Adrian Mooy & Co - Accountants Derby

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Bad debts are a fact of business life and most businesses will suffer a bad debt from time to time. This may be because the customer goes out of business after the work has been done or the goods have been supplied, or runs into financial difficulty resulting in them defaulting on the debt. Unfortunately, sometimes the customer may just not pay and refuse all attempts to recover it.

While there are actions that the business can take to recover the debt (such as making a claim using the Money Claim Online service), there is no guarantee that these will work, and the business may simply have to accept that the debt has gone bad.

Having suffered a bad debt, it would be adding insult to injury if the business had to pay tax on income that had not actually received. Fortunately, the tax system offers some relief for bad debts.

The way in which relief is given depends on whether the accounts are prepared under the cash basis or the accruals basis.

Cash basis

One of the advantages of the cash basis is that it provides automatic relief for bad debts. Under the cash basis, income is not recognised until it is received, so if an invoice is not paid, it is not taken into account when calculating taxable profits. Consequently, there is no need for special rules to deal with bad debts.

Traders with cash basis receipts of £150,000 or less can elect to use the cash basis. It is the default basis for landlords with rental cash basis receipts of £150,000 or less, and landlords not wishing to use the cash basis must elect for the accruals basis to apply. Companies cannot use the cash basis to prepare their accounts.

Accruals basis

Under the accruals basis, income must be recognised when earned. This means that if work is undertaken, the associated income is taken into account when the work is done not when the invoice is paid. Consequently, the invoiced amount will be reflected in the calculation of taxable profit, regardless of whether it has been paid. The amount owing will show in the balance sheet as a debtor of the business.

Normally, a deduction is not allowed for a debt owed to a business in computing the taxable profit. However, an exception is made for a bad debt and for a doubtful debt to the extent that it is estimated to be bad. This will be the total amount of the debt less any amount that the business may reasonably expect to receive.

Where a debt is bad or doubtful, a deduction can be made in the period in which the debt became bad or doubtful. This may not necessarily be the same period as when the income is taxed if at that point it was expected that the debt would be paid.

Example

ABC Ltd prepares accounts to 31 March each year. As a company, it prepares accounts using the accruals basis.

On 21 March 2022 it invoices a customer for £3,000.

The invoice is taken into account in calculating the taxable profit for the year to 31 March 2022.

In July 2022, the customer went into liquidation without paying the debt. Recovery looks very unlikely.

Tax relief is given in the form of a deduction of £3,000 when calculating the profit for the year to 31 March 2023 as this is the period in which the debt went bad.

The registrar of companies has the power to strike a company off a register if the registrar has reasonable cause to believe that the company is no longer carrying on a business or is in operation. This may be the case if the company has failed to file its annual accounts or its annual confirmation statement, there is no director in place or mail sent to the company is returned unopened.

However, before the registrar can move to strike the company off, he or she must first send two letters to the company. If a response is not received from the company within one month of sending the first letter, the registrar must (within 14 days of the end of the expiration of that month) send a second letter by registered post. The second letter must refer to the first letter and state that an answer to that letter has not been received and also that if an answer is not received to the second letter within one month of the date on the letter, a notice will be placed in the Gazette with a view to striking the company’s name off the registrar. If letters are received, they should not be ignored; rather, they should be dealt with promptly.

In the event that no answer is received to the second letter within a month of the date of that letter and the registrar has not received evidence that the company remains in business, the registrar will place a first notice in the Gazette that unless evidence is received to show that the business is still in operation, it will be struck off the register two months after the date of the notice.

Object

An objection to the proposed striking off can be made after the notice has been placed in the Gazette. An objection can be made by a director or a shareholder, or another interested party, such as a supplier or a customer. The objection can be made by email (enquiries@companieshouse.gov.uk).

When making an objection, it is necessary to provide evidence that the company is still trading, is owed money or owes money. The evidence may be in the form of customer or supplier invoices or statements or company bank statements. If the striking off application has been made because the company has failed to file its accounts or its confirmation statement, the outstanding documents should also be filed.

The objection must be made at least two weeks before the expiry of the Gazette notice (which is two months from the date of publication of the notice).

If the objection is successful, the registrar will discontinue the strike and file form DISS40, Striking off action discontinued.

Company struck off

If no objection is made by the expiry of the first notice, a second notice will be posted in the Gazette, stating that the company has been struck off. It will be dissolved on the publication of this notice.

Sometimes a business may have ceased trading but then receives income or incurs expenses that have not been included in the final cessation accounts e.g. an insurance payment may be received or a debt that the business owner thought would never be paid is paid. Such receipts would have arisen due to the previous carrying on of the trade. Any such income is charged to tax separately from the profit of the trade (i.e. the previous cessation period is not reopened) but the receipt is still taxed as trading income. A business that has ceased trading may also find itself paying expenses after cessation. Examples include the costs relating to the collection of debts taken into account in computing earlier trade profits before the trade ceased and remedying what is found to be defective work carried out before cessation.

A deduction is allowed for a loss or expense which, if the trade had not ceased  would have been deducted in calculating the profits of the trade for corporation or income tax purposes, or would have been deducted from or set off against the profits of the trade. Such allowable expenses can be offset against any post cessation receipts. However, if the business does not have any post-cessation receipts, relief may still be available for post-cessation bad debts and certain specified expenses (broadly expenses incurred in remedying defective work or paying associated damages). Relief is given sideways against other income and capital gains of the same year and must be claimed by 31 January but one from the end of the tax year in which the payment was made e.g. if a qualifying payment is made in 2022/23, relief must be claimed by 31 January 2025. If an expense cannot be fully relieved using any of these methods then it is carried forward to be deducted from any post cessation receipts that may be received in the future, otherwise it is lost.

