Helpsheets ... continued 33 from homepage

A look at the capital gains tax principal private residence relief position if an old dwelling is demolished and a new one is built in its place.

Principal private residence (PPR) relief broadly applies to gains accruing to individuals on the disposal of (or of an interest in) all or part of a dwelling house which has (or has at any time during their period of ownership) been their only or main residence.

Unrestricted PPR relief normally applies if the house has been the individual’s only or main residence throughout their period of ownership (or throughout their period of ownership except for all or any part of the last nine months).

How long?

If someone buys a dwelling house, has it demolished, and builds a new house on the same land as the old one, does the ‘period of ownership’ for PPR relief purposes relate to the land on which both houses were built, or to the period during which the new house existed?

This distinction can be important for PPR relief purposes. If the period of ownership relates to the land, there will be a period between the old house being demolished and the new house being built when there was no residence to occupy; so there would be a potential restriction in PPR relief on a future disposal. Conversely, if the ‘period of ownership’ relates to the newly-built dwelling, which was occupied as the individual’s only or main residence until its eventual disposal, PPR relief should not be restricted on that basis. But which interpretation of ‘period of ownership’ is correct?

Starting over

In Revenue and Customs v Lee & Anor [2023] UKUT 242 (TCC), in October 2010, Mr and Mrs Lee jointly purchased land for £1,679,000. Between October 2010 and March 2013, the original house was demolished, and a new house built. On 19 March 2013, Mr and Mrs Lee took up residence in their new house. On 22 May 2014, they sold the dwelling for nearly £6m. HM Revenue and Customs (HMRC) enquired into Mr and Mrs Lee’s tax returns for 2014/15. HMRC noted that the period between Mr and Mrs Lee acquiring and moving into the rebuilt house was 29 months (i.e., October 2010 to March 2013), and the total ownership period was 43 months (i.e., from October 2010 to May 2014). HMRC considered that the PPR relief available should be 18/43rds of the gain, being the PPR relief available at the time for the last 18 months of ownership. Mr and Mrs Lee appealed against HMRC’s restriction in PPR relief. The First-tier Tribunal (FTT) allowed their appeal. HMRC appealed to the Upper Tribunal (UT).

HMRC argued that the FTT made an error in deciding that the ‘period of ownership’ referred to ownership of the new house, as opposed to the plot of land. However, the UT pointed out that the whole focus of PPR relief was on there being a dwelling house. The UT considered that an ownership interest in a dwelling house required that the house existed. Mr and Mrs Lee’s interpretation of the ‘period of ownership’ was accepted.

Practical tip

It has been reported in the professional press that HMRC confirmed it will not be appealing the UT’s decision in Lee. In addition, HMRC has amended its self-assessment helpsheet (HS283) on PPR relief (tinyurl.com/HMRC-HS283) accordingly (at Examples 3 and 5).

The ‘golden brick’ and its effect on the VAT treatment of new residential property in the construction industry.

It is not uncommon, in these cash-strapped times, for construction companies to start work on a housing project and either run out of money or stop building due to a lack of demand for the houses.

Example: Part-built properties

A construction company (Buildit) buys a piece of bare land that the seller has opted to tax, so the purchase is plus VAT. Buildit obtains planning permission to build ten houses and starts construction, recovering the VAT on the purchase price based on the future zero-rated taxable sale of the houses.

After six months, they run out of cash and decide to sell the part-built properties to another construction company. The foundations for all ten houses have been laid and five of them are built to nearly first floor level.

Buildit has not opted to tax (there was no need; they thought they were going to sell zero-rated houses) and now it is going to sell the part completed construction site. It has been advised that it will either have to opt to tax and charge VAT to the purchaser or make an exempt supply of the property and repay the VAT it has claimed on the purchase of the land and the construction so far as it relates to an exempt supply – so, what should it do?

‘Golden brick’

The law states that you can zero-rate the first grant of a major interest, which is a freehold sale or a lease exceeding 21 years (20 years or more in Scotland) in a new residential building.

