Helpsheets ... continued 28 from homepage

Many landlords purchase their investment properties with the aid of a mortgage. In the current climate of rising interest rates, landlords may be wondering whether any tax relief is available to help them. While tax relief is available for interest and finance costs (but not capital repayments), the nature of the relief depends on the type of let. The relief may also be capped if the landlord has extended the mortgage since first letting the property.

No tax relief is available for interest on a loan to buy a main residence.

General rule

Regardless of the type of let, the general rule is that tax relief is available for interest and finance costs on borrowings up to the market value of the property at the time that it was first let. The borrowings do not have to be secured on the let property – the landlord can release equity from their main home and use this to buy the let property and still claim tax relief for the associated interest.

To take advantage of rising house prices, the landlord may remortage a property to release equity to use as a deposit to expand their property portfolio. However, from a tax relief perspective, problems arise if the borrowing exceeds the value of the property when first let as relief is only available on borrowings up to that level. Interest paid on borrowings in excess of this does not qualify for relief.

Example

Julie bought an investment property many years ago for £100,000, letting it immediately. The property is now worth £500,000 and Julie has released equity to expand her portfolio. The mortgage is currently £400,000. Julie is only eligible for tax relief on borrowing of £100,000; no relief is available for the interest payable on the remaining £300,000.

Residential lets

Stricter rules govern the tax relief that is available to unincorporated landlords letting residential properties. Here, relief is given as a tax deduction equal to 20% of the interest and finance costs (capped at the tax due on the rental profits). The landlord cannot deduct the interest and finance costs when calculating the taxable profits. This means that where the landlord is a higher or additional rate taxpayer, they do not get relief at their marginal rate of tax. The relief is capped at 20%.

Other lets

The rules applying to non-residential lets, including furnished holiday lettings, and to companies (regardless of the type of let) are more generous. Interest and finance costs can be deducted in full when calculating taxable profits, ensuring relief is given at the landlord’s marginal rate of tax.

A tax charge may arise under the benefit in kind legislation where a company van is available for an employee’s private use. If fuel is also provided for private journeys, a separate fuel benefit tax charge arises. The van and fuel benefit charges for 2023/24 have now been announced.

Van benefit charge

The van benefit charge only arises if the company van is not an electric van and private use of the van is not limited to home-to-work travel. The amount is set each tax year and increased in line with the increase in the consumer price index. The taxable amount is £3,960 for 2023/24, up from £3,600 for 2022/23. The rise means that a basic rate taxpayer will pay £792 a year in tax and a higher rate taxpayer will pay £1,584 on the benefit of their company van for 2023/24.

Restricted private use

It is possible to have a company van and to use it for home-to-work travel without incurring a tax charge as long as the ‘restricted private use’ conditions are met. This test has two parts – the ‘commuter use requirement’ and the ‘business travel requirement’.

The commuter use requirement is met if the terms on which the van is made available to the employee prohibit private use other than for ordinary commuting journeys or journeys that are substantially the same. Ordinary commuting is normal home-to-work travel. In addition, the employee (or the employee’s family) must not have actually used the van for private use other than for ordinary commuting.

The business travel requirement is met if the van is made available to the employee mainly for business use.

If this test is met, the van benefit charge does not apply.

Electric vans

The charge for an electric van is nil. Consequently, employees with electric company vans can, where permitted to do so by their employer, use their company van for unrestricted private use without any associated tax charge. This makes an electric company van a tax-free benefit.

Fuel charge

A separate van fuel charge applies if a van charge arises in respect of the van and the employer meets the cost of fuel for private travel. This is set at £757 for 2023/24, up from £688 for 2022/23. Consequently, the perk of ‘free fuel’ will cost a basic rate taxpayer £151.40 in tax for 2023/24. For a higher rate taxpayer, the tax cost is £302.80.

There is no charge if fuel is provided for home-to-work travel and the restricted private use requirement is met. Likewise, there is no charge if the employer meets the cost of electricity for private travel in an electric van.

Under the original plans, landlords with rental income (or combined rental and business income) of more than £10,000 would have needed to comply with Making Tax Digital for Income Tax (MTD for ITSA) from 6 April 2024.

However, the start date has now been delayed, and its introduction is to be phased in.

Phased introduction

MTD for ITSA will now apply from 6 April 2026. However, from that date, it will only apply to self-employed traders and landlords with business and/or rental income of more than £50,000. It will be extended to include traders and landlords with business and/or rental income of between £30,000 and £50,000 from 6 April 2027.

Taxpayers have the option to join MTD for ITSA voluntarily ahead of their compulsory start date.

As yet, no start date has been announced for landlords with rental income (or rental and trading income) of £30,000 or less. The government have announced that they are to conduct a review into the needs of smaller businesses, particularly those whose income is below £30,000. The review will consider how ‘MTD for ITSA can be shaped to meet the needs of the smaller business and the best way for them to fulfil their income tax obligations’. The review will also inform any future roll-out of MTD for ITSA beyond April 2027.

Nature of MTD for ITSA

Under MTD for ITSA, landlords who fall within its scope are required to maintain digital records using MTD-compatible software. Landlords must also send quarterly updates to HMRC within one month of the quarter end and an end of period statement by 31 January following the end of the tax year. They must also make a final declaration by the same date.

Impact of changes

In determining whether they will need to join MTD for ITSA and when, landlords must consider not only their rental income, but also any income that they may have from self-employment. It is their total trading and rental income that determines their MTD start date, not just their rental income. This may mean that a landlord with low rental income will need to comply with MTD for ITSA from April 2026 if their combined rental and self-employment income is more than £50,000, whereas a landlord with only rental income which is just under £30,000 a year will remain outside MTD for ITSA.

Case study 1

James has one rental property from which the rental income is £4,000 a year. He is also a self-employed gardener, with profits of £60,000 a year. His combined trading and rental income is £64,000. He must therefore comply with MTD for ITSA from April 2026.

The start date is two years later than under the original plans.

Case study 2

Julie has rental income of £28,000 a year from letting out two properties. She is also employed as a teacher, earning £40,000 a year.

In determining her MTD for ITSA start date, only her rental income is taken into account. Her teacher’s salary is taxed under PAYE. As her rental income is below £30,000, she is currently outside MTD for ITSA. Under the original plans she would have been required to comply with MTD for ITSA from April 2024. She no longer needs to do this.

With different rates and limits of National Insurance contributions (NIC) for the 2022/23 year, anyone who has more than one paid job or who is both employed and self-employed could easily find themselves paying too much in NIC. Problems can arise because the PAYE system does not easily cater for multiple jobs. HMRC are supposed to check and make any repayment; however, this does not always happen. So how do you work out whether you have overpaid and, if you have – how do you get the money back?

NIC is calculated separately for each employment and self-employment on a ‘standalone basis’. Calculation difficulties arise for individuals with multiple sources of income where the limit for Class 1 employee NIC paid is not exceeded for each separate source of earnings but when total earnings are considered, the maximum amount is exceeded and a refund due. The maximum amount is not a fixed amount and needs to be calculated on a person-by-person basis. The annual maximum Class 1 and Class 2 NIC payable by any taxpayer whatever the source of earnings is 53 weeks at the primary (employee) Class 1 contribution rate (currently 12%) between the primary earnings threshold and the upper earnings limit plus an additional 2% on all remaining earnings in excess of the upper earnings limit.

2022/23

The calculation of the annual maximum has been made slightly complicated this year by changes to the NIC limits part way through such that composite rates apply. The primary threshold for 2022/23 is £190 per week (£823 per month) to 5 July 2022 rising to £242 per week (£1,048 a month) from 6 July 2022 creating a maximum limit of £11,909 for the year. The upper earnings limit is £967 per week (£4,187 a month) for 2022/23. The changes in the employee primary threshold meant that the lower profits limit for Class 4 NIC for the self-employed was aligned with the personal allowance to £11,909. The Class 2 small profits threshold remained unchanged at £6,725.

Calculation for self-employed

The calculation of the maximum amount for anyone with two or more employments is relatively straightforward. However, for those with a mixture of sources of income, the regulations detail a nine-step process of calculation to ascertain the amount of Class 4 NIC payable. The calculation starts with calculating the theoretical maximum ‘main rate’ as the maximum Class 2 and Class 4 NIC for the tax year taking contributions to the upper profits limit. The total amount of Class 1 and Class 2 NIC already paid is then deducted from the ‘main rate’ amount. The resultant figure is categorised into three ‘cases’ – which one to use is dependent upon the amount and mix of income. A negative figure (in practice when employment income subject to Class 1 NIC is more than the ‘main rate’) means that any profit exceeding than the Class 4 NIC lower profits limit is charged at the uncapped 2.73%. A positive figure means further steps in a more complicated calculation are required.

Reclaim NIC overpayment

Unlike tax, there is no annual return form to report total income for NIC purposes. Instead HMRC use information provided on the self-assessment return, together with information they already hold, to determine the amount of any Class 2 and/or Class 4 NIC payable. The deadline for reclaim of Class 2 NIC is six years but there is no time limit for a Class 4 reclaim.

Deferment

The effect of deferment is a suspension of contributions on PAYE earnings. After the end of the tax year HMRC will calculate whether anything is owed, in effect deferring payment. Neither Class 2 nor Class 4 NIC can be deferred; deferment only applies to Class 1 NIC.

Furnished holiday lettings have tax benefits that are not available to landlords of residential lets. However, to qualify as a holiday let, certain conditions must be met.