If the post-cessation receipts arise within six years of cessation, the person receiving the income can elect to carry back the receipts to the date of cessation

Restricted relief

If there are insufficient post-cessation receipts against which to offset the post-cessation expenses, (i.e. there is a loss), then there is a restriction on the amount of claimable expenses can be allowed against the other net income or capital gains for the tax year in which they are paid. The set off is subject to the £50,000 or 25% of adjusted total income cap. The relief is also restricted by the amount of any unpaid debts owed by the trader at the date of cessation. If an unpaid debt restricted the amount of relief in an earlier tax year, it is not allowed in a later year either. However, if the outstanding debt is repaid, the payment is a ‘qualifying payment’ and can be relieved.

Capital allowances are a mechanism for providing tax relief for capital expenditure.

Relief is generally given in the form of a writing down allowance, although a first year allowance is available for expenditure on new and unused zero-emission cars. Expenditure on cars does not qualify for the annual investment allowance or for the time-limited super-deduction or 50% first-year allowance available to companies. Capital allowances cannot be claimed where the simplified expenses system is used to pay mileage allowances.

Capital allowances for cars can be claimed by both unincorporated businesses and companies. They can also be claimed where the cash basis is used as expenditure on cars cannot be deducted under the cash basis capital expenditure rules.

First-year allowance

A 100% first-year allowance is available for expenditure on new and unused zero-emission cars. This means that the cost can be deducted in full in computing taxable profits in the period in which the expenditure is incurred.

The first-year allowance is only available for new cars; second-hand zero-emission cars only qualify for a writing down allowance.

A balancing charge, equal to the sale proceeds, will arise if the car is sold.

Writing down allowances

There are two rates of writing down allowance – the main rate and the special rate. The available rate depends on the car’s CO2 emissions and the date on which the expenditure was incurred.

New and used cars purchased on or after 6 April 2021 which have CO2 emissions of 50g/km or less (other than new electric cars qualifying for a 100% first-year allowance) are added to the main rate pool and receive main rate allowances at the rate of 18% on a reducing balance basis.

Cars purchased on or after 6 April 2021 with CO2 emissions in excess of 50g/km must be added to the special rate pool. They attract special rate writing down allowances of 6% on a reducing balance basis.

If the car is sold, the sale proceeds must be added to the relevant pool. This ensures that capital allowances are given for the difference between the cost and the proceeds over the life of the car.

Private use

If a sole trader or partner uses a car partly for business and partly for private use, capital allowances are proportionately reduced to reflect the private use. Cars used for business and private use have their own pool rather than being added to the main rate or special rate pool.

Employees

Employees are not able to claim capital allowances for cars, even if they use them for business. The approved mileage rates (which may be paid tax-free up to the approved amount) provide an element to cover depreciation.

HMRC has finally set out its new timetable and criteria for joining its Making Tax Digital pilot. When will you be able to sign up and should you bother?

Overdue update

At the end of 2021 HMRC said that early in 2022 it would widen the availability of its Making Tax Digital for Income Tax Self Assessment ( MTD ITSA ) pilot for businesses. However, it’s taken it until half way through the year to do so and importantly well past the start of the 2022/23 tax year.

MTD ITSA becomes obligatory in April 2024 and will initially be for landlords, sole traders and self-employed individuals, not partnerships or companies. The latter need not concern themselves with the pilot.

Catching up

One of the main features of MTD ITSA is online quarterly reporting of business income and outgoings to HMRC. The trouble is that businesses able to join the pilot under the new criteria won’t be able to do so until July after the first quarterly reporting period has ended. If you join you’ll have little time (especially as the holiday season is upon us) to ensure that your records for the past quarter meet the MTD ITSA requirements in time to submit the first report due on 5 August 2022.

During the pilot period there are no penalties for submitting late quarterly reports. So, if you’re keen to join the pilot during 2022/23, while you must submit all four reports for the year you’ll be able to catch up for any quarter you’ve missed without the risk of being penalised.

Software trouble

Possibly a bigger stumbling block if you want to join the pilot is the very limited range of software available. MTD ITSA reports can only be made using compatible software. There are currently only three HMRC-approved providers. The big names such as Xero, Sage, Intuit Quickbooks and many others are still working on their products. If your provider is not on the short approved list for MTD ITSA software, we recommend waiting to join the pilot until it is rather than changing software at this stage.

The new criteria apply from July 2022. You can join the pilot if your bookkeeping software is compatible but currently there are only three such providers. You can join later but you’ll need to submit retrospective reports

No-one wants to pay more tax than they need to. Consequently, it is important to keep good records of business expenses so that deductible expenses are not overlooked.

General rule - The basic rule is that a deduction is allowed for expenses incurred wholly and exclusively for the purpose of the trade, profession or vocation. Unlike the equivalent rule for employment expenses, there is no requirement that the expense is ‘necessarily’ incurred. This means that as long as an expense is incurred for the purposes of the business and only for that purpose, a deduction is given.

Private expenses are not deductible - No deduction is given for private expenditure and under no circumstances should private items be `put through the business’. It is good practice to keep private and business expenditure separate and to have a separate bank account for business expenses. If you run your business as a limited company, the company should have its own bank account.

Mixed use expenses - If you incur an expense for both business and private purposes, you can deduct the business element if this can be separately identified. This may be the case if you use a phone for business and private calls. Any apportionment should be on a just and reasonable basis. If you cannot separate out the private use and the expense has a dual purposes (such as work clothes which also provide warmth and decency), the expense should not be deducted.

