FA2003 int r oduced j oint and sever al liabilit y f or cer t ain t r ader s. This measur e is indust r y specif ic, and is int ended t o apply t o t he f ollowing sect or s only:

• Telephones, t elephone par t s and accessor ies, and • Comput er equipment , including par t s, accessor ies and sof t war e.

J oint and sever al liabilit y is specif ically t ar get ed at missing t r ader f r aud. Wher e a business r eceives a supply of specif ied goods or ser vices in


cir cumst ances wher e t hey knew or had r easonable gr ounds t o suspect t hat VAT on t hose goods and ser vices would go unpaid, t he t r ader will be held j oint ly and sever ally liable f or t he t ax due in t he event of def ault by t he supplier . This int r oduces t he concept of j oint and sever al liabilit y t hr oughout t he supply chain f or f r audulent t r ansact ions in t hese goods.

E12.3 Payment of VAT

Businesses which pay VAT electronically will aut omat ically r eceive a 7 day

extension t o t he deadline f or t he submission of t he VAT r et ur n and t he VAT due. The 7-day ext ension is 7 calendar days. An elect r onic payment , or an e-payment , is one of t he f ollowing:

• BACS – Banker s Aut omat ed Clear ing Syst em;

• CHAPS – Clear ing House Aut omat ed Payment Syst em; or

• Bank Gir o Cr edit t r ansf er .

However t his 7-day ext ension is not available t o t r ader s making payment s on account or using t he annual account ing scheme.

Cust oms have st at ed t hat businesses may pay t heir VAT in Eur os if t hey wish but t he declar at ions of t heir liabilit y must be made in st er ling and VAT r epayment s will also be made in st er ling.

E12.4 Monthly Payments on Account

Ver y large traders ar e r equir ed t o pay their VAT monthly in advance on account of t heir act ual VAT liabilit y f or a r et ur n quar t er . Ret ur ns ar e st ill only submit t ed quar t er ly but payment s ar e made mont hly. For t wo mont hs a payment on account is made and f or t he t hir d mont h of a VAT r et ur n t he t r ue payment is made. So t he t r ue payment due, as shown on t he VAT r et ur n, is made when t he VAT r et ur n is submit t ed. Mont hly payment s on account ar e not r equir ed if t he t r ader makes mont hly VAT r et ur ns.

VAT Not ice 700/ 60/ 96

SI 1993/ 2001

Businesses meet ing t he def init ion of a ver y lar ge t r ader make t hese mont hly payment s on account . Ther e ar e t wo t est s. Test 1 st at es t hat t he t r ader ’s t ot al VAT liability f or t he pr evious year ended 30 Sept ember , 31 Oct ober , or 30 November exceeded £2 million. The Sept ember , Oct ober or November dat es apply accor ding t o whet her t he t r ader is a gr oup 1, gr oup 2 or gr oup 3 t r ader . For example if a t r ader was in st agger gr oup 2 it would be t he t ot al VAT liabilit y f or t he year ended 31 Oct ober . I f it has exceeded £ 2million, t hen t he business would be a ver y lar ge t r ader .

VAT Not ice 700

Par a 21.3

Account ing f or VAT

541

I t is t he t ot al VAT liabilit y f or t he pr evious year t o eit her Sept ember , Oct ober or November , depending on whet her it is st agger gr oup 1, 2 or 3 t ypes of business, t hat det er mines if a t r ader is lar ge or not . Test 2 consider s t he businesses’ t ot al VAT liabilit y in any subsequent per iod of one year t est ed at t he end of each pr escr ibed account ing per iod i.e. each VAT r et ur n per iod. I f it exceeds £ 2 million t hen t he business is a ver y lar ge t r ader . At t he end of ever y VAT r et ur n per iod if one year ’s t ot al of VAT exceeds £ 2 million, t he business’ is a ver y lar ge t r ader .

Whet her a t r ader is def ined as lar ge under t est 1 or t est 2 is impor t ant because it ef f ect s t he per iods in r espect of which t he payment s on account ar e r equir ed. I f t est 1 is sat isf ied t hen payment s on account will be r equir ed f or t he whole of t he following VAT year . VAT year s commence on 1 Apr il, 1 May or 1 J une, depending on whet her it is a gr oup 1, 2 or 3 t r ader . I n t he ear lier example, look at t he VAT liabilit y t o t he year ended 31 Oct ober and if it exceeded £ 2 million, t hen f r om t he next 1 May t he t r ader would be making payment s on account .

I f t he business sat isf ies t est 2 t hen t he liabilit y t o make payment s on account commences f r om t he ver y next pr escr ibed account ing per iod, i.e. VAT r et ur n per iod. So t he next VAT r et ur n per iod af t er t he VAT r et ur n per iod in which t he £ 2 million t hr eshold was exceeded, becomes t he f ir st t ime t he t r ader will st ar t t o make payment s on account .

Illustration 1

Giant Limit ed has a VAT year -end of 31 May. I n t he year t o 30 November 2006 it s VAT liabilit y t ot alled £ 2.1 million.

Giant Limit ed has a VAT year -end of 31 May so it is a gr oup 3 t r ader . The company exceeds t he £ 2 million t hr eshold in t he 30 November year -end per iod consider ed in t est 1.

Hence, Giant Limit ed is a ver y lar ge t r ader and is now liable t o make payment s on account . These payment s on account , because it sat isf ies t est 1, will commence wit h t he VAT year beginning 1 J une 2007.

I f t he year t o 30 November 2006 was t he ver y f ir st t ime t hat Giant Limit ed had exceeded t he £ 2 million t hr eshold t hen look at t est 2 as well. At t he end of a VAT r et ur n per iod, if f or t he year t hen ending t he VAT liabilit y exceeds t he £ 2 million t hr eshold, t he t r ader is due t o make payment s on account f r om t he next pr escr ibed account ing per iod. So payment s on account will be due f r om Giant Limit ed f or t he 28 Febr uar y 2007 r et ur n per iod as well.


Example 1

Enor mous Limit ed has a 31 Mar ch VAT year -end. The company’s VAT liabilit y over r ecent r et ur n per iods has been: Liabilit y Annual Tot al £ £

31.12.05 300,000 31.3.06 400,000 30.6.06 500,000 30.9.06 600,000 1,800,000 31.12.06 400,000 1,900,000 31.3.07 450,000 1,950,000 30.6.07 750,000 2,200,000

Which is t he f ir st VAT r et ur n per iod af f ect ed by POA?

E12.5 Due Date for Payments on Account

Payment s on account ar e due at t he end of the second month and the third

month in t he pr escr ibed account ing per iod i.e. t he VAT r et ur n per iod. The balance is t hen due when t he VAT r et ur n is submit t ed so, in ot her wor ds, one mont h af t er t he pr escr ibed account ing per iod ends.

I f t he payment s on account exceed t he t ot al amount due f or t he VAT r et ur n per iod t hen Cust oms will r epay t he excess when t he VAT r et ur n is submit t ed.

How much is t he payment on account ? I t is 1/24th of a total VAT liability for

a year but which t ot al VAT liabilit y f or t he year depends on whet her t est 1 or t est 2 was sat isf ied.

I f t est 1 was sat isf ied t hen it is t he t ot al VAT liabilit y t o t hat 30 Sept ember , 31

Oct ober , 30 November year end dat e as appr opr iat e t o t he st agger gr oup f or t he t r ader . I f it was t est 2 t hat was sat isf ied, t hen it is 1/ 24t h of t he t ot al VAT liabilit y f or t hat year in which t he £ 2 million t hr eshold was exceeded.

I n bot h cases VAT due on goods impor t ed f r om out side t he EU is excluded. Cust oms ar e r equir ed t o not if y t he t r ader of t he amount payable, how it has been calculat ed and when t he payment is due. I n cer t ain cir cumst ances, Cust oms have t he power t o r educe or incr ease t he amount of t he payment on account .

Ther e is one ot her t hing I want t o ment ion about t est 2 – wher e t he t hr eshold is exceeded f or t he ver y f ir st t ime under t est 2 t hen only one payment on account is r equir ed in t he f ir st r et ur n per iod under t he scheme. The balance is t hen due wit h t he r et ur n. The usual payment s on account r egime kicks in af t er t hat .

E12.6 More on POA

The def ault sur char ge r egime does apply t o payment s on account . Thus a business will st ill have t o get ever yt hing paid on t ime and a r et ur n sent in on t ime under t he scheme.


543

I f t he t ot al VAT liabilit y in f our successive r et ur ns f alls below 80% of t he t ot al t hat was used f or t he r ef er ence per iod (t he r ef er ence per iod being t he per iod on which t he payment s on account have been calculat ed), t hen t he t r ader can apply f or a r educt ion in t he payment on account . The t r ader can apply f or t his r educt ion immediat ely, r at her t han wait ing f or t he next annual r evision which is always based on t he t est 1 r ef er ence per iod.

I f a t r ader ’s VAT liabilit y f alls t o less t han £ 1.6 million f or a one year per iod ending under t est s 1 or 2, t hen t he t r ader can apply t o Cust oms t o be r eleased f r om his dut y t o make payment s on account . When Cust oms have given t heir wr it t en appr oval t he t r ader can leave t he payment s on account syst em.

E12.7 Annual Accounting

Annual account ing allows small and medium sized t axable per sons t o pay VAT on an annual basis. I t allows t hem t o only submit one VAT r et ur n and make some est imat ed payment s on account dur ing t he year wit h a f inal VAT balance due at t he year end.

SI 1995/ 2518 Reg 49-55

VAT Not ice

732

Under t he annual account ing scheme the VAT liability f or t he cur r ent year is act ually estimated by Cust oms. 90% of this estimate is then paid by direct

debit in nine equal instalments on t he last day of mont hs 4, 5, 6, 7, 8, 9, 10, 11 and 12 of t he VAT year . The VAT year is t he year ended 31 Mar ch, 30 Apr il, or 31 May depending on t he st agger gr oup of t he t r ader . The balance of VAT due is sent wit h t he single annual VAT return on the last

day of the second month following the year-end. Ther e is only one VAT r et ur n ever y year which is f illed in wit h t he whole year ’s det ails and t her e is t wo mont hs af t er t he year end t o get t his r et ur n f illed in and calculat e t he VAT t hat is due. The payment s on account alr eady made ar e t hen deduct ed and t he balance is sent t o Cust oms wit h t he r et ur n. I f a r epayment is due t o t he t r ader , t his will be r epaid by Cust oms when t he VAT r et ur n is submit t ed.

A business may apply t o make only 3 int er im payment s inst ead of 9, and if t his r equest is appr oved, t he business will pay 25% of t he est imat ed t ax on t he last day of t he 4t h, 7 t h and 10t h mont h wit h t he balancing payment due on t he last day of t he 14 t h mont h.

Illustration 2

J une pays VAT f or t he year t o 30 Apr il 2007 under t he annual account ing scheme. Cust oms had est imat ed t hat she would be due t o pay £ 25,000 f or t he year and she based her payment s on t his est imat e. On complet ing her VAT r et ur n f or t he year £ 29,000 of VAT is due. Cust oms had est imat ed t hat J une would be due t o pay £ 25,000 f or t he year so her payment s on account wer e based on t his est imat e. Thus 90% will be paid in nine equal inst alment s – so 90% of £ 25,000 divided by 9 is £ 2,500. These will be paid on t he last day of mont hs 4, 5, 6, 7, 8, 9, 10, 11, and 12. Mont h 4 is


August , so t he 31st August 2006 is t he dat e of t he f ir st POA and t hus J une pays £ 2,500 by t his dat e. J une will t hen pay £ 2,500 ever y mont h unt il t he 30 t h Apr il 2007. Over 9 mont hs J une will pay £ 22,500. J une’s payment s wer e t hus: £

31 August 2006 (£ 25,000 x 90% ÷ 9) 2,500

30 Sept ember 2006 2,500

31 Oct ober 2006 2,500

30 November 2006 2,500

31 December 2006 2,500

31 J anuar y 2007 2,500

28 Febr uar y 2007 2,500

31 Mar ch 2007 2,500

30 Apr il 2007 2,500

22,500

VAT balance due wit h VAT r et ur n on 30 J une 2007 6,500

29,000

When t he VAT r et ur n is sent in J une will pay any balance due. The r et ur n is due t wo mont hs af t er t he year -end so it will be due on t he 30 t h J une. The balance of £ 6,500 t o make up t o t he £ 29,000 of VAT will also be due at t his t ime.

E12.8 Annual Accounting Conditions

Ther e ar e var ious condit ions which have t o be met by t he t r ader bef or e he can use t he annual account ing scheme. Fir st ly if t he annual value of t axable supplies is expect ed t o be up t o £ 1,350,000 t hen t he t r ader may j oin t he scheme at any t ime once r egist er ed f or VAT. Pr ior t o FA2006 if a t r ader ’s annual t ur nover was mor e t han £ 150,000 but no mor e t han £ 660,000 t he t r ader could only j oin t he scheme when he has been r egist er ed f or 12 mont hs. The £ 1,350,000 t ur nover f igur e (pr ior t o FA2006 £ 660,000) excludes VAT. Secondly, t he t r ader must not have ceased t o oper at e t he annual account ing scheme in t he past 12 mont hs. Finally, t he t r ader was not a member of a VAT group r egist r at ion or a divisional r egist r at ion.


545

I n cer t ain cir cumst ances t he t r ader is obliged t o leave t he scheme. Fir st ly he must leave the scheme if his turnover exceeds £1,600,000 (prior to FA2006

£825,000). So, if at t he end of t he year , t he value of his t axable supplies has exceeded £ 1.6 million in t hat year , he must cease t o use t he scheme immediat ely. Also if at any t ime he has r eason t o believe t hat t he value of his t axable supplies in t he cur r ent year will exceed £ 1.6 million t hen he must also inf or m Cust oms and leave t he scheme. A t r ader must leave the scheme if he becomes insolvent, on his deat h or if he ceases t o t r ade. Cust oms have t he power t o wit hdr aw aut hor isat ion f r om a t r ader t o use t he annual account ing scheme in cer t ain cir cumst ances. As a gener al r ule, t his will occur wher e t he t r ader has done somet hing wr ong. For example, Cust oms can wit hdr aw t heir aut hor isat ion t o a t r ader t o use t he annual account ing scheme;

• I f a f alse st at ement was made on t he applicat ion f or aut hor isat ion in t he f ir st place; or

• I f t he t r ader f ails t o f ur nish his annual VAT r et ur n on t ime; or

• I f t he t r ader f ails t o make any payment s under t he scheme; or

• I f a t r ader f ails t o pay t he f ull amount of any t ax due in r espect of a r et ur n t hat he submit t ed bef or e he j oined t he annual account ing scheme, he can be made t o leave t he scheme.

Ot her sit uat ions when a t r ader can be f or ced t o leave t he scheme include:

• if t he t r ader br eaches t he £ 1.6 million t ur nover t est but has f ailed t o leave t he scheme; and

• f inally wher e it is necessar y f or t he pr ot ect ion of t he r evenue.

Ther e may be cash f low advant ages f or a t r ader when he uses t he annual account ing scheme and it ’s main advant age is t hat a t r ader knows exact ly what he is paying and when he is paying it which can help many t r ader s t o budget . Anot her advant age of t he annual account ing scheme is t he f act t hat t he def ault sur char ge can har dly be applied because t her e is only one VAT r et ur n ever y year . However if a t r ader f ails t o submit his VAT r et ur n on t ime he can have aut hor isat ion t o use t he annual account ing scheme wit hdr awn.


E12.9 Cash Accounting

Under t he nor mal r ules of VAT, we use ‘t ax point s’ t o decide which VAT r et ur n per iod a t r ader account s f or it ems in. Smaller businesses ar e allowed t o dispense wit h t he nor mal VAT r ules f or account ing f or VAT and inst ead ar e allowed t o use t he cash account ing scheme as an alt er nat ive. The idea of t he cash account ing scheme is t hat a t r ader only has t o account f or VAT in r espect of when money is r eceived and money is paid. We t her ef or e use t he cashbook t o decide when input t ax can be r eclaimed and out put t ax is account ed f or . What is impor t ant is t he date cash is paid or received, not the tax point.

VAT Not ice 731

SI 1995/ 2518 Reg 56-65

One of t he maj or advant ages of t he cash account ing scheme is automatic bad

debt relief. For most t r ader s t hat sell on cr edit it is ver y possible t hat t he t ime comes f or t hem t o pay over t he out put t ax t o Cust oms bef or e it has even been collect ed f r om t he cust omer . I f t he cust omer does not pay, t hen t he VAT st ill has t o be account ed f or t o Cust oms. The bad debt means t hat t he t r ader has suf f er ed and he has t o wait 6 mont hs bef or e he can even t hink about claiming bad debt r elief and get t ing back f r om Cust oms t he out put t ax he had t o pay t hem even t hough he never collect ed it f r om his cust omer . Under t he cash account ing scheme, if t he cash was never r eceived f r om t he cust omer , t hen t he out put t ax is not paid t o Cust oms hence aut omat ic bad debt r elief .

VAT Not ice

731 par a 1.3

Obviously t her e ar e some condit ions t o sat isf y bef or e oper at ing t he cash account ing scheme.

The main condit ion is t hat t her e must be r easonable gr ounds f or believing t hat t he value of taxable supplies will not exceed £660,000 in t he next 12 mont hs.

I n addit ion t o t his all VAT returns must have been made up to date and any outstanding VAT has been paid. I f t he VAT has not been paid t hen if an ar r angement has been made wit h t he Commissioner s t o pay t hat VAT by inst alment s, t his should not bar a t r ader f r om j oining t he cash account ing scheme.

I n addit ion, in t he past year , t he t r ader has not been convict ed of any of f ence in connect ion wit h VAT or has not been assessed t o a Sect ion 60 penalt y – t his is wher e t her e is t ax evasion involving dishonest y – or has not been r emoved f r om t he cash account ing scheme f or t he pr ot ect ion of t he r evenue. I f t he condit ions ar e sat isf ied it is not necessar y t o apply t o Cust oms or even t o not if y t hem t hat a t r ader is going t o use t he cash account ing scheme.

The way t he scheme wor ks is t hat out put t ax is account ed f or when t he cust omer pays. I nput t ax is only account ed f or when t he t r ader pays t he cr edit or or t he seller .


547

When t he scheme is f ir st used it is necessar y t o ident if y separ at ely r eceipt s f r om debt or s out st anding at t he beginning of t he per iod. The out put t ax on t hese debt s will have alr eady been account ed f or under t he nor mal r ules so do not include t hem again. Similar ly, t he payment of cr edit or s needs t o be kept separ at e. However , once t he scheme is up and r unning it is j ust r eceipt s int o t he cashbook and payment s out of t he cashbook t hat det er mine out put t ax and input t ax f or t he VAT r et ur n.

The Gover nment has asked t he Eur opean Commission f or a der ogat ion t o incr ease t he t ur nover limit f or ent r y int o t he cashing account ing scheme f r om £ 660,000 t o £ 1.35 million. At t he t ime of wr it ing t his had not yet been gr ant ed.

E12.10 Receipts and Payments for Cash Accounting

I f a t r ader r eceives cash t hen t he dat e used t o decide whet her an it em f alls int o a par t icular VAT r et ur n is t he dat e t he cash was r eceived.

I f it is a cheque t hat t he t r ader r eceives t hen t he dat e of int er est is t he lat er of t he dat e on t he cheque or t he dat e t he cheque was r eceived. I f a cheque bounces t hen do not t r eat it as a r eceipt unt il it is honour ed.

I f it is a cr edit car d sale use t he dat e on t he sales voucher .

I f money comes as par t of a bank t r ansf er t hen it is t he dat e t he bank account was cr edit ed.

Payment s ar e ef f ect ively a mir r or image of r eceipt s. I f it is cash t hat t he t r ader is paying t hen use t he dat e on t he invoice t hat you ar e paying. I f it is a cheque t hen it is t he lat er of t he dat e t he cheque was dispat ched or t he dat e on t he cheque.

For a cr edit car d payment , it is t he dat e on t he voucher .

For a bank t r ansf er is t he dat e t he bank account was debit ed. I t is st ill necessar y t o meet all t he ot her condit ions f or VAT and so if t he t r ader want s an input t ax deduct ion, he must hold a valid VAT invoice et c. A ver y det ailed cashbook called an analysed cash book is r equir ed, which shows how much VAT is included in r eceipt s and payment s. The VAT r et ur n is complet ed using t he inf or mat ion in t he analysed cashbook.

VAT Not ice

731 par a 3.4


E12.11 Leaving the Cash Accounting Scheme

Ther e will be sit uat ions when a t r ader will leave t he cash account ing scheme. A t r ader is act ually r equir ed t o leave the cash accounting scheme if the turnover in t he 12 mont hs t o t he end of a r et ur n per iod exceeds £825,000. A t r ader can also leave t he scheme volunt ar ily at t he end of a r et ur n per iod if t he t r ader f eels it is not benef icial or if t he t r ader f eels he is unable t o meet t he r equir ement s f or cash account ing scheme. Cust oms t hemselves can act ually expel a t r ader f r om t he scheme if it appear s necessar y t o do so f or t he pr ot ect ion of t he r evenue.