The three tests

There are three tests to pass for the let to be treated as a furnished holiday let for tax purposes. These are:

the pattern of occupation condition;

the availability condition; and

the letting condition.

The pattern of occupation condition caps lets that exceed 31 days at 155 days a year.

The availability condition requires the property to be available for letting as furnished holiday accommodation for at least 210 days in the year. Days when the landlord is staying at the property are not counted in this total.

The letting condition requires that the property must be commercially let as furnished holiday accommodation to the public for at least 105 days in the year. Lets of more than 31 days are excluded from this total unless the visit unexpectedly lasted longer than 31 days due to circumstances beyond the visitor’s control, such as flight cancellations or illness.

If the tests are not met in a particular year, where the landlord has more than one furnished holiday let, an averaging election may allow the property to qualify if on average the properties are let commercially as furnished holiday lettings for at least 105 days in the year.

Where the tests have been met previously, a period of grace election may allow the property to qualify for a year where the intention was to meet the letting condition but this did not happen.

Need for lets to be commercial

Only commercial lets are counted when testing to see if the letting condition is met. Days when the landlord stayed at the property do not count, nor do any days where the property was let to family or friends at a reduced or zero rate. These are not commercial lets.

When letting friends or family stay in the property, it is necessary to be mindful of the impact on the letting condition if you are planning on letting them stay for free or at a reduced rate. Timing can be crucial here – in peak season the commercial rate is likely to be much higher than in the off-season. Letting friends stay cheaply in peak season when the property can be easily let at a higher price will not count as a commercial let. However, in the off-season where bookings are sparse, letting to friends cheaply when the property would otherwise be empty could be argued to be a commercial let.

Where possible, sufficient lettings should be agreed with members of the public at a commercial rate to meet the lettings condition before agreeing lets with family and friends.

Deductibility of expenses

Care should also be taken not to compromise the deductibility of expenses as a result of use by family and friends.

Where the property is kept solely for letting as furnished holiday accommodation, but is in fact closed for part of the year because there are no customers or no business, HMRC allow a deduction for all associated expenses incurred in this period as long as there is no private use. However, a deduction is not permitted where the property is used privately during this period. This would include non-commercial or free use by family and friends.

Avoid the traps

To avoid the traps, ensure that the property is available for letting to the public for 210 days a year and actually let for 105 days. Use by family and friends at discounted rates can be accommodated around these lets.

Most directors know that as of 1 April 2023, companies with taxable profits in excess of £250,000 will pay corporation tax at the main rate of 25%. Companies with taxable profits of £50,000 or less will still be charged at 19% and those with profit levels between £50,000 and £250,000 will pay tax at 25%, reduced by marginal relief. However, many directors may be unaware that rules for determining associated companies are being reintroduced at the same time and may not have considered the impact the change in the rules may have on their bottom line.

These rules state that companies with subsidiaries or associated with each other will share the  marginal relief thresholds thereby drastically increasing the tax bill for some companies. Originally in place nearly eight years ago, the reason for their reintroduction is that following the increase in tax rate some companies may consider splitting the company's activities across multiple entities in an attempt to fall below these thresholds. The 'associated' rules mean that is not possible. Calculations show that, should there be three associated companies, when calculating the marginal relief available, the lower profits limit for each will be as low as £16,667 with the upper profits limit being £83,333.

What is an ‘associated company’?

The tax rules state that ‘a company is to be treated as an associated company of another at a given time if at that time, or at any other time within one year previously, one of the two has control of the other or both are under the control of the same person or persons.’ Therefore, if company A controls company B then, generally speaking, they are associated. Similarly, if all or some of the same individuals also control other companies, those companies may be associated and so have to share thresholds.

The important word here is ‘control’. Usually ‘control’ rests with the person or persons owning the majority of a company’s shares with voting rights but this need not be the case. If a person is entitled to acquire the greater part of the company's income or assets either on winding up or otherwise, then that also comes under the definition of ‘control’. A company may also be associated with another despite not being under the common control of one person if there is what is termed in the regulations as ‘substantial commercial interdependence’ between them, e.g. if the two companies share premises or staff. In the past HMRC have deemed a dry-cleaning company and the agent of that company as being ‘associates’.

If this type of connection exists, any shareholder must also count their relatives, business partners and certain trusts and estates when considering whether a company is ‘associated’ with another.

The only time that the ‘associated’ rules do not apply is when a company has no business activities during the relevant accounting period, so here we are looking at dormant companies and companies incorporated to passively hold investments (actively buying and selling investments will mean coming within the rules).

Calculation 2022/23

An associated company with an accounting period straddling 1 April 2023 will divide its profits between the period up to and including 31 March 2023, and the period thereafter. Profits incurred during the first period will be taxed at 19%, with profits falling after (within the financial year 2023) taxed at the appropriate rate depending on the level of profits falling into that period with the upper and lower profits limits being proportionately reduced depending upon the number of associated companies.

Tax repayment claims are usually made via the submission of a tax return. The time limit for amending a return (whether individual or company) is usually one year from the deadline for submitting the tax return. If that date has passed, a claim can only be made via an overpayment relief claim. Under this relief, the general rule is that a refund or repayment cannot be claimed more than four years after the end of the tax year to which the claim relates for personal taxes and more than four years from the end of the relevant accounting period for corporation tax after the end of the relevant accounting year. Overpayment relief also applies to claims for overpaid Class 4 National Insurance contributions.

How to claim

The claim process should be relatively straightforward. However, this is one occasion whereby HMRC insist that the claim is in a set format or it can be refused. The claim must be in writing, signed by the taxpayer or someone entitled to sign on their behalf, e.g. a power of attorney for the taxpayer's financial affairs, but not their accountant. For a company, the claim must be signed by someone with authority, e.g. a director.

The claim must state that the person is making an overpayment relief claim and the best way to do this is to quote the section of the relevant taxes act under which the repayment is being claimed (i.e. ‘This claim is being made under Schedule 1AB Taxes Management Act 1970’ for personal taxes, or ‘This claim is being made under para. 51 Schedule 18 Finance Act 1998’ for corporation tax). The claim must also state the tax year or accounting period and the reason why the overpayment or excessive assessment has occurred. Documentary proof is needed of tax deducted or suffered and the claim should include a declaration signed by the claimant stating that the particulars given in the claim are correct and complete to the best of their knowledge and belief. If the person or company has previously appealed in connection with the payment or the assessment, that also needs to be stated.

When the claim will be disallowed

HMRC will not accept an overpayment claim if the return was made according to the ‘practice prevailing at the time’ but the interpretation of the law changed later e.g. because of a decision in a subsequent court case. Neither will they accept a claim due to a mistake or failure in making an election or where the matter has already been the subject of a tribunal decision or court hearing.

The relief cannot be used where an overpayment arises due to an error in a capital allowances claim. A business has a choice of whether or when to claim capital allowances. If a deliberate choice was made when calculating capital allowances and at a later date it is found that more tax relief would have been allowed if calculations had been undertaken differently, then no relief is available.

‘Special relief’

There is an exception from the above four-year time limit for ‘special relief’ cases. Special relief is a form of overpayment relief that can only apply to amounts charged in HMRC determinations where no other statutory remedy is available. Unlike claims for overpayment relief, there is no time limit for making a claim. The relief is also not automatically excluded where the business knew, or ought reasonably to have known, that it had some other means of correcting an overpayment or over-assessment.

If you let a furnished property, it is very likely that you will need to replace domestic items from time to time. A specific relief provides tax relief for the cost of replacing certain domestic items. The relief does not extend to the initial purchase of the items.

The relief is available to both unincorporated landlords and corporate landlords. However, it does not apply where the property is a furnished holiday letting or where rent-a-room receipts have been received.

Domestic items are items for domestic use such as movable furniture, furnishings, household appliances and kitchenware.

Conditions for relief

Availability of the relief is contingent on the following four conditions being met:

The individual or company must carry on a property business that includes the letting of one or more dwelling house(s).

An old domestic item has been provided for use in the property and it is replaced with a new domestic item. The new item must be available for the exclusive use of the lessee, and the old item must no longer be available for their use.

The new item must be used wholly and exclusively for the purposes of the business (such that a deduction for the cost of that item in computing taxable profits of the rental business would not be prohibited under the ‘wholly and exclusively rule’) but a deduction would be denied on the basis that the expenditure is capital expenditure.

Capital allowances have not been claimed in respect of the expenditure on the new item.

Amount of the relief

Tax relief is given as a deduction in calculating taxable profits for the cost of the new item on a ‘like-for-like’ basis. If the new item is superior to the old item, there is no relief for the cost of the improvement element. In this case, the deduction is equal to the lower of:

the cost of the new item; and

the cost that would have been incurred had the old item been replaced with an equivalent replacement.

Example

Andrew lets a furnished flat. He replaces an old washing machine (which cost £150) with a new washer-dryer that cost £325. An equivalent washing machine would cost £200.

As the washer-dryer is an improvement over the old washing machine, the full cost cannot be deducted. Instead, the deduction is capped at £200, which is the cost of a new washing machine equivalent to the model being replaced.

Incidental expenditure

A deduction is also allowed for incidental capital expenditure, such as delivery and installation costs and the cost of disposing of the old item.

Sale proceeds for old item

If the old item is sold, the amount of the deduction is reduced by the consideration received from the sale of that item. In the above example, had Andrew received £30 from the sale of the old washing machine, the deduction would be reduced by £30 to £170.