But how do you get a zero-rated sale when you have not completed the houses? To do this, the seller must be seen as ‘constructing’ the building or buildings. The VAT Tribunal has held that “a building must be seen to be under construction on the land”, and HMRC states:

“This is usually when walls begin to be constructed upon the foundations. These walls need not be above ground level”.

Hence the term ‘golden brick’.

So how does this affect Buildit, as some of the houses have at least one metre of walls constructed, while the others are still only at foundation level? Buildit does not want to opt to tax the property as this will add to the costs of the purchaser, but does not want to pay back half the VAT it has incurred so far (half the building has progressed beyond the ‘golden brick’ stage).

Buildit agrees with the purchaser that before completion, they will lay a couple of rows of bricks on the existing foundations, so that all properties are beyond the ‘golden brick’ and the whole project can be zero-rated. This way there is no VAT for the purchaser to pay and VAT to be paid back by Buildit.

More good news

The zero-rating does not just apply to Buildit. The new owner can complete the project and when it sells the completed houses, these will still be zero-rated supplies so it can recover all the VAT on its costs.

Even better, if the new owner decides it cannot complete the project and sells on to a third developer, this sale can be zero-rated as well as the final sale of the completed houses.

Deposit paid before ‘golden brick’

HMRC’s view is that where the deposit is released to the vendor, and it is clear from the contract that what will be supplied at completion will be partly completed dwellings (i.e., beyond ‘golden brick’), the deposit is part-payment for the grant or supply that will occur at that time; as such, zero-rating will be appropriate.

Practical tip

A construction business should make sure it has constructed the houses above foundation level and it can zero-rate the sale and save VAT.

The basic principles of the capital gains tax exemption for only or main residences.

For most of us, the house in which we live – our ‘only or main residence’ in the terms of the tax legislation – is our most valuable asset. For many of us, it is one that has increased in value substantially over the years.

For most assets, an increase in value is subject to capital gains tax (CGT) on a sale or disposal, but there is a specific exemption for the only or main residence. This applies to a house and garden or grounds of up to half a hectare (or a larger area if this is needed for the reasonable enjoyment of the property, bearing in mind its size and character).

Further, some periods when a property is not, in fact, occupied as the main residence may still qualify for the exemption. Examples are the last nine months of ownership, absences of up to three years in total for any reason, four years if employment requires the owner (or their spouse or civil partner) to work elsewhere in the UK, or longer if they have to work abroad.

Elections and apportionment

An individual (or spouses and civil partners) may only have one main residence eligible for exemption from CGT. If they own more than one property that they use themselves (e.g., a city flat where they live during the week and a country cottage for the weekends), they can elect which is to be treated as their main residence. This election must be made within two years of the properties becoming available for their use and it can be changed from one property to another.

If the exemption applies only to a property for part of its period of ownership, any gain must be apportioned on a time basis to determine the exempt element.

Example: Apportioned gain

Mr Smith bought a house for £100,000 in January 2010, which he rented out until December 2015. From January 2016, he lived in the property with his family until December 2022, when they moved to a new house. Unfortunately, the old house was not sold until December 2023, at a sale price of £250,000.

Ignoring the costs of acquisition and sale, which would be deductible (along with the cost of any capital improvements), the total gain is £150,000 over the period of ownership of 14 years (i.e., 168 months). He occupied the property as his main residence for seven years (i.e., 84 months), and the proportion of the gain relating to this period – and the final nine months of ownership (93 months) – is exempt. The chargeable gain will therefore be £66,964 (i.e., £150,000 x (75)/168 months).

Occupation of the property

Generally, there must be ‘a degree of permanence or expectation of continuity’ if a property is to be treated as the only or main residence.

If the whole property is not occupied as a main residence (e.g., because a part is used exclusively for business purposes or is let out as residential accommodation), any gain on disposal must be apportioned on a time and area basis to establish the non-exempt element. If part of the gain relates to residential letting while the owner occupies part of the property, there is an exemption of up to the lower of £40,000 and the amount of the gain that would otherwise be exempt.

Conclusion

This article covers only some of the aspects of the only or main residence exemption, and professional advice should be sought if there is any doubt as to whether the whole gain would be eligible for relief.