VAT Not ice

731 par as 2.6,

5.1, 5.3

Businesses t hat leave t he cash account ing scheme eit her volunt ar ily or because t hey have exceeded t he t ur nover limit can br ing out st anding VAT int o account on a cash basis f or six mot hs af t er t hey leave t he scheme. This new r ule only applies t o supplies made and r eceived whilst using t he cash account ing scheme. Example 2

Fill in t he missing 12 mont hs t axable t ur nover f igur es: Maximum Leaving J oining Limit Limit Maximum

Cash Account ing Scheme £ …………… £ ………………

Annual Account ing Scheme £ …………… £ ………………


549

Answer 1

The year -end f or t his gr oup 1 t r ader is t he 30 t h Sept ember . The r esult s t o t he 30 t h Sept ember 2006 ar e given and t he annual VAT liabilit y f or t he year t hen ending is £ 1.8 million. This does not exceed £ 2 million and so t est 1 is not sat isf ied.

Test 2 says t hat at t he end of ever y quar t er , look at t he year ’s VAT liabilit y f or t he quar t er t hen ended. By 30t h J une 2007, t he annual VAT liabilit y f or t hat per iod t hen ending exceeds £ 2 million because it is £ 2.2 million. The VAT r et ur n t o 30t h J une 2007 is t he one which sat isf ies Test 2 and so payment s on account st ar t f r om t he next VAT r et ur n per iod which will be t he quar t er t o 30 t h Sept ember 2007.

Thus t he quar t er t o 30 t h Sept ember 2007 is t he cor r ect answer .

Answer 2

Maximum Leaving J oining Limit Limit Maximum

Cash Account ing Scheme £ 660,000 £ 825,000

Annual Account ing Scheme £ 1.35 million £ 1.6 million


SUMMARY – ACCOUNTING FOR VAT

Lar ge t r ader s wit h a t ot al VAT liabilit y f or t he pr evious year exceeding £ 2 million ar e r equir ed t o pay t heir VAT mont hly in advance. Ret ur ns ar e st ill submit t ed quar t er ly and wit h t he balancing payment due Thus a payment on account is made at t he end of mont h 2 and mont h 3 wit h t he balancing payment being due a mont h lat er when t he VAT r et ur n is submit t ed. VAT r et ur ns and any VAT due must be submit t ed t o Cust oms wit hin one calendar mont h af t er t he end of t he VAT r et ur n per iod in quest ion. I f a VAT r epayment is shown as due on t he r et ur n t his will be r epaid t o t he t r ader as soon as Cust oms r eceive t he VAT r et ur n. Businesses which pay VAT elect r onically aut omat ically r eceive a 7 day ext ension t o t he nor mal submission dat e f or t he VAT r et ur n. Annual account ing allows small and medium sized businesses t o pay VAT on an annual basis. Ther e is one annual r et ur n t o be made t wo mont hs af t er t he VAT year end. Dur ing t he year 90% of t he est imat ed VAT liabilit y is paid by dir ect debit on t he last day of mont hs 4, 5, 6, 7, 8, 9, 10, 11 and 12. As an alt er nat ive t he t r ader may choose t o make t hr ee payment s of 25% in mont hs 4, 7 and 10. When t he VAT r et ur n is submit t ed t he balance of VAT act ually due is paid at t he same t ime. The annual account ing scheme is only available t o t r ader s wit h t axable supplies not exceeding £ 1.35 million per annum. Tr ader s must leave t he scheme when t ur nover exceeds £ 1.6 million per annum. The cash account ing scheme allows t r ader s t o dispense wit h t he nor mal t ax point r ules t o decide which VAT r et ur n t o account f or input t ax and out put t ax on. I nst ead movement s t hr ough t he cash book – i.e. input t ax r eceived and out put t ax paid det er mine which VAT r et ur n it ems ar e account ed f or on. The maj or advant age of t he cash account ing scheme is t he benef it of aut omat ic bad debt r elief . The cash account ing scheme is only available t o businesses wit h a t axable supply t ot al per annum not exceeding £ 660,000. Such t r ader s must leave t he scheme when t axable supplies exceed £ 825,000.

E13: BAD DEBT RELIEF

I n t his chapt er you will cover t he way in which r elief is given in r espect of VAT wher e a t r ader has a bad debt .

E13.1 Introduction

Consider t he sit uat ion wit h t wo t r ader s, Tr ader A, Tr ader B, and Cust oms. Tr ader A sells goods t o Tr ader B. Tr ader A also r aises an invoice f or t he goods at £ 1,000 plus VAT. Tr ader B pays t he invoice f air ly pr ompt ly so £ 1,175 is paid t o Tr ader A.

s.36 and SI 1995/ 2518 Reg 165-172

On t he VAT Ret ur n of Tr ader A t her e is out put VAT of £ 175, and t his will be paid t o Cust oms. On Tr ader B’s VAT Ret ur n t her e is input t ax of £ 175 and t his will be r eclaimed f r om Cust oms on Tr ader B’s VAT Ret ur n. Thus t he out put and input posit ion is cir cular . No one has act ually yet bor ne t he out put VAT and t his is quit e r ight because it is only t he f inal consumer t hat bear s t he VAT. The f inal consumer has not yet been int r oduced int o t he chain. Cust oms have balanced t heir books, t hey have r eceived out put t ax f r om Tr ader A, but t hey have given it back t o Tr ader B by way of an input r eclaim.

E13.2 The problem

Pr oblems ar ise wher e Tr ader B f ails t o set t le t he invoice pr ompt ly. Using t he same example, wit h Cust oms, Tr ader A and Tr ader B. Goods ar e sold f r om Tr ader A t o Tr ader B and Tr ader A r aises an invoice f or £ 1,000 plus VAT. Tr ader B in t his example is a lat e payer , so no cash act ually goes acr oss f r om Tr ader B t o Tr ader A. Assuming t hat bot h t r ader s ar e under invoice account ing, Tr ader A will st ill have an obligat ion t o pay out put t ax t o Cust oms of £ 175. As f ar as Tr ader A is concer ned t he t ax point has passed and out put VAT is due. I n Tr ader B’s books t hey again account f or VAT on an invoice basis so t her ef or e t hey ar e ent it led t o r eclaim f r om Cust oms £ 175 by way of input t ax. This is r egar dless of whet her or not t hey have paid Tr ader A. So at t he moment t her e is inequit y. Cust oms ar e in t he same posit ion as bef or e because t hey r eceive money f r om Tr ader A and have paid it out t o Tr ader B. Tr ader A is not ent ir ely happy. They have account ed f or out put t ax of £ 175 wit hout r eceiving anyt hing f r om Tr ader B. Tr ader B however , is ext r emely happy. Cust oms have given him £ 175 and he has not paid Tr ader A.


Let us assume 6 mont hs have passed f r om t he due dat e of t he invoice. At t his point Tr ader A is ent it led t o claim bad debt r elief . A bad debt claim is wher e Tr ader A claims back £ 175 f r om Cust oms and t his claim will be as par t of t he input t ax on Tr ader A’s VAT r et ur n, but t his cannot be made unt il 6 mont hs have passed since t he or iginal due dat e. Cust oms ar e now out of pocket , t hey have paid back £ 175 t o Tr ader A.

s.36(1)

I n or der f or Cust oms t o balance t heir books, t her e is a r equir ement f or Tr ader B t o r epay t he or iginal input t ax claim t o Cust oms once 6 mont hs has passed. When Tr ader B does event ually pay Tr ader A it will account f or t he out put t ax, and Tr ader B can t hen claim back t he input t ax again.

E13.3 Conditions

The f ir st condit ion is t hat Tr ader A must have supplied goods or services and must have accounted for and paid the output VAT on the supply.

s.36

The whole or par t of t he consideration has been written off in Tr ader A’s account s as a bad debt . This is simply an ent r y in t he bad debt s account wit hin Tr ader A’s books. Six months must have elapsed since t he dat e of supply and t he due dat e of t he invoice. So consequent ly it is ver y impor t ant t o show t er ms of payment on invoices. The value of t he supply must be equal t o or less t han it s open mar ket value. The 3 year cap is not an issue, as most t r ader s would be claiming bad debt r elief as soon as a debt is over 6 mont hs old as t hey ar e per mit t ed t o do so.

E13.4 Records required

Unless Cust oms allow ot her wise, bef or e submit t ing a claim t he claimant must hold t he f ollowing in r espect of ever y r elevant supply. • A copy of any VAT invoice pr ovided or , wher e t her e was no obligat ion t o

pr ovide a VAT invoice, a document showing t he t ime and nat ur e of t he supply, pur chaser and consider at ion.

• Recor ds, or any ot her document , showing t hat VAT has been account ed

f or and paid on t he supply and t hat t he consider at ion has been wr it t en of f in his account s as a bad debt .

SI 1995/ 2518 Reg 167

Any business making a claim f or bad debt r elief must keep a r ecor d of t hat claim and, unless Cust oms allow ot her wise, t hat r ecor d must consist of t he f ollowing inf or mat ion in r espect of each claim made.

Bad Debt Relief

553

• I n r espect of each r elevant supply f or t hat claim

(i) t he amount of t he VAT char geable; (ii) t he VAT per iod in which t he VAT char geable was account ed f or

and paid t o Cust oms; (iii) t he dat e and number of any invoice issued or , wher e t her e is no

such invoice, such inf or mat ion as is necessar y t o ident if y t he t ime, nat ur e and pur chaser ; and

(iv) any payment r eceived f or t he supply (including any payment

r eceived by t he claimant or by a per son t o whom a r ight t o r eceive it has been assigned and any payment made by any per son by way of consider at ion f or t he supply r egar dless of whet her such payment ext inguishes t he pur chaser ’s debt t o t he claimant or not ).

• The ‘out st anding amount ’ t o which t he claim r elat es. • The amount of t he claim. • The VAT per iod in which t he claim was made. • A copy of any not ice t o t he cust omer r equir ed under 14.5 below. Any r ecor ds cr eat ed under t hese pr ovisions must be kept in a single account t o be known as t he ‘r ef unds f or bad debt s account ’.

SI 1995/ 2518 Reg 165, 168

Unless Cust oms allow ot her wise, t he claimant must pr eser ve t he evidence and r ecor ds r equir ed above f or a per iod of f our year s f r om t he dat e of making t he claim. He must also pr oduce t hem, on demand, f or inspect ion by an aut hor ised per son and per mit t hat per son t o r emove t hem at a r easonable t ime and f or a r easonable per iod. This r equir ement does not alt er t he st andar d r equir ement t o r et ain r ecor ds f or six year s.

SI 1995/ 2518 Reg 169

E13.5 Notification

For supplies made prior t o 1 J anuar y 2003 t he debt or must be inf or med t hat a claim f or bad debt r elief has been made. Not if icat ion is wit hin 7 days of making t he claim. The not if icat ion must cont ain t he dat e of issue of t he not if icat ion, t he dat e of claim, t he dat e and number of r elevant invoices, t he amount of consider at ion of t he claim and f inally, t he amount of t he claim t hat is, t he VAT amount of t he claim. The t r ader must r ecor d t he claim and keep a copy of t he not if icat ion. Cust oms will want sight of t he not if icat ion should t hey ever conduct a cont r ol visit on t he t r ader . I f a t r ader cannot pr ove f or mal not if icat ion has been given t hen t hat is not a valid bad debt claim and penalt ies may be an issue.


However f or supplies made 1 J anuar y 2003 and t her eaf t er , FA2002 r emoved t he r equir ement t o give not if icat ion t o t he debt or . Again using t he example wit h Tr ader A, Tr ader B and Cust oms goods ar e sold f r om Tr ader A t o Tr ader B, and an invoice is r aised f or £ 1,175. Tr ader B is again a lat e payer , but t ax point s ar e st ill t r igger ed in Tr ader A f or out put t ax and f or input t ax in Tr ader B. Once again Cust oms have balanced t heir books. Six mont hs have passed since t he due dat e of t he invoice and Tr ader A claims bad debt r elief in r espect of t he out st anding invoice. He would do t his in t he nor mal way claiming addit ional input t ax in Box 4 on his VAT Ret ur n. The change in Finance Act 2002, is t hat t her e is no longer a not if icat ion r equir ement . Tr ader A need not not if y Tr ader B t hat t hey have claimed bad debt r elief . However t he new pr ovisions mean t hat Tr ader B is obliged t o r epay t he £ 175 on any debt t hat is over 6 mont hs over due. Once again Cust oms have balanced t heir books. I n r elat ion t o a supply made on or af t er 1 J anuar y 2003, wher e a per son has • claimed deduct ion of t he whole or par t of t he VAT on t he supply as input

t ax, and s. 26A

• not paid t he whole or any par t of t he consider at ion f or t hat supply by t he

‘r elevant dat e’ i.e wit hin six mont hs of

(i) t he dat e of t he supply, or (ii) if lat er , t he dat e on which t he consider at ion f or t he supply, or (as

t he case may be) t he unpaid par t of it , became payable t hen, subj ect t o below, he must make a negat ive ent r y in t he VAT allowable por t ion of his VAT account f or t he VAT per iod in which t he end of t he r elevant six-mont h per iod f alls. For t he pur poses of (ii) above, Cust oms will accept t he dat e of invoice as t he due dat e f or payment . This means t hat , nor mally, t he dat e on which input t ax becomes r epayable is six mont hs af t er t he dat e of invoice (unless t he supplier allows t ime t o pay, f or example, 30 or 60 days, in which case r epayment of input t ax is not r equir ed unt il six mont hs f r om t his lat er dat e). The only except ion is, on t he r ar e occasions, wher e t he invoice is not issued wit hin 14 days of t he dat e of supply and wher e t he due dat e f or payment f alls bef or e t he dat e on which t he invoice is issued. I n such a case, t he input t ax will become r epayable six mont hs af t er t he dat e of supply or , if lat er , t he dat e when t he payment was due. Wher e a cust omer is in disput e wit h t he supplier , and t he supplier agr ees t o ext end t he due dat e f or payment of t he amount in disput e, r epayment is not r equir ed unt il six mont hs af t er t he agr eed ext ended dat e f or payment .

VAT Not ice 700/ 18/ 02

par a 4.4

Bad Debt Relief

555

E13.6 Part Payments

Quit e of t en t r ader s pay sums on account - t hey have an account r unning wit h a par t icular t r ader and t hey pay an amount ever y now and t hen, and t his comes of f invoices t hat ar e out st anding. On bad debt claims t her e is a gener al r ule t hat cash r eceived is allocat ed t o t he older invoices f ir st - unless t he pur chaser ident if ies t he payment as r elat ing t o a par t icular invoice. This will be impor t ant when t he t r ader r aises invoices which have dif f er ent VAT liabilit ies. For example, t he invoices could be a mixt ur e of zer o r at ed, 5%, 17.5%, some could even be exempt . Supplies made on t he same day ar e aggr egat ed and t r eat ed as one and any payment s ar e r at eably appor t ioned bet ween t hose t wo invoices.

Reg. 170

SI 1995/ 2518

Reg. 4 SI 2002/ 3027

Illustration 1

I nvoices Net VAT Gr oss £ £ £ 4.1.07 600 105 705 10.1.07 1,000 - 1,000 15.2.07 400 70 470 19.3.07 800 140 940 20.4.07 2,000 350 2,350

The due dat e is wit hin 7 days of t he invoice dat e. Cash was paid on 1 Mar ch 2007 of £ 2,000, wit hout any specif ic invoice allocat ion. As t he payment was not invoice specif ic, allocat e t he cash t o t he older invoices f ir st . Consequent ly £ 705 clear s t he invoice on 4 J anuar y 2007, £ 1,000 clear s t he invoice on 10 J anuar y 2007 and t he balance of £ 295 goes against t he invoice dat ed 15 Febr uar y 2007. Amount s out st anding:

I nvoices Net VAT Gr oss Cash paid Out st anding £ £ £ £ £

4.1.07 600 105 705 705 - 10.1.07 1,000 - 1,000 1,000 - 15.2.07 400 70 470 295 175 19.3.07 800 140 940 - 940 20.4.07 2,000 350 2,350 - 2,350

Once t he cash r eceived has been allocat ed t he t r ader can pr epar e t he VAT r et ur n t o 30 Sept ember 2007.


At 30 Sept ember 2007 t her e ar e invoices which have been out st anding f or over 6 mont hs. The invoice dat ed 15 Febr uar y 2007 would have had a due dat e of 22 Febr uar y 2007. Consequent ly, t hat is over 6 mont hs old and bad debt r elief is available in t he quar t er t o 30 Sept ember 2007. So t her ef or e 7/ 47t hs of t he out st anding amount gives us a bad debt claim of £ 26.06p. The invoice dat ed 19 Mar ch 2007 has a due dat e of 26 Mar ch 2007, so again is mor e t han 6 mont hs out st anding, t her ef or e f ull bad debt claim of £ 940 x 7/ 47t hs which is £ 140. That gives a bad debt claim of £ 166.06p, and t hat will be t r eat ed as input t ax in box 4 in t he r et ur n t o 30 Sept ember 2007. The invoice dat ed 20 Apr il 2007 will not be 6 mont hs old unt il 27 Oct ober 2007, t her ef or e t he business will have t o wait unt il t he f ollowing quar t er t o claim bad debt r elief in r espect of t hat invoice.

Example 1

Thud Lt d r aised t he f ollowing invoices on Lex Lt d:

I nvoices Net VAT Gr oss £ £ £

15.3.07 1,000 - 1,000 20.4.07 200 35 235 24.4.07 600 105 705 29.5.07 2,000 350 2,350 29.5.07 500 - 500 16.6.07 800 140 940

Lex Lt d paid £ 235 on 15.5.07 and st at ed t hat t he payment was in r espect of t he invoice r aised on 20.4.07. Lex Lt d paid a f ur t her £ 3,000 on 31.8.07

Calculat e t he bad debt r elief claim t o be made on t he r et ur n t o 30 November 2007.

Bad Debt Relief

557

Answer 1

I nvoices Net VAT Gr oss Cash paid Out st anding £ £ £ £ £

15.3.07 1,000 - 1,000 1,000 - 20.4.07 200 35 235 235 - 24.4.07 600 105 705 705 - 29.5.07 2,000 350 2,350 See below 29.5.07 500 - 500 1,295 See below 16.6.07 800 140 940 - 940

The cash paid on 15 May 2007 was specif ically allocat ed against t he invoice dat ed 20 Apr il 2007. The second payment on 31 August 2007 is allocat ed in t he nor mal way, t hat is against older invoices f ir st . £ 1,000 goes against t he invoice dat ed 15 Mar ch 2007. £ 705 goes against t he invoice dat ed 24 Apr il 2007, and f inally, £ 1,295 goes against t he invoices dat ed 29 May 2007. Those invoices have been r aised on t he same day so t hey ar e ef f ect ively t r eat ed as one invoice. The bad debt claim is t her ef or e on t he t axable amount out st anding on t he invoices dat ed 29 May 2007. To calculat e what pr opor t ion of t he £ 2,350 is st ill out st anding, appor t ion t he cash allocat ion of £ 1,295 t o t hese t wo invoices.

£ [2,350 – (1,295 x 2350

2350 + 500 ) x 7

47 ] = £ 190.96

Thus t he bad debt r elief claim on t he r et ur n t o 30 November 2007 will be £ 190.96. The invoice r aised 16.6.07 is not 6 mont hs old so does not qualif y f or bad debt r elief .


SUMMARY – BAD DEBT RELIEF

Bad debt r elief is available t o t r ader s when a debt or of 6 mont hs st anding has not yet paid over t he VAT which t he t r ader has alr eady paid t o Cust oms. Var ious condit ions must be met t o enable a bad debt r elief claim t o be made. The f ir st condit ion is t hat Tr ader A must have supplied goods or ser vices and must have account ed f or and paid t he out put VAT on t he supply. The whole or par t of t he consider at ion has been wr it t en of f in t he t r ader ’s account s as a bad debt . This is simply an ent r y in t he Bad Debt s Account . Six mont hs must have elapsed since t he dat e of supply and t he due dat e of t he invoice. The value of t he supply must be equal t o or less t han it s open mar ket value. For supplies made pr ior t o 1 J anuar y 2003 t he debt or must be inf or med t hat a claim f or bad debt r elief has been made. For supplies made on or af t er 1 J anuar y 2003 t he r equir ement t o not if y has been r emoved. The debt or has an aut omat ic obligat ion t o r epay input t ax t o Cust oms wher e debt s ar e over six mont hs over due.

E14: CONTROL VISITS, APPEALS AND ASSESSMENTS

I n t his chapt er you will look at cont r ol visit s cover ing in par t icular : what a cont r ol visit is; what happens if any ir r egular it ies ar e discover ed; t he t ime limit s f or HMRC Of f icer s t o r aise assessment s; t he f or malit ies in r espect of an appeal t o t he VAT Aut hor it ies.

E14.1 Introduction

This chapt er looks at how HM Revenue and Cust oms (HMRC) enf or ce compliance wit h t he VAT legislat ion.

Fir st ly it will consider t he way HMRC use t he cont r ol visit pr ocedur e t o monit or t he oper at ion of VAT by t he t axable per son.