No deduction for drawings - If you operate your business as a sole trader or other unincorporated business and you pay yourself a salary or take drawings from the business, you cannot deduct these when working out your profit. You pay tax on your profit and are free to use the profits as you please. However, if you operate as a personal or family company, you can deduct any salary that you pay yourself (together with any employer’s National Insurance and employer pension contributions).

Capital expenditure - Capital expenditure can only be deducted in computing profits if you use the cash basis and the expenditure can be deducted under the cash basis capital expenditure rules. You cannot deduct capital expenditure if you prepare accounts under the accruals basis.

Common deductible expenses - The actual expenses that can be deducted will vary from business to business – what is important is that they are incurred wholly and exclusively for the purpose of the business. However, the following are example of common deductible business expenses.

1. Cost of goods sold, such as raw materials and goods brought for resale.

2. Distribution and packaging costs.

3. Office expenses, such as stationery and printing costs and phone bills.

4. Travel and subsistence expenses, such as fuel parking and fares for using public transport.

5. Motor expenses, such as car insurance, MOTs and repairs.

6. Staff costs, such as wages, salaries, employer’s National Insurance and pension costs.

7. Rent and rates.

8. Gas, electricity and water bills.

9. Repairs to business expenses.

10. Advertising and promotion costs.

11. Bank interest and other finance costs.

12. Accountancy, legal and other professional costs.

13. Uniforms (but not general clothing even if only worn for work).

Non-deductible expenses - A deduction for certain expenses is expressly prohibited. This includes the cost of business entertaining, which if deducted in computing accounting profit must be added back to arrive at taxable profit. Likewise, depreciation (an accounting concept) is not deductible in arriving at taxable profit; instead relief is given in the form of capital allowances.

For inheritance tax (IHT), there are potentially two nil rate bands available. The first – the nil rate band – is available to everyone and is set at £325,000 until 5 April 2026. An estate does not have to pay any IHT up to this amount.

The second nil rate band is the residence nil rate band (RNRB). This is available where the main residence is left to a direct descendant, such as a child or grandchild. The RNRB is set at £175,000 until 5 April 2026. However, unlike the nil rate band, the RNRB is tapered where the value of the estate is more than £2 million. The RNRB is reduced by £1 for every £2 by which the value of the estate exceeds £2 million, meaning that it is not available to estates valued at £2.35 million and above.

Spouses and civil partners

An IHT inter-spouse exemption means that no IHT is payable on anything that a person leaves to their spouse or civil partner.

Each spouse/civil partner has their own nil rate band and RNRB for IHT purposes. The IHT rules also allow any portion of the nil rate band or RNRB which is not used on the death of the first spouse/civil partner to be transferred to the surviving spouse/civil partner and claimed by their executors on their death. This is useful where a couple wish to leave their estate to their surviving spouse/civil partner in the first instance and to their children following the surviving spouse/civil partner’s death, but do not want to waste their nil rate bands.

Transferring the nil rate band

The percentage of the nil rate band that was not used when the first spouse/civil partner died can be used by the surviving spouse/civil partner’s estate as long as:

 the couple were married or in a civil partnership when the first death occurred; and

 the unused nil rate band is claimed within two years of the death of the surviving spouse or civil partner.

It is important to note that it is the unused percentage of the nil rate band that is transferred, not the absolute amount. This provides an automatic adjustment if the nil rate band changes between the first death and the second death.

The way in which the claim is made depends on whether a full IHT return (IHT400) is needed. If a full return is required, the claim should be made on form IHT402, which should be sent to HMRC with the IHT400 (and any other forms that are required). The IHT400 should be sent to HMRC within 12 months of the date of death.

If the death occurred after 1 January 2022 and the estate is an excepted estate, the transferable nil rate band can be claimed when applying for probate.

Transferring the unused RNRB

As with the nil rate band, the unused percentage of the RNRB is available on the estate of the surviving spouse or civil partner. Again, this must be claimed. This is done on form IHT435 which should be sent to HMRC with the IHT400.

Example

Polly died in June 2017 leaving her estate valued at £600,000 to her husband Paul. At the time of her death, the nil rate band was £325,000 and the RNRB was £100,000.

Paul dies in May 2022. He leaves his entire estate, valued at £1.4 million to his daughter Poppy. In addition to his nil rate band of £325,000 and his residence nil rate band of £175,000 his estate is able to claim the unused portion of Polly’s nil rate band and RNRB, which is 100% in each case. Consequently, Paul’s estate is able to benefit from a further nil rate band of £325,000 and a further residence nil rate band of £175,000. As it is the unused percentage that is transferred, Paul’s estate benefits from 100% of the RNRB at its value of the time of his death (i.e. £175,000), rather than the absolute value of the RNRB at the time of Polly’s death (i.e. £100,000). Consequently, IHT is only payable to the extent that the value of his estate exceeds £1m (2x £325,000 + 2 x £175,000).

The Construction Industry Scheme (CIS) is a tax deduction scheme under which tax is deducted from payments made to subcontractors for construction work unless the subcontractor is registered with HMRC for gross payment status. HMRC recently published guidance on the application of the CIS to property investment companies after it came to their attention that many property investment companies undertaking substantial redevelopments were unaware that they needed to register as a contractor within the CIS.

A property investment company will need to comply with the CIS if it is acting as a contractor. Failing to register for, and comply with, the scheme may result in an unexpected tax liability which it might be unable to recover from the subcontractor.