This is particularly important because tax on residential property gains must be declared and paid on or before the 60th day after the completion of the disposal using a UK land disposal return.

Practical tip

The only or main residence exemption is subject to special rules in the cases of spouses and civil partners, particularly on a separation or divorce, and also when ownership is transferred between them.

The operation and practical implications of the income tax starting rate band for savings.

The starting (savings) rate band for interest income is one of the most difficult concepts for taxation students (and some tax qualified professionals!) to understand, so it is not a surprise that most taxpayers without detailed technical tax teaching, do not understand it either.

If you take a quick ‘Google’, you will see that it is applied to the first £5,000 of savings income; but this overly simplifies the benefit.

Taxation of savings income

When looking at how non-savings income is taxed, there are simply three rates: the basic rate at 20%, the higher rate at 40% and the additional rate at 45%.

The taxpayer’s savings, however, are taxed at four rates. In addition to the rates detailed above, they are also taxed on the zero-percentage rate, and this is applied in two situations.

The starting (savings) rate band

The first of these is the starting (savings) rate band. This band is confusing, as it is only applicable if the taxpayer’s non-savings taxable income is under £5,000. Remember, although we are trying to find the rate to tax the savings income, it is the level of non-savings income that is being considered to establish how much of the savings income is taxable at 0%.

The taxpayer’s non-savings income includes such income as employment income, sole trading income, income from the taxpayer’s share in a partnership, royalties and income from some trusts. Taxpayers that have low (i.e., under £5,000) levels of taxable non-savings income are entitled to have up to the first £5,000 of their savings income taxed at 0%.

Individuals who are likely to benefit from this are pensioners no longer receiving employment or trading income but who have generated savings over their lives, earning taxable interest.

If the taxpayer has some non-savings taxable income up to £5,000, this will reduce the £5,000 capacity for taxing the savings income at 0% accordingly.

Example 1: Savings and non-savings income

Janet earned the state pension in 2023 of (say) £10,000, and also earned £3,000 in royalty income. After deducting the personal allowance, her taxable non-savings income was £430 (i.e., £13,000 - £12,570). She also earned £10,000 in interest on a term deposit. Without the starting (savings) rate band and the personal savings allowance (see below), the tax on all her interest would be at the basic rate of 20%; but due to the savings rate band, £4,570 will be taxed at 0%. This represents the difference between the absolute amount of the starting rate band of £5,000 and Janet’s taxable non-savings income of £430.

The personal savings allowance

The news gets even better. In addition to the savings rate band, taxpayers who earn taxable interest may also be entitled to the personal savings allowance (PSA). This allowance is means-tested and can be used only for savings income. Basic-rate taxpayers are entitled to earn £1,000 interest annually that can be taxed at 0%. Higher-rate taxpayers can earn £500 but for those additional-rate taxpayers, there is no personal savings allowance. The PSA is applied after the SRB.

Example 2: Interest and the PSA

In our example of Janet, the £10,000 that she earned in interest will, as explained above, have £4,570 taxed at 0% as a result of the starting (savings) rate band. In addition, as Janet is a basic-rate taxpayer, £1,000 will be able to be taxed at 0% as a result of the personal savings allowance. This leaves only £4,430 taxable at 20%.

Practical tip

The savings rate band is not means-tested and is available to every taxpayer resident in the UK. Husbands, wives and civil partners should therefore ensure that they split their interest earning investments such that they both receive up to the maximum savings rate band (if they are eligible given their non-savings income level) and personal savings allowances possible.

Check whether tax advisers are on HMRC’s ‘naughty’ list before seeking tax advice.

Taxpayers might be forgiven for considering that HM Revenue and Customs (HMRC) has more than enough powers to tackle taxpayers over what it regards as ‘naughty’ behaviour. However, taxpayers are not alone; HMRC’s attention seems to be turning increasingly to agents and tax advisers, including for (what HMRC regards as) leading taxpayers astray with ‘dodgy’ tax schemes.