E14.2 The Control Visit

HMRC (Cust oms) of f icer s will per iodically visit t axable per sons. These visit s will be by pr ior appoint ment , alt hough Cust oms obviously r eser ve t he power t o ent er and sear ch pr emises on a war r ant gr ant ed by a magist r at e. I n t he past , r egist er ed t r ader s could expect t heir f ir st cont r ol visit wit hin t hr ee year s of r egist r at ion. Visit s ar e now mor e t ar get ed and a “low r isk” t r ader may not have his f ir st visit f or many year s. Tr ader s who r eceive cash t akings or wor k in a complicat ed ar ea might be r egar ded as “high r isk” and as such t hey can expect r egular visit s f r om Cust oms. Cont r ol visit s will var y in dur at ion depending on t he per ceived r isk f act or and t he size and complexit y of t he business.

I n addit ion, a t r ader who sends in a lat e VAT r et ur n or VAT r et ur ns t hat ar e incor r ect , or inconsist ent , can also expect t o be visit ed mor e f r equent ly t han would per haps ot her wise be t he case. The cont r ol visit usually t akes place on t he business pr emises and Cust oms will inspect t he account ing r ecor ds of t he t r ader . They will also t est t he accur acy of VAT r et ur ns t hat have been submit t ed so f ar .

A cont r ol visit cannot be regarded as an audit. The f act t hat a cont r ol of f icer does not discover any er r or s does not equat e wit h giving t he business a clean bill of healt h.

The pur poses of a cont r ol visit ar e wide r anging. The pr imar y obj ect ive of t he cont r ol visit is t o ensur e t hat t he f ull amount of VAT due has been pr oper ly account ed f or , hence t he check of r ecor ds and t he check of VAT r et ur ns pr eviously submit t ed. The r ecor ds of t he business and also t he act ivit ies car r ied on by t he business will be scr ut inised by t he cont r ol of f icer .


The cont r ol of f icer will also discuss var ious aspect s of t he business wit h t he t axable per son. I f a t r ader uses t he oppor t unit y af f or ded by t he cont r ol visit t o seek t he advice of HMRC on par t icular issues t hen t he t r ader must ensur e t hat any advice on which he is going t o r ely is conf ir med in wr it ing.

. The cont r ol of f icer will also discuss any VAT pr oblems t hat t he business may be exper iencing and per haps may of f er advice on how t o cope wit h t hese. Once again, such advice needs t o be in wr it ing.

Finally, t he cont r ol of f icer will highlight any er r or s t hat have been f ound dur ing t he cont r ol visit and will explain what happens next and how t he business should act t o cor r ect t hem.

I f under -declar at ions of VAT do come t o light dur ing t he visit , or maybe if excessive amount s of input t ax have been claimed, t hen t he cont r ol visit will be f ollowed by t he issue of an assessment and per haps also int er est and penalt ies may be char ged.

E14.3 Examination of records

A cont r ol visit will nor mally t ake place at the trader’s main place of business. This is so t hat t he of f icer cannot only examine t he business r ecor ds, but can also have a look at t he business act ivit ies car r ied on. All of t he r ecor ds which t he t r ader is obliged by law t o keep should be made available. I f any r ecor ds ar e not kept at t he main pr emises Cust oms should be so inf or med at t he t ime t hat t he appoint ment is made f or t he cont r ol visit . Cust oms can t hen out line which of t he r emot e r ecor ds t he cont r ol visit of f icer will need t o examine.

Wher e r ecor ds ar e held on comput er t he t r ader is obliged t o give t he of f icer assist ance in assessing t hose r ecor ds. A t axable per son is liable t o civil penalt ies if he f ails t o pr ovide inf or mat ion or document s demanded or if he f ails t o r et ain r ecor ds t hat he is r equir ed by law t o keep.

The per son who is r esponsible f or dealing wit h all t he VAT af f air s of t he business should also be available whilst t he cont r ol of f icer is conduct ing t he cont r ol visit . The t r ader ’s account ant , or maybe anot her pr of essional adviser , may also be t her e if t he t r ader f eels t his would be helpf ul. The par t icular pr ocedur es f ollowed dur ing t he cont r ol visit var y accor ding t o t he nat ur e of t he business, but if lot s of cash t r ansact ions ar e car r ied out in t he business t hen it is likely t hat t he control officer will carry out a gross profit

calculation or a mark-up computation. Cont r ol of f icer s use a number of t echniques t o t est t he cr edibilit y of out put t ax f igur es and, especially as r egar ds r et ailer s selling goods, quit e a popular cr edibilit y check is t he mar k-up comput at ion.

Cont r ol Visit s, Appeals and Assessment s

561

A mar k-up comput at ion makes use of t he known value of pur chases, which can be obt ained f r om t he t ax invoices which have been r et ained as evidence of an input t ax cr edit . I t also uses t he pr of it mar gin mar k-ups t hat ar e made on each of t he var ious t ypes of goods sold.

The cont r ol of f icer will use t his inf or mat ion t o ef f ect ively est imat e t he value of sales in a per iod and hence t he value of out put t ax t hat should have been account ed f or . This will be compar ed t o t he act ual out put t ax account ed f or and if a lar ge dif f er ence occur s t hen per haps a f ur t her invest igat ion will be car r ied out .

Illustration 1

Alex sells childr en’s t oys which ar e all t axed at t he st andar d r at e of VAT. His aver age r at e of mar k-up is 40%. He est imat es t hat 5% of his st ock is lost due t o shoplif t ing, t hef t , et c. I n J anuar y he has a sale wher e appr oximat ely 50% of his st ock is sold at an aver age mar k-up of only 10%.

Pur chases f or t he t est per iod t ot al £ 50,000 (excluding VAT). Out put t ax declar ed f or t he t est per iod was £ 7,250.

How cr edible is t he out put t ax declar ed?

The mar k-up comput at ion f or t he t est per iod will st ar t of f by t aking t he pur chases in t he t est per iod and adj ust ing t hem f or t hef t , shoplif t ing, et c. I n t he example, t her e wer e £ 50,000 wor t h of pur chases in t he t est per iod of which about 5% would nor mally be pilf er ed. So £ 2,500 is deduct ed f r om £ 50,000 pur chases t o give £ 47,500 of pur chases in t he t est per iod.

£ Tot al pur chases 50,000 Deduct : 5% f or t hef t et c (2,500)

47,500

The next par t of t he calculat ion is t o t ake t hese pur chases and assume t hat t hey ar e all sold, t hus wor king out hypot het ical sales f or t he t est per iod. Hypot het ical Sales: £

50% x £ 47,500 @ 1.40 (i.e. 40% mar k-up) 33,250 50% x £ 47,500 @ 1.10 (i.e. 10% mar k-up) 26,125

59,375


I n t he t est per iod, 50% of st ock is sold wit h a 40% mar k-up and 50% is sold in t he sale per iod wit h only a 10% mar k-up. So t ake 50% of £ 47,500 of pur chases and mult iply it by 1.4%, i.e. t he 40% mar k-up t o give sales in t hat t est per iod of £ 33,250. The ot her 50% of pur chases in t he per iod mult iply by 1.10 t o give a 10% mar k-up and hence sales of £ 26,125.

Tot al sales in t he t est per iod ar e £ 59,375.

Next wor k out t he VAT t hat should have been account ed f or on t hese sales. £

Out put t ax due t her eon £ 59,375 x 17.5%

10,391

Out put t ax declar ed (7,250)

Dif f er ence 3,141

£ 59,375 at 17.5% equals £ 10,391 out put t ax which should have been paid over t o Cust oms, but Alex only act ually declar ed (i.e. paid over ) £ 7,250 of out put t ax. Ther e is a £ 3,141 dif f er ence and t hat , on t hese f igur es, is f air ly signif icant . Wit h a r esult like t hat t he cont r ol of f icer will pr obably invest igat e Alex f ur t her and per haps r aise an assessment on him f or what he would assume t o be t he missing out put t ax f igur e.

E14.4 Assessments

A cont r ol of f icer will issue an assessment wher e it appear s t hat a VAT r et ur n has not been submit t ed, or if it has been submit t ed, it is incomplet e or incor r ect . The assessment must be made t o t he best of t he Commissioner s’ j udgement . The under lying phr ase comes f r om an impor t ant case, Van Boeckel v CCE (1981). The phr ase ef f ect ively means t hat Cust oms of f icer s must consider f air ly all t he mat er ial put bef or e t hem by t he t r ader and t hat is what t hey must base t heir decision on. That decision must also be a r easonable decision.

s.73 (1)–(3)

So long as t her e is some mat er ial on which t he cust oms of f icer can act , however , t hey ar e not r equir ed t o make any f ur t her invest igat ion. I n ot her wor ds t he cust oms of f icer will use t he inf or mat ion given t o him t o r aise his assessment but does not act ually have t o delve f ur t her t o f ind out if t he f igur es he is coming up wit h ar e pr ecisely accur at e. The f ollowing t r ibunal case gives a good example of using best j udgement when r aising an assessment . Mr Singh, a f ir ewor k wholesaler , was visit ed by Cust oms who examined his pur chase r ecor ds. They concluded t hat he had r ecor ded all of his pur chases accur at ely. However , t hey did not car r y out a mar k-up exer cise, inst ead t hey made an assessment based on a mont h’s t ill r olls.


563

The t r ibunal concluded f r om t he evidence t hat Mr Singh’s t ill had been used as an all-pur pose calculat or . Apar t f r om r ecor ding act ual sales, it was used: • To calculat e t he value of cust omer s’ select ions pr ior t o sale; • To calculat e t he value of pot ent ial sale f or t elephone enquir ies; • To calculat e t he value of f axed or der s pr ior t o sale; • For t r aining exer cises • For calculat ing t he t ot al value of pur chases; • For calculat ing bankings; and • To calculat e sandwich or der s. Mr Singh explained t hat cer t ain ent r ies on t he t ill r olls could not have been sales; t hey wer e t oo lar ge. His cust omer s wer e local newsagent s and gr ocer s and would not have had a licence t o t r anspor t t he quant it ies of f ir ewor ks implied by t he size of t he f igur es on t he t ill r olls.

The t r ibunal not ed t hat a mar k-up exer cise would have pr oduced f igur es ver y close t o t hose on Mr Singh’s VAT r et ur ns. Cust oms wer e awar e t hat t he t ill was used ot her t han f or r ecor ding sales and wer e happy wit h Mr Singh’s pur chase r ecor ds. They also knew his mar k-up and so had not , in t he t r ibunal’s opinion, used best j udgement in making t heir assessment .

18480: J halman Singh (4.4.04)

E14.5 Assessment Time Limits

Ther e ar e t ime limit s t o be obser ved f or t he r aising of an assessment by Cust oms. An assessment must be r aised by t he lat er of ;

s.77

• Two year s af t er t he end of t he pr escr ibed account ing per iod in quest ion;

or

• One year , af t er evidence j ust if ying t he r aising of an assessment comes t o light .

So t he lat er of t hese t wo dat es is t he last dat e on which Cust oms can r aise an assessment , but t her e is also an over all t ime limit . This over -r iding t ime limit f or t he issue of an assessment st at es t hat an assessment must be issued not lat er t han t hr ee year s af t er t he end of t he pr escr ibed account ing per iod concer ned, or wher e an individual has died, not lat er t han t hr ee year s af t er his deat h.

However , wher e an under payment ar ises f r om f r aud or dishonest conduct t hen t he t hr ee-year limit is incr eased t o t went y year s. Time limit s ar e ver y impor t ant because Cust oms can only r aise assessment s wit hin t he st r ict def ined per iods of t ime.


Example 1

Dur ing a cont r ol visit on t he 29 t h J anuar y 2007 t he Cust oms Of f icer discover s an under -declar at ion of out put VAT on t he VAT r et ur n t o t he quar t er 31st Mar ch 2006. By which dat e must a Cont r ol Of f icer r aise an assessment t o collect t his VAT t hat ’s due? a) 31 Mar ch 2008 b) 29 J anuar y 2008 c) 31 Mar ch 2009

E14.6 Global Assessment

I t is possible f or Cust oms t o make a global assessment . This is basically an assessment f or t wo or mor e pr escr ibed account ing per iods, but which does not allocat e t he amount of t ax involved int o each of t he individual per iods. I n t he case of a global assessment t he t ime limit oper at es f r om t he end of t he ear liest per iod included in t he assessment . Do not conf use a global assessment wit h a document which is made up of a number of assessment s f or dif f er ent pr escr ibed account ing per iods which j ust happen t o be not if ied t oget her . The quest ion of whet her a global assessment has been made, or a number of separ at e assessment s have been made, is one of f act and will be based upon t he f or m in which Cust oms not if y t he t r ader .

E14.7 Appeals

I n t he event of a disput e wit h Cust oms t her e ar e ef f ect ively t wo r out es open t o r esolve t he issue in quest ion. I n most cases t he t axpayer will ask Cust oms t o r econsider t heir decision. This is somet imes called a ‘local review’ or a ‘local

reconsideration’.

s.82-87

I f t his cour se of act ion is chosen t he r equest should be made in writing within

30 days of the disputed assessment and r elevant inf or mat ion should be pr ovided t o Cust oms t o back up t he case f or a local r eview. I t is at t his point t hat t he t r ader should also ask Cust oms t o ext end t he usual t ime limit f or an appeal, j ust so t hat t he second opt ion is lef t open t o t he t r ader if a local r eview f ails t o sat isf y.

Not ice 700 Par as 28.2, 28.5

SI 1986/ 590

The second r out e available is t he right of appeal against cer t ain Cust oms assessment s or decisions. An appeal must be made in wr it ing wit hin 30 days of t he dat e of t he disput ed Cust om’s assessment or Cust om’s let t er . These t ime limit s ar e ver y impor t ant and have t o be met . I f a local r eview has been r equest ed it may r esult in a r evised decision in which case t he t axpayer has 30 days t o appeal against t his t o a t r ibunal pr ovided t hat Cust oms agr eed t o ext end t he appeal t ime limit in t he f ir st place.


565

On t he ot her hand, Cust oms, af t er a local r eview, may j ust conf ir m t heir or iginal decision. I n t his case, again assuming t hat an ext ension t o t he appeal per iod t ime limit has been gr ant ed, t he t r ader has 21 days f r om t he dat e of t he conf ir mat ion of t he or iginal decision t o appeal t o t he t r ibunal. This is summar ised as f ollows:

Disput ed Decision

Local r eview Appeal Amended - 30 days Conf ir med - 21 days A signif icant disadvant age of a local r eview is t hat unlike an appeal t her e is no legal ent it lement t o t he r ecover y of cost s. However , Cust oms may make an ex-gr at ia payment of cost s in cases wher e a decision is r ever sed f ollowing a local r eview.

E14.8 Appealable Matters

I t is only possible t o appeal in r espect of cer t ain mat t er s which include t he f ollowing:

s.83

• Regist r at ion or cancellat ion of a r egist r at ion;

• Ref usal of a gr oup r egist r at ion applicat ion;

• Assessment f or VAT and/ or assessment f or penalt ies;

• The VAT t hat is char geable on a supply of any goods or any ser vices;

• The input t ax t hat can be r eclaimable by a t axable per son;

• The use of special schemes including r et ail schemes, cash account ing, f lat r at e f or f ar mer s scheme et c.

An impor t ant advant age t o act ually making an appeal is t he legal ent it lement t o t he r ecover y of cost s if t he appeal is successf ul. The maj or disadvant age of an appeal is t hat it can be quit e a lengt hy pr ocedur e par t icular ly if it t hen becomes a case t hat is pur sued t hr ough higher cour t s and, of cour se, it can be cost ly if unsuccessf ul. I n addit ion t o all t his, pr e-payment of t he disput ed t ax is of t en a r equir ement and t he appeal hear ing is public which can lead t o unnecessar y, per haps unwant ed, publicit y.


I n pr act ise it is pr obably t he cost of an appeal t hat is t he maj or deciding f act or in whet her a t r ader goes ahead or not . This is especially so if t he case on which t he appeal is being made is not a r ock solid one.

E14.9 Before an appeal can be made

Bef or e an appeal can be made a t r ader must have made all VAT r et ur ns which he is r equir ed t o have made t o dat e and have paid all t he t ax due on t hose t ax r et ur ns t o dat e as well. The ef f ect of t his r ule is t hat a t r ader is unable t o appeal against any decision or any assessment if he has out st anding VAT r et ur ns or an out st anding VAT liabilit y.

s.84

However in PW Coleman (VTD 15906,VTD 16178) (TVC 2.10) it was held t hat an appellant had a dir ect ly enf or ceable r ight under t he EC 6 t h Dir ect ive t o have an appeal hear d and t his r ight over r ode t he condit ions in VATA 1994, s.84(2). Following t hat case, Cust oms now accept t hat t he condit ion t hat all r et ur ns and payment s have t o be up-t o-dat e is cont r ar y t o t he EC pr inciple of pr opor t ionalit y. Pending any change in t he UK legislat ion Cust oms will not apply f or appeals t o st r uck out solely because r et ur ns and payment s ar e out st anding f or VAT per iods which ar e not under disput e. They will cont inue t o make applicat ions wher e a r et ur n has not been r ender ed f or a VAT per iod subj ect t o a disput ed assessment or wher e t he VAT in disput e has not been paid. (C&E Business Br ief 23/ 99,17 November 1999).

I n t he case of an appeal against an assessment (and ot her cer t ain ar eas):

(i) The amount which Cust oms have det er mined t o be payable as VAT has

been paid or deposit ed wit h t hem; or (ii) On being sat isf ied t hat t he appellant would ot her wise suf f er har dship,

Cust oms agr ee, or t he appeal body decides, t hat t he appeal be ent er t ained not wit hst anding non-payment . Not e t hat if t he har dship applicat ion is gr ant ed but , subsequent ly, t he appeal is lost , def ault int er est on t he amount of t he disput ed VAT may be payable. Conver sely, if t he har dship applicat ion is lost but , subsequent ly, t he appeal is won, Cust oms ar e liable t o pay int er est on any amount of disput ed VAT paid or deposit ed wit h t hem which is r epayable.

The t r ibunal in PW Coleman held t hat t he condit ion (i) above was accept able and did not conf lict wit h EC 6t h Dir ect ive because of t he har dship pr ovision under (ii) above and because Cust om’s decision on t hat is r eviewable by t he appeal body.

(VATA 1994, s.84(3)(3A); FA 1997, s.45(3)(5)).

To summar ies, wher e an appeal is being made in r espect of t he VAT char geable on a supply, or on t he assessment of a penalt y, t her e is an addit ional r equir ement . This r equir ement is t hat t he t r ader must have eit her paid or deposit ed t he t ax demanded, or if not paid, has sat isf ied t he appeal body t hat he would suf f er har dship if t he payment was made.


567

To apply t o t he appeal body t o consider waiving t he r equir ement t o pay is subj ect t o t he same t ime limit s as t he appeal. I f Cust oms oppose t he har dship applicat ion t he appeal body will hold a pr eliminar y hear ing t o decide whet her or not t o allow t he applicat ion.

E14.10 Procedure

A VAT appeal body gener ally is compr ised of a chair man and 2 ot her member s. At least one of t hese is likely t o have an account ancy backgr ound. However , t he chair man may j ust sit alone, especially if it appear s t hat t he mat t er under disput e is a quest ion of law only, r at her t han a quest ion of f act .

Sch 12 Par a 9

Cust oms must make available t o t he t r ader any document s which t hey int end t o pr ovide t o t he t r ibunal and also pr ovide a list of any cases which t hey ar e going t o cit e. The t r ader has t o do likewise. At t he appeal t he t axpayer can conduct his own case or any per son he wishes t o appoint , so f or example his account ant , can r epr esent him. Cust oms may likewise be r epr esent ed by any per son t hey wish t o appoint and t hey ar e usually r epr esent ed by a member of t heir own Solicit or s of f ice.

SI 1986/ 590

At t he appeal hear ing each par t y t o t he appeal is allowed t o addr ess t he appeal body t o give evidence, t o call wit nesses and t o cr oss-examine wit nesses. Usually t he pr ocedur e is t hus; t he appellant nor mally pr esent s f ir st , f ollowed by Cust oms and t hen t he appellant has a r ight of r eply. I n a t ax evasion appeal, (t his is an appeal against a liabilit y f or a penalt y which has been imposed f or conduct involving dishonest y) t he bur den of pr oof lies wit h t he Commissioner s. This means t hat t he Commissioner ’s r epr esent at ive and not t he appellant will open t he case. This changed or der f or t he hear ing will also apply wher e t her e is an appeal against bot h an assessment and an accompanying penalt y f or dishonest conduct .

At t he end of t he appeal hear ing it is ver y unlikely t hat a decision will be made. Decisions ar e usually given in wr it ing a f ew days lat er . The appeal body may also dir ect t he payment of cost s by one par t y t o t he ot her . The gener al r ule is t hat cost s ar e awar ded t o t he successf ul par t y. Cost s ar e not awar ded t o an unsuccessf ul par t y unless t her e ar e except ional cir cumst ances. I t is also a condit ion t hat t he cost s ar e incident al t o and consequent upon t he appeal, and no ent it lement t o cost s ar ises if a disput e is set t led wit hout a f or mal appeal. Cost s which ar ose bef or e t he not ice of appeal was ser ved ar e not gener ally allowable, but once t he appeal has been lodged a r ight t o cost s ar ises even if t he disput e bet ween t he par t ies is set t led and t he appeal is wit hdr awn.


As a gener al r ule Cust oms do not seek cost s against unsuccessf ul appellant s. They do however , ask f or cost s in cer t ain nar r owly def ined cases in or der t o pr ovide pr ot ect ion f or public f unds. Ther ef or e Cust oms ask f or cost s at appeal hear ings of subst ant ial and complex cases wher e lar ge sums ar e involved which ar e compar able wit h High Cour t cases, unless t he appeal involves a gener al point of law which r equir es clar if icat ion.