Property developers - The work of a property developer is the creation of new buildings or the renovation or conversion of existing buildings. Consequently, they will fall within the definition of a mainstream contractor for the purposes of the CIS. As a result, they should register as a contractor and apply the CIS.

Speculative builders should also register a contractor for the purposes of the CIS as their work involves the creation or renovation of buildings.

Property investment companies - Property investment companies acquire and dispose of buildings for a capital gain or acquire buildings which they rent out to generate rental income. Unlike a property developer, they may not undertake construction work, and consequently, a property investment company will not necessarily fall with the ambit of the CIS.

However, this will not always be the case and the CIS should not simply be dismissed as ‘not relevant’. Where the property investment company’s property estate is large enough, the expenditure that it incurs on construction operations may be sufficient for it to fall within the scope of the CIS as a deemed contractor. A deemed contractor is a non-construction business that spends more than £3 million in a rolling 12-month period on construction operations. A deemed contractor must register and operate the CIS.

However, if the spend on construction operation is less than £3 million in a 12-month period, the property investment company will not be a deemed contractor and will remain outside the CIS scheme, as long as its main business remains property investment rather than property development.

Example - A property investment company acquires a former warehouse which it renovates and converts into flats before letting them out. The cost of the construction operations exceeds £3m in a 12-month period. The property investment company must register as a deemed contractor under the CIS and operate the scheme.

Change in the nature of the business - Where a property investment company enters into substantial or multiple construction contracts, they may need to assess whether their business has changed and they have become a property developer. If this is the case, they may need to register as a mainstream contractor under the CIS, even if they revert to being a property investment company once the construction work has concluded. Consideration should be given to what is the main nature of the business at that particular time.

It will not always be apparent when a hobby tips over into a trade and the point at which you need to declare your income to HMRC. There is no statutory definition of a trade beyond that a trade includes a ‘venture in the nature of a trade’. Consequently, in deciding whether a trade exists, HMRC look to the ‘badges of trade’. These are indicators of trading developed from case law.

The badges of trade

There are nine badges of trade.

Profit-seeking motive: an intention to make a profit support trading but is not by itself conclusive.

The number of transactions: systematic and repeated transactions will suggest a trade.

The nature of the asset: is the asset of a type than can only be turned to advantage by sale, does it yield an income or does it provide ‘pride of possession’ (for example, a picture for personal enjoyment). An asset which is acquired for sale would suggest trading, whereas an asset acquired to yield an income would suggest an investment.

Existence of similar trading transactions or interests: transactions that are similar to those of an existing trade may themselves be trading.

Changes to the asset: has the asset been repaired, modified or improved to make it more easily saleable of saleable at a greater profit?

The way in which the sale was carried out: was the asset sold in a way that was typical of a trading organisation, which would suggest the existence of a trade, or did it have to be sold to raise cash in an emergency?

The source of finance: was money borrowed to buy the asset and could the funds only be repaid by selling the asset?

The interval between the purchase and the sale: assets that are the subject of a trade will normally (but not always) be sold quickly. Consequently, the intention to sell an asset shortly after sale will suggest trading. However, where the intention is to hold the asset indefinitely, it is less likely to be the subject of a trade.

Method of acquisition: an asset that is acquired by way of inheritance or as a gift is less likely to be the subject of a trade.

It is important to note that the above is not a checklist and it is not necessary for every badge to be present for there to be a trade. Further, no particular badge is conclusive evidence of a trade. Rather, it is a case of considering each badge and whether it is present or absent to form an overall impression of whether a trade exists.

Telling HMRC

If you are earning a small amount of money from your hobby, for example, making and selling occasional birthday cakes, it is unlikely that you will need to tell HMRC. The trading allowance means that if the income from your self-employment is less than £1,000 you do not need to report it to HMRC. However, it should be noted that each person is only allowed one trading allowance across all sources of self-employment. Consequently, a person who is already self-employed and earning more than £1,000 will need to pay tax on any income from a hobby business, even if the income from the hobby is less than £1,000 a year.

If your income from your business for the tax year is more than £1,000, you will need to register for self-employment by 5 October after the end of the tax year.

Where a business is operated as a family company, it is necessary to extract the profits from the company in order to use them outside the company for personal use, such as to meet living expenses. Extracting profits may trigger further tax and National Insurance liabilities, and when formulating a strategy, it is advisable to extract profits in as tax-efficient manner as possible. What this will look like will, to a certain extent, depend on individual circumstances. However, that said, a popular and tax-efficient profit extraction strategy is to take a small salary and extract further profits as dividends.

For 2022/23, assuming the personal allowance is not used elsewhere, the optimal salary is equal to the primary threshold of £11,908 where the employment allowance is not available and equal to the personal allowance of £12,570 where the employment allowance is available to shelter employer’s National Insurance.

Dividend allowance

The dividend allowance is not an allowance as such. Rather, it is a zero-rate band. Where dividends fall within this band, they are taxed at a zero rate so that they are free of tax in the hands of the shareholder. The dividend allowance is available to all taxpayers, regardless of their marginal rate of tax. For 2022/23, the dividend allowance is set at £2,000. Dividends are taxed as the top slice of income and the dividend allowance uses up part of the tax band in which it falls.

Dividend policy

In a family company scenario, the availability of the dividend allowance can be used to drive dividend policy. However, when paying dividends to utilise available dividend allowances, it should be remembered that dividends can only be paid out of retained profits and must be paid in accordance with shareholdings. This can be overcome by the use of an alphabet share structure by which each shareholder has their own Class of shares, e.g. A ordinary shares, B ordinary shares, C ordinary shares, etc, and which provides flexibility to tailor dividends to individual circumstances.