Naming…and shaming

For example, since 2009 HMRC has had the power to ‘name and shame’ taxpayers where penalties for deliberate behaviour (including tax return errors) have been imposed if the potential lost revenue exceeds £25,000, except in limited circumstances. The tax offenders’ register is published on the Gov.uk website (tinyurl.com/HMRC-CLDTD). This policy of publishing information was extended (in FA 2022) in relation to tax avoidance schemes. HMRC can publish any information or documents it considers appropriate “…to inform taxpayers about the risks associated with a tax avoidance scheme and/or to protect the public revenue”. The information HMRC can publish includes:

 • Details of schemes HMRC suspects to be tax avoidance schemes.

 • The names of suspected ‘promoters’ of such schemes (and connected persons).

 • Where a tax avoidance scheme promoter has suggested that their schemes always work, details of other schemes they have promoted that have been defeated.

In addition, HMRC may generally publish information about anyone who has (or is suspected of having) any other role in making the tax avoidance scheme available. However, if HMRC intends publishing information that identifies a person, HMRC must first give the person 30 days to make representations about whether the information should be published.

Giving taxpayers a ‘heads-up’

HMRC will generally publish information on the Gov.uk website, and possibly write directly to warn taxpayers about the risks of tax avoidance schemes. For example, HMRC might contact users of publicised tax avoidance schemes by letter to warn of the risks of continuing in such arrangements, or to inform them about the actions that HMRC is taking in relation to a scheme. Other appropriate channels may also be used to publish information about tax avoidance schemes, so that the information reaches the widest audience possible.

And so it begins…

Despite these powers only having been in place since 24 February 2022, HMRC has wasted no time in using them:

 • A ‘Current list of named tax avoidance schemes, promoters, enablers and suppliers’ has been published on the Gov.uk, which is regularly updated (tinyurl.com/HMRC-TAS-info).

 • HMRC has also started publishing documents such as evidence of marketing material used by scheme promoters and suppliers to encourage taxpayers to use their tax avoidance schemes (e.g., see tinyurl. com/HMRC-TAS-Evidence).

People who believe they are involved in a tax avoidance scheme are advised to contact HMRC as soon as possible (03000 534 226). HMRC is also urging people who have been encouraged to get into a tax avoidance scheme or have had contact with someone selling tax avoidance schemes to report this by using an online form (www. gov.uk/report-tax-fraud).

Practical tip

If a tax avoidance scheme has not been included in HMRC’s list, this does not mean that the scheme works as intended, or that HMRC has ‘blessed’ it. HMRC does not ‘approve’ tax avoidance schemes. So, taxpayers should consider seeking a second professional opinion if they are offered tax planning arrangements, particularly if they seem too good to be true.

Just because an expense is paid out of a business bank account does not necessarily mean it will be tax-deductible. The general rule for all businesses is that expenses are tax-deductible if they are incurred ‘wholly and exclusively’ for that business. The sole purpose must be for the trade as incurred for the benefit of the business.

Potential confusion

A typical situation where confusion may arise is where a business pays for a table at an annual charity quiz night for the industry; is this entertaining clients (not allowed), a donation (allowed), or advertising (allowed)? The answer is ‘not allowed’ as the split between business and non-business cannot be differentiated.

Travel expenses can also confuse. For example, for a sole trader or partnership whose business is based away from home, the costs of travelling (commuting) to the business base are not deductible as these are incurred to put the person in a position to work, rather than being incurred in running the business. However, if the business is based at home, the costs of travel from home to the premises of a customer or supplier are deductible. Where the business is run as a company, all travel costs met by the company are deductible in computing the company’s profits.

However, ‘wholly and exclusively’ also means no private use element. Should a company meet the costs of private travel of an employee or director (e.g., home-to-work travel costs), a benefit-in-kind tax charge may be levied on the employee and a Class 1A National Insurance contributions (NICs) liability on the company.

Identifying the purpose

It is important to appreciate that the existence of a non-trade or private purpose will preclude the deduction in full if it is not possible to identify each element separately. If it is possible to differentiate, a deduction may be permitted for the trade portion only, calculated on a ‘just and reasonable’ basis. However, it is not always easy to separate business from private, particularly if the business is home-based.