Cust oms will also seek cost s wher e t he appellant has misused t he appeal pr ocedur e. Examples of t his include a f r ivolous appeal or wher e t he appellant has f ailed t o appear or t o be r epr esent ed at a mut ually ar r anged hear ing wit hout suf f icient explanat ion.

A right of appeal exists to the High Court in a case wher e eit her par t y is dissat isf ied on a point of law wit h t he decision of t he t r ibunal. The decision of t he appeal body on quest ions of f act is f inal. Fr om t he High Cour t t he appeal can pr oceed, if necessar y, t o t he Cour t of Appeal and t hen t o t he House of Lor ds.

I n cer t ain cir cumst ances it is possible t o leapf r og over t he Cour t of Appeal and f or t he appeal t o pr oceed dir ect ly f r om t he High Cour t t o t he House of Lor ds. I t is also possible f or an appeal against a decision of t he appeal body t o be hear d by t he Cour t of Appeal, hence leapf r ogging over t he High Cour t . This can only apply wher e t he point of law at issue is a quest ion of st at ut or y int er pr et at ion and t he decision of t he Cour t of Appeal is r eally r equir ed.

Example 2

Tick t he st at ement s which ar e cor r ect . Her e is a clue – only 3 of t he 6 st at ement s ar e t r ue!

I f cor r ect

Tick t he cor r ect st at ement s:

R

1. Cont r ol visit s ar e ef f ect ively an “audit ” of t he t r ader ’s VAT r ecor ds.

2. Cont r ol visit s t ake place at t he t r ader ’s business pr emises

3. Assessment s ar e made t o t he best of t he t r ader ’s j udgement .

4. The nor mal t ime limit f or an appeal against an assessment is 30 days af t er t he assessment was issued.

5. Cost s ar e always awar ded t o a successf ul appellant .

6. The r ight of appeal t o t he High Cour t can only be made on “a point of law”.


569

Answer 1

The cor r ect dat e is 31 Mar ch 2008. The lat er of : (i) 2 year s af t er t he end of pr escr ibed account ing per iod in quest ion 31.3.06

+ 2 = 31.3.08

(ii) 1 year af t er evidence j ust if ying an assessment comes t o light 29.1.07 + 1 = 29.1.08

Lat er of 2 dat es = 31.3.08

3 year over all limit

3 year s f r om end of PAP in quest ion

31.3.06 + 3 = 31.3.09

When consider ing t he 3 year over all limit of 31st Mar ch 2009. The 31st Mar ch 2008 dat e calculat ed ear lier is well wit hin t his 3 year over all t ime limit and so 31st Mar ch 2008 will be t he lat est dat e by which an assessment must be r aised by t he cont r ol of f icer .

Answer 2

1. Cont r ol visit s ar e ef f ect ively an “audit ” of t he t r ader ’s VAT

r ecor ds.

X

2. Cont r ol visit s t ake place at t he t r ader ’s business pr emises

R

3. Assessment s ar e made t o t he best of t he t r ader ’s j udgement .

X

4. The nor mal t ime limit f or an appeal against an assessment is

30 days af t er t he assessment was issued.

R

5. Cost s ar e always awar ded t o a successf ul appellant . X

6. The r ight of appeal t o t he High Cour t can only be made on “a point of law”.

R


SUMMARY – CONTROL VISITS, APPEALS & ASSESSMENTS Cont r ol visit s ar e one way in which HMRC can enf or ce compliance wit h t he VAT legislat ion. The lengt h of a cont r ol visit and t he int er val bet ween cont r ol visit s will depend on t he size, complexit y and VAT compliance of t he business. The pr imar y obj ect ive of t he cont r ol visit is t o ensur e t hat VAT has been account ed f or pr oper ly. I f VAT is f ound t o be due, a Cont r ol Of f icer will r aise an assessment . Assessment s must be made t o t he best of t he Commissioner s j udgement . They must also be made wit hin specif ic t ime limit s. I n t he event of a disput e wit h Cust oms, t her e ar e ef f ect ively t wo r out es available t o r esolve t he issue. The f ir st r out e is called t he local r eview wher e a t axpayer will ask Cust oms t o r econsider t heir decision. The second r out e is t o r aise an appeal. An appeal must be made in wr it ing wit hin 30 days of t he dat e of t he disput ed Cust oms assessment or let t er . I t is only possible t o appeal in r espect of cer t ain mat t er s. Bef or e an appeal can be made, t he t r ader must have made all VAT r et ur ns t o dat e and paid all t ax due t o dat e. A VAT Appeal Body gener ally compr ises a chair man and t wo ot her member s of which one is likely t o have an account ancy backgr ound. At t he appeal t he t axpayer may conduct his own case or choose any per son he wishes t o r epr esent him. Likewise Cust oms may be r epr esent ed by any per son t hey wish t o appoint . At t he appeal hear ing each par t y t o t he appeal is allowed t o addr ess t he Appeal Body t o give evidence, t o call wit nesses and t o cr oss-examine wit nesses. The Appeal Body may also dir ect t he payment of cost s by one par t y t o t he ot her . As a gener al r ule Cust oms do not seek cost s against unsuccessf ul appellant s. However , t hey will ask f or cost s in cer t ain cases in or der t o pr ovide pr ot ect ion f or public f unds. A r ight of appeal exist s t o t he High Cour t and t o t he Cour t of Appeal and House of Lor ds.

E15a: MISDECLARATION PENALTY

The misdeclar at ion penalt y penalises a t r ader who submit s an incor r ect VAT r et ur n or who accept s an assessment f or VAT which has under est imat ed t he VAT due. I n t his chapt er we will look at : when t he penalt y is char ged; how t he penalt y can be avoided.

E15a.1 Introduction

This chapt er looks at t he misdeclar at ion penalt y. A misdeclar at ion penalt y may ar ise wher e an incor r ect r et ur n is pr epar ed or an under assessment is accept ed. I f t he er r or or under assessment exceeds cer t ain limit s Cust oms have t he power t o impose a 15% penalty i.e. 15% of t he er r or or under assessment . I nt er est may also be char ged on t he er r or or under assessment .

s.63 and Not ice 700/ 92/ 02

So in summar y, t he er r or or under assessment must be paid, a 15% penalt y may be levied and int er est may also be due.

E15a.2 Error in VAT return

A t r ader may have omit t ed cer t ain out put s f r om his r et ur n or over claimed input s. Eit her way t her e is an under declar at ion of t he VAT due. Illustration 1

A t r ader has submit t ed a VAT r et ur n which shows out put t ax of £ 110,000, input t ax of £ 75,000, leaving an amount due of £ 35,000. I t lat er t r anspir es t hat t he cor r ect posit ion is out put t ax of £ 200,000, input t ax of £ 75,000 and VAT due of £ 125,000. Consequent ly t her e is an er r or of £ 90,000. The VAT of £ 90,000 would obviously have t o be paid and int er est would also be r unning on t he £ 90,000 t oo.

The quest ion is, is a penalt y due?


Ther e ar e t wo t est s f or a misdeclar at ion penalt y as f ollows: 1. I s t he er r or greater than or equal to £1 million? I n I llust r at ion 1 it is

obviously not gr eat er t han £ 1 million and or dinar ily it would be unlikely t o be so.

2. I s t he error greater or equal to 30% of the gross amount of tax (GAT)?

The gr oss amount of t ax is simply t he correct output tax plus the correct input tax. I n I llust r at ion 1 GAT would be £ 200,000 plus £ 75,000, which equals £ 275,000. Consequent ly 30% of GAT is £ 82,500 (£ 275,000 x 30%). The er r or of £ 90,000 exceeds £ 82,500.

Thus a misdeclar at ion penalt y of £ 13,500 will apply (i.e. 15% x £ 90,000).

Example 1

Alpha Limit ed pr epar ed it ’s VAT r et ur n f or t he quar t er t o 31st December 2006 as f ollows; Out put t ax £ 700,000, input t ax £ 600,000, amount due £ 100,000. On a subsequent cont r ol visit Cust oms f ound t hat input t ax had been incor r ect ly claimed on t he f leet of company car s. The er r or amount ed t o £ 350,000. What is t he amount of misdeclar at ion penalt y, if any?

E15a.3 Underassessment

Wher e an assessment is made which under st at es a t r ader ’s liabilit y t o VAT, and at t he end of t he per iod of 30 days beginning on t he dat e of assessment no act ion is t aken t o dr aw t he under assessment t o t he at t ent ion of Cust oms, a penalt y may ar ise. This could occur in cases wher e no VAT r et ur n is submit t ed. Cust oms would or dinar ily r aise an assessment in such cir cumst ances. I f t he t r ader does not hing f or 30 days, t hey ar e deemed t o have accept ed it . I f t he assessment is gr eat ly dif f er ent f r om t he act ual amount due, t he t r ader may be liable t o a misdeclar at ion penalt y. Illustration 2

No VAT r et ur n has been submit t ed by a t r ader f or t he quar t er t o 31st Mar ch 2006. Cust oms issue an assessment f or £ 200,000 and t he t r ader t akes no act ion wit hin 30 days. When t he r et ur n is f inally submit t ed t he VAT due amount ed t o £ 375,000 per t he act ual r et ur n. I s a penalt y due?

Misdeclar at ion Penalt y

573

Again t her e ar e t wo separ at e t est s. 1. I s t he under assessment greater or equal to £1 million? Again, in t he

example it is not and gener ally it is unlikely t o be so. 2. I s t he under assessment greater than or equal to 30% of the true

amount of tax (TAT)? TAT is simply t he cor r ect VAT amount , i.e. correct output tax minus correct input tax. I n t he example t his is £ 375,000. 30% of £ 375,000 is £ 112,500. The under assessment amount s t o £ 175,000 which exceeds 30% of TAT (£ 112,500).

Consequent ly a penalt y of £ 26,250 will be due which is 15% of t he under assessment .

Example 2

No VAT r et ur n is submit t ed f or t he quar t er t o 30 J une 2006. Cust oms issue an assessment f or £ 125,000 and t he t r ader t akes no act ion wit hin 30 days. The cor r ect posit ion is est ablished by Cust oms on a subsequent cont r ol visit . They det er mine t hat out put t ax should be £ 400,000, input t ax £ 225,000, leaving VAT due of £ 175,000. What is t he amount of misdeclar at ion penalt y, if any?

E15a.4 Avoiding the Penalty

Reasonable excuse is one way of complet ely avoiding t he penalt y. Has a t r ader got a r easonable excuse f or t he er r or or under assessment ? A r easonable excuse is quit e dif f icult t o pr ove and t her e ar e ver y f ew cases which Cust oms will accept as a r easonable excuse. A ser ious illness in t he f amily may be r egar ded as a r easonable excuse by Cust oms, but it will depend on t he act ual cir cumst ances. Voluntary disclosure of an er r or will avoid t he possibilit y of a misdeclar at ion penalt y. This volunt ar y disclosur e however must not be pr ompt ed by a pending Cust oms visit . Cust oms must f eel t he r eason f or your volunt ar y disclosur e is t ot ally unconnect ed wit h any f or t hcoming cont r ol visit .

Discovery within the period of grace may avoid t he penalt y. For example a t r ader has an er r or in t he quar t er t o 31 December 2006. Cust oms have a cont r ol visit in Febr uar y or Mar ch 2007. At t his visit Cust oms f ind t he er r or in t he quar t er t o 31 December 2006. The per iod of gr ace st ar t s f r om t he f ir st day af t er t he er r or quar t er and r uns t o t he f iling dat e of t he next r et ur n, i.e. t he 30 Apr il 2007. Consequent ly as t he er r or has been discover ed wit hin t he per iod of gr ace t her e is no misdeclar at ion penalt y.


This ef f ect ively gives t he benef it of doubt t o t he t r ader . Ther e is a pr esumpt ion t hat when t he t r ader came t o pr epar e t he next quar t er ’s r et ur n he may well have f ound t he er r or himself , so no misdeclar at ion penalt y is char ged.

Tax point errors of t en give r ise t o er r or s on VAT r et ur ns. Simply including an out put in a lat er quar t er will not give r ise t o a misdeclar at ion penalt y. Addit ionally Cust oms have indicat ed t hat a penalt y will not nor mally be imposed if t he penalt y amount would be less t han £ 300. Finally, misdeclarations under £2,000 will never give r ise t o a misdeclar at ion penalt y. This £ 2,000 f igur e is t he net er r or . Thus a t r ader could have one er r or f or £ 100,000 and anot her er r or going t he opposit e way f or £ 99,000. Over all t he net misdeclar at ion is only £ 1,000, t her ef or e no misdeclar at ion penalt y.

E15a.5 Reducing the Penalty

Customs can mitigate a penalty by any amount t hey f eel appr opr iat e. The VAT

tribunal can also mitigate penalties on appeal. s.71

When consider ing mit igat ion Cust oms cannot take into account t he f ollowing:

• I nsuf f iciency of f unds;

• No signif icant loss of t ax; or

• The t r ader act ed in good f ait h.

Fact or s which may be taken into account ar e as f ollows:

• Disclosur e;

• Co-oper at ion; and

• At t endance at meet ings. The mit igat ion can be anywher e f r om 0% t o 100%, it j ust depends on t he f act or s involved. I deally a misdeclar at ion penalt y should be avoided in t he f ir st place by t he t imely complet ion of accur at e VAT r et ur ns. However , if t his has not been t he case f or what ever r eason, it may be possible t o avoid t he penalt y or r educe t he penalt y by way of mit igat ion. Obviously ever y case is dif f er ent and individual f act or s must be t aken account of .

Misdeclar at ion Penalt y

575

Answer 1

The cor r ect posit ion, which is always our st ar t ing point t o det er mine GAT, is as f ollows; Out put t ax £ 700,000; and I nput t ax £ 250,000 (input t ax was or iginally £ 600,000, but £ 350,000 of t hat had been misclaimed). This leaves an amount due of £ 450,000. GAT is t her ef or e £ 700,000 plus £ 250,000 i.e. t he cor r ect out put t ax plus t he cor r ect input t ax. That equals £ 950,000. 30% of £ 950,000 is £ 285,000 and we compar e t his t o an er r or of £ 350,000. The er r or is bigger t her ef or e a penalt y of 15%, i.e. £ 52,500 will be levied. This is in addit ion t o t he t r ader having t o pay £ 350,000 of addit ional VAT, i.e. t he over claimed input t ax and t he int er est on t hat amount .

Answer 2

The cor r ect answer is zer o. Ther e is no penalt y due. The t r ue amount of t ax is £ 175,000 i.e. cor r ect out put t ax minus cor r ect input t ax. 30% of t his is £ 52,500. The under assessment was f or £ 50,000. This is lower t han t he penalt y-qualif ying amount . Consequent ly no misdeclar at ion penalt y will be levied. Do r emember however , t hat t he t r ader will st ill have t o pay t he ext r a VAT due i.e. t he £ 50,000 plus int er est on t hat amount .


SUMMARY – MISDECLARATION PENALTY I f a VAT r et ur n is submit t ed which is incor r ect , a misdeclar at ion penalt y will only be char ged if t he er r or exceeds cer t ain limit s. The f ir st limit is wher e t he er r or is gr eat er t han or equal t o £ 1 million. The second limit is wher e t he er r or is gr eat er t han or equal t o 30% of t he gr oss amount of t he t ax – i.e. out put t ax plus input t ax as cor r ect ed f or t he er r or . Wher e t he er r or exceeds t hese limit s a penalt y will apply which is equal t o 15% t imes t he er r or . I f an assessment is issued which under st at es a t r ader ’s liabilit y t o VAT and wit hin 30 days f ollowing t he assessment no act ion is t aken by t he t r ader t o dr aw t he under est imat e t o t he at t ent ion of Cust oms, t hen a penalt y may ar ise. Again t he penalt y ar ises if t he amount of t he er r or – i.e. t he under assessment exceeds cer t ain limit s. These limit s ar e gr eat er t han or equal t o £ 1 million or gr eat er t han or equal t o 30%, t his t ime of t he t r ue amount of t ax which is t he t r ue t ax t hat should have been assessed. I f a penalt y is char ged it is 15% of t he er r or . Reasonable excuse is one way t o avoid t he misdeclar at ion penalt y. Volunt ar y disclosur e of an er r or will also avoid t he penalt y. I f t he er r or is char ged t hen Cust oms have t he power t o mit igat e t he penalt y by up t o 100%.

E15b: LATE REGISTRATION PENALTY

This chapt er looks at t he penalt y t hat is char ged wher e a t r ader is lat e not if ying Cust oms t hat he should have been r egist er ed f or VAT.

E15b.1 Introduction

When a t r ader is lat e not if ying Cust oms t hat he should be r egist er ed f or VAT t hr ee t hings happen:

• His registration is backdated t o t he dat e f r om which he was liable t o be r egist er ed. So in ot her wor ds, f r om t he dat e t o which he should have been r egist er ed if he had not if ied t hem on t ime.

• He must also account for output tax on his supplies and deemed

supplies f r om t hat dat e, i.e. f r om t he dat e on which he should have been r egist er ed. However , cr edit f or input t ax can be given, if t he nor mal r ecover y r ules have been sat isf ied on pur chases made in t he same per iod of t ime.

• He is liable to a late registration penalty f or t he per iod of def ault , unless he can convince Cust oms t hat t her e is a r easonable excuse f or his delay.

E15b.2 The Penalty

The lat e r egist r at ion penalt y is a per cent age of t he net t ax due f or t he per iod of def ault and t hat per cent age depends on t he delay involved. The per iod of delay is f r om when Cust oms should have been not if ied t o when t hey f inally wer e not if ied or discover ed t he f act t hat t he t r ader should have been r egist er ed f or VAT.

s. 67

I f r egist r at ion is no more than 9 months late, t hen a 5% penalty is imposed.

I f r egist r at ion is over 9 months, but not more than 18 months late, t hen a 10% penalty.

I f r egist r at ion is over 18 months late t hen a 15% penalty.

Ther e is a minimum penalty of £50 f or lat e r egist r at ion and Cust oms have t he power t o mitigate (s.70) any penalt y char ged by up t o 100%. I nt er est is not char geable on any out st anding VAT which is subj ect t o t he lat e r egist r at ion penalt y.


Example 1

G Limit ed became liable t o r egist er f or VAT f r om 1 Apr il 2006, but t he Company did not r ealise t his unt il af t er t he appoint ment of a new Finance Dir ect or in December 2006. Sales in t he per iod f r om 1 Apr il 2006 t o t he dat e Cust oms wer e not if ied, (which was 31 December 2006) wer e £ 150,000. Pr oper document at ion f or pur chases was not kept so input t ax cannot be r ecover ed f or t his per iod.

You ar e r equir ed t o calculat e t he penalt y payable by G Limit ed.

E15b.3 Reasonable Excuse

I f a t axpayer has a r easonable excuse f or not if ying Cust oms lat e, Cust oms have t he power not t o impose t he lat e r egist r at ion penalt y. Ther e is no def init ion of r easonable excuse in t he legislat ion. Ther e is, however , a def init ion of what is not a r easonable excuse.

VAT Not ice 700/ 41/ 02

par a 3.1

The legislat ion st at es t hat an insufficiency of funds t o pay t he t ax is not a r easonable excuse f or not paying VAT and t hat reliance on another person t o per f or m t he t ask is not a r easonable excuse. Reasonable excuse applies t o sever al dif f er ent penalt ies.

s.67(8)

For example, if a business had been wait ing f or it s account ant t o t ell it when it should r egist er f or VAT and t he business uses t hat as a r easonable excuse f or being lat e, t hen t hat is r eliance on anot her per son t o per f or m t he t ask and t hat is not a r easonable excuse. Hence t he penalt y would st ill be imposed.

Cust oms have issued a leaf let which gives ideas as t o when a r easonable excuse could be accept ed f or lat e r egist r at ion. I n par t icular , Cust oms ident if y compassionate circumstances and give an example of t he ser ious illness of a sole t r ader , or a close member of his f amily. Also given as an example of a r easonable excuse is wher e t her e is a t r ansf er of a business as a going concer n wher e t her e was lit t le br eak (or per haps no br eak at all) in act ivit y, r et ur ns wer e made on t ime, t ax was paid on t ime, but under t he pr evious owner ’s r egist r at ion number . This would be a r easonable excuse.

I f t her e was any doubt about t he liabilit y of supplies, f or example, if t hey wer e exempt or st andar d r at ed, and wher e cor r espondence had been ongoing wit h Cust oms t hen t hat might be a r easonable excuse. Doubt about employment st at us, wher e cor r espondence has been ongoing wit h t he Revenue on whet her t he individual is self -employed and hence subj ect t o VAT, or an employee and hence not subj ect t o VAT. This could be anot her example of a r easonable excuse.