Dividends are paid from post-tax profits and have already suffered corporation tax.

To prevent dividend allowances being wasted and optimise the opportunity to extract profits without triggering further tax liabilities, in a family company scenario it makes sense to make family members shareholders, even if they have other income and do not work in the company. The benefits are illustrated by the following case study.

Case study

Dave is the director of a family company DJ Ltd. His wife and two grown-up daughters are shareholders in the company. Dave has 100 A ordinary shares, his wife has 100 B ordinary shares and his daughters, Delia and Diane, have, respectively, 100 C ordinary shared and 100 B ordinary shares.

The company has made a post-tax profit of £20,000 that Dave wishes to extract. Dave has received a salary of £12,570 from the company, as does his wife, Debbie. Both Dave and Debbie have income from property and pay tax at the higher rate.

If a dividend of £200 per share is declared for A class shares, Dave will receive a dividend of £20,000. After deducting the dividend allowance of £2,000, the balance of £18,000 is taxed at 33.75% -- a tax bill of £6,075.

If, instead, the company declares a dividend of £1,400 per share for A class shareholders and a dividend of £20 per share for B, C and D Class shareholders, Dave will receive a dividend of £14,000 and his wife and daughters will each receive a dividend of £2,000.

In this scenario, Dave will pay tax of £4,050 on his dividend (33.75% (£14,000 - £2,000)). However, his wife and daughters will receive their dividends tax-free as they are sheltered by their dividend allowances.

By using an alphabet share structure and taking advantage of family members’ dividend allowances, the combined tax bill has been reduced by £2,025.

If his daughters have not fully utilised their basic rate bands, changing the dividend mix to make use of this can produce further savings.

Sometimes it is evident that a trade is being undertaken -- a plumbing business, a manufacturing business, an accountant or solicitor are all 'trades'. However, not all trading activities are easily identifiable. If you buy and sell a property in relatively quick succession for example, is that a trade in HMRC's eyes or investment? Each source of income is taxed differently so the distinction is important. Generally, profits made from the sale of land and buildings are taxable under the capital gains tax (CGT) rules which, in most circumstances, results in a lower tax bill than profits charged to income tax.

There is a definition of 'trade' to be found in both the Income Tax Act 2007 and the Corporation Tax Act 2010 but it is far from being clear stating that a trade is 'any venture in the nature of trade'. It has therefore been left to case law to delve deeper into the meaning. Using the various cases that have come before the courts in the last 20 years HMRC have compiled what are termed ‘badges of trade’.

At present HMRC lists nine 'badges of trade' being:

•  a profit seeking motive;
•  the number of transactions;
•  the nature of the asset;
•  existence of similar trading transactions or interests;
•  changes to the asset;
•  the way the sale was carried out;
•  the source of finance;
•  interval of time between purchase and sale;
•  method of acquisition.

If any of the 'badges' are present in a transaction then HMRC may argue that any 'profit' is taxable as income, and while the existence of one badge can be enough to confirm an activity as trading, this need not necessarily be the case.

From the decided court cases that have been held, it is clear that no one 'badge' is more persuasive than another. Neither do all 'badges' have to be present. It is possible for more than one badge of trade to apply without an activity counting as trading. For example, it is clear that having an intention to make a profit can indicate a trading activity, however by itself this is not enough. In the 1979 case of Salt v Chamberlain 53TC143, a research consultant made an overall loss on the Stock Exchange after trying to forecast the market. The loss was made over several years and over 200 transactions. The court decided that this was not a trade as share trading by a private individual can never be subject to any of the badges of trade. Therefore the transactions were subject to CGT.

One recent court case where many of the 'badges' were considered was Mark Campbell v HMRC 2022 TC08398. In this case the court concluded that the purchase, modification and sale of four properties in five years was not trading and was therefore subject to CGT rather than income tax. HMRC brought the case because they had information that Mr Campbell had acquired and disposed of four properties between 2010 and 2015 selling each one for more than he paid. The court decided that, while they agreed that profits had been generated from the activities, on balance, the activities were not trading. The decision was made by considering the following factors relating to 'badges of trade':

•  The length of ownership of the properties was short.
•  The properties had been modified prior to sale.
•  There was a repeated pattern of renovation.
•  There was no connection with an existing trade or activity over a protracted period of time.
•  The Appellant was not a professional property developer.
• The court gave credence that Mr Campbell was employed full time in work unrelated to property development and had not been engaged in such activities elsewhere.
• This case shows that no single 'badge' is conclusive evidence in itself. It is therefore necessary to critically examine the overall picture, distinguishing any unique features.

In common with other types of business, expenses are unavoidable when running a property business. However, subject to certain conditions, it is possible to obtain tax relief for the expenses of running a property business.

Allowable expenses - The general rule is that a landlord can deduct revenue expenses which are incurred wholly and exclusively for the purposes of renting out the property.

Examples of typical expenses incurred by a landlord running a property business for which a deduction may be available include:

• advertising costs;
• accountancy costs;
• cleaning costs;
• letting agency fees;
• gardening costs;
• repairs and maintenance;
• cost of utilities where met by the landlord;
• council tax where met by the landlord;
• legal fees;
• travel costs.

No relief is available for costs met by the tenant. Typically, a tenant in a buy-to-let would pay the utility bills and the council tax. However, where a landlord lets furnished holiday accommodation, the utility bills and any business rates may be paid by the landlord. These can be deducted.