HMRC agrees that a home-based business incurs additional expenses (heating, lighting, water and internet, etc.). For the self-employed, there is a flat rate (both tax and NICs-free with no evidence required) that can be claimed depending on the number of hours worked (e.g., for up to 50 hours a week, the allowance is £10 a week). The amount for a director-employee is £6 a week with no hourly restriction.

Calculating the claim

However, with energy costs rising, a business owner should be looking at whether it would be more tax-efficient to use the alternative method of calculation – that of percentages. The business versus private use still needs to be considered when calculating any claim. For a more accurate figure, the total bills could be divided by the floor space for the room used or calculated as a percentage of the room’s use for work only. If the office is used for (say) ten hours a day, but two of those hours are not work-related, the claim can be for 80% work use for the room. Note that council tax, mortgage payments and rent do not count as expenses, because these are incurred regardless.

In addition, the exemption only covers additional costs; therefore if the cost is the same whether the person works from home or not, it will not be allowable.

Practical tip

In court cases brought by HMRC to determine whether an expense was ‘wholly and exclusively’ incurred, judges have confirmed that what matters is the purpose of the expenditure and not the motive. Therefore, it is not sufficient that the expenditure results in an advantage for the trade; the direct and immediate purpose of the expenditure is what matters.

Expenses incurred by an employee on behalf of a company can only be reimbursed under the 'wholly, exclusively and necessarily' rules for work undertaken 'in the performance of the duties of or employment'. It is not enough for the expense to be relevant to the job, or to be incurred in connection with the duties of the job. The point of this rule is to prohibit the cost of expenditure that has a private purpose and is therefore taxable as 'emoluments'. Where this situation may pose a problem is in claims for reimbursement of expenses by an employee when travelling for business reasons as sometimes personal expenses will also be incurred.

However, the incidental overnight expenses exemption enables an employer to meet small personal expenses when an employee stays away for work, without the employee suffering a tax charge and without needing to report the expenses to HMRC. Examples quoted in HMRC's employment manual include newspapers, laundry costs and telephone calls, i.e. small incidental items where a receipt may not be available. A key feature of the exemption is that the employer must reimburse the expense – the relief is unavailable otherwise.

The exemption limit for travel within the UK is £5 per night when there is an overnight stay and £10 per night for overseas trips. The exemption can be applied as long as the total incidental overnight expenses do not exceed the allowance for the entire trip. Importantly, should a payment be made exceeding these limits, the whole payment becomes taxable and not just the excess. However, there are two methods under which a company and its employees can take advantage of this exemption:

1. Make it a company policy that any excess is reimbursed by the employee where personal expenses exceed the limit. The effect will be to bring the whole payment back within the tax exemption.

 2. The company can pay a £5 or £10 per night allowance (for UK overnight stays and non-UK overnight stays respectively) for personal costs regardless of whether it is spent. If it is not spent, there is no requirement for it to be repaid and no tax implications for the company or employee.

Employers wishing to pay or reimburse employees’ expenses at a rate other than those set can apply for HMRC's approval of a 'bespoke rate'. An application must set out the rate that the employer wishes to pay and demonstrate that the amount is a reasonable estimate of the expenses incurred and that a deduction would usually be allowed in respect of those amounts.

Where additional services are part and parcel of the room tariff and not separately charged, no benefit in kind applies. However, where the company pays for additional facilities e.g. pay-per-view movies or use of the hotel gym or pool, these are taxable on the employee.

Practical point

The incidental expenses allowance relates to employees only. A director can claim if employed by the company but the same cannot be achieved by someone who is self-employed (there being no employee).

Whether a claim for the cost of work clothes is tax deductible is covered by the general rule for deduction of any expenses incurred by an employee. Statute states that any expense incurred is allowed if the employee is obliged to incur the expense and that amount is incurred 'wholly, exclusively and necessarily in the performance of the duties of the employment'. For the self-employed, the condition is less severe, requiring the expense to be incurred 'wholly and exclusively' for the purposes of the trade.

As everyone has to wear clothes, any expenditure usually fails these statutory tests as there is a duality of purpose (even if only worn for work). Apportionment of expenditure on ordinary clothing, used exclusively at work, between allowable business purposes and non-allowable personal purposes is also impossible.