Lat e Regist r at ion Penalt y

579

E15b.4 Leading cases

J o-Ann Neal v C&E A f r eelance model began self -employment in Apr il 1985, when she was 19 year s of age. She became liable t o r egist er f or VAT in Oct ober 1985, but did not do so unt il Mar ch 1986. The Commissioner s imposed a penalt y under what is now VATA 1994 s.67 and she appealed, cont ending t hat she had no knowledge of VAT and was unawar e t hat her income exceeded t he r egist r at ion limit s. I t was held t hat her ignor ance of t he law could not const it ut e a r easonable excuse. J War nock A t r ader , whose wif e act ed as his bookkeeper , appealed against a penalt y under what is now VATA 1994, s.67, giving evidence t hat his wif e had been ill, and t hus had been unable t o keep his books up t o dat e. He had t her ef or e been unawar e t hat his t ur nover had exceeded t he r egist r at ion t hr eshold. The t r ibunal allowed t he appeal, holding t hat t he cir cumst ances const it ut ed a r easonable excuse. K E J enkinson J , who had pr eviously been an employee, began self employment in May 1987. He sought advice concer ning VAT f r om G, an acquaint ance, whom he had met while t r avelling t o wor k by t r ain. G had t old J t hat he was a qualif ied account ant , and pr omised J t hat he would ar r ange his r egist r at ion f or VAT. I n May 1987 he gave J a r egist r at ion number , which J used on his invoices. I n Sept ember 1987 J t elephoned his local VAT of f ice t o enquir e why he had not r eceived a VAT r et ur n. I t t r anspir ed t hat t he number which G had given t o J was not an of f icial r egist r at ion number , and G had not r egist er ed J f or VAT. J subsequent ly discover ed t hat G was not in f act a qualif ied account ant . The Commissioner s imposed a penalt y on J under what is now VATA 1994 s.67, and J appealed, cont ending t hat he had a r easonable excuse because he had genuinely believed t hat he was r egist er ed. The t r ibunal allowed J ’s appeal. Mer ely delegat ing a t alks t o a t hir d par t y was not a r easonable excuse, but in t his case J had act ually been given what he believed t o be a r egist r at ion number , and G’s misr epr esent at ions did amount t o a r easonable excuse.


Example 2

Fr an uses her r edundancy pay t o st ar t up a t ea r ooms in Didsbur y village. Her t akings ar e as f ollows: £ £ 2006 2007

Apr il 2,000 8,000 May 5,000 12,000 J une 7,000 18,000 J uly 8,000 25,000 August 11,000 30,000 Sept ember 15,000 27,000 Oct ober nil nil November 14,000 15,000 December 8,000 J anuar y 2006 3,000 Febr uar y 2006 3,000 Mar ch 2006 6,000

Fr an’s only cost s ar e f ood (which of cour se is zer o r at ed and has no VAT input t ax on it ), st af f wages and r ent on t he shop. Fr an closes in Oct ober each year t o go on holiday. I n November 2007 Fr an r ealises t hat she should have r egist er ed f or VAT and she t hen not if ies Cust oms on For m VAT 1 on 30 November 2007.

You ar e r equir ed t o calculat e t he penalt y Fr an will be liable t o pay due t o her lat e not if icat ion.

Lat e Regist r at ion Penalt y

581

Answer 1

G Limit ed had sales in t he def ault per iod, 1 Apr il 2006 t o 31 December 2006 which ar e deemed t o be VAT inclusive. I t did not char ge VAT because it was not VAT r egist er ed, but must t r eat t he amount char ged as if it included VAT, because r eally it should have included VAT since t he t r ader should have been VAT r egist er ed. So £ 150,000 x 7/ 47 gives t he out put VAT due which is £ 22,340. The penalt y is a per cent age of t his out put VAT due. The Company not if ied Cust oms not mor e t han 9 mont hs lat e so a 5% penalt y will apply which gives an over all lat e r egist r at ion penalt y of £ 1,117.

Answer 2

Adding up Fr an’s t ur nover on a mont hly basis one f inds t hat by t he t ime she get s t o t he end of November 2006 she has had a t ur nover of £ 62,000. This exceeds t he VAT r egist r at ion limit of £ 61,000. Ther ef or e Fr an should have not if ied Cust oms by t he end of December 2006 and t hey would have r egist er ed Fr an f r om 1 J anuar y 2007. Thus t he dat e on which she should have been r egist er ed f or VAT is 1 J anuar y 2007 and t his is basically t he st ar t of her def ault per iod.

The def ault per iod will t hen r un unt il t he dat e Fr an f inally got ar ound t o not if ying Cust oms which was 30 November 2007 and in t his per iod of t ime her sales t ot al £ 147,000. These sales ar e deemed t o be VAT inclusive. So VAT at 7/ 47t hs is £ 21,894.

Because Fr an was bet ween 9 and 18 mont hs lat e not if ying Cust oms t her e is going t o be a 10% penalt y which is a £ 2,189 penalt y f or lat e not if icat ion of r egist r at ion.


SUMMARY – LATE REGISTRATION PENALTY A lat e r egist r at ion penalt y is applied t o t he VAT which is due and payable on t he f ir st VAT r et ur n t hat must be submit t ed by t he t r ader which cover s t he per iod f r om t he dat e t he t r ader should have been r egist er ed unt il t he dat e he f inally not if ies Cust oms of his liabilit y t o r egist r at ion. The lat e r egist r at ion penalt y is a per cent age of t he net t ax due f or t he per iod of def ault and t he per cent age depends on t he delay involved. The per iod of def ault is t he per iod of delay f r om when Cust oms should have been not if ied t o when Cust oms f inally wer e not if ied t hat t he t r ader was liable t o r egist er f or VAT. I f r egist r at ion is no mor e t han 9 mont hs lat e a 5% penalt y applies. Over 9 mont hs but not mor e t han 18 mont hs lat e, a 10% penalt y applies. Over 18 mont hs lat e r esult s in a 15% penalt y. Ther e is a minimum penalt y of £ 50 and Cust oms have t he power t o mit igat e any penalt y char ged by up t o 100%. I f a t axpayer has a r easonable excuse f or not if ying Cust oms lat e, t hen Cust oms have t he power not t o impose t he penalt y.

E15c: DEFAULT SURCHARGE

Wher e a VAT r et ur n is submit t ed lat e or a payment of VAT is made lat e, t hen a def ault sur char ge may ar ise. This chapt er looks at when t he def ault sur char ge ar ises and how it can be avoided.

E15c.1 Introduction

A def ault is wher e eit her a VAT r et ur n is submit t ed lat e or a payment of VAT is made lat e. I n such a case a def ault sur char ge may be imposed on t he wr ongdoer . The first time a def ault occur s Cust oms ef f ect ively issue a warning. The war ning is t he issue of a def ault sur char ge liabilit y not ice and such a not ice will cover a per iod of 12 mont hs. I n ot her wor ds t he t r ader is put on war ning f or t he next 12 mont hs. The 12 mont h per iod is ef f ect ively t he per iod t hat ends on t he anniver sar y of t he end of t he account ing per iod of t he def ault . This 12 month period is called the Surcharge Period.

s.59

A def ault dur ing t his 12 mont h sur char ge per iod has 2 consequences. Fir st ly a sur char ge is calculat ed. The sur char ge is a per cent age of t he unpaid t ax due. The second consequence is t hat t he sur char ge per iod is ext ended t o 12 mont hs f r om t he end of t he quar t er of def ault .

E15c.2 The Surcharge

The amount of sur char ge calculat ed depends on pr evious def ault s in t he cur r ent sur char ge per iod.

No. of def ault s dur ing cur r ent sur char ge per iod

% of unpaid VAT

1 2 2 5 3 10

4 or mor e 15 For 1 def ault dur ing t he cur r ent sur char ge per iod (i.e. t he t r ader ’s f ir st def ault dur ing t hat 12-mont h per iod), 2% of t he unpaid VAT will equal t he amount of t he sur char ge. For t he second def ault it is 5%, f or t he t hir d def ault 10% and t hen f or t he f our t h or any subsequent def ault 15% of t he unpaid VAT is t he amount of sur char ge t he t r ader has t o pay. The t r ader has t o pay t he unpaid VAT as well. The t r ader ’s def ault sur char ge is in addit ion t o t he unpaid VAT.

s.59

Cust oms will not assess a sur char ge of less t han £ 400 unless t he 10% or t he 15% r at e applies in which case t hey will assess t he sur char ge, what ever amount it is and bear ing in mind t hat t her e is a minimum char ge of £ 30.



A sur char ge liabilit y will not apply if a nil or a r epayment r et ur n has been submit t ed lat e. A nil r et ur n is one wher e t he amount of VAT due is exact ly nil. Nor will it apply if t he t ax is paid on t ime alt hough t he r et ur n it self is submit t ed lat e. However , in t hese scenar ios, t her e has st ill been a lat e r et ur n and so t her e has st ill been a def ault . The sur char ge per iod will t her ef or e be ext ended. However , such an event does not incr ease t he r at e of sur char ge f or t he next def ault in t he sur char ge liabilit y per iod. I n addit ion, t o help small businesses penalt ies will not be applied aut omat ically f or lat e payment wher e t he t axable t ur nover of t he business is less t han £ 150,000.

Example 1

Alpha Lt d has submit t ed r ecent VAT r et ur ns as f ollows;

Dat e Dat e Quar t er t o submit t ed VAT due VAT paid Def ault £

31.3.05 28.4.05 5,000 28.5.05 30.6.05 20.7.05 10,000 20.7.05 30.9.05 25.11.05 (5,000) N/ A 31.12.05 25.1.06 15,000 25.1.06 31.3.06 21.4.06 12,000 21.4.06 30.6.06 17.7.06 10,000 25.7.06 30.9.06 2.11.06 13,000 2.11.06 31.12.06 19.1.07 11,000 19.1.07 Tick t he box t o show which r et ur ns ar e in def ault .

Def ault Sur char ge

585

Illustration 1

Alpha Lt d has submit t ed r ecent VAT r et ur ns as f ollows; Dat e Dat e Quar t er t o submit t ed VAT due VAT paid Def ault £

31.3.05 28.4.05 5,000 28.5.05 R 30.6.05 20.7.05 10,000 20.7.05 30.9.05 25.11.05 (5,000) N/ A R 31.12.05 25.1.06 15,000 25.1.06 31.3.06 21.4.06 12,000 21.4.06 30.6.06 17.7.06 10,000 25.7.06 30.9.06 2.11.06 13,000 2.11.06 R 31.12.06 19.1.07 11,000 19.1.07 The f ir st def ault r et ur n is t he r et ur n t o 31 Mar ch 2005. This is t he f ir st ever def ault so a war ning is issued, in ot her wor ds a sur char ge liabilit y not ice (SLN) is issued which cover s t he 12 mont h per iod f r om 1 Apr il 2005 t o 31 Mar ch 2006.

The next def ault r et ur n is t he r et ur n t o 30 Sept ember 2005, t his is dur ing t he sur char ge per iod and so a sur char ge will be calculat ed.

This is t he f ir st def ault in t he sur char ge per iod - 2% sur char ge.

However , it is r epayment r et ur n, so t her e is act ually no VAT due t o Cust oms and 2% of not hing is not hing. Thus, ef f ect ively, no sur char ge is act ually char ged. However , t he sur char ge per iod is st ill ext ended t o 30 Sept ember 2006, i.e. 12 mont hs f r om t his cur r ent def ault . The 2% penalt y r at e is not used and is ‘saved’ f or next t ime!

The next def ault j ust f alls int o t he 12-mont h sur char ge per iod because it is t he r et ur n t o 30 Sept ember 2006. The 2% sur char ge is st ill available. Thus 2% of £ 13,000, t he VAT t hat was due, gives a £ 260 def ault sur char ge penalt y. However , since t his is less t han £ 400 it will not be collect ed by Cust oms. The sur char ge per iod is also ext ended t o 30 Sept ember 2007.


15c.3 Avoiding Default Surcharge

Ef f ect ively t he only way t o “escape” from the surcharge period is to submit 4

quarterly returns, or f or mont hly r et ur ns 12 mont hly r et ur ns, on time and pay

the VAT due on time. I n t his way t he sur char ge per iod t hen j ust elapses and t he t r ader st ar t s again wit h a clean sheet . I f a t r ader def ault ed again t hat would be t he f ir st def ault , a war ning would be issued, in ot her wor ds a sur char ge liabilit y not ice would be issued f or t he next 12 mont hs, but no penalt y as yet . I f t he t r ader t hen def ault ed in t hat sur char ge per iod he would be int o t he 2% penalt y and so on. The t r ader must get t hose 4 quar t er ly r et ur ns in on t ime and t he VAT paid on t ime if he want s t o st ar t all over again wit h a clean sheet .

A default can be disregarded f or t he pur poses of t he penalt y in t wo sit uat ions. The f ir st sit uat ion is wher e t he return and the tax were dispatched t o Cust oms at such a t ime and in such a manner t hat it was expected that they would arrive on time. Cust oms have indicat ed t hat post ing a r et ur n f ir st class at least 1 wor king day pr ior t o t he due dat e is accept ed as r easonable. The second sit uat ion is wher e t he t r ader had a reasonable excuse for his

default. Alt hough it is f ar f r om easy t o sat isf y Cust oms t hat a r easonable excuse exist s, case law indicat es t hat a dist inct ion should be dr awn bet ween t he r eason f or t he f ailur e and t he excuse. That is if t he t r ader ’s lat eness can be t r aced not t o say an insuf f iciency of f unds, but r at her t o some under lying cause of t hat insuf f iciency of f unds t hen a r easonable excuse may be accept ed.

s.59 s.71

I n t he case of C&E Commr s v Salevon Lt d a shor t f all in f unds due t o t he dishonest y of a f or mer employee was held t o be a r easonable excuse. I n t he case of C&E Commr s v St ept oe it was held t hat t her e was r easonable excuse wher e t he t axpayer was unable t o pay t he VAT due because t he cust omer f or whom he wor ked almost exclusively was per sist ent ly lat e in paying invoices. Finally, it should be not ed t hat def ault sur char ge cannot be mitigated, it is an all or not hing penalt y.

15c.4 Alternatives

The def ault sur char ge syst em is not appr opr iat e f or ever y t r ader . For example, a t r ader t hat submit s ever y f if t h r et ur n lat e, will never act ually be penalised under t he def ault sur char ge syst em. For such t r ader s Cust oms have t he opt ion of imposing an alt er nat ive daily penalt y. Ther e is also a separ at e def ault sur char ge syst em f or lar ge t r ader s who have t o make payment s on account .


587

Example 2

Tick t he answer box if t he st at ement is cor r ect :

1. I f t he t ax is paid on t ime t hen a lat e VAT r et ur n does not

const it ut e a def ault

2. I f t he r et ur n t o 30 Sept ember 2006 is lat e t he sur char ge per iod

will r un t o 30 Sept ember 2007.

3. A sur char ge of less t han £ 400 will always not be collect ed by

Cust oms

4. Def ault sur char ge can be mit igat ed by Cust oms.

5. A VAT r et ur n sent on t ime but which ar r ives lat e due t o a post al st r ike is disr egar ded f or def ault sur char ge pur poses.


Answer 1

Dat e Dat e Quar t er t o submit t ed VAT due VAT paid Def ault £

31.3.05 28.4.05 5,000 28.5.05 R 30.6.05 20.7.05 10,000 20.7.05 30.9.05 25.11.05 (5,000) N/ A R 31.12.05 25.1.06 15,000 25.1.06 31.3.06 21.4.06 12,000 21.4.06 30.6.06 17.7.06 10,000 25.7.06 30.9.06 2.11.06 13,000 2.11.06 R 31.12.06 19.1.07 11,000 19.1.07 When looking at t he r et ur n f or t he quar t er ended Mar ch 2005 it is obvious t hat t he VAT is paid lat e, alt hough t he r et ur n it self has been submit t ed on t ime, so t his is a def ault .

I n t he next r et ur n, bot h t he VAT and t he cash is on t ime.

Looking at t he r et ur n t o 30 Sept ember 2005, t his t ime t he r et ur n is lat e, but t her e is no VAT t o be paid because it is a r epayment r et ur n. However , because t he r et ur n is lat e it is st ill in def ault .

The next 3 r et ur ns ar e all submit t ed on t ime and t he cash is paid on t ime. The 30 Sept ember 2006 r et ur n is a sit uat ion wher e bot h t he r et ur n and t he cash is lat e - t hus anot her def ault .

Answer 2

1. I f t he t ax is paid on t ime t hen a lat e VAT r et ur n does not

const it ut e a def ault X

2. I f t he r et ur n t o 30 Sept ember 2006 is lat e t he sur char ge per iod

will r un t o 30 Sept ember 2007.

R

3. A sur char ge of less t han £ 400 will always not be collect ed by Cust oms

X

4. Def ault sur char ge can be mit igat ed by Cust oms. X

5. A VAT r et ur n sent on t ime but which ar r ives lat e due t o a post al st r ike is disr egar ded f or def ault sur char ge pur poses.

R


589

SUMMARY – DEFAULT SURCHARGE

A def ault is wher e eit her a VAT r et ur n is submit t ed lat e or a payment of VAT is made lat e. For t he f ir st def ault , Cust oms issue a war ning called a sur char ge liabilit y not ice which out lines a per iod of 12 mont hs st ar t ing wit h t he end of t he t ax r et ur n of def ault . This 12 mont h per iod is called t he sur char ge per iod. The def ault dur ing t he 12 mont h sur char ge per iod has t wo consequences. Fir st ly a sur char ge is calculat ed which could be at a 2% r at e f or a f ir st def ault , 5% f or a second def ault , 10% f or a t hir d def ault , 15% f or a f our t h or mor e def ault . The per cent age is of t he unpaid VAT as at t he nor mal due dat e. The second consequence is t hat t he cur r ent sur char ge per iod is ext ended t o 12 mont hs f r om t he dat e of t he cur r ent def ault . Cust oms will not assess a sur char ge of less t han £ 400 unless t he 10% or 15% r at e is applying. Ther e is a minimum char ge of £ 30, when consider ing t he 10% and 15% penalt y. A sur char ge liabilit y will not apply if a nil or r epayment VAT r et ur n has been submit t ed lat e. However , because t her e has been a lat e r et ur n t he sur char ge per iod will st ill be ext ended.

E15d: REPEATED MISDECLARATION PENALTY The r epeat ed misdeclar at ion penalt y applies in sit uat ions wher e t he misdeclar at ion penalt y will not apply but t he t r ader is making r epeat ed small er r or s. This chapt er will look at : wher e t he r epeat ed misdeclar at ion penalt y applies; how much is char ged; how t o avoid t he penalt y.

E15d.1 Introduction

Ther e is a penalt y called t he r epeat ed misdeclar at ion penalt y which only applies t o er r or s t hat ar e const ant ly being r epeat ed but ar e of such a size t hat t hey ar e t oo small t o suf f er a penalt y under t he misdeclar at ion penalt y r egime. The r epeat ed misdeclar at ion penalt y it self is 15% of t he t ax lost if t he er r or had not been discover ed. Repeat ed misdeclar at ion penalt y does not apply t o under assessment s but only applies wher e VAT r et ur ns under st at e t he out put t ax t hat is due or over st at e t he ent it lement t o input t ax r ecover y. When cont r ast ing r epeat ed misdeclar at ion penalt y t o t he st r aight f or war d misdeclar at ion penalt y, t his penalt y only applies t o VAT r et ur ns wher eas t he ot her penalt y applies t o bot h VAT r et ur ns and assessment s.

s.64

E15d.2 Material Inaccuracy

For t he r epeat ed misdeclar at ion penalt y t o apply t her e needs t o be a mat er ial inaccur acy in a r et ur n, t he quant it y of which equals or exceeds t he lower of t wo t hings - £ 500,000 and 10% of t he gr oss amount of t ax f or t he per iod. The gr oss amount of t ax (GAT) f or t he per iod is calculat ed in exact ly t he same way as f or t he misdeclar at ion penalt y; it is t he cor r ect amount of out put t ax added t o t he cor r ect amount of input t ax. However , t his t ime only 10% of GAT is used t o decide if t he er r or , (inaccur acy) war r ant s a penalt y being char ged.

Illustration 1

J ules submit s her VAT r et ur n t o 31 December 2006 showing:

£ Out put t ax 137,500 I nput t ax (57,500)

Net out put t ax due 80,000

The cor r ect amount of out put t ax is lat er est ablished as £ 160,000. Thus out put t ax was or iginally under st at ed by £ 22,500.

Repeat ed Misdeclar at ion Penalt y

591

The under st at ement is quant if ied at £ 22,500. I s t hat sizeable enough t o be consider ed a mat er ial inaccur acy f or t he pur poses of r epeat ed misdeclar at ion penalt y?

The £ 22,500 under st at ement is a mat er ial inaccur acy if it equals or exceeds t he lower of :

(i) £ 500,000

(ii) 10% of GAT.

GAT = £ (137,500 + 22,500 + 57,500)

10% of £ 217,500 = £ 21,750

The lower f igur e is £ 21,750. £ 22,500 er r or exceeds t his so it is a mat er ial inaccur acy.

Example 1

XYZ Lt d submit s it s VAT r et ur n t o 31 Mar ch 2007 showing: £ Out put t ax 720,000 I nput t ax 480,000

VAT Payable 240,000

I t is lat er discover ed t hat input t ax should have been £ 400,000. I s t her e a mat er ial inaccur acy?

E15d.3 Penalty Liability Notice

Once a mat er ial inaccur acy has been made, t hen Cust oms have t he power t o issue somet hing known as a Penalt y Liabilit y Not ice (PLN). The PLN cover s a cer t ain per iod of t ime (see below).

s.64

A Penalt y Liabilit y Not ice must be issued by t he end of t he f our t h consecut ive r et ur n per iod af t er t he r et ur n per iod in which t he mat er ial inaccur acy was made. The PLN will cover a per iod equal t o eight consecut ive VAT r et ur ns beginning wit h t he VAT r et ur n in which t hat PLN is issued.