Interest and finance costs - Landlords running a property business cannot deduct interest and finance costs, such as mortgage interest, when calculating their taxable profit. Instead, they can deduct 20% of those costs from the tax that they owe. The deduction is capped at the amount of tax – it cannot generate a repayment. However, any unrelieved interest and finance costs can be carried forward.

These rules do not apply to furnished holiday lettings, in respect of which interest and finance costs can be deducted in full in calculating profits.

Private and business expenses - Relief is only available for business expenses, and where an expense is incurred for both private and business purposes, relief is only available if the business element can be separately identified. If a car is, for example, used both privately and for the business, relief is available for business mileage costs, but not private journeys. Approved mileage rates can be used.

Domestic items - Separate rules also apply to domestic items, such as furniture, furnishings and white goods, in a residential let. No relief is available for the initial cost of the item, but where the item is replaced, the cost of a like-for-like replacement can be deducted in calculating profits.

These rules do not apply to furnished holiday lettings.

Capital expenditure - The treatment of capital expenditure depends on the way in which the accounts are prepared. The cash basis is the default basis where rental receipts do not exceed £150,000. Where this is used, capital expenditure can be deducted in calculating profits unless such as deduction is expressly prohibited. The main exclusions are land and buildings and cars.

Under the accruals basis, relief is available either in the form of capital allowances (which are limited in a residential let) or when computing the gain on the eventual sale.

Keep records - It is important to keep good records of expenses so nothing is overlooked.

Property that is jointly-owned may be let out. As people are taxed individually, the income must be allocated in order to work out the tax that each joint owner is liable to pay. The ways in which income from jointly-owned property is taxed depends on the relationship between the owners.

Joint owners are not married or in a civil partnership - Assuming there is no property partnership, where property is jointly-owned by persons who are not married or in a civil partnership, the income arising from the property will normally be allocated in accordance with each person’s share in the property. Each person is taxed on the income that they receive.

Example - Andrew, Alison and Anthony are siblings who own a property together which is let out. Andrew owns 50% of the property, Alison owns 30% and Anthony owns the remaining 20%.

The property generates rental income of £10,000. The income is allocated as follows in accordance with the ownership shares:

• Andrew: £5,000;
• Alison: £3,000; and
• Anthony: £2,000.

Each is taxed on the share that they receive.

The joint owners do not have to share profits in accordance with their ownership shares – they can agree a different split. If they do, they are taxed on what they actually receive.

Spouses and civil partners - Where property is owned jointly by spouses and civil partners, the default position is that the income is treated as being allocated 50:50 for tax purposes, regardless of the amounts that they actually receive. This can be useful from a tax planning perspective where spouses or civil partners have different marginal rates of tax. The no gain/no loss capital gains tax rules can be used to transfer a small share in a property to a spouse or civil partner paying tax at a lower rate, transferring 50% of the income for tax purposes in the process.

Example - Frank is a higher rate taxpayer. He owns a property generating rental income of £20,000 a year. He transfers a 5% stake in the property to his wife Felicity, whose only income is a salary of £15,000. Frank and Felicity are each taxed on £10,000 of the rental income. Felicity pays tax at 20% on her share. Had the property remained in Frank’s sole name, he would have paid tax at 40% on the full amount of the rental income. Taking advantage of the rules saves them tax of £2,000 a year.

This rule does not apply to income from furnished holiday lettings.

Form 17 - Where spouses or civil partners own a property jointly in unequal shares, they can elect for the income to be taxed by reference to their underlying ownership shares. However, this is only possible where they own the property as tenants in common (and each own their own share); where the property is owned as joint tenants (and as such the owners have equal rights over the whole property), the income split remains 50:50.

The election is made on Form 17. It must be made by both spouses/civil partners jointly and they must declare that they own the property in the shares stated on the form. The income split takes effect from the date of the latest signature, and to be effective must reach HMRC within 60 days of the signature.

The ability to elect for income to be taxed in accordance with ownership shares opens up tax planning opportunities, particularly as use can be made of the capital gains tax no gain/no loss rules for transfers between spouses and civil partners to change the ownership slip without triggering a chargeable gain.

HMRC's basic premise is that where a company pays a personal bill, there will be tax and National Insurance implications unless the expense is work related, incurred 'wholly, exclusively and necessarily' for the job.

How the tax is accounted for and whether it is solely the employee who is liable to NI or both the employer and employee who are liable will depend on whose name the bill is made out to and who pays the bill. If the employee arranges for the goods or services in their own name with the employer paying the bill then the employer has discharged the employee’s debt. Payment is deemed as 'salary', treated as a benefit in kind for tax purposes and liable to both employers’ and employees’ NI. Strictly, the employer should deduct tax as if the employee had been paid in cash but as tax cannot be deducted from a payment made to a third party, the payment is treated as a taxable benefit-in-kind. The end result is that the individual may suffer both income tax and NI, whilst the company pays employers’ NI, on the same amount, exactly as if the employer had paid the employee cash. Whether a tax charge is levied will depend on the type of expense. Certain professional memberships are allowable, for example, tax-free to the employee and allowable in the company’s expenses. Any NI is accounted for in the tax month the bill is paid on the employee’s behalf.

In comparison if the purchase is made in the employer's name on the employee's behalf, then it is a company expense. It will also probably be a benefit-in-kind assessable on the employee again declarable on a P11D. However, unlike other benefits in kind, there will be no employees’ NI although NI will be payable by the employer.

The position where the company pays a director's private bill will differ depending on whether the director has a contract of employment. If there is one in place then the above points apply as the director is an employee. However, if payments, made to or incurred on behalf of a director, do not form part of their remuneration package, then the payment could be set against the director’s loan account. HMRC accepts this overrides the treatment as a benefit in kind and, in most situations, the employers NI as salary. Instead, it becomes a debt that needs to be repaid at some time. Repayment can be by debiting salary/bonus, a dividend or the director repaying the payment made.