The only exception HMRC permits is for a uniform or clothing worn for protective reasons, but potential difficulties can arise here. There is no specific section of any Act covering the deduction for the cost of work clothes, therefore HMRC has to rely on precedent when deciding whether to allow a claim.

Over the years, taxpayers have attempted to claim that a particular job requires a particular type of clothing and therefore should be allowed. However, tribunals have ruled that having to wear a particular type does not mean a deduction is possible. For example, the Mallalieu v Drummond [1983] case established that no deduction was allowed for clothing forming an ‘everyday’ wardrobe. Ms Drummond was a barrister who tried to claim the cost of the black clothes, white blouse, etc required when making court appearances under the Bar Council’s dress code and contended that these clothes would not normally be purchased. The expense was not allowed due to the dual-purpose rule as the clothing enabled the claimant to be warm, properly dressed and allowed her to work.

In comparison, a case where a taxpayer did win was Gemma Daniels v HMRC [2018]. Ms Daniels was a self-employed 'exotic danger' and claimed tax relief for her work clothing, lingerie, dry cleaning, make-up, beauty treatments and hairdressing. It was held that there was no duality of purpose, her clothes were not required for 'warmth and decency' and, importantly, not worn outside work.

Protective clothing

HMRC will normally agree a claim for clothing required to be worn due to the nature of the employee’s job, preventing physical injury or protecting normal clothing against damage. Here we are looking at items such as safety boots and shoes, hard hats,  aprons, ear defenders, safety goggles and overalls. The taxpayer's particular occupation will determine the protective clothing required and in certain industries this is set down in health and safety legislation. During the Covid outbreak, HMRC confirmed that the provision of personal protective equipment (PPE) by an employer (or the purchase by an employee and reimbursement) is tax-free.

Uniform

The cost of a uniform intended to identify its wearer as having a particular occupation is allowed. In its manuals, HMRC quotes the traditional nurse or police uniforms. HMRC will also usually allow clothing provided by construction companies and related businesses (e.g. electricians, plumbers, etc) that bears the employer's logo or name – the reasoning here is that the employer-provided clothing is clearly distinguishable from clothing worn for private use, but HMRC confirms that each case is considered on its merits. Note that the badge must be fixed or sewn into the garment – 'a detachable badge is not sufficient to make the clothing to which it is attached part of a uniform’ (EIM32475).

Practical point

Trade unions have negotiated flat rate deductions on a national basis covering the cost of otherwise non-allowable protective clothing and general laundry expenses. These flat rate deductions only apply to employees in specified occupations. Therefore, if a claim is not possible under the 'work clothes' rules, some of the cost can be claimed under the flat rate deduction scheme.

As the cost-of-living crisis continues to bite, the idea of earning tax-free income is appealing. If you have a spare room, you can make this a reality by letting it out and taking advantage of the rent-a-room scheme.

What is rent-a-room?

The rent-a-room scheme allows you to earn up to £7,500 tax free each tax year by renting out one or more rooms in your own home. If the income is shared between two or more people, each can earn up to £3,750 tax free each year.

To qualify, the let room must be in your main home and it must be let furnished. You can also benefit from the scheme if you run a guest house or bed and breakfast business.

Nature of exemption

If your gross rental receipts are not more than your rent-a-room limit (£7,500 or £3,750 depending on whether one or more people receive the income), you do not need to tell HMRC about the income or pay tax on it. Your gross rental receipts are the money that you receive from letting the room before deducting any expenses.

If your gross rental receipts are more than your rent-a-room limit, you can still choose to use the scheme and deduct your rent-a-room limit rather than your actual expenses to arrive at your rental profit if this is more beneficial. This will be the case if your actual expenses are less than your rent-a-room limit.

Example

Kelly has two spare rooms in her home which she lets furnished to lodgers for £100 a week. Her rental income from each room is £5,200 a year – a total from both rooms of £10,400. She incurs expenses of £2,000 in the tax year.

As Kelly’s gross rental receipts are more than her rent-a-room limit of £7,500, her income is not exempt.