Illustration 2

Consider again I llust r at ion 1 and J ules. The VAT r et ur n t hat J ules submit t ed which had t he mat er ial inaccur acy on it was t he r et ur n f or t he quar t er ended 31 December 2006. Cust oms can issue a PLN at any t ime t o t he end of t he f our t h consecut ive r et ur n per iod t hat f ollows t his r et ur n Per iod. So basically, t hey can issue a PLN at any point up t o t he 31 December 2007.


Cust oms issue a PLN on 25 November 2007, which is wit hin our t ime per iod. This PLN will cover eight consecut ive r et ur n per iods beginning wit h t he one in which t he PLN is issued. This PLN is issued in November 2007 which is t he quar t er ly r et ur n r unning f r om 1 Oct ober 2007 t o 31 December 2007. That is t he f ir st r et ur n t hat will be cover ed by t he eight r et ur n per iods. The PLN will cover t he per iod f r om 1 Oct ober 2007 unt il t he 30 Sept ember 2009. This per iod is an eight VAT r et ur ns per iod.

A t r ader is only act ually liable t o pay a r epeat ed misdeclar at ion penalt y if he makes a mat er ial inaccur acy dur ing t he eight VAT r et ur ns PLN per iod. Even t hen he does not pay a penalt y on his f ir st mat er ial inaccur acy in t hat per iod – he will only suf f er a penalt y f or any second or subsequent mat er ial inaccur acy. The mat er ial inaccur acy is always calculat ed t o see if t he er r or exceeds or equals t he lower of t he t wo f igur es.

Illustration 3

Consider t he pr evious I llust r at ion and say t hat af t er t he penalt y liabilit y not ice is issued, J ules makes t wo mor e mat er ial inaccur acies in t he eight r et ur ns per iod. The f ir st mat er ial inaccur acy is in t he VAT r et ur n per iod t o 31 Mar ch 2008 and t ot als £ 45,000 – t hat is t he amount of her er r or . The second mat er ial inaccur acy is in t he VAT r et ur n per iod t o 31 December 2008 and t ot als £ 52,000.

Ther e is no penalt y in r espect of t he f ir st mat er ial inaccur acy made in t hat eight r et ur ns per iod. But f or any second or subsequent mat er ial inaccur acy t her e is a penalt y and t he penalt y is 15% of t he er r or - 15% x £ 52,000 = a £ 7,800 penalt y. The penalt y is paid in addit ion t o t he ext r a t ax t hat needs t o be paid.

E15d.4 Other points

An er r or at t r act ing a misdeclar at ion penalt y will not also be subj ect t o a r epeat ed misdeclar at ion penalt y. But , an er r or can count as a mat er ial inaccur acy f or which Cust oms could issue a penalt y liabilit y not ice or if a not ice has alr eady been issued and an eight r et ur n penalt y per iod is r unning, t hen it could be t r eat ed as a f ir st mat er ial inaccur acy dur ing t hat penalt y per iod.

s.64

An er r or will not count as a mat er ial inaccur acy (MI ) no mat t er what it s size is if t her e is a r easonable excuse f or t he er r or . Thus if t he per son who has made an inaccur acy on a VAT r et ur n has a r easonable excuse f or doing so, t hen t he er r or is not t r eat ed as an MI .

s.71

An er r or will also not count as an MI if t her e is a f ull volunt ar y disclosur e t o Cust oms of t he er r or at a t ime when t he t r ader has no r eason t o believe he is being invest igat ed by Cust oms – so it is pur ely volunt ar y. The ext r a t ax due because of t he er r or will have t o be paid, but t he penalt y will not be incur r ed or t he r egime will not be t r igger ed on t op.


593

I f a r epeat ed misdeclar at ion penalt y is char ged t hen mit igat ion against t he penalt y is available at Cust om’s discr et ion.

s.70

Example 2

I n t he pr evious example involving XYZ Limit ed, assuming t hat t he VAT r et ur n t o 31 Mar ch 2007 did cont ain a mat er ial inaccur acy. Up t o which dat e can Cust oms issue a Penalt y Liabilit y Not ice? a) 31.3.2008 b) 31.3.2009 c) 31.3.2010 d) 31.3.2011


Answer 1

I naccur acy = over declar at ion of input VAT. = £ 80,000 Mat er ial inaccur acy if equals or exceeds t he lower of : (i) £ 500,000 (ii) 10% x GAT

10% x £ (720,000 + 400,000) 10% x £ 1,120,000 = £ 112,000

Lower f igur e is £ 112,000. £ 80,000 does not equal/ exceed t his t hus not mat er ial inaccur acy.

Answer 2

The answer is A. The PLN must be issued bef or e t he end of t he f our t h consecut ive r et ur n per iod af t er t he r et ur n per iod in which t he mat er ial inaccur acy is made.


595

SUMMARY – REPEATED MISDECLARATION PENALTY A r epeat ed misdeclar at ion penalt y only applies wher e a VAT r et ur n under st at es t he out put t ax due or over st at es t he ent it lement t o input t ax r ecover y. I t does not apply t o under -assessment s. The penalt y applies wher e t her e is a mat er ial inaccur acy in a r et ur n which equals or exceeds t he lower of £ 500,000 and 10% of t he gr oss amount of t ax f or t he per iod. The gr oss amount of t ax is t he out put t ax plus t he input t ax as cor r ect ed f or t he er r or . Once a mat er ial inaccur acy has been made, Cust oms have t he power t o issue a penalt y liabilit y not ice. This not ice must be issued by t he end of t he f our t h consecut ive r et ur n per iod af t er t he VAT r et ur n per iod in which t he mat er ial inaccur acy was made. The penalt y liabilit y not ice will cover a per iod of 8 consecut ive VAT r et ur ns beginning wit h t he VAT r et ur n in which t he penalt y liabilit y not ice is issued. I f a t r ader makes a mat er ial inaccur acy dur ing t he 8 VAT r et ur n penalt y liabilit y not ice per iod, t hen he will not pay a penalt y on his f ir st mat er ial inaccur acy in t hat per iod. Rat her , he will suf f er a penalt y f or his second or subsequent mat er ial inaccur acy in t hat per iod. The penalt y will be equal t o 15% of t he inaccur acy.

E15e: OTHER PENALTIES, INTEREST AND MITIGATION

This chapt er looks at a var iet y of penalt ies and t he pot ent ial mit igat ion of t hose penalt ies, including: when cr iminal pr osecut ion may occur as an alt er nat ive t o a penalt y f or civil f r aud; what happens when VAT invoices or cer t if icat es of zer o r at ing ar e issued wit hout aut hor it y; t he var iet y of penalt ies t o discour age t r ader s f r om making a var iet y of br eaches of t he r egulat ions; when int er est is char ged on VAT t hat is over due; what happens when er r or s ar e discover ed; when Cust oms ar e willing t o mit igat e penalt ies t hat t hey have char ged t he t r ader .

E15e.1 Criminal Prosecution

A cr iminal pr osecut ion can r esult f or of f ences such as; s. 72

• f r audulent evasion of VAT;

• f ur nishing f alse document s or inf or mat ion;

• making f alse st at ement s. Cr iminal pr osecut ion is r eser ved f or t he mor e ser ious VAT of f ences. Criminal fraud is wher e a per son knowingly t akes st eps t o evade VAT or t o enable anot her per son t o evade VAT. Cr iminal pr oceedings will be t aken in such a case. The level of penalt y t hat will r esult f r om t he cr iminal pr oceedings depends on whet her t he convict ion is secur ed as a summar y convict ion, in ot her wor ds in a magist r at es cour t , or a convict ion on indict ment , which is basically a convict ion bef or e a j ur y, so in a Cr own Cour t . I n eit her case t he penalt y consist s of a f ine and/ or impr isonment .

I f someone is held t o be guilt y of cr iminal f r aud in a Magist r at es cour t , t he maximum t er m of impr isonment is 6 mont hs and t he maximum f ine t hat can be imposed is t he gr eat er of £ 5,000 or 3 t imes t he t ax evaded. Cont r ast t his t o wher e someone is f ound guilt y in a cr iminal cour t , i.e. a pr oper Cr own Cour t , wher e t he maximum imprisonment is 7 year s and t he f ine is unlimit ed.

E15e.2 Civil Fraud

Civil f r aud is basically t he civil equivalent of cr iminal f r aud, but it is easier f or Cust oms t o pr ove civil f r aud since t hey only have t o pr ove it on t he “balance of pr obabilit ies” which is cont r ast ed wit h a Cr iminal Cour t wher e pr oof has t o be “beyond r easonable doubt ” t hat f r aud was commit t ed. Civil f r aud ar ises wher e a per son t akes st eps or omit s t o t ake st eps in or der t o evade VAT and his conduct involves dishonest y.

s. 60 s. 71

Ot her Penalt ies, I nt er est and Mit igat ion

597

The penalty for civil fraud is 100% of the tax evaded. The t ax evaded has t o be paid as well so ef f ect ively you ar e paying t his amount t wice. Cust oms have t he power t o mit igat e t his penalt y by up t o 100%.

HMRC have announced a new appr oach t o civil invest igat ion of f r aud. I n t he past , t he pr ocedur es have been dif f er ent f or t he t wo depar t ment s – t he I nland Revenue used t he “Hansar d pr ocedur e”, and Cust oms invest igat ed under Not ice 730. The mer ger of t he depar t ment s, t he cont inuing impact of t he Human Right s Act , and comment s f r om t he cour t s in a number of cases about invest igat ions, have led t o changes. The f ull st at ement of t he new appr oach is r epr oduced her e:

Issue

Bot h HM Cust oms and Excise and t he I nland Revenue had pr ocedur es f or t ackling ser ious act s of evasion using civil power s. The f or mer I nland Revenue’s Hansar d pr ocedur es and t he f or mer Cust oms & Excise Civil Evasion pr ocedur es (excluding Cust oms Dut ies Civil Evasion Penalt ies applied t o t r aveller s at por t s and air por t cont r ols) ar e being r eplaced wit h a common Civil I nvest igat ions of Fr aud pr ocedur e f or HMRC.

Date

The new pr ocedur es will come int o ef f ect on 1st Sept ember 2005 f or new cases wit h a new Code of Pr act ice 9 (2005). Exist ing cases will be wor ked t o a conclusion under t he old Hansar d pr ocedur es (Code of Pr act ice 9 ), New Appr oach or Not ice 730. I nit ially t he pr ocedur e will only be used by of f icer s ser ving in HMRC Special Civil I nvest igat ions.

Why we are introducing a new civil fraud procedure?

I t is being int r oduced t o ensur e t hat HMRC has in place a single pr ocedur e f or dealing wit h cases of ser ious f r aud which is consist ent acr oss all indir ect and dir ect t ax r egimes.

What are the main changes?

The main pr ocedur al change will impact on t he f or mer I nland Revenue Hansar d policy. Under t he new pr ocedur e, it will not be necessar y t o conduct int er views under caut ion or t o t ape r ecor d t hose meet ings.


What does the procedure offer to the taxpayer?

I t will of f er t he t axpayer one oppor t unit y t o secur e maximum benef it f r om making a f ull disclosur e of all ir r egular it ies wit hin t he dir ect and indir ect t ax r egimes. I f a t axpayer decides not t o make a f ull disclosur e and co-oper at e, HMRC will conduct t heir own invest igat ion, using st at ut or y inf or mat ion power s if necessar y. I f ir r egular it ies ar e discover ed t hey will issue f or mal assessment s and pur sue collect ion of unpaid t ax wit h int er est . Any penalt ies due ar e likely t o be signif icant ly higher t o r ef lect t he f act t hat t axpayer s did not t ake t he oppor t unit y given t o t hem t o disclose. Once t he decision in HMRC has been made t o f ollow a civil r out e f or invest igat ion and t he pr ocedur e is of f er ed t o t he t axpayer , HMRC r et ains no under lying t hr eat of pr osecut ion f or t he or iginal t ax loss.

Does this mean you will not prosecute for the fraud under the new civil

procedures?

That is cor r ect , however , t her e is a pr osecut ion sanct ion but only f or making a mat er ially f alse disclosur e (including deliber at e f alse st at ement s dur ing t he cour se of t he invest igat ion or f ur nishing f alse document s at t he conclusion of t hat invest igat ion).

Can we have single meetings to discuss indirect and direct tax matters?

Once t he new pr ocedur e is int r oduced, wher e suspicions of ir r egular it ies cut acr oss dir ect and indir ect t axes, one single meet ing can be held t o cover all r egimes. However , t he meet ing will be st r uct ur ed so t hat each t ax is cover ed separ at ely using power s appr opr iat e t o t hat t ax; and so t hat it is clear at all t imes t o t he t axpayer which t ax is being dealt wit h and what inf or mat ion is being r equest ed f or which t ax.

Does this mean that any disclosure reports prepared by professional advisers

will now cover direct and indirect tax irregularities in the same document?

Yes, t her e ar e cost savings and ot her benef it s t o t he t axpayer in submit t ing a single disclosur e r epor t .

Are the procedures compliant with the Human Rights Act?

Yes, we believe t hey ar e. The civil f r aud pr ocesses cur r ent ly oper at ing in bot h depar t ment s have r eceived consider able scr ut iny in t er ms of Human Right s and, in par t icular , Ar t icle 6 – Right t o a Fair Tr ial. The views of t he cour t s in t he lead Human Right s Act (HRA) r ulings of Han & Yau and Gill & Gill and advice f r om leading counsel have pr ovided t he backgr ound t o def ining t he out line f or a consist ent appr oach, which incor por at es impor t ant Human Right s saf eguar ds wit hin t he pr ocedur es. The r ecent case of Khan v Commissioner s of Cust oms and Excise (2005) has endor sed t hese pr inciples, which will be inher ent in t he new pr ocedur e.

Business Br ief

18/ 05


599

E15e.3 Unauthorised Issue of VAT invoices

Cust oms have a whole r ange of civil penalt ies t hat t hey can char ge a t axpayer who has done somet hing wr ong. These penalt ies allow Cust oms t o ensur e t hat compliance wit h VAT legislat ion is t he number one concer n wit h VAT r egist er ed t r ader s, because not t o comply can cost t hem quit e dear ly.

s. 67

The f ir st penalt y is f or t he unaut hor ised issue of a VAT invoice. This would be wher e a per son who is not r egist er ed f or VAT, or ot her wise aut hor ised t o issue VAT invoices, act ually goes ahead and issues an invoice which pur por t s t o include VAT. This invoice shows VAT on it , even t hough t he per son should not be issuing a VAT invoice. The penalt y f or t his misdemeanour is t he greater of £50 or 15% of the

purported VAT and t hat is whet her or not t he amount of VAT is act ually shown separ at ely. A misdemeanour has occur r ed if t he invoice implies t hat VAT is included. This penalt y will not be due if it can be shown t hat t her e is a r easonable excuse f or t he misdemeanour .

E15e.4 Incorrect Certificates

Ther e ar e a number of sit uat ions wher e a per son has t o supply a cer t if icat e t o show t hat zer o r at ing applies, f or example t o a supply of land and buildings, or t hat a r educed r at e of VAT applies t o a supply. I f someone gives an incor r ect cer t if icat e t hey ar e liable t o a penalt y and t he penalty is equal to the tax thereby undercharged. Once again, t he penalt y can be appealed against on t he gr ounds of r easonable excuse f or t he misdemeanour .

s. 62

E15e.5 EU Sales List

An EU sales list (EUSL) has t o be submit t ed when sales ar e made t o VAT r egist er ed cust omer s in EU member st at es. Such sales ar e list ed by t he cust omer s’ over seas VAT r egist r at ion number s and show t he quant it y of sales f or ever y per iod. Ther e ar e basically t wo cir cumst ances when penalt ies can occur in r espect of an EU sales list .

s. 65 and

s. 66

The f ir st sit uat ion is f or f ailur e t o submit an EU sales list by t he due dat e. I f t he EU sales list is not submit t ed by t he due dat e, t hen Cust oms may issue a not ice. I f t he EU sales list is not submit t ed wit hin a f ur t her 14 days t hen a penalt y will be due. Penalt ies can also be levied f or any f ur t her lat e EU sales list ings unt il 12 mont hs have elapsed wit hout an EU sales list being submit t ed lat e. The penalt y is at a daily r at e of £ 5 per day, f or a f ir st def ault , £ 10 per day f or a second def ault and £ 15 per day f or any subsequent def ault .


The maximum penalt y is 100 days wor t h of t he daily r at e and t he minimum penalt y is £ 50. The second sit uat ion is wher e t her e is a mat er ial inaccur acy in any EU sales list . A mat er ial inaccur acy is def ined as t he inclusion or omission of inf or mat ion as a r esult of which t he EU sales list is misleading in any mat er ial r espect . When a mat er ial inaccur acy is f ir st discover ed Cust oms may issue a wr it t en war ning. I f a f ur t her mat er ial inaccur acy is discover ed on an EU sales list ing due f or submission wit hin t he 2 year s f ollowing t he issue of t his war ning t hen a f ur t her war ning may be issued. I f a f ur t her mat er ial inaccur acy is discover ed on an EU sales list ing dur ing t he next 2 year s t hen a penalt y of £ 100 is due. These ar e quit e complicat ed penalt ies, but ar e ver y impor t ant t o t he t r ader who makes sales over seas t o ot her EU member st at es.

E15e.6 EU trade civil penalty procedure

Businesses impor t ing and expor t ing goods f r om and t o out side t he EU ar e subj ect t o a civil penalt y r egime f or non compliance (including er r or s) and f or evasion. The non compliance penalt ies ar e int ended t o apply in cases of :

• Occasional ser ious er r or involving at least £ 10,000 of impor t VAT and/ or dut y;

• Per sist ent f ailur e t o comply wit h r egulat or y obligat ions, including low level er r or s in declar at ions, and

• Failur e t o put r ight def iciencies in syst ems, oper at ions or physical secur it y when dir ect ed t o do so by Cust oms.

War ning not ices will be issued, and t r ader s who st ill r emain non compliance will incur a penalt y of up t o £ 2,500. Ther e will be nor mal r ight s of appeal, and r easonable excuse will apply. Mit igat ion will be possible. Less ser ious cases of evasion of dut y and VAT will be liable t o civil penalt ies of up t o 100% of t he VAT and or dut y evaded, but once again mit igat ion will be available. These penalt ies do not pr event Cust oms seizing goods as f or f eit , but allow a speedy r esolut ion f or non compliance and minor evasion cases.

E15e.7 Breaches of Regulations

Also included in t he legislat ion is a r eal ‘cat ch ever yt hing else’ t ype clause; br eaches of r egulat ions. Ef f ect ively t hese ar e penalt ies f or br eaches of VAT r egulat ions of any kind. Ther e ar e dif f er ent br eaches out lined and dif f er ent penalt ies out lined below.

s. 69


601

Br each Penalt y Failur e t o not if y cessat ion of t axable supplies (Not e 1)

Fixed Daily Rat e (FDR)

Failur e t o make r ecor ds FDR Failur e t o r et ain r ecor ds £ 500 Failur e t o f ur nish inf or mat ion and document s FDR Failur e t o make a VAT r et ur n (Not e 2) Failur e t o pay VAT due on t ime

Gr eat er of FDR and t ax gear ed penalt y

Any ot her br each of r egulat ions FDR

Note 1

The f ir st br each is t he f ailur e t o not if y cessat ion of t axable supplies – i.e. a t r ader doesn’t t ell Cust oms t hat he is no longer making t axable supplies. The penalt y f or t his is t he f ixed daily r at e penalt y.

Note 2

For a f ailur e t o make a VAT r et ur n and a f ailur e t o pay t he VAT due on t ime - t he penalt y in t his case is t he gr eat er of t he f ixed daily r at e and a t ax gear ed penalt y. An ear lier session looked at def ault sur char ge which penalised a t r ader f or making VAT r et ur ns lat e and f ailing t o pay VAT on t ime. This penalt y is an alt er nat ive f or Cust oms t o using t he def ault sur char ge penalt y r egime.

The penalt y char ged depends on t he number of pr evious f ailur es in t he last t wo year s.

Number of previous failures Fixed Daily Rate Tax Geared

Penalty

No f ailur e in pr evious 2 year s £ 5 1/ 6% of t ax due One f ailur e in pr evious 2 year s £ 10 1/ 3% of t ax due Two f ailur es in pr evious 2 year s £ 15 1/ 2% of t ax due I f t her e has been no f ailur e, (no br each of r egulat ion in t he pr evious t wo year s) t he f ixed daily r at e is £ 5 per day and t he t ax gear ed penalt y is one sixt h of 1% of t he t ax due. Wit h one f ailur e in t he pr evious t wo year s t he f ixed daily r at e penalt y goes up t o £ 10 per day and t he t ax gear ed penalt y is one t hir d of 1% of t he t ax due. Wit h 2 f ailur es in t he pr evious 2 year s, t he f ixed daily r at e is £ 15, t he t ax gear ed penalt y is one-half of one per cent of t he t ax due. The minimum penalt y char ged is £ 50. The maximum penalt y char ged is 100 days wor t h of t he appr opr iat e penalt y. The daily penalt y can only be assessed, in t he case of a f ailur e t o submit r et ur ns or pay t ax on t ime, if Cust oms have issued a wr it t en war ning of t he consequences of t he t r ader ’s f ailur e t o comply wit h his obligat ions.


Example 1

Paul’s VAT r et ur n f or t he quar t er t o 31 December 2006 was r eceived by Cust oms 55 days lat e. The t ax due was £ 8,900. Paul’s r et ur n f or t he 31st Mar ch 2006 had also been lat e alt hough all of t he ot her r et ur ns due have been f iled on t ime. Assume t hat an appr opr iat e war ning has been given by Cust oms and calculat e t he penalt y Paul will have t o pay under t he br eaches of r egulat ions legislat ion.

Example 2

Mat ch t he misdemeanour t o t he cor r ect penalt y. Out lined below ar e lot s of boxes cont aining a wr ongdoing and t hen lot s of boxes wit h a penalt y in it . Dr aw a line t o mat ch t he t wo t oget her . VAT evasion; Dishonest conduct 5% of VAT due Failur e t o r et ain r ecor ds 100% of t he VAT

under char ged 5 mont hs lat e r egist er ing f or VAT

100% of VAT lost

I ssuing a VAT invoice when not VAT r egist er ed

15% of t he VAT due or £ 50 if gr eat er

Cer t if icat e of zer o-r at ing issued when pr oper t y did not qualif y f or zer o-r at ing.

£ 500

E15e.8 Interest

A t axable per son may be char ged int er est in t he f ollowing cir cumst ances. (a) Wher e Cust oms r aise an assessment f or a VAT per iod t o r ecover any

VAT which has been under declar ed or over claimed on a VAT r et ur n. (b) Wher e Cust oms r aise an assessment f or a VAT per iod in r espect of which

an ear lier assessment has alr eady been not if ied (i.e. wher e Cust oms issue an assessment f ollowing t he f ailur e t o submit a VAT r et ur n but a f ur t her assessment is necessar y as t he or iginal assessment is lat er f ound t o be t oo low).

(c) Wher e Cust oms r aise an assessment r elat ing t o a VAT per iod which

exceeds t hr ee mont hs and begins on t he dat e wit h ef f ect f r om which t he per son concer ned was, or was r equir ed t o be, r egist er ed.


603

(d) Wher e Cust oms r aise an assessment r elat ing t o a VAT per iod at t he beginning of which t he per son concer ned was, but should no longer have been, exempt ed f r om r egist r at ion under VATA 1994, Sch 1 par a 14(1), VATA 1994, Sch 3 par a 8 or VATA 1994, Sch 3A par a 7.

(e) Wher e, bef or e an assessment is made under (a)−(d) above, t he VAT due

or ot her amount concer ned is paid by volunt ar y disclosur e (so t hat no assessment is necessar y). I nt er est is only char ged on volunt ar y disclosur es wher e t he net value of er r or s exceeds £ 2,000 (i.e. it will not be char ged wher e t he t axable per son could have adj ust ed t he er r or s in his cur r ent VAT r et ur n but chose inst ead t o make volunt ar y disclosur e dir ect t o Cust oms).

I n gener al, however , Cust oms only char ge int er est wher e t hey consider it r epr esent s ‘commer cial r est it ut ion’, i.e. compensat ion f or t he loss of use of any under declar ed or over claimed VAT. They nor mally only char ge int er est if t hey have been depr ived of t his VAT f or a per iod of t ime. They would not , f or example, gener ally char ge int er est if an amount of VAT is under declar ed which would have been immediat ely r eclaimable as input t ax by a t hir d par t y. An example of such a sit uat ion would be wher e a t r ader makes a st andar d r at ed supply t o anot her business, but in er r or t r eat s t he supply as zer o r at ed and does not char ge 17.5% VAT. I f t he supplier had char ged VAT t hen t he cust omer would have r eclaimed t hat VAT as input t ax and so t her e has been no over all loss t o t he Exchequer . I n a case like t his Cust oms will r aise an assessment f or t he VAT t hat t he t r ader should have char ged at t he st andar d r at e, but will not , in addit ion, char ge int er est . I nt er est r at es ar e f ixed by Cust oms and changed per iodically. I nt er est is calculat ed on a daily basis f r om t he dat e t he or iginal VAT was due t o t he dat e t he assessed VAT is paid. I n pr act ice Customs assess from the date the

original VAT was due until a dif f er ent dat e - the date of the assessment. Illustration 1

J Limit ed omit t ed £ 10,000 of out put t ax f r om it s VAT r et ur n t o 30 Sept ember 2005. The er r or is discover ed at a cont r ol visit and an assessment is r aised on 21 May 2006. J Limit ed pays t he VAT due on 28 May 2006. For which t ime per iod is int er est char ged?

The VAT r et ur n is t o 30 Sept ember 2005 f r om which VAT has been omit t ed. The VAT r et ur n t o 30 Sept ember 2005 was due at t he end of Oct ober , i.e. by 31 Oct ober 2005 and t hat is when t he VAT on t he r et ur n should have been paid. The assessment was r aised on 21 May 2006 and t he VAT assessed was paid on 28 May 2006.


I n pr act ice Cust oms will char ge int er est f r om t he dat e t he VAT was due unt il t he dat e t he assessment is r aised so t he int er est per iod is 31.10.2005 t o 21.5.2006. The legislat ion it says t hat int er est could be char ged f r om t he dat e t he VAT was due t o be paid unt il t he dat e it act ually is paid. So in t his example Cust oms would be ent it led t o an ext r a 7 days wor t h of int er est t o 28.5.2006, but in pr act ice t hey don’t . Wher e an assessment is r aised t o collect out st anding VAT, int er est is calculat ed f r om a point no ear lier t han 3 year s f r om t he assessment dat e. I n ot her wor ds, if an assessment is r aised t o collect VAT t hat should have been paid 5 year s ago, int er est on t hat out st anding VAT can only r un f or a maximum of 3 year s. Thus t he int er est per iod is capped t o a maximum of 3 year s pr ior t o t he dat e t he er r or is f ound. I nt er est is also char ged wher e an unr egist er ed per son issues a VAT invoice and shows an amount of VAT on t his invoice. The amount of VAT shown will suf f er int er est f r om t he dat e of t he invoice unt il t he dat e t he amount of VAT is paid over t o Cust oms. I nt er est also applies wher e a per son who is not r egist er ed under t he f lat r at e f ar mer scheme char ges a f lat r at e commission on his invoices as if he was a f lat r at e f ar mer .

E15e.9 Discovery of Errors

I f a t r ader discover s an er r or himself it r eally is best t o disclose t hat er r or t o Cust oms immediat ely.

A voluntary disclosure of an er r or should be made by let t er t o t he local VAT of f ice or on f or m VAT 652.

A t r ader should make a volunt ar y disclosur e because it will enable him t o avoid any misdeclaration penalty. However , int er est is not avoided and will be char ged. However , net errors of £2,000 or less in t ot al do not have t o be disclosed, but can be corrected for by adjusting the VAT account and including t he net amount of t he adj ust ment in t he VAT due or t he VAT r eclaimed box on t he cur r ent VAT r et ur n i.e. t he next VAT r et ur n due t o be submit t ed. This £ 2,000 t est r elat es t o net er r or s discover ed in an account ing per iod, even t hough t hose er r or s t hemselves may r elat e t o dif f er ent account ing per iods. What is impor t ant is what is discover ed at t he cur r ent point in t ime. When net er r or s of £ 2,000 or less ar e discover ed int er est will also not be char ged. The discover y of over st at ed out put t ax of £ 3,000 and also of over st at ed input t ax of £ 4,000 would give a net er r or of £ 1,000 being discover ed and t his of cour se can be adj ust ed f or in t he VAT account .


605

Example 3

Mr A Simple has r eviewed his 2007 VAT r et ur ns and f ound t he f ollowing er r or s: Quar t er t o:

31.3.07 Over st at ed input t ax £ 4,000 30.6.07 Over st at ed out put t ax £ 1,000 30.9.07 Under st at ed out put t ax £ 2,000 31.12.07 Under st at ed input t ax £ 4,500

What is t he amount of t he net er r or ?

To summar ise;

• I nt er est will be imposed t o pr ovide commer cial r est it ut ion wher e t ax has been under st at ed on a VAT r et ur n.

• I nt er est will also be char ged wher e an unr egist er ed per son issues an invoice char ging VAT.

• I nt er est cannot r un f r om a dat e mor e t han 3 year s bef or e t he dat e of assessment / payment .

• Net er r or s of £ 2,000 or less can be cor r ect ed by a t r ader adj ust ing t he VAT account .

• Net er r or s exceeding £ 2,000 r equir e a f or mal disclosur e t o Cust oms and int er est will be char ged.

E15e.10Mitigation

Mit igat ion is basically r educt ion of a penalt y and it is only allowed in r espect of cer t ain of f ences. These of f ences ar e:

• Tax evasion; conduct involving dishonest y. The or iginal penalt y f or t hat of f ence was 100% of t he t ax evaded.

• Misdeclaration penalty.

• Repeated misdeclaration penalty.

• Late notification of a liabilit y t o r egist er r esult s in a VAT penalt y.

• Unauthorised issue of VAT invoices can also r esult in a penalt y.

• Investment gold has a special compliance r egime and if t he t r ader does not comply cor r ect ly t hen a penalt y can be char ged.

s.70 s.60 s.63 s.64 s.67 s.67 s.69A


Mitigation can be made by Customs or by a VAT appeal body on appeal. Cust oms or t he VAT appeal body can r educe t he penalt y t o what ever amount it t hinks pr oper which can even include nil.

s.70

A VAT appeal body can r ever se any r educt ion in penalt y t hat was gr ant ed by Cust oms, alt hough t his does not happen ver y of t en.

Cust oms have st at ed what t heir policy on mit igat ion of penalt ies is in Not ice 730. They envisage maximum discount s as f ollows:

• 40% f or pr ompt and accur at e disclosur e.

• Up t o 25% f or f ull co-oper at ion.

• 10% f or pr oduct ion of document s and at t endance of int er views.

• This leaves a balance of 25% which Cust oms have said could be mit igat ed in except ional cir cumst ances.

Wher e Cust oms have char ged a penalt y and t he t r ader would like t he penalt y t o be mit igat ed he will need t o pr ovide Cust oms wit h good r eason.

By law none of t he f ollowing it ems can be t aken int o account when deciding on t he mit igat ion of a penalt y by Cust oms or a t r ibunal;

• An insuf f iciency of f unds t o pay t he t ax due or t o pay t he penalt y

• The f act t hat t her e has been no loss of t ax or no signif icant loss of t ax

• The f act t hat t he per son liable f or t he penalt y or a per son act ing on his behalf has act ed in good f ait h.

E15e.11Disclosing VAT avoidance schemes

I n or der t o cur t ail ant i-avoidance schemes, Finance Act 2004 int r oduced var ious disclosur e r equir ement s in r espect of such schemes.

Sch 11A

A st at ut or y list of schemes t hat have t o be disclosed has been published by Cust oms. The use of one of t hese schemes by a business wit h supplies in excess of £ 600,000 must be not if ied t o Cust oms. The not if icat ion must be made wit hin 30 days of t he due dat e f or t he f ir st r et ur n t o which a ‘list ed’ scheme applies. The penalt y f or f ailing t o disclose at t he pr oper t ime will be 15 per cent of t he t ax avoided.

Cer t ain businesses must disclose ‘schemes t hat have cer t ain hallmar ks of avoidance’. The not if icat ion must be made wit hin 30 days of t he due dat e f or t he f ir st r et ur n t o which t he scheme applies. The penalt y f or f ailing t o not if y a scheme will be £ 5,000. However , businesses will be excused f r om not if ying pur chased schemes if t he pr omot er has r egist er ed it wit h Cust oms. A business is only liable t o disclose hallmar ked schemes if it exceeds t he minimum t ur nover limit s.

Par a 7 Sch 11A VATA 1994

Not ice 730


607

Eit her : a) t ot al t axable and exempt supplies in t he year pr ior t o t he r et ur n or

r et ur n per iods included in a volunt ar y disclosur e af f ect ed by a scheme must exceed £ 10 million; or

b) t he t ot al t axable and exempt supplies must exceed t he appr opr iat e

pr opor t ion of £ 10 million in t he pr escr ibed account ing per iod immediat ely pr ior t he pr escr ibed account ing per iod in which t he r equir ement t o not if y ar ose.


Answer 1

Paul will pay a penalt y t hat is t he gr eat er of t wo t hings; t he f ixed daily r at e penalt y or t he t ax gear ed penalt y. St ar t ing wit h t he f ixed daily r at e penalt y wit h one f ailur e in t he pr evious t wo year s Paul would be looking at a f ixed daily r at e of £ 10 per day. The r et ur n is 55 days lat e at £ 10 per day which would give Paul £ 550 of penalt y. Alt er nat ively, Paul could be looking at t he t ax-gear ed penalt y wit h one f ailur e in t he pr evious t wo year s t hat would be one-t hir d of 1% of t he t ax due. The t ax due is £ 8,900, a t hir d of 1% of t his daily, so f or 55 days £ 1,632. The gr eat er of t he t wo f igur es is t he penalt y which Paul will have t o pay which comes t o £ 1,632.

Answer 2

VAT evasion; Dishonest conduct 5% of VAT due Failur e t o r et ain r ecor ds 100% of t he VAT

under char ged 5 mont hs lat e r egist er ing f or VAT

100% of VAT lost

I ssuing a VAT invoice when not VAT r egist er ed

15% of t he VAT due or £ 50 if gr eat er

Cer t if icat e of zer o-r at ing issued when pr oper t y did not qualif y f or zer o-r at ing.

£ 500


609

Answer 3

The way t o appr oach t his sor t of quest ion is t o look at t he out put t ax and t he input t ax separ at ely. Out put t ax I nput t ax £ £

31.3.07 (4,000) 30.6.07 (1,000) 30.9.07 2,000 31.12.07 4,500 1,000 500

£ 1,000 out put t ax payable and £ 500 input t ax r epayable means net £ 500 out put t ax payable.

I n t he r et ur n t o t he end of Mar ch t he t r ader has over st at ed input t ax by £ 4,000 - £ 4,000 of input t ax or iginally claimed back f r om Cust oms which we now owe t o Cust oms. I t is a negat ive £ 4,000 in t he input t ax column.

I n t he r et ur n t o J une t he t r ader has over st at ed out put t ax, and paid Cust oms £ 1,000 of out put t ax t oo much. I t is a negat ive f igur e, but t his t ime in t he out put t ax column.

I n t he quar t er t o Sept ember t he t r ader has under st at ed out put t ax by £ 2,000, - £ 2,000 owed t o Cust oms in t he out put t ax column.

I n t he r et ur n t o December t he t r ader has under st at ed t he input t ax by £ 4,500 – t hus anot her £ 4,500 claimed as input t ax f r om Cust oms in t he input t ax column.

I n summar y, looking at t he out put t ax column, Cust oms owe t he t r ader £ 1,000 and t he t r ader owes Cust oms £ 2,000. Over all t he t r ader owes £ 1,000. Looking in t he input t ax column, t he t r ader owes £ 4,000, Cust oms owes t he t r ader £ 4,500 so over all Cust oms owe £ 500.

Ther e is £ 1,000 of out put t ax payable and £ 500 of input t ax r epayable, so t he net f igur e is £ 500 of out put t ax payable and because t his is £ 2,000 or less t he t r ader will adj ust f or it on t he next VAT r et ur n t o be submit t ed.


SUMMARY – OTHER PENALTIES, INTEREST & MITIGATION

Cust oms have a choice of cr iminal pr osecut ion or a civil penalt y when encount er ing f r aud. Unaut hor ised issue of invoices and incor r ect cer t if icat es of zer o r at ing r esult in penalt ies. EU sales list s must be t imely and accur at e or penalt ies ar e char ged. Ther e ar e also new non-compliance and evasion penalt ies f or impor t er s and expor t er s. I n addit ion Cust oms have a whole r ange of penalt ies f or a whole r ange of misdemeanour s. I f VAT has not been shown as due on a VAT r et ur n and is lat er collect ed by assessment , t hen Cust oms may char ge int er est on t hat unpaid VAT. I nt er est is not char ged in cases wher e it does not r epr esent commer cial r est it ut ion. I nt er est is calculat ed on a daily basis f r om t he dat e t he or iginal VAT was due t o t he dat e t he assessed VAT is paid. I n pr act ice Cust oms only assess int er est unt il t he dat e an assessment is act ually issued. I nt er est cannot r un f r om a dat e mor e t han 3 year s bef or e t he dat e of t he assessment . Net er r or s of £ 2,000 or less can be cor r ect ed by a t r ader adj ust ing t he VAT account and no int er est will be char ged. Net er r or s exceeding £ 2,000 r equir e a f or mal disclosur e t o Cust oms and int er est will be char ged. Cust oms have t he power t o mit igat e any penalt y char ged by up t o 100% in r espect of cer t ain of f ences. Those of f ences ar e: - t ax evasion; - misdeclar at ion penalt y; - r epeat ed misdeclar at ion penalt y; - lat e not if icat ion of a liabilit y t o r egist er f or VAT; - unaut hor ised issue of VAT invoices, and - t he invest ment gold penalt y. Mit igat ion can be given by Cust oms or by a VAT Tr ibunal on appeal. Ther e is a r equir ement f or cer t ain businesses t o not if y Cust oms of t heir use of VAT avoidance schemes.

E16: REFUNDS, REPAYMENT SUPPLEMENT AND INTEREST

This chapt er cover s f our t opics: - r ef unds; - r epayment supplement ; - int er est ; - secur it y.

E16.1 Introduction

This chapt er cover s f our t opics; r ef unds, r epayment supplement , int er est and secur it y. The f ir st t hr ee it ems ar e r oughly connect ed because t hey ar e all t o do wit h t he sit uat ion when VAT is r ef unded t o t he t axpayer . Secur it y is a dif f er ent t opic and shall be dealt wit h on it s own at t he end of t he session.

E16.2 Refunds

Ref unds of VAT can t ake t wo f or ms; f ir st ly Cust oms will make a r ef und of VAT when t he out put t ax is less t han t he input t ax on a VAT r et ur n. I n such a case t her e will be a negat ive f igur e calculat ed on t he VAT r et ur n and t his f igur e will be r ef unded t o t he t r ader , usually when t he VAT r et ur n is submit t ed.

s.80

The t r ader may also get a r ef und of VAT t hat he has over paid at an ear lier point in t ime – an over payment may have occur r ed if he incor r ect ly classif ied somet hing as st andar d r at ed when it should have been zer o-r at ed, et c. Thus t he VAT he paid over and above t he amount due will be r ef unded t o him.

E16.3 Refund of VAT shown on a VAT return

Once a VAT r et ur n showing t hat VAT is r epayable t o t he t axpayer is submit t ed t o Sout hend t he r ef und due will be aut omat ically dealt wit h by t he VAT Cent r al Unit . They will issue inst r uct ions t o issue a cheque or make a r ef und payment int o a not if ied Bank account . I f t he t ime t aken t o sor t out t he r epayment exceeds t he set limit t hen r epayment supplement will be added on t o t he r epayment made.

s.80

E16.4 Repayment Supplement

Repayment supplement is added t o a r epayment if t he Commissioner s f ail t o issue an inst r uct ion f or a r epayment wit hin a 30-day per iod.

s.79

Pr ovided cer t ain condit ions ar e met , r epayment supplement is t he gr eat er of £ 50 or 5% of t he r epayment of t ax due.

Not ice 700/ 58/ 02

The 30-day per iod is not t he 30-day per iod f r om submit t ing t he r et ur n. The 30-day per iod begins on t he later of t wo dat es;


• t he day af t er t he last day of t he pr escr ibed account ing per iod t o which

t he claim r elat es. • t he dat e of t he r eceipt of t he claim, i.e. t he day t hat t he VAT r et ur n is

submit t ed.

The f ir st of t hese dat es count er s t r ader s submit t ing VAT r et ur ns bef or e t he end of t he quar t er end when a r epayment is due. Cer t ain per iods ar e ignor ed when calculat ing t hat 30-day per iod. The per iods lef t out of account when calculat ing t he 30-day per iod ar e t hose wher e it is necessar y t o r aise r easonable enquir ies or cor r ect er r or s. The per iod t o leave out of t he 30 days is def ined as beginning when t he Commissioner s f ir st decide t hat it is necessar y t o make enquir ies and t hen ends when t hey sat isf y t hemselves t hat t hey have r eceived complet e answer s t o t he quest ions t hey r aised, or when t hey decide not t o pur sue t he enquir ies any f ur t her . Any delay on Cust oms par t in act ing on t hat decision is included. I n pr act ice it is Cust oms policy not t o “st op t he clock”, unt il t hey have not if ied t he t r ader of an enquir y. Repayment supplement is denied if t he r epayment on t he r et ur n t ur ns out t o be incor r ect and t hus no r epayment supplement will be given t o t he t r ader f or his r epayment . The def init ion of “incor r ect ” is t hat t he r et ur n is over st at ed by mor e t han t he gr eat er of £ 250 or 5% of t he cor r ect r epayment . I n addit ion t o t his, no r epayment supplement is paid at all if t he VAT r et ur n in quest ion was submit t ed lat e.

Repayment supplement will not be paid on • r ef unds paid t o EU t r ader s; • r ef unds t o do-it -your self house builder s; • claims r elat ing t o ser vices r eceived af t er der egist r at ion; • amount s not if ied by Cust oms as over declar ed (including t hose r esult ing

f r om volunt ar y disclosur es made in wr it ing t o Cust oms); or • claims f or int er est as a r esult of of f icial er r or .

VAT Not ice 700, par a

21.6

Ref unds, Repayment Supplement and I nt er est

613

Illustration 1

J oe submit s his VAT r et ur n f or t he quar t er t o 31 December 2006 on 28 J anuar y 2007 showing a VAT r epayment due of £ 1,800. J oe is r ar ely in a r epayment sit uat ion so Cust oms decide on 3 Febr uar y t o st ar t an enquir y and t hey not if y J oe of t his enquir y on 10 Febr uar y 2007.

Af t er answer ing a f ew quest ions and amending t he r epayment due f r om £ 1,800 down t o £ 1,700, t he enquir y is complet ed on 20 Febr uar y 2007. Due t o and administ r at ive er r or , t he r epayment is not made t o J oe unt il 12 Mar ch 2007.

Will t her e be any r epayment supplement paid t o J oe in addit ion t o t he £ 1,700 r epayment ? To answer t his quest ion t he f ir st st ep is t o decide whet her t he r epayment was issued lat e; lat e being in excess of t he 30-day per iod. St ar t by looking at t he t ime bet ween t he r eceipt of t he r et ur n, which was 28 J anuar y 2007, and t he issue of t he r epayment or der , which was 12 Mar ch 2007 which is 42 days.

I nit ially it looks as if a r epayment supplement will be due since 42 days is def init ely in excess of 30 days.

However , t her e was an enquir y dur ing t his per iod of t ime and t he enquir y per iod has t o be deduct ed f r om t he 42 days. The enquir y per iod was f r om 10 Febr uar y 2007 t o t he 20 Febr uar y, which is 11 days long.

42 days minus 11 days is 31 days. This exceeds t he 30-day cut -of f point and hence r epayment supplement will be due. However , t he or iginal r epayment claim f or £ 1,800 had t o be amended and was adj ust ed downwar ds by £ 100. To be ent it led t o r epayment supplement t he £ 100 adj ust ment needs t o be less t han t he gr eat er of t wo f igur es – t he gr eat er of £ 250 or 5% of t he cor r ect payment . The cor r ect r epayment was £ 1,700, which at 5% gives £ 85. The gr eat er of £ 250 and £ 85 is £ 250. So, t he £ 100 adj ust ment needs t o be less t han £ 250, which it is. By being less t han £ 250, r epayment supplement is due which is 5% of t he r epayment made of £ 1,700, i.e. £ 85. The r epayment paid t o J oe will be £ 1,700 plus £ 85.

One f ur t her t hing t o not e about t he or iginal 42-day per iod. I t is t he t ime bet ween t he dat e t he r et ur n was r eceived by Cust oms and t he issue of t he r epayment or der . Do not include 28 J anuar y or 12 Mar ch when wor king out t he per iod. A common er r or is t o calculat e a per iod of 44 days by count ing t he f ir st day (t he st ar t dat e), and t he last day (t he end dat e). Those dat es ar e act ually ignor ed.

When looking at t he enquir y per iod do add a st ar t and end dat e. Thus include 10 Febr uar y and 20 Febr uar y t o get t o 11 days.


Example 1

Alpha Limit ed submit s it s VAT r et ur n f or t he quar t er t o 31 Mar ch 2006 on 22 Apr il 2006. The r et ur n shows a r epayment of £ 2,500.

On 5 May 2006 Cust oms st ar t an enquir y int o t he r et ur n not if ying Alpha Limit ed of t his on 8 May 2006. Af t er a cont r ol visit , which discover s no ir r egular it y, t he enquir y is closed down on 24 May 2006.

Alpha Limit ed r eceives it s r epayment on 8 J une 2006.

Will r epayment supplement also be paid?

E16.5 Refund of overpaid VAT

A r ef und of over paid VAT would occur wher e a per son has paid mor e VAT t o Cust oms t han was or iginally due. For example, a t r ader has t r eat ed cer t ain supplies as st andar d r at ed when r eally t hey should have been zer o-r at ed. On t he r eceipt of t he claim, Cust oms will make a r ef und of t he over paid VAT t o t he t r ader .

s.80(1)

Ther e is a r est r ict ion wher e a t r ader makes t he claim f or a r ef und of VAT which he or iginally paid because he had a mist aken assumpt ion about t he way t he VAT r ules applied. I n a case like t his a r ef und will only be made t o t he ext ent of t he loss or t he damage which t he t r ader can show he has suf f er ed as a r esult of t he mist aken assumpt ion. Ot her wise, Cust oms will allege t hat any r epayment will give unj ust enr ichment .

s.80(3A) – (3C)

A number of changes (BN CE 8) wer e made wit h ef f ect f r om 23 Mar ch 2005 t o t he r ules on unj ust enr ichment . As ment ioned above a def ence of unj ust enr ichment is available t o Cust oms in most cases when an incor r ect VAT char ge has been passed on t o cust omer s. I n f ut ur e, however , t he def ence by Cust oms will be available t o all claims and not mer ely t hose wher e businesses have over paid VAT. Thus it will not mat t er whet her t he claimant is in a net payment or r epayment posit ion. Claims f or input t ax and f or duplicat ed payment s of VAT will not be subj ect t o t he def ence of unj ust enr ichment . Repayment s will be allowed on t he basis t hat t hey will be r epaid t o t he cust omer – t his will pr event t he t axpayer being unj ust ly enr iched and Cust oms have t he power t o make r egulat ions f or over seeing t he r eimbur sement of t r ader s’ cust omer s wher e a r ef und has been made t o t he t r ader j ust f or t hat pur pose. By t he same t oken, Cust oms can make r egulat ions t o claw back any r ef und which was supposed t o be passed on t o t he cust omer but t he t r ader did not do t his.

Not ice 700/ 45/ 02


615

Cust oms ar e not liable to refund tax paid to them more than 3 years before

the date of the claim, or 3 year s bef or e t he dat e t he t r ader commenced legal pr oceedings if t his is ear lier . This 3 year limit applies t o all claims f or input t ax, cor r ect ion of er r or s, adj ust ment s t o t ake account of a change in t he consider at ion f or a supply, pr e-r egist r at ion expenses, post der egist r at ion expenses, adj ust ment s under t he Capit al Goods Scheme and claims f or bad debt r elief . I t is an all encompassing t hr ee year limit . Following FA 2005 t he st ar t dat e f or t he t hr ee year t ime limit f or claiming in t he case of er r or s on r et ur ns or volunt ar y disclosur es or t ax account ed f or on assessment s is t he end of t he r elevant account ing per iod. I n t he case of a duplicat e payment , it is t he dat e of t he payment .

Example 2

Paul mist akenly char ged st andar d r at e VAT on all Widget A supplies made since 1 J anuar y 1980. He appealed t o a VAT Appeal Body on 14 Apr il 2006 t hat supplies of Widget A should be zer o-r at ed. The Appeal Body r uled in Paul’s f avour on 12 Sept ember 2006. A claim was lodged f or a VAT r ef und t he next day.

The r ef und is r est r ict ed t o VAT paid f r om which dat e? A

1 J anuar y 1980

D

14 Apr il 2003

B

14 Apr il 2006

E

12 Sept ember 2003

C

12 Sept ember 2006

F

13 Sept ember 2003

E16.6 Protective claims

Legally t her e is no such t hing as a ‘pr ot ect ive’ claim. However , Cust oms accept t hat , wit h a t hr ee-year t ime limit f or making claims, it is impor t ant f or businesses t o pr ot ect t heir posit ions when submit t ing claims subj ect t o long-t er m lit igat ion. Wher e t her ef or e • an Appeal Body has not r esolved an issue, or • an issue has been decided in f avour of Cust oms but is subj ect t o appeal, Cust oms policy is t o inf or m businesses t hat t hey do not consider t hat a valid claim can be made in light of t he cur r ent lit igat ion but , t o avoid a needless appeal, t he claim submit t ed will be held on f ile and r econsider ed in light of any j udgment which subsequent ly suppor t s t he validit y of t he claim. Once t he claim has been r econsider ed it is eit her paid or r ej ect ed. I f r ej ect ed, t he business may lodge an appeal.


Cust oms will not f ollow t his cour se of act ion in all cases. For example, t hey will r ej ect speculat ive claims submit t ed on t he basis t hat f ut ur e lit igat ion of benef it t o t heir claim may be under t aken by an unconnect ed par t y, i.e. f or a claim t o be valid eit her t he claimant must be pr epar ed t o def end t he basis of t he claim bef or e an Appeal Body or t her e must alr eady be on-going lit igat ion.

E16.7 Interest on overpaid VAT

This will be int er est t hat is paid in addit ion t o t he over paid t ax being r ef unded t o t he t r ader . I f a t r ader has over paid VAT t hen t her e has been a per iod of t ime when he has been unable t o use his own money because ef f ect ively Cust oms have had his money. I f t his over payment ar ose as a r esult of an er r or on t he par t of Cust oms, t hen int er est can be paid t o t he t r ader . Ther e ar e many r easons why VAT might have been over paid ; maybe t oo much VAT was paid t o Cust oms in t he f ir st place; maybe t oo lit t le input VAT was r eclaimed on a VAT r et ur n; or maybe t he t r ader in some way was pr event ed f r om r ecover ing VAT at t he pr oper t ime.

s.78

I nt er est will be applied t o t he r epayment of VAT and is calculat ed on a daily basis at f ixed r at es. Ther e is a three-year restriction as seen bef or e. J ust as over paid t ax is r est r ict ed t o t ax paid in t he pr ior t hr ee-year per iod, similar ly int er est is r est r ict ed t o t he same t hr ee year s. To claim t he int er est a t r ader must make a claim in wr it ing wit hin t hr ee year s of t he end of t he per iod t o which it r elat es. I nt er est is calculat ed on a daily basis but t her e ar e some days t hat Cust oms can ignor e f or t he calculat ion. These days ar e per iods of t ime r esult ing f r om an unr easonable delay by t he claimant in making t he claim, or maybe in pr oviding inf or mat ion so t hat Cust oms can est ablish t he claim bot h in quant it y and suit abilit y f or r epayment .

Example 3

This is a summar y of t he chapt er so f ar - f ill in t he missing wor ds, out of t he t hr ee opt ions, only one of which is cor r ect .

Select t he cor r ect answer :

• Repayment supplement is t he gr eat er of £250 / £150/ £50 or 15%

/ 10% / 5% of t he r epayment due and is given on r epayment s of VAT wher e t he VAT r et ur n was submit t ed on t ime and wher e a r epayment or der was not made wit hin 10 / 30 / 60 days.

• Over payment s of VAT will be r ef unded pr ovided t he claimant will not be unjustly enriched / unfairly gained / unjustly profited.

• The r ight t o a r ef und and, if appr opr iat e, int er est is limit ed t o VAT paid in t he 1 / 3 / 6 year s pr ior t o t he claim.


617

E16.8 Compensation by Customs in cases of official error (ex gratia payments)

The Tr easur y has pr ovided guidance on compensat ion payment s by gover nment depar t ment s and agencies in cases wher e maladminist r at ion has occur r ed t o t he det r iment of an individual, company or ot her body or t he sub-st andar d qualit y of t he ser vice pr ovided has had a similar ef f ect . The guidance does not cover

• cases wher e t her e is a st at ut or y or ot her legal obligat ion t o make payment s by way of compensat ion; or

• out of cour t set t lement s or claims f or compensat ion f or br each of cont r act or negligence (on t he assumpt ion t hat , in such cases, t he depar t ment involved will act on t he basis of specif ic legal advice).

The quest ion of whet her f inancial r edr ess should be paid may ar ise

• as a r esult of a r ecommendat ion by t he Par liament ar y Ombudsman;

• in cases wher e t he complaint has been made dir ect ly t o Cust oms which concludes t hat maladminist r at ion has occur r ed;

• in cer t ain cases wher e t he st andar d of ser vice pr ovided has f allen below t hat t o which Cust oms has publicly commit t ed it self (in t he cont ext of t he Cit izen' s Char t er or ot her wise); and

• in cases of maladminist r at ion discover ed by Cust oms it self r at her t han r aised by a complainant .

Claims against Cust oms ar e most likely t o ar ise wher e t he complainant has been put t o addit ional expense or f r uit less expendit ur e. I f it is accept ed t hat maladminist r at ion has occur r ed and t hat f inancial r edr ess is appr opr iat e, t he gener al pr inciple is t o pay compensat ion which is f air and r easonable in t he light of all t he f act s and cir cumst ances of t he case. Wher e t he complainant has suf f er ed act ual f inancial loss as a r esult of t he maladminist r at ion, or f aced cost s which would ot her wise not have been incur r ed (and which ar e r easonable in t he cir cumst ances), t he gener al appr oach is t o r est or e t he complainant t o t he posit ion he or she would have enj oyed had t he maladminist r at ion not occur r ed. Cust oms will not meet cost s incur r ed by a business in est ablishing it s obligat ions under t he t ax or in dealing wit h r easonable enquir ies by visit ing st af f . Tr ader s or t heir r epr esent at ives should submit t heir claims t o Cust oms in wr it ing. Any claims f or cost s r elat ing t o wor k car r ied out should gener ally be suppor t ed by an it emised bill of cost s including

• dat e of wor k;

• t ime spent ;

• descr ipt ion of wor k;

• st at us of per son involved (e.g. par t ner , VAT consult ant ); and

• hour ly r at es involved.


Ther e is no pr ovision f or ex gr at ia payment s t o be set of f against any VAT liabilit ies which may exist .

C&E Manual V1-33, par as 15.1-15.3 Appendices C&D

E16.9 Security

Secur it y is wher e Cust oms ask f or some money up f r ont , nor mally because t he t r ader has def ault ed in t he past . Secur it y can be pr ovided in cash or by guar ant ee f r om an appr oved f inancial inst it ut ion and is usually r equir ed wit hin 30 days f r om t he dat e of Cust oms’ not ice r equir ing secur it y.

Sch 11 Par a 4

Ther e ar e t hr ee sit uat ions in which Cust oms may r equir e a per son t o give secur it y. The f ir st st at es t hat as a condit ion of making a VAT cr edit t o a per son if it appear s necessar y f or t he pr ot ect ion of t he r evenue. I t will be held unt il Cust oms consider t he r isk t o collect ion no longer applies.

s.48(7) and s.83(6)

The second st at es t hat as a condit ion of allowing t hat per son t o supply goods or ser vices by way of a t axable supply; again such act ion is necessar y f or t he pr ot ect ion of t he r evenue. I n pr act ice Cust oms will nor mally seek secur it y on pr ot ect ion of r evenue gr ounds if t he per son or per sons concer ned in a business have a bad VAT hist or y. For example, t hey have f ailed t o pay VAT in t he past or t hey have commit t ed a VAT of f ence or , pr eviously wer e ver y poor at meet ing VAT compliance. Businesses t hat ar e r un by disqualif ied dir ect or s or undischar ged bankr upt s ar e also likely t o be subj ect ed t o a r equir ement t o give secur it y. Wit h ef f ect f r om 10 Apr il 2003, Cust oms’ power s t o r equir e secur it y wher e t hey consider t hat a business r epr esent s ‘a dir ect r isk t o t he collect ion of VAT’ wer e ext ended. The new pr ovisions ar e int ended t o af f ect businesses ‘which, despit e war ning, cont inue t o deal wit h ot her businesses or individuals t hat evade paying t ax’ by deliber at ely using VAT r egist r at ion number s belonging t o ot her businesses wit hout t heir knowledge; by going missing; or by becoming insolvent while owing VAT. The aim of t he new pr oposal is ‘t o t ackle ser ious cases of VAT evasion wher e sever al businesses act t oget her t o at t ack t he VAT syst em’. The new pr ovisions will allow f or a pr opor t ionat e secur it y r equir ement f r om each business, in or der t o pr ot ect t he t ot al t ax at r isk in a VAT supply chain.

The t hir d sit uat ion wher e Cust oms may r equir e secur it y is wher e a per son has f ailed t o act upon Cust oms’ dir ect ion r equir ing him t o appoint a VAT r epr esent at ive.

The amount of secur it y t hat Cust oms gener ally ask f or is 6 mont hs est imat ed VAT liabilit y. This can be r educed and of t en, f or t r ader s t hat make mont hly VAT r et ur ns it is r educed t o 4 mont hs of t he est imat ed VAT liabilit y.


619

Answer 1

Dat e r et ur n submit t ed (Not e 1) 22 Apr il 2006 Dat e r epayment made 8 J une 2006

46 days

Less: Enquir y not if ied (Not e 2) 8 May 2006 Enquir y ceased 24 May 2006

17 days

Tot al (46 – 17) (Not e 3)

29 days

Repayment not lat e – no r epayment supplement due.

Not e 1: Fir st wor k out t he init ial per iod of t ime, i.e. f r om t he dat e t he r et ur n was submit t ed, which was 22 Apr il 2006, unt il t he dat e t he r epayment was made, which was 8 J une. That is 46 days r emember ing not t o count 22 Apr il or 8 J une but r at her look at t he per iod in bet ween t hese dat es.

Not e 2: Fr om t he 46 day per iod deduct t he enquir y per iod and t hat st ar t s when t he enquir y was not if ied t o t he company, 8 May, unt il t he enquir y ceased on 24 May. This t ime do include 8 and 24 May - 17 days.

Not e 3: Tot al per iod of t ime of 46 days minus 17 days is 29 days. The r epayment ef f ect ively was made 29 days lat e, which is not in excess of 30 days, so it was not made lat e enough f or r epayment supplement t o be added t o it . Thus t her e is no r epayment supplement due on t op of t he r epayment f or Alpha Limit ed.


Answer 2

The cor r ect answer is D.

3 year s pr ior t o ear lier of :

Dat e legal pr oceedings st ar t ed 14 Apr il 2006

Dat e of claim 13 Sept ember 2006

14 Apr il 2006 less 3 year s = 14 Apr il 2003

The claim is r est r ict ed t o a t hr ee-year per iod which is t he t hr ee year s pr ior t o t he ear lier of t wo dat es. Fir st is t he dat e legal pr oceedings wer e st ar t ed which in t he example was 14 Apr il 2006. The second dat e is t he dat e of t he claim. The claim was not lodged unt il af t er t he appeal hear ing was hear d on 13 Sept ember 2006. So t he ear lier of t hose t wo dat es is 14 Apr il 2006. Go back t hr ee year s f r om t his dat e and t he claim can be made on VAT char ged since 14 Apr il 2003.

Answer 3

• Repayment supplement is t he gr eat er of £50 or 5% of t he r epayment due and is given on r epayment s of VAT wher e t he VAT r et ur n was submit t ed on t ime and wher e a r epayment or der was not made wit hin 30 days.

• Over payment s of VAT will be r ef unded pr ovided t he claimant will not be unjustly enriched.

• The r ight t o a r ef und and, if appr opr iat e, int er est is limit ed t o VAT paid in t he 3 year s pr ior t o t he claim.


621

SUMMARY – REFUNDS, REPAYMENT SUPPLEMENT & INTEREST Ref unds of VAT can occur when input t ax exceeds out put t ax on a VAT r et ur n. On submission of t he VAT r et ur n, a r ef und will aut omat ically be made by t he VAT Cent r al Unit . Repayment supplement will be added t o a r epayment if Cust oms f ailed t o issue a r epayment inst r uct ion wit hin a 30 day per iod. Repayment supplement is t he gr eat er of £ 50 or 5% of t he r epayment of VAT due. VAT will also be r ef unded if it was over paid in an ear lier per iod, f or example supplies which wer e t r eat ed as st andar d r at ed when r eally t hey should have been zer o r at ed. On r eceipt of a claim Cust oms will make a r ef und of t he over paid VAT t o t he t r ader . The Commissioner s have t he power t o wit hhold a r ef und of VAT if t hey f eel it would unj ust ly enr ich t he claimant . Wher e VAT has been over paid, int er est will also be paid in addit ion t o t he r ef und of over paid t ax if t he over payment ar ose as a r esult of an er r or on t he par t of Cust oms. I nt er est is r est r ict ed t o t he pr ior 3 year per iod and is calculat ed on a daily basis. I n cases of of f icial er r or t her e ar e pr ocedur es available t o claim compensat ion f r om Cust oms. Wher e a t r ader wishes t o t ake advant age of a decision subj ect t o f ur t her appeal, it may lodge a pr ot ect ive claim t o ensur e it does not f all f oul of t he t hr ee year cap. Secur it y is wher e Cust oms ask f or some money upf r ont because t hey ar e unsur e of t he t r ader . Secur it y can be pr ovided in cash or guar ant ee f r om an appr oved f inancial inst it ut ion and is usually r equir ed wit hin 30 days of t he dat e of Cust oms not ice r equir ing secur it y. Secur it y is usually asked f or wher e t he t r ader has a poor VAT hist or y in r espect of an ear lier business ent er pr ise.

Documents

Principles of Business Taxation - MEC · Principles of Business Taxation ‘Finance Act 2006’ Chris Jones, BA CTA (Fellow) ATT Amsterdam Boston Heidelberg London New York Oxf ord