These amounts may not be an allowable company expense and therefore not be deductible for corporation tax purposes if they do not form part of a remuneration package. Generally, the tax value of a benefit-in-kind is the cost to the employer.

Sometimes the company owes the director money because the DLA is in credit, possibly because the director lent the company money on start up. If the director requires the company to apply some of those funds to settle a third party debt then the payment does not arise out of the director’s employment rather, it is a loan and therefore not subject to tax or NI.

The summer is a popular time for events and event parking is often limited. If you have a drive or field that you do not use, you could consider renting it out to make some money. This need not give rise to a tax headache.

However, it should be remembered that all income from renting UK property owned by the same person or persons forms a single UK property business. Consequently, if a person has other rental properties, rental income from renting a driveway cannot be considered in isolation; instead it forms part the income of the existing property business.

Nature of the property allowance - The property allowance is a £1,000 tax free allowance which enables an individual to earn tax-free income from property of up to £1,000 a year.

If property income is less than £1,000, there is no need to tell HMRC about it or to return it on the self-assessment tax return.

Example - Peter lives in Wimbledon. He has space on his drive for two cars in addition to his own car. During the Wimbledon fortnight he rents out each space for £30 a day. During Wimbledon 2022 he makes £720 from renting his drive.

He has no other income from property.

As the income from property is less than £1,000, he is able to enjoy it tax-free and does not need to report it to HMRC.

Income exceeds £1,000 - An individual can still take advantage of the £1,000 property allowance even if their income from property is more than £1,000 in the tax year. The allowance can be deducted from the income to arrive at the taxable profit. This will be beneficial where the actual expenses are less than £1,000.

Example - Petra lives near a popular outdoor concert venue. During July and August she rents a parking space on her drive. In 2022, this generate her income of £1,500. She incurs expenses of £200 in advertising the space and associated administrative costs.

She has no other property income.

As her income exceeds £1,000, she must tell HMRC about it. However, she can take advantage of the property allowance to reduce the tax that she pays on that income.

If Petra does not claim the property allowance, her taxable profit will be £1,300 (rental income of £1,500 less expenses of £200). However, by claiming the allowance, she is able to reduce her taxable profit to £500 (rental income of £1,000 less property allowance of £1,000). Claiming the allowance will save her tax of £160 if she is a basic rate taxpayer and £320 if she is a higher rate taxpayer.

Expenses of more than £1,000 - Claiming the property allowance will not be beneficial if associated expenses are more than £1,000. Where this is the case, it is better to deduct the actual expenses.

Example - Paul has a field that he is uses to offer event parking. In July 2022, he makes rental income of £8,000. He also incurs expenses of £1,200 on staff and admin costs.

If he calculates his rental profit in the usual way, his taxable profit is £6,800 (£8,000 - £1,200). However, if he claims the property allowance, his rental profit increases to £7,000 (£8,000 - £1,000). Claiming the property allowance is not worthwhile.

LossesIt is also better not to claim the allowance where deducting expenses from rental income would give rise to a loss so as to preserve the loss. The deduction of the allowance cannot create a loss. However, this will involve some administration and completion of the return. Consequently, if rental income is less than £1,000 and there is little opportunity to use the loss, claiming the property allowance may be the preferred option.

Business Property Relief (BPR) is an attractive inheritance tax (IHT) relief potentially providing 100% tax relief in respect of qualifying assets (termed 'relevant business property') relating to both lifetime transfers of business assets or in the death estate, providing, of course, certain provisions apply. Different conditions apply depending on whether the assets are transferred during the donor's lifetime or on death.

BPR works by offsetting the value attributable to the 'relevant business property' when calculating the taxable estate by a percentage of either 50% or 100% (depending on the type of business property) as follows:

•  Unincorporated business 100%
•  Controlling holding of unquoted shares 100%
•  Any unlisted, unquoted shares 100%
•  Controlling holding of quoted shares 50%
•  Certain assets used in a business 50%

Shares in an unquoted trading company

Such shares should qualify for BPR in full, providing the shares have been held for at least two years and there is no binding contract in place to sell the shares. However, where there is more than one shareholder of a private limited company, understandably many such shareholders have a binding agreement to ensure the company's continuity. Such agreements state that should a shareholder die, their personal representatives are required to sell the shares to the surviving shareholder(s). If such a binding agreement is in place then the shares will not qualify for BPR because the personal representatives are no longer considered to own the shares. Where this happens the value of the right to receive the proceeds is included in the estate, and is taxable in full as the right is not 'relevant business property'.

Practical point

Rather than having a binding agreement, the agreement should be made optional, providing the estate with an option to sell, and the remaining shareholders the option to buy. Care should be taken that the agreements are not made on the same day (or nearly the same day) otherwise HMRC could deem the agreement to be an ordinary agreement for sale. The termination dates for the estate’s and the shareholders’ options need to be different.

Land and Buildings

Many company's operate out of land or buildings owned by a shareholder personally. Such assets also do not automatically attract BPR; they are only 'relevant business property' where the transferor controls the company. As a 50% shareholder does not control a company, BPR will not apply. A planning point will be to ensure that should BPR be required that the shareholder must retain at least 51% shareholding.