If she calculates her profit in the usual way by deducting her actual expenses from her gross rental receipts, her taxable profit will be £8,400.

However, if she opts to deduct the rent-a-room limit instead of her actual expenses, her taxable profit will only be £2,900 (£10,400 – £7,500). This is clearly preferable.

Choosing your method

If your gross rental receipts are more than your rent-a-room limit, you will need to complete a Self Assessment tax return. HMRC will automatically calculate your profits in the usual way by deducting your actual expenses from your rental income (Method A) unless you tell them otherwise. If you want to deduct the rent-a-room limit instead (Method B), you will need make the deduction in box 37 of the UK property pages of your Self Assessment tax return.

You can switch between the methods as necessary to achieve the best result.

Losses

If you make a loss, and your gross rental receipts are below the rent-a-room limit, you may wish to instead calculate the loss in the normal way rather than claiming rent-a-room relief so that the loss is available to set against any future profits. In this situation you must complete a tax return without claiming rent-a-room relief.

The current capital gains tax rules do not provide any relief for inflationary gains. This can mean that when an investment property or second home which has been owned a long time is sold, there is a significant amount of capital gains tax to pay. The rules effectively treat the entire gain over the period of ownership as if it were a gain in the year of disposal, such that only the current year’s annual exempt amount is available to reduce the amount of the gain. This can be particularly problematic if equity has been withdrawn from the property to provide deposits for further investment properties.

The following example illustrates the problem.

Example

Lucy purchased a two-bedroom property in 2004 for £120,000. In 2024, the property is worth £280,000. Lucy has re-mortgaged the property several times to fund deposits on further properties to expand her rental portfolio. The property currently has a mortgage of £250,000.

As a result of the rise in interest rates, Lucy now wishes to sell the property.

The incidental costs of sale and acquisition are £10,000.

The gain on the disposal is £150,000 (£280,000 – £120,000 – £10,000). Lucy has yet to use her annual exempt amount of £6,000 (2023/24 rate), which reduces the chargeable gain to £144,000.

As Lucy is a higher rate taxpayer, she must pay capital gains tax of £40,320 (£144,000 @ 28%) within 60 days of the completion date. The proceeds are not sufficient to pay the tax and clear the loan.

Had Lucy instead invested in shares and sold sufficient shares each year to use up her annual exempt amount, she would have been able to realise a significant tax-free gain over the same 20-year period.

When Lucy purchased the property, she was able to buy a two-bedroom property at the market rate. However, selling the property many years later and paying capital gains tax on the entire gain over the period of ownership means that she would not have sufficient funds should she wish to reinvest in an equivalent property. Capital gains tax is payable even though the property has simply increased in line with inflation, and the longer the property is held, the more of a problem this becomes.

The position is exacerbated because capital gains tax, which was introduced in 1965, has not been rebased since 1982.

Think ahead

When looking to property as a long-term investment, for example, to provide funds for retirement, the inflationary gains trap should be borne in mind. Paying capital gains on sizeable inflationary gains where a property has been held for many years will seriously reduce the funds available when the property is sold.

Earlier in the year, it was erroneously reported in the press that new tax rules were coming into force which would mean that anyone selling online would need to tell HMRC and pay tax on their earnings.

There is, however, no change in the tax rules, which apply to online sellers as they do to other traders. However, from 1 January 2024 onwards, digital platforms are now required to collect information on online sellers and their income, and they must report this to HMRC by January 2025. Consequently, online sellers who have previously failed to declare taxable income may now come to HMRC’s attention.

Taxable income and gains

Not everyone selling online will need to pay tax or tell HMRC. This is only necessary if the person is trading or makes a capital gain. A person selling some old clothes on Vinted for less than they paid for them does not need to tell HMRC about their income or pay tax on it.

Trading

A person will normally be trading if they sell goods or services for a profit. The normal ‘badges of trade’ apply to determine whether a trade exists.

An online seller who is trading must tell HMRC about their income if their gross trading income is more than £1,000 in the tax year. This limit applies to all income from trading – not just that from online sales.

The £1,000 trading allowance means that if gross trading income is less than £1,000, the income can be enjoyed tax-free and does not need to be reported to HMRC. If gross trading income is more than £1,000, the trader has the option of deducting the trading allowance or their actual expenses. Where actual expenses are less than £1,000, it will be beneficial to deduct the £1,000 trading allowance instead to arrive at the taxable profit.

If the trader has made a loss from selling online, they may wish to report this, even if their gross trading income is below the £1,000 limit. This will allow them to utilise the loss.

Where income from online selling needs to be reported to HMRC, this is done in the Self-Employment pages of the Self Assessment tax return. New online sellers who have not previously filed a return will need to register for Self Assessment no later than 5 October after the end of the tax year in which their trade commenced (so by 5 October 2024 where they started their trade in the 2023/24 tax year).

Capital gains

An online seller may also need to tell HMRC if they make a chargeable gain. However, the chattels rules mean that a gain on a single chattel only needs to be declared if the proceeds are more than £6,000 and the chattel is not exempt, as is the case for private cars.

Individuals making capital disposals do not pay capital gains tax if their net gains for the tax year (chargeable gains less allowable losses for the year) are covered by the annual exempt amount. This is essentially a personal allowance for capital gains tax purposes, and each individual is entitled to their own annual exempt amount.

The annual exempt amount is set at £6,000 for 2023/24 (down from £12,300 for 2022/23). It is further reduced to £3,000 for 2024/25. If it is not used in the tax year, it is lost – it cannot be carried forward.

If you are planning disposals that are likely to trigger a gain, it is important to consider the timing and, where the 2023/24 annual exempt amount remains available, whether to make the disposal before the 2023/24 tax year comes to an end on 5 April 2024.

Case study 1

Jacob has not made any disposals in 2023/24. He is planning on selling a residential  investment property which will realise a gain of £20,000.

Jacob is single and pays tax at the higher rate.

By making the disposal before the end of the 2023/24 tax year, Jacob will be able to use his 2023/24 annual exempt amount of £6,000, leaving him with a gain of £14,000 on which capital gains tax of £3,920 (£14,000 @ 28%) is payable.

However, if he delays the disposal until after 5 April 2024, he will only benefit from an annual exempt amount of £3,000, leaving a chargeable gain of £17,000 on which capital gains tax of £4,760 will be due.

By making the disposal before 6 April 2024, Jacob is able to save tax of £840. He is also able to preserve his 2024/25 annual exempt amount.

Case study 2

Jane sold a flat in May 2023 realising a loss of £15,000. She plans to sell a painting which will realise a gain of £2,000.

If Jane sells the painting in 2023/24, the gain of £2,000 will be set against the loss of £15,000, reducing the net loss available to carry forward to £13,000. Her annual exempt amount for 2023/24 will be wasted.

If Jane makes the disposal in 2024/25, and this is her only disposal in that year, it will be sheltered by the annual exempt amount of £3,000. Jane will have losses from 2023/24 of £15,000 to carry forward to set against future gains.

Case study 3

John has made chargeable gains of £8,000 in 2023/24. He plans to sell a holiday home, realising a gain of £30,000.

If he sells the property before 6 April 2024, the full gain will be taxable as he has already used his annual exempt amount. However, if he waits until after 5 April 2024 to make the disposal, he will be able to use his 2024/25annual exempt amount to reduce the chargeable gain to £27,000, reducing his tax bill by £840 if he is a higher rate taxpayer.

Spouses and civil partners

Spouses and civil partners each have their own annual exempt amount. While they cannot pass unused annual exempt amounts to their partner, they can transfer assets between themselves at a value that gives rise to neither a gain nor a loss.

When planning asset disposals, spouses and civil partners need consider not only their own available annual exempt amount, but also that of their spouse/civil partner, and the rate at which they each pay tax.

If you have used your annual exempt amount for 2023/24 but your spouse has not, it may be worth transferring the asset to them prior to disposal and making the disposal before 6 April 2024 to utilise their 2023/24 annual exempt amount.

Case study 4

Julian and Jackie are married. Julian has used up his annual exempt amount for 2023/24, but Jackie