If the old item is part-exchanged for the new item, the deduction is the amount paid on top of the part-exchange value.

Taking on a renovation project can be hugely appealing, particularly if the property is subsequently sold at a profit. However, from a tax perspective, it may not always be clear-cut how any ‘profit’ should be taxed – is it a capital gain liable to capital gains tax or a trading profit liable to income tax?

Investment v trading

If a gain is made on the disposal of a residential investment property, that gain is liable to capital gains tax. After allowing for any available exempt amount and allowable losses, the gain is taxed at 18% where income and gains for the tax year do not exceed the basic rate band of £37,700 and at 28% where income and gains exceed the basic rate band. Gains on residential property must be reported to HMRC within 60 days and the associated tax paid within the same time frame.

By contrast, if a property developer is trading and makes a trading profit, the gain is liable to income tax rather than to capital gains tax. At 20%, 40% and 45%, the income tax rates are higher than those applying for capital gains tax purposes.

Where the property is owned by a company the gain/profit is taxed at the relevant corporation tax rate, so the distinction is less of an issue.

Importance of intention

The intention of the owner at the outset is crucial in determining whether there is an investment or a trade. For example, if a person buys a property with the intention of doing it up quickly to sell on at a profit, using the proceeds to buy another renovation project to do up and sell on at a profit, this has the hallmarks of trading. The profit on sale would be a trading profit and would be liable for income tax.

By contrast, if a person buys a property to do up and then rent out, or to use as a holiday home, the intention is to hold the property as an investment. If the property is eventually sold at a gain, the gain would be liable to capital gains tax rather than income tax.

It is important to recognise that circumstances may change, and it is here where the original intention can be particularly important. For example, if a person buys a property with a view to doing it up and letting it out for the foreseeable future, the intention at the outset is for that property to be an investment property. If, due a change in personal circumstances, the property is sold after a relatively short time realising a gain, the character of the property does not change – it remains an investment property and the gain is liable for capital gains tax not income tax.

The Employment Allowance is an allowance that eligible employers can claim to set against their secondary (employer’s) Class 1 National Insurance liability. The employment allowance is set at £5,000 for 2023/24, capped at the employer’s secondary Class 1 National Insurance for the year where this is less. It is not given automatically and must be claimed.

Eligible employers

The National Insurance Employment Allowance is only available to eligible employers. An employer can claim the allowance for 2023/24 if their employer’s Class 1 National Insurance liabilities in 2022/23 were less than £100,000, provided that the employer is not otherwise excluded. Where the employer is part of a group, the £100,000 limit applies to the group as a whole. Likewise, where the employer runs more than one payroll, the total employer’s Class 1 National Insurance liabilities across all the payrolls must be less than £100,000 for 2022/23.

Certain categories of employers are not able to claim the Employment Allowance even if their employer’s Class 1 National Insurance bill for 2022/23 was less than £100,000. This includes companies where the sole employee is also a director (ruling out most personal companies) and public bodies.

Making a claim

The employment allowance is not given automatically, and employers must claim it. The claim is made through the employer’s payroll software. If the employer uses HMRC’s Basic PAYE Tools package or a claim cannot be made through the employer’s payroll package, this can be used to make the claim.

The claim is made in an Employer Payment Summary (EPS) by selecting ‘yes’ for the ‘Employment Allowance indicator’ field.

If an employer is no longer eligible for the allowance or a claim has been made in error, the employer should enter ‘no’ in the ‘Employer Allowance indicator’ field when submitting their next EPS. If a claim is stopped before the end of the tax year, any Employment Allowance that has already been given will be clawed back, and the employer will need to pay the secondary Class 1 National Insurance previously sheltered by the allowance.

Claims can be made for the previous four tax years.

Using the allowance

Once the allowance has been claimed it will be set against the employer’s secondary Class 1 National Insurance liability until it is used up, reducing the amount that the employer has to pay. Where the allowance has not been fully utilised by the end of the tax year because the employer’s Class 1 National Insurance liability for the year is less than £5,000, the remaining allowance is lost; it cannot be carried forward to the next tax year or set against Class 1A or Class 1B liabilities.

Changes to the corporation tax regime come into effect from 1 April 2023 – the start of the financial year (FY) 2023. From that date there will no longer be a single rate of corporation tax; rather, the rate at which a company pays tax on its profits will depend on the level of those profits.

Small profits rate

Companies whose taxable profits are below the lower limit continue to pay tax on those profits at the rate of 19%.

The lower limit is set at £50,000 for a stand-alone company.

Main rate

Companies with profits above the upper profits limit will from 1 April 2023 pay corporation tax at the main rate of 25% on those profits.

The upper limit is set at £250,000 for a stand-alone company.

Availability of marginal relief

Where a company’s profits fall between the lower and upper limits (£50,000 and £250,000 for a stand-alone company), corporation tax is charged at the rate of 25% as reduced by marginal relief. This gives an effective rate of between 19% and 25% depending on where in the band the profits fall.

Marginal relief is calculated by the following formula:

F X (U – A) x N/A

Where:

F is the standard marginal relief fraction

U is the upper limit

A is the amount of augmented profits

N is the amount of the taxable profits.

For the financial year 2023, the marginal relief fraction is 3/200.

Augmented profits are total taxable profits plus qualifying exempt distributions that are received from companies that are not 51% subsidiaries or owned through a consortium.

Where the company has no qualifying exempt distributions (so that A and N in the above formula are the same), the formula can be simplified to:

F x (U – N)

Example

A company prepares accounts to 31 March each year. For the year to 31 March 2024, it has taxable profits of £120,000. It did not receive any qualifying exempt distributions.

It must pay tax of £30,000 (£120,000 @ 25%) less marginal relief.

As the company has no qualifying exempt distributions, the simplified marginal relief calculation can be used.

The marginal relief is therefore 3/200 (£250,000 - £120,000) = £1,950.

The company’s corporation tax bill is therefore £28,050 (£30,000 – £1,950), an effective rate of 23.375%.

Associated companies and short accounting periods

If a company has associated companies, the lower and upper limits are divided by the number of associated companies plus one.

The limits are also proportionately reduced if the accounting period is less than 12 months.

Accounting period straddling 1 April 2023

Where the accounting period straddles 1 April 2023, the profits must be apportioned. Those relating to the period before 1 April 2023 are taxed at 19%, whereas those relating to the period on or after 1 April 2023 are taxed according to the rules set out above, prorating the limits accordingly.

A popular profit extraction strategy is to pay a small salary and to extract further profits as dividends.

Why pay a salary?

There are a number of benefits of paying a small salary in order to take money out of a personal or family company for personal use.

Reason 1

If a salary is paid at a level that is at least equal to the lower earnings limit for Class 1 National Insurance purposes – set at £6,396 for 2023/24 – the year will be a qualifying year for state pension and contributory benefit purposes. An individual needs 35 qualifying years to be eligible for the full single-tier state pension, and at least ten qualifying years to access a reduced state pension.

Where the salary is at least equal to the lower earnings limit and does not exceed the primary threshold (set at £12,570 for 2023/24), the individual is treated as having paid Class 1 National Insurance contributions at a zero rate. This effectively gives them a qualifying year for free.

If you do not currently have the requisite 35 years, it is worthwhile paying a small salary to secure an additional qualifying year.

Reason 2

If your available personal allowance is at least equal to the salary that is paid, the salary can be paid tax-free. Extracting profits from the company without triggering a tax bill is worthwhile.

Reason 3

Salary payments and any associated employer’s National Insurance are deductible in calculating the taxable profits for corporation tax purposes. This will save corporation tax at the prevailing rate, which from 1 April 2023 is between 19% and 25% depending on the level of your taxable profits.

Reason 4

A salary can be paid regardless of the level of the company’s profits. Indeed, it is still possible to pay a salary even if doing so means that the company makes a loss. By contrast, dividends can only be paid if you have sufficient retained profits from which to pay them.

Salary level

The optimal salary level will depend on personal circumstances. However, as the standard personal allowance and the National Insurance primary threshold are now the same, if the personal allowance remains available, the position is more straightforward than in previous years.

Where the standard personal allowance is available in full, the optimal salary is one equal to the personal allowance, set at £12,570 for 2023/24. At this level, there is no tax to pay and no primary Class 1 National Insurance contributions to pay either.

There may, however, be some secondary (employer’s) National Insurance contributions to pay if the employment allowance is not available (as is the case for a personal company where the sole employee is also a director), or if it has been used up. Where this is the case, employer contributions are payable at the rate of 13.8% where the salary exceeds the secondary threshold, set at £9,100 for 2023/24. If a salary of £12,570 is paid, the secondary Class 1 National Insurance bill will be £478.86.

However, as with the salary, employer National Insurance contributions are deductible for corporation tax purposes, meaning that paying a salary equal to the personal allowance is still worthwhile.

If the employment allowance is available, as may be the case for a family company, there will be no secondary National Insurance to pay on a salary equal to the personal allowance.

Once the personal allowance has been used up, it is better to extract further profits as dividends, which are taxed at a lower rate. Any additional salary will attract tax at 20% and employee’s Class 1 National Insurance of 12%, in addition to any employer’s National Insurance that may be due. This will outweigh any associated corporation tax savings.

If the full personal allowance is not available, it is necessary to crunch the numbers as the optimal salary will depend on both individual circumstances and the rate at which the company pays corporation tax.

Many businesses view entertaining clients and customers to be an important part of their marketing budgets, whether as a networking opportunity, a thank you for business or an incentive to attract more business – but what is the tax position?

The tax rules are clear. HMRC define entertainment expenses as those costs incurred when providing subsidised or free hospitality to clients or staff. Whether payment for lunch with a customer or tickets for a sporting event – whatever the reason, any cost incurred for entertaining customers is not an allowable expense for tax purposes. The amount can still be paid out of the business bank account as an expense set against income, but it will not be tax deductible. The only ‘entertaining’ expense allowed is for the entertaining of staff which can include directors/shareholders. The situation is different for costs incurred in entertaining overseas customers/clients as such expenses are income and corporation tax deductible so long as carried out at a reasonable scale and undertaken for business purposes only..

One key point to remember when taking clients out is always to pay through the business rather than through personal bank accounts. This is because whilst the expense may not be an allowable deduction for corporation tax purposes, paying via the company will save the income tax charge that would otherwise be payable on withdrawing the funds (particularly if you are a higher rate director taxpayer).

In comparison, entertaining staff is fully tax deductible for both income and corporation tax purposes. The employee will not be charged a benefit in kind so long as the total spend per head is less than £150 annually (including VAT) and all employees (or all those at one branch or department) are invited to the event. Should a benefit arise then tax will be payable on the total cost, not just the spend above £150. However, this amount is doubled should the employee bring a guest. The business will also be liable to pay Class 1A NIC on the taxable amount.

Businesses usually use this £150 limit to cover some or all of the cost of Christmas parties. However, it can be used for other annual events such as a summer party. The events must be regular rather than ‘one-offs’. Companies with just one director/employee would find it hard to justify £150 a head as tax deductible however those companies with two or more directors should be able to claim. If the cost per head of two events together exceeds the limit (e.g. one being £70 and the other being £90), only one could qualify for the tax relief, with the other being fully taxable.

An alternative exemption to the £150 limit can be found under the trivial benefits rules. The benefit will be exempt from tax if the cost of providing the benefit does not exceed £50 (or the average cost per employee if a benefit is provided to a group of employees and it is impracticable to work out the exact cost per person).

Reclaiming VAT

Generally, input VAT cannot be claimed on the cost of business entertainment unless relating directly to staff or overseas customers. The VAT rules for staff events are more generous than for direct tax because there is no limit to the amount of input tax that can be recovered. If there is a combination of employees and non-employees at an event, with no hosting function for the employees, then input tax should be apportioned and reclaimed.

Practical point

Should a business host an event where clients and employees attend, making a small charge to non-employees will enable VAT input tax to be claimed because ‘free hospitality’ is not being provided. However, it will mean that a small amount of output VAT will be payable on the money received. As ever the paper trail is key.

Under English law, there are two ways in which property can be owned jointly – as joint tenants or as tenants in common. The way in which a joint property is owned can have tax implications.

Joint tenants

Where a property is owned by two or more people as joint tenants, they collectively own the whole property, rather than each individual owning a particular share. If one of the joint owners dies, their share automatically passes to the surviving joint owner(s). However, their stake in the property forms part of their estate at death.

Tenants in common

Where a property is owned jointly as tenants in common, each person owns a specified share of the property. On their death, their share is passed on in accordance with their will or, where there is no will, the intestacy provisions. It does not automatically pass to the surviving tenants in common.

Income tax

The income tax implications where property is owned jointly depend predominantly on the relationship between the owners and whether or not they are married or in a civil partnership.

Where the joint owners are not married or in a civil partnership, income from the property is normally allocated according to ownership shares – equally where the property is held as joint tenants and in relation to actual ownership shares where the property is held as tenants in common. However, the owners can choose to override this and split the income in such a way as is agreed between them. Each owner is then taxed on the income that they actually receive.

However, if the owners are married or in a civil partnership, regardless of how the property is owned or the actual beneficial ownership, the default position is that any income arising from the property is treated for tax purposes as arising to them equally. This will not always be optimal from a tax perspective If the property is owned as tenants in common in unequal shares, the couple can elect (by making a Form 17 election) for the income from the property to be allocated for tax purposes in accordance with their actual beneficial shares. Should they wish to change their ownership share, they can take advantage of the no gain/no loss rules to do this without triggering a capital gains tax liability. The option to make a Form 17 election is only available where the property is owned as tenants in common in unequal shares. If the property is owned as joint tenants, the only permissible split is a 50:50 split. Spouses and civil partners buying an investment property should consider owning the property as tenants in common to provide the flexibility to make a Form 17 election where this is beneficial. Where the property is owned as joint tenants, the ownership can be changed to tenants in common by severing the joint tenancy.

Capital gains tax

For capital gains tax, each owner is taxed on the gain in relation to their actual share. Where the property is owned as joint tenants, each owner is treated as having an equal share. If the property is owned as tenants in common, the gain attributable to each owner is determined by reference to their actual ownership share.

If you have a personal or family company, taking dividends is a popular and tax-efficient way to extract profits. However, while they remain tax efficient, recent tax changes have eroded some of the advantages. What do you need to know when planning your dividend extraction strategy for 2023/24?

Impact of corporation tax changes

From 1 April 2023, changes are made to the way in which corporation tax is calculated. If your profits are more than £50,000, you will pay corporation tax at a higher rate than prior to that date, reducing the post-tax profits that you have available to pay as a dividend. Remember, dividends are paid from retained profits and you can only pay a dividend if you have sufficient retained profits from which to pay it. Even if your profits are unchanged, you may not be able to maintain previous dividend payments if your effective rate of corporation tax rises from 1 April 2023.

Reduction in the dividend allowance

All individuals, regardless of the rate at which they pay tax, are entitled to a dividend allowance. This was set at £2,000 for 2022/23 but is halved to £1,000 for 2023/24. It is to be further reduced to £500 for 2024/25.

The dividend allowance operates as a zero-rate band. Dividends which are covered by the allowance are taxed at a zero rate, but the allowance uses up some of the tax band in which the dividends (taxed as the top slice of income) fall. The reduction in the dividend allowance will reduce the profits that can be extracted free of further tax.

In a family company, an alphabet share structure is often used to facilitate the payment of dividends to family members whose dividend allowance would otherwise be wasted, increasing the profits that can be extracted tax-free. This strategy may need reviewing in light of the falling dividend allowance.

Dividend tax rates

Dividends are attractive as the dividend tax rates are lower than the income tax rates. However, it should be remembered that corporation tax has already been paid on the profits which are paid out as dividends.

The dividend tax rates were increased by 1.25 percentage points from 6 April 2022 pending the introduction of the now-cancelled Health and Social Care Levy. Although the Health and Social Care Levy is not going ahead, the dividend tax rates are to remain at the increased levels for 2023/24. Consequently, dividends are taxed at 8.75% where they fall in the basic rate band, at 33.75% where they fall in the higher rate band and at 39.35% where they fall in the additional rate band.

Additional rate threshold

The dividend additional rate will apply if dividends are paid in excess of the dividend allowance and taxable income exceeds the additional rate threshold. This is reduced to £125,140 for 2023/24 from £150,000 previously.

Summary

As a result of these changes, you may have less profits available from which to pay dividends. Where dividends are paid, only £1,000 will be tax-free. Above this level, dividends will continue to be taxed at the higher rates introduced from April 2022. Further, the additional rate will now bite where taxable income exceeds £125,140.

For a brief period it seemed that the days were numbered for the additional rate of tax following the announcement in the ill-fated mini Budget that it was to be scrapped. Like much of the mini Budget, its planned abolition was swiftly reversed. However, this was not the end of the additional rate tax saga; the Autumn Statement delivered a further plot twist with the announcement that the additional rate threshold is to fall to £125,140 from 6 April 2023.

Why £125,140?

The new threshold is the point at which the personal allowance is completely lost. The personal allowance (which is frozen at its current level of £12,570 until April 2028) is reduced by £1 for every £2 by which income exceeds £100,000.

The combination of the abatement of the allowance and the 40% tax rate that applies at this level means the marginal rate of tax in this band (£100,000 to £125,140) is 60%. Lowering the additional rate threshold to below £125,140 would raise the marginal rate of tax in the abatement zone above 60%.

Additional rate tax landscape

Until 5 April 2023, the additional rate threshold remains at £150,000. This creates the slightly anomalous effect that the marginal rate on income between £100,000 and £125,140 is 60%. Once the personal allowance has been lost, the marginal rate drops to 40% on income between £125,140 and £150,000, rising to 45% on income in excess of £150,000.

From 6 April 2023, this second 40% band will be lost – the new additional rate threshold will mean that income is taxed at 45% once the personal allowance has been fully abated.

Where the income in question is dividend income, it is taxed at 33.75% where it falls in the higher rate band and at 39.35% where it falls in the additional rate band. In the personal allowance abatement zone, the marginal rate is 50.6%.

Planning opportunities

The new lower additional rate threshold does not come into effect until 6 April 2023. This may provide the opportunity to advance income so that it is taxed at the higher rate in 2022/23 rather than at the additional rate in 2023/24. However, care must be taken not to move income from the additional rate band to the personal allowance abatement zone where the marginal rate is higher.

Case study

Tim is the director of T limited. He has income of £130,000 a year. He was planning on paying a dividend of £20,000 in May 2023. If he does so, the dividend will be taxed at the additional rate of 39.35%, meaning Tim will pay tax of £7,870 on the dividend.

However, if retained profits permit, he could instead pay the dividend before 6 April 2023 so that it is taxable in 2022/23 rather than 2023/24. This would mean that it would be taxed at the upper dividend rate of 33.75% rather than at the dividend additional rate of 39.35%. Consequently, the tax payable on the dividend would be £6,750. Advancing the dividend would save him tax of £1,120. On the downside, the tax would be payable a year earlier.

If, however, Tim has income of £100,000 in 2022/23 before paying the dividend and expects to have income of £130,000 in 2023/24 before paying a dividend, it is not worthwhile advancing the dividend payment to before 6 April 2023. If he does this, he will increase his income for 2022/23 to £120,000, meaning he will lose £10,000 of his personal allowance. The tax hit of doing so is more than paying tax at the additional rate. Consequently, it is better for him to pay the dividend on or after 6 April 2023.

Property is generally a good investment, and where an investment property or second home has been held for many years, it may be worth considerably more than you paid for it. It may be tempting to sell the property to release the equity, perhaps to fund retirement or to help your children get on the property ladder. However, the capital gains tax system is not kind to those who sell assets which they have held for a long time as it provides no relief for inflationary gains. Even if your property has done no more than increase in value in line with inflation, you may find that if you sell, you have to give a sizeable chunk to the taxman.

Case study

Andrew bought an investment property for £100,000 in 2003. The mortgage has now been paid off and the property is worth £300,000.

Andrew is approaching retirement and wishes to sell the property to release some funds and also to give some money to his two children to help them with a deposit so they can each buy a property. However, if Andrew sells the property, he will incur a chargeable gain.

If it is assumed that the costs of sale and purchase are £10,000, Andrew will realise a gain of £190,000. If the sale completes before 6 April 2023 and he has not realised any other gains in the year, he will be able to set his 2022/23 annual exempt amount of £12,300 against the gain, reducing the chargeable gain to £177,700.

Andrew is a higher rate taxpayer. He must therefore pay capital gains tax on the chargeable gain at the rate of 28% – a tax bill of £49,756. The gain must be reported to HMRC and the tax paid within 60 days of completion.

The annual exempt amount reduces to £6,000 for 2023/24. Consequently, if the sale does not complete until after 5 April 2023, the chargeable gain will be £184,000 and Andrew’s tax bill will be £51,520.

Although in real terms there has been no increase in value – the property price has simply kept pace with the market – the tax system does not recognise this. There is no longer any relief for inflationary gains meaning that those selling a property that they have owned for a long time are likely to face a large tax bill.

After paying the tax, Andrew is no longer able to afford to repurchase the asset he has just sold.

Alternatives

Rather than selling the property, Andrew could consider remortgaging the property or undertaking an equity release to provide the cash to fund his retirement and help his children. However, this comes at a cost, and as interest rates rise, the costs will increase. If the property is let out, it may be that the rent will be sufficient to cover the borrowing costs. However, it should be remembered that the rent is taxable at Andrew’s marginal rate (which, if he is a higher rate taxpayer, is 40%). Further, if the property is a residential let, relief is only available for interest costs as a basic rate tax deduction.

Where the capital gains tax hit of selling is high, it is advisable to consider alternatives. However, there is no substitute for doing the sums.

To encourage pension savings, tax relief is available on contributions made to registered pension schemes. However, there are limits on the contributions that can qualify for relief, and punishing tax charges can apply if these limits are exceeded.

Limit 1 – 100% of relevant earnings

Tax relief on private pension contributions is capped at 100% of your relevant earnings or, if lower, £3,600. Relevant earnings include earnings from an employment or self-employment, benefits in kind and statutory payments. Rental income from furnished holiday lettings (whether in the UK or the EEA) counts as relevant earnings, whereas that from other lettings, such as residential lets, is treated as investment income and is not part of relevant earnings. Other investment income, such as interest and dividends, is similarly excluded.

It is the individual’s responsibility to check that they have not made tax-relieved contributions in excess of the higher of their annual relevant earnings and £3,600. Landlords and those running a business through a personal or family company can easily fall foul of this rule as their income may be high but their relevant earnings low.

Contributions can be made by or on behalf of those with little or no relevant earnings up to £3,600 gross (£2,880 net) a year.

Limit 2 – annual allowance

The annual allowance caps tax-relieved contributions to a registered pension scheme at £40,000 a year. Where the annual allowance is not fully used in the year, the unused amount can be carried forward for up to three years. However, the current year’s allowance must be used before unused allowances from previous years. Contributions made by an employer also count towards the annual allowance.

The annual allowance is reduced where both threshold income (broadly income after pension contributions) is over £200,000 and adjusted income (broadly income before pension contributions) is over £240,000. The annual allowance is reduced by £1 for every £2 by which adjusted income exceeds £240,000 until the minimum amount of the allowance is reached. This is currently £4,000. This means that once income reaches £312,000, the annual allowance is at the minimum level of £4,000.

A reduced annual allowance of £4,000 also applies where someone has flexibly accessed a defined contribution (money purchase) pension scheme on reaching age 55 or above.

If contributions are made in excess of the available annual allowance, the tax relief is clawed back by means of the annual allowance charge.

Limit 3 – lifetime allowance

The final cap on tax-relieved pension savings is the lifetime allowance. This is set at £1,073,100. If you think your pension savings may be nearing this limit, you should check with your pension provider before making further contributions. Where pension savings exceed the lifetime allowance, the tax relief is clawed back by means of the lifetime allowance charge. This is 55% where the excess is taken as a lump sum and 25% otherwise.

Method of relief

There are two ways of giving effect to the tax relief on pension contributions – relief-at-source and net pay.

In a relief-at-source scheme, contributions are made from the individual’s net pay. Where contributions are deducted from pay, the employer deducts the contributions after deducting tax. The pension scheme reclaims tax relief at the basic rate of 20% from the government. If the individual is a higher or additional rate taxpayer, the difference between the marginal rate that they pay and the basic rate of 20% is reclaimed through their self-assessment tax return.

Under a net pay scheme, contributions are deducted from gross pay before calculating tax. In this way, relief is automatically given at the employee’s marginal rate of tax. However, this is disadvantageous if the employee’s earnings are below the personal allowance as the top-up given under a relief-at-source scheme is lost.

Companies and self-employed businesses with a turnover exceeding £150,000 a year are obliged to prepare their accounts using the ‘accrual’ basis of calculating profits i.e. recognising the income received and expenses paid on an invoice basis, regardless of whether or when the cash is received. Such a method of calculation may result in some customers not paying their dues and a business may have to write off that payment as a bad debt.

HMRC have specific rules on how to treat a bad debt for tax relief to be claimed, whether that claim is under income tax or corporation tax or VAT. Most importantly, a review of each debt must be made and once the potential bad debts are identified, HMRC will only allow a claim if a reasonable effort has been made to recover the amounts owed. Every business should have a system in place to chase and record bad debts. Relatively small debts may constitute a few automated chaser letters and, if no payment is received, apply bad debt relief; the likelihood is that HMRC will accept a claim. Debts of more significant amounts say, £10,000, will require the claimant to do more e.g.  employing a debt collector.

Bad debt relief is given in the period that the business decides a debt is irrecoverable, preferably in the same period that the invoice was issued; this way tax will not be payable on unpaid invoices. If the debt is not identified as irrecoverable until the next period, a full year may go by before the relief is given.

Property received in exchange for debt

Sometimes the debtor is unable to repay the debt in cash and looks to repay using other assets such as property or shares. In this situation the property is treated as transferred for a consideration not greater than its market value. Where the market value of the asset is less than the amount of the outstanding debt, the difference may be allowed as a deduction, provided the debtor agrees that any excess of the disposal proceeds be treated as a trading receipt in their accounts on disposal of the asset. That agreed amount will not be included in any subsequent capital gains tax calculation.

What if a bad debt is recovered?

You will have to bring that receipt in for the year in which you get paid, but you won’t have to make any adjustment to the earlier year for which you thought the debt was bad.

VAT recovery

VAT on a bad debt can be claimed when an invoice has remained unpaid, or partly unpaid, for six months after the due date for payment. If the debt is subsequently repaid the VAT is declared on the next tax return.

As part of the move to Making Tax Digital for Income Tax Self-Assessment (MTD for ITSA), the basis period rules are being reformed. Despite the delay to the MTD for ITSA start date – which will now take effect from April 2026 rather than April 2024 – the reform of the basis period rules is to go ahead as planned.

Nature of the reform

Under the reform, sole traders and unincorporated businesses will, from 2024/25 onwards, be taxed on the profits of the tax year (the tax year basis) rather than, as now, on the profits for the accounting period ending in the tax year (the current year basis). If profits are prepared to a date other than 5 April or 31 March (which is deemed to be equivalent to 5 April), the profits from two accounting periods will need to be apportioned to correspond to the tax year. Accounting dates falling between 1 and 4 April are also treated as being equivalent to the tax year.

To enable traders to move from the current year basis to the tax year basis, 2023/24 is a transitional year.

Making the transition

Where an unincorporated business does not prepare accounts to 31 March or 5 April (or a date in between), the profits assessed in 2023/24 will cover more than a single accounting period.

The basis period for a continuing trade (i.e. one which commenced before 2023/24 and did not cease in 2023/24) starts on the day after the end of the basis period for 2022/23 and ends on 5 April 2024.

The basis period comprises up to three elements:

the standard part;

the transition part; and

days following a late accounting date.

Not all parts will be applicable in all cases.

In addition, relief will be given in 2023/24 for any overlap profits arising on commencement or a change in accounting date which have not yet been relieved.

The standard part is the first 12 months of the basis period. This period starts the day after the end of the basis period for 2022/23. This will usually be the 12 months to the accounting date ending in 2023/24.

If the standard part ends before 31 March 2024 (as will be the case if the accounting date does not fall in the period from 31 March to 5 April), the basis period for 2023/24 will include a transition part as well as the standard part. If it ends on or after 31 March 2024 but before 5 April 2024, the trader is taxed on profits to the accounting date (referred to as a late accounting date); there is no need to calculate the transition element. However, an election can be made to disapply this rule and for the profits for the period from the late accounting date to 5 April 2024 to be taxed in 2023/24.

The transition part is the period that begins immediately after the standard part and ends on either:

5 April 2024; or

the late accounting date.

If the trader has overlap profits which were taxed twice either on commencement or on a previous change of accounting date, these are relieved in calculating the profits assessed in 2023/24.

Example

A trader prepares accounts to 30 June. The basis period for 2022/23 on the current year basis is the year to 30 June 2022. In the 2023/24 transitional year, the standard part is the period from 1 July 2022 to 30 June 2023 and the transition part is the period from 1 July 2023 to 5 April 2024.

Spreading

Unless the accounting period matches the tax year, more than 12 months’ worth of profits will be assessed in the 2023/24 transitional year. To prevent the trader suffering an unusually high tax bill for 2023/24, the profits for the transition part, less any overlap relief, are spread over five tax years.

The effect of this is that 20% of this amount is assessed in 2023/24 in addition to the standard part, and 20% is added to the profits assessed on the tax year basis in each of the tax years 2024/25, 2025/26, 2026/27 and 2027/28. The trader will have higher tax bills in each of those years.

Where beneficial, the trader can elect for some or all of the spread profits to be taxed in an earlier year. This may be the case where the trader’s marginal rate is lower in an earlier year.

Change of accounting date

To prevent the need to apportion profits from more than one accounting period to arrive at the profits for the tax year, consideration could be given to changing the accounting date to 31 March or 5 April.

Post-pandemic, many businesses are finding that their trading circumstances have changed such that the non-standard VAT scheme under which the business is registered is no longer appropriate. The turnover may have increased so they are no longer eligible.

VAT schemes are designed to simplify how some VAT-registered businesses calculate and account for VAT and are voluntary to join. By choosing the most suitable VAT scheme a business can have better control over its cash flow and sometimes be better off financially than when using the standard VAT scheme. However, care must be taken to avoid falling foul of the conditions required to use the scheme.

There are eight VAT schemes available, the main ones being the cash accounting scheme (CAS), the annual accounting scheme (AAS) and the flat rate scheme (FRS). A key point is that the leaving threshold is higher than the joining limit in each case. You can choose to leave the scheme at any time but you must leave if the business is no longer eligible.

Cash accounting scheme

Compared with the standard VAT scheme (where VAT is paid and claimed using the invoice date), VAT under the Cash Accounting Scheme (CAS) is paid on sales when the customer pays and reclaimed on purchases when the supplier is paid. A business using the CAS must leave at the end of any VAT period where the taxable sales for the previous twelve months have exceeded £1.6 million excluding VAT. However, a business can remain if it is believed that taxable sales in the next twelve months after going over the exit limit will not exceed the joining threshold, i.e. £1.35 million excluding VAT. If the business is paid promptly by its customers but takes time to pay its suppliers, then this scheme may not be worthwhile.

Annual accounting scheme

The main advantage of the Annual Accounting Scheme (AAS) is that only one return is submitted per year instead of four quarterly returns. Payments on account are made throughout the accounting year, based on the net liability of the previous year’s return. This scheme is useful for those businesses who want certainty in the amounts to pay every month and possibly have a static monthly turnover. The disadvantage is that overpayments can arise as, even if turnover is lower in the current year, payments will remain at the same rate as for the previous year. As any overpayment is not claimable until the end of the year, the scheme may not be beneficial for seasonal businesses. The conditions for remaining within the scheme are the same as for the CAS.

Flat rate scheme

This scheme removes the need to record the VAT element on sales and purchases separately. Businesses apply a fixed percentage to the gross turnover to arrive at the amount to pay, with the percentages varying depending on the business sector. The Flat Rate Scheme (FRS) is only available to businesses with a turnover of less than £150,000 (excluding VAT). However, once a business is within the scheme, it can remain even if turnover rises above £150,000, as long as it does not exceed £230,000 (at which point the business must leave). The disadvantage of FRS is that should the VAT claimable on purchases exceed the VAT charged, a refund would be due under the standard VAT scheme but under the FRS a payment would be made.

Care needs to be taken when operating the FRS as a flat rate percentage of 16.5% applies in place of the business-specific percentage to any business which meets the definition of a ‘limited cost business’. This is a business which spends less than 2% of its VAT-inclusive turnover on ‘relevant goods’ or more than 2% of its turnover but less than £1,000 a year on such goods. ‘Relevant goods’ are goods used exclusively for business purposes e.g. stationery and other office supplies.

FRS requires a fixed percentage to be applied to gross sales without considering zero-rated or exempt sales. Therefore, a business such as a builder who works on zero-rated new builds should not use the FRS as no VAT is charged on sales.

In March last year, the government published a White Paper setting out its final position on reforming Companies House ahead of introducing legislation. The big headline from the reforms is that micro and small companies will have to report profit and loss statements i.e. the option to file ‘filleted’ accounts is to be removed. Some smaller ‘one-man band’ companies may not be happy to see their profit figures displayed on the Companies House website for all to see and decide it is time to disincorporate.

Practicalities

‘Disincorporation’ is the process of a company changing its legal form to a sole trader or partnership. It is easier for a sole trader or partnership to incorporate than for a company to disincorporate as the latter process involves the transfer of the business as a going concern, including assets and liabilities (i.e. goodwill, property, plant and machinery, stock and creditors) from the company to its shareholders.

Capital gains

The most significant problem is the treatment of capital gains under corporation tax as there will normally be a capital disposal of the company's assets, deemed at market value. Such gains are more likely to arise concerning land and premises and any other non-wasting, or large, tangible assets including goodwill. ‘Roll-over’ or ‘hold-over’ relief on assets initially transferred to the company on incorporation may have to be considered in any tax computation. A few years ago there was a tax relief designed to remove this tax charge (‘Disincorporation relief’) but this was abolished as from 1 April 2018.

Should you disincorporate?

Following various governments' tax reforms, there are now limited tax savings to be achieved in operating through a company if the profit is relatively low (i.e. approximately £50,000 or less). Factor in the increased accountancy and administration fees that come with running a company and it may be that the corporate structure is leaving the business owner out of pocket. Other factors that might tip the balance in deciding whether or not to disincorporate include where the company does not hold land and buildings or, where it does, they stand at a relatively small taxable gain and there is minimal goodwill (or what goodwill there is gives rise to a relatively small gain).

The main reason for such companies to remain is to build credibility with potential customers, investors and peers, or if the company holds copyrights or trademarks, or to protect its brand. Protecting owners from personal liability used to be a reason but, again, there are various examples where this protection is no longer as strong as it was.

The Annual Tax on Enveloped Dwellings (ATED) is an annual tax payable on residential property valued at more than £500,000 which is held by a company, a partnership or a collective investment scheme (such as a unit trust).

There are various reliefs and exemptions available. This may mean that there is nothing to pay.

Revaluation

Properties must be revalued every five years for the purposes of the ATED. The 2023/24 chargeable period is a revaluation period and tax due for this period is based in the valuation of the property at 1 April 2022. Where the property was acquired after 1 April 2022, the valuation at the acquisition date is used.

Amount of the charge

The chargeable amount is based on the value of the property. The amounts applying for the 2023/24 chargeable period (which runs from 1 April 2023 to 31 March 2024) are shown in the table below.

Exemptions and reliefs

There are a number of exemptions and reliefs from ATED.

The main relief is that which applies where the property is let on a commercial basis to a third party and is not occupied at any time by anyone connected to the owner. Corporate landlords letting residential properties valued in excess of £500,000 should be able to benefit from this relief.

Relief is also available in respect of properties owned by a property trader as stock of the business and held solely for the purpose of resale.

Full details of the exemptions and reliefs can be found on the Gov.uk website at https://www.gov.uk/guidance/annual-tax-on-enveloped-dwellings-reliefs-and-exemptions.

File the return and pay the charge

Where a property is within the charge to ATED on 1 April 2023, the return for 2023/24 must be filed online using HMRC’s ATED online service by 30 April 2023. The ATED due should be paid by the same date. Where the property is acquired in the 2023/24 period, the return must be filed within 30 days of acquisition and the tax paid by the same date. For newly built properties, the deadline is 90 days from the earlier of the date that it becomes a dwelling for council tax or it is first occupied.

If you have paid too much tax, you will be able to get a refund from HMRC. The mechanics for obtaining your refund depending on how the overpayment arose. Claims must be made within four years from the end of the tax year to which the refund relates.

Self-assessment overpayment

If you pay tax under a self-assessment tax return, you may be due a refund if your income has fallen and the payments that you made on account are more than your actual tax liability for the tax year.

You can claim a refund when you complete your tax return. You will need to complete the ‘If you have paid too much tax’ section of the return. If you want the refund to go to you, you will need to provide details of your bank or building society account into which you want the refund to be made. Taxpayers without a bank or building society account can opt for a cheque to be sent to them or to a nominee whose details must be provided on the return. Where tax was originally paid by card, HMRC will attempt to pay the refund back to that card before making the payment to a bank or building society account.

HMRC ask taxpayers to allow four weeks to receive the payment before contacting them.

You can also claim a refund by signing into your self-assessment account online and selecting the ‘request a repayment’ option. Where a claim has been made in the tax return, it is not necessary to claim online.

If you have outstanding tax liabilities, any overpayment will first be set against these liabilities before a refund is made.

PAYE overpayment

If you pay tax under PAYE, for example, on income from employment or a pension, an overpayment may arise if your tax code is incorrect if you worked at the start of the tax year but did not work for the full tax year.

If you have paid too much (or too little) tax, HMRC will send you a tax calculation letter (P800). If the letter indicates that you are owed a tax refund, you will be to claim the refund either online via the Gov.uk website or through the HMRC app.

A claim can be made online by signing into your personal tax account, selecting ‘Claim a refund’ and following the instructions. A refund can also be claimed via the HMRC app. To do this log into the app and select PAYE, which will show a summary of your tax position. If you are due a tax refund, the summary will show the amount of tax that HMRC owes you. You can make a refund claim by clicking the ‘Claim a refund’ button and following the instructions.

The repayment should be made within two weeks. However, if you have not received it in this time frame, HMRC asks that you wait four weeks before contacting them.

Interest

HMRC will pay interest on the overpaid tax from the date of payment to the date of refund. The rate is set at the base rate of less than 1% (subject to a minimum rate of 0.5%). From 21 February 2023, the repayment interest rate is 3%.

Beware of refund scams

Fraudsters may send scam texts or emails that promise tax rebates to trick people into providing their bank details. HMRC does not contact taxpayers by text or email to advise them that they are due a refund. If you think you are due a refund, check either your personal tax account or the app, and where one is due, claim through the correct channels.

In an alphabet share structure, each shareholder has a different class of share. For example, one shareholder may have A ordinary shares, another B ordinary shares, another C ordinary shares, and so on. The benefit of an alphabet share structure is that it provides the flexibility to tailor dividends to take account of the shareholder’s personal circumstances. Under company law, dividends must be paid in proportion to shareholdings. Having an alphabet share structure overcomes this restriction and is popular in family companies.

Utilising the dividend allowance

One advantage of an alphabet share structure is that it allows dividends to be paid to a shareholder who may work outside the family company but who has not fully used their dividend allowance for the tax year. The available dividend allowances can be utilised to increase the profits that can be extracted tax-free.

However, the dividend allowance is being reduced, curtailing the opportunities to extract tax-free profits in this manner. The dividend allowance was set at £2,000 for 2022/23. It is reduced to £1,000 for 2023/24 and to £500 for 2024/25. Thus, in a family company with four shareholders, it was possible to extract £8,000 of profit tax-free by making use of the shareholders’ dividend allowance in 2022/23. By 2024/25, it will only be possible to extract £2,000 of profit tax-free in this way.

Using lower tax bands

Although the reduction in the dividend allowance reduces the potential to extract profit free of further tax, having an alphabet share structure in place may still be beneficial if the shareholders have different marginal rates of tax, allowing dividends to be tailored so that they are taxed at the lowest possible rate. For 2023/24 dividends are taxed at 8.75% where they fall in the basic rate band, at 33.75% where they fall in the higher rate band and at 39.35% where they fall in the additional rate band.

Example

Albert, Betty, and Charlotte are shareholders in ABC Ltd. Albert has 100 A ordinary shares, Betty has 100 B ordinary shares and Charlotte has 100 C ordinary shares.

For 2023/24 the company has profits of £45,000 that they wish to extract. Albert has another job and is an additional rate taxpayer. Betty has an income from property of £35,270 a year and Charlotte has an income of £20,270 from her part-time job. They all have their dividend allowance available.

To minimise the tax payable, the company declares a dividend of £10 per share for A ordinary shares, a dividend of £150 per share for B ordinary shares and a dividend of £290 per share for C ordinary shares.

Albert receives a dividend of £1,000. This is sheltered by his dividend allowance and is tax-free.

Betty receives a dividend of £15,000 of which £1,000 is sheltered by her dividend allowance and is tax-free. The remaining £14,000 is taxable at the dividend ordinary rate of 8.75% (a tax bill of £1,225), which uses up her remaining basic rate band.

Charlotte receives a dividend of £29,000 of which £1,000 is sheltered by her dividend allowance and received tax-free. The remaining £28,000 falls within her basic rate band and is taxed at 8.75% (a tax bill of £2,450).

The total tax bill is £3,675.

Had each taxpayer received a dividend of £15,000, the total tax bill would have been £7,959. Albert would pay tax on £14,000 of his dividend at 39.35% and Betty and Charlotte would each pay tax at 8.75% on £14,000 of their dividend. The remaining £1,000 of each dividend would be sheltered by the dividend allowance. By having an alphabet share structure, they can tailor the dividends to reduce the total tax bill by £4,284.

As far as National Insurance was concerned, the 2022/23 tax year was a tricky one featuring in-year changes to the primary threshold and in-year changes to the Class 1, 1A, 1B and 4 rates. This resulted in some strange numbers, with average rates applying for the purposes of Class 1A, Class 1B and Class 4 contributions. Average rates are also applied for Class 1 purposes to company directors who have annual earnings periods.

Hopefully, 2023/24 will be more straightforward. At the moment, the NIC landscape for 2023/24 looks as follows.

Employees and employers: Class 1

The Class 1 thresholds remain unchanged for 2023/24 and are as shown in the table below.

National Insurance thresholds for 2023/24

Threshold                                    Weekly      Monthly      Annual

Lower earnings limit                        £123              £533       £6,396

Primary threshold                            £242          £1,048      £12,570

Secondary threshold                       £175             £758        £9,100

Upper earnings limit                        £967          £4,189      £50,270

Upper secondary for under 21s       £967         £4,189      £50,270

Apprentice upper secondary           £967          £4,189      £50,270

Veterans’ upper secondary             £967          £4,189      £50,270

Freeport upper secondary              £481          £2,083       £25,000

Employees will pay contributions at the main rate of 12% on earnings between the primary threshold and the upper earnings limit and at the additional primary rate of 2% on earnings above the upper earnings limit. Employees with earnings between the lower earnings limit and the primary threshold are treated as paying contributions at a notional zero rate, giving them a qualifying year for state pension purposes for zero contribution cost.

The employer pays secondary contributions at the secondary rate of 13.8% on the employee’s earnings where these exceed the secondary threshold or, as appropriate, the relevant upper secondary threshold.

The Employment Allowance remains at £5,000 for 2023/24.

Employers: Class 1A

Class 1A National Insurance contributions are payable by employers only on most taxable benefits in kind, and also on taxable termination payments over the £30,000 threshold and taxable sporting testimonials over the £100,000 threshold. The Class 1A rate is aligned with the secondary Class 1 rate and is set at 13.8% for 2023/24.

Employers: Class 1B

Class 1B National Insurance contributions are also employee-only. They are payable on items included in a PAYE Settlement Agreement (PSA) in place of Class 1 or Class 1A liabilities that would otherwise arise, and also on the tax due under the PSA. As with Class 1A, the Class 1B rate is aligned with the secondary Class 1 rate, set at 13.8% for 2023/24.

Self-employed: Class 2

Class 2 contributions are how the self-employed build up entitlement to the state pension. For 2023/24, Class 2 contributions are payable at £3.45 per week where profits exceed the lower profits threshold of £12,570. Where contributions are between the small profits threshold of £6,725 and the lower profits threshold, the self-employed earner is treated as making contributions at a zero rate, securing a qualifying year for zero contribution cost.

Where profits are below the small profit’s threshold, Class 2 contributions can be paid voluntarily. This is a cheaper option than making Class 3 contributions.

Self-employed: Class 4

The self-employed also pay Class 4 contributions on their profits. These contributions do not secure any benefit entitlement and are more akin to a tax.

For 2023/24, Class 4 contributions are payable at the main rate of 9% where profits are between the lower profits limit of £12,570 and the upper profits limit of £50,270, and at the additional Class 4 rate of 2% on profits over the upper profits limit.

Voluntary contributions: Class 3

An individual can pay voluntary Class 3 contributions to make up for gaps in their National Insurance record. For 2023/24, the Class 3 rate is £17.45 per week.

HMRC are currently taking an inordinately long time to issue VAT registration numbers. You used to be able to get a VAT number within 24 hours but HMRC now advise a delay of up to three months.

The delay is because HMRC have updated the registration process, requiring businesses to submit applications via a new VAT Registration Service. Meanwhile many businesses need to issue invoices. A business that has not been allocated a VAT registration number can be disadvantaged as it cannot issue VAT invoices to customers. In addition, a VAT number is often used as proof of being in business.

A business must start accounting for VAT from the ‘effective date of registration’, being the end of the month following the relevant month from which the business was obliged to register (due to the business turnover exceeding £85,000 during the previous 12 months) or the date of voluntary registration or from an earlier date agreed with HMRC.  All invoices from this point (the date of registration) should include VAT.

Whilst waiting for the number, during the interim period HMRC recommend a business which knows its effective date of registration should adjust its prices to reflect the gross amount received. VAT should not be shown separately on any invoice.

Basic tax point

The basic tax point for a supply of goods is the date the goods are removed/time of shipping sent to, or taken by, the customer. If the goods are not removed, then it is the date the goods are made available. The basic tax point for a supply of services is the date the services are performed. In the case of both goods and services, where a VAT invoice is raised or payment is made before the basic tax point, there is an earlier actual tax point created either at the time the invoice is issued or payment received, whichever occurs first. If a business supplies products or performs services more than 14 days before a VAT invoice is issued for those goods or services, then the basic tax point becomes the date those goods or services were supplied. The basic tax point is always overridden by an actual tax point.

A tax point can only be created by the issue of a ‘proper’ VAT invoice, which needs to show the name and address of the supplier and customer, a description of the goods or services, the supplier’s VAT number, the tax point/date and the VAT rate applicable.

It should be noted that a receipt is not an invoice, but an acknowledgement of payment. While much of the information might be the same, an invoice must show the word ‘invoice’ and include specific information that a receipt typically does not. A modified invoice showing the VAT inclusive value of sales is the same as a full one but can be used by retailers for sales greater than £250 (excluding VAT).

When the VAT number finally arrives

On receipt of the number, all invoices issued and sent in the interim period between the date of registration and the arrival of the VAT number need to be reissued. It is only from that date that customers can claim the VAT charged.

Practical point

Issue the invoices but include the words ‘VAT registration applied for’ so that the customer is aware that they cannot claim the VAT payment but will be able to do so sometime in the future. For clarity, many businesses also show the words 'This is not a VAT invoice'.

Pre-pandemic, giving discounts to employees was invariably only offered by the larger companies. However, because employee benefit schemes save the employer money, many SMEs are looking to provide such schemes. The discounts need not relate to the company's products – there are schemes available that give employees access to a wide range of deals with other companies via a points system, allowing them to shop and save all year round on items that matter to them.

The discount amount needs to be carefully calculated to ensure no benefit in kind arises. There will be no benefit so long as the price paid by the employee is below the marginal costs of providing the goods. The marginal costs comprise the cost to the employer of the production or acquisition of the goods or services concerned, together with a proportion of any overhead expenses directly related to that production or acquisition (e.g. delivery charges, taxes or duties paid in respect of the goods or services by the employer). However, fixed costs, such as rent are excluded.

Staff contribution

Should the employee pay an amount towards the scheme, the benefit in kind is reduced. The benefit will be the cost of the product less any amount ‘made good’ by the employee. There may be instances where the employee is better off cash-wise by making a payment as the example shows.

Example

A company offers a staff discount of 15%. The product has a selling price of £40 (including VAT) so the employee pays £34 (85% x £40). If the marginal cost is £32 (£30 + postage) there will be no benefit in kind as the payment exceeds the marginal cost. The employee is better off by £6 because of the discount which is not taxable.

In some instances, HMRC will accept that there is no benefit in kind where the discount is also offered to the general public.

Employee tax charge

If a taxable benefit arises the amount is treated as earnings in the tax year in which the discounted goods or services are provided. Since this is a benefit in kind rather than a cash payment, the employer is not obliged to operate PAYE. However, the benefit will be subject to income tax and Class 1A NIC on the employer. Such benefits can be reported under the payrolling benefits and expenses online service to show that tax on the benefits is being collected via the payroll.

Even if there is no charge under the benefits code, one may arise under the 'second-hand value rules' if the value of the goods the employee buys exceeds the price paid. The tax charge will be on the second-hand value less any amount paid by the employee. Again, income tax and Class 1A NIC will be in point.

Voucher schemes

The discounts do not need to be of the company's products or services. Many independent companies provide voucher schemes offering a wide choice of where employees can spend their money. Some offer tax-free monthly lotto draws and competitions and the employee can choose which shop/service to use.

Vouchers which can be converted into cash or exchanged for goods which can be turned into cash, are subject to tax and NIC. However, if the items purchased are exempt (e.g. a bicycle qualifying for the cycle-to-work scheme), the voucher will also be exempt.

Practical point

With inflation meaning items are increasing in value/cost on nearly a daily basis, regular review of the relevant costs and extent of the discount will be necessary.

Furnished holiday lettings are generally liable to business rates rather than council tax. This can be very beneficial, particularly where the landlord only has one business property and is eligible for 100% small business rate relief, meaning that there is nothing to pay. However, new eligibility rules are being introduced from 1 April 2023 for self-catering properties and to remain within business rates furnished holiday lets must meet the new eligibility criteria.

If the property does not pass the tests, the landlord will instead be liable for council tax.

Different rules apply in England and Wales.

The tests – England

From 1 April 2023, a furnished holiday let in England will only be eligible to pay business rates if the property:

is available for letting commercially for short periods totalling 140 days or more in the previous and current year; and

is actually let commercially for 70 days or more in the previous 12 months.

The tests – Wales

The tests applying in Wales are stricter than those applying in England. For a property in Wales to be eligible for business rates from 1 April 2023, the property must:

be available to let commercially for short periods that total 252 days or more in the previous and current year; and

be actually let commercially for 182 days or more in the previous 12 months.

Commercial lets

Only commercial lets are taken into account in determining whether the tests are met. A property is let commercially if it is let with the intention of making a profit. The property would normally be advertised on sites such as Airbnb and Booking.com or by holiday cottage lettings agents and let out at market rates. Non-commercial lettings to family and friends are ignored.

Interaction with the tax rules

For tax purposes, to qualify as a furnished holiday letting, the property must be available for letting for 210 days in the tax year and actually let for 105 days in the tax year. Lets exceeding 31 days and those to family and friends on non-commercial terms are not taken into account.

If a property in England qualifies as a furnished holiday let for tax purposes, it will be eligible for business rates. However, where the property is in Wales, the property will not automatically fall within business rates as the business rates tests in Wales are stricter than the tax tests.

Applying the tests

To determine whether the property qualifies for business rates, the Valuation Office Agency will look at whether the property was occupied immediately before midnight. For example, if a holiday cottage is let out from Friday afternoon until Monday morning, the property will be treated as having been let for three days – it is occupied just before midnight on Friday, Saturday and Sunday. Although the guests remained in the property on Monday morning, Monday does not count as a day when the property was let as the guests left before midnight.

Trivial benefits have their own tax exemption, which if used wisely can be used to treat employees. The exemption can also be used by personal and family companies as part of a tax-efficient profit extraction strategy.

Nature of the exemption

The exemption applies if all of the following conditions are met:

The cost of providing the benefit does not exceed £50.

The benefit is not cash or a cash voucher.

The employee is not contractually entitled to the benefit.

The benefit is not provided in recognition of particular services.

Where the benefit is provided to a group of employees and it is impracticable to work out the cost of providing the benefit to each individual employee, the average cost can be used instead. To fall within the terms of the exemption, this should not exceed £50.

The exemption can be used to give employees Christmas or birthday gifts or treats unrelated to their performance.

There are, however, a number of traps to be wary of.

Trap 1: Close company trap

If the employer is a close company, the total value of tax-free trivial benefits that can be provided to a director or other office holder (or a member of their family or household) is capped at £300 a year. Otherwise there is no limit on the number of tax-free trivial benefits that can be provided in the tax year.

Trap 2: Reward for services trap

The exemption does not apply if the benefit is a reward for services. This means that it does not apply to a gift given to an employee for working later or for going above and beyond what is expected to deliver an excellent service to a client. This restriction also means that it cannot be used to shelter a taxi home when an employee works late and the journey is not covered by the separate exemption for late night taxis. In each case, the benefit is a reward for services and does not pass the trivial benefit test.

Trap 3: Contractual entitlement trap

The exemption does not apply if the employee has a contractual right to the benefit. This includes a right to expect it based on employer behaviour. Here, HMRC have previously used the (somewhat ridiculous) example of employees being given a cream cake every Friday to argue that their provision falls outside the trivial benefit exemption; employees have the expectation that they will receive a cake each Friday and as such the provision will fail the ‘no contractual entitlement’ test. While this may be an extreme example, it is probably wise to vary benefits provided under the terms of the exemption to avoid a potential challenge from HMRC. However, HMRC guidance instructs HMRC staff not to challenge a gift such as a birthday or Christmas gift simply because it is provided every year. They also accept that the provision of free tea and coffee is within the exemption.

Trap 4: The gift card trap

The trivial benefit exemption only applies if the cost of the benefit does not exceed £50. Caution needs to be exercised if the benefit is provided via an app or the employee is given a gift card, which is topped up periodically. Here the cost is the total cost for the tax year, rather than that each time the app or gift card is used, and where this exceeds £50 for the tax year, the exemption will not apply. For example, if an employee is given access to an app that allows them to order a free bunch of flowers costing £30 each month, the exemption will not apply despite the fact that each bunch of flowers costs less than £50 as the cost of using the app is £360 for the tax year. The trap applies in a similar way if the employee is given a season ticket for sporting or cultural events.

Proceed with caution

Used wisely, the trivial benefits exemption can be a tax-efficient way to treat employees and engender goodwill. However, care must be taken not to fall foul of the traps. If the exemption does not apply, it may be possible for the employer to use a PAYE Settlement Agreement to settle the tax bill on the employee’s behalf.