Furnished holiday lets

For income tax purposes the operation of a furnished holiday let (FHL) is deemed to be a business and not a property income investment. As such any qualifying FHL qualifies for capital gains tax relief on sale under Business Asset Disposal Relief. However, just because the lettings are deemed a business for income tax and CGT purposes does not mean that the business also qualifies for BPR. HMRC’s view is that furnished holiday lets generally do not qualify for BPR stating that income derived from such businesses largely comprises rent in return for the occupation of property and as such is an investment rather than a trading business. However, they appreciate that there may be some cases where the level of additional services provided is 'so high that the activity can be considered as non-investment', and, as ever, 'each case needs to be treated on its own facts'.

Therefore, to succeed in a claim for BPR the burden of proof must necessarily be greater than required for either income tax or CGT. HMRC is more likely to allow relief where the lettings are short term (e.g. weekly or fortnightly) and the owner (either themselves or a relative or housekeeper) has been substantially involved with the holidaymaker(s) in terms of their activities on and from the premises even if the lettings were for part of the year only. Merely providing maintenance, cleaning, etc. will not be enough. HMRC's guidance states that the business needs to be looked at 'in the round' when deciding whether 'the holding of property as investment was the main component of the business. If it was not, then the business was entitled to business relief'.

The Covid-19 pandemic forced large numbers of employees to work from home for the first time. Having made the transition to home working, post pandemic, many employees have continued to work from home some or all of the time.

Household expenses

Employees who work from home may incur costs as a result, such as increased household bills. The tax legislation allows employers to make a tax-free payment of £6 per week (£26 per month) to employees who work from home at least some of the time to help them meet the costs. The payment can be made tax-free regardless of whether the employee works from home through choice.

If the employer does not contribute towards the costs of additional household expenses, the employee may be able to claim tax relief. During the Covid-19 pandemic, the conditions were relaxed and employees who were required to work from home during the pandemic were able to make a claim of £6 per week for 2020/21 and 2021/22 for the full tax year (even if they returned to the office for some of the year). However, the easement came to an end on 5 April 2022, and for 2022/23 onwards relief is only available where the employee is required to work from home (either by the employer or the nature of the work), but not where the employee has the option to work at home or at the employer’s premises but chooses to work from home.

Hybrid working arrangements are attractive because of the flexibility that they offer. However, the choice element will limit to ability to claim a deduction for household expenses. Requiring the employee to work from home on, say, one specified day of the week will open the door to a claim.

Homeworking equipment

Where an employee works from home, depending on the nature of their job, they may need equipment to enable them to do so. Where the employer provides homeworking equipment, no tax liability arises in respect of that equipment.

During the Covid-19 pandemic, the rules were relaxed so that where an employee purchased homeworking equipment, the cost of which was later reimbursed by the employer, the reimbursement was not taxed. If the employer did not reimburse the cost, the employee could claim a tax deduction.

However, this easement ended on 5 April 2022. The strict statutory rules now apply, and as employees are not able to claim a deduction for capital expenditure (such as the cost of a computer), where this cost is reimbursed by the employer, the reimbursement will be taxable.

However, a deduction is allowed for revenue expenses wholly, necessarily and exclusively incurred in undertaking the employment duties, and any reimbursement of those costs can be made tax-free.

The First-tier Tribunal (FTT) recently considered whether money from property sales was trading income or capital gains, and if private residence relief was due. The FTT ruling provides useful guidance on both issues

Serial property sales - Mr Campbell (C) bought and sold four properties in little over five years. He made a substantial profit from the transactions which he declared as capital gains. He claimed private residence relief (PRR) against each gain, meaning that in his view there was no tax to pay. HMRC disputed that the profits were capital gains, arguing instead that C was trading as a property developer and so any profits were liable to income tax to which, of course, PRR cannot apply. HMRC also argued that even if the profits were capital gains PRR wasn’t due as C hadn’t lived in the properties.

Trading or not? - For HMRC to succeed at the First-tier Tribunal (FTT) it had to show that one or more of the generally accepted tests established by case law, known as the “badges of trade”, applied to C’s buying and selling of properties. While some of these applied, e.g. there were multiple transactions and C had spent money improving the properties to varying degrees, the FTT decided that on balance the money made by C wasn’t trading income.

Mitigating factors - In arriving at this decision it took account of the fact that C was employed full time in work not related to property development and had not been engaged in such activities elsewhere. We’re not so sure the FTT’s decision was right. However, it is a reminder that where there’s doubt tribunals will usually come down in favour of the taxpayer.

While the existence of one badge of trade can be enough to confirm an activity as trading it doesn’t automatically do so despite HMRC’s assertion. As in this case it’s possible for more than one badge of trade to apply without an activity counting as trading.

Private residence relief - Having dodged the “trading” bullet C’s claim for PRR was now in the line of fire. Here his luck ran out. C had argued that although he had not lived in the properties PRR applied because it was his intention to but he was prevented because he lived in job-related accommodation. This is one of the exceptions that allows PRR for periods of absence from your home but the FTT decided the alleged job-related accommodation was actually C’s home. Several factors indicated this, not least was that in his evidence C referred to the accommodation as his home. The property was his parents’ home and C lived there not because of his work but to look after his father with dementia.

It’s worth noting that had C’s claim for PRR not failed for the reasons we’ve explained, HMRC had a further argument in reserve. Legislation specifically precludes PRR for gains made from properties specifically purchased for the purpose of making a gain. If this argument had been needed we think it would have had a better than 50/50 chance of succeeding.

HMRC failed to show that buying, improving and selling properties for a profit was trading. The FTT said the tests for trading activity were not met. However, HMRC won its argument that private residence relief didn’t apply. The taxpayer’s argument that he didn’t live in the properties as he was in job-related accommodation wasn’t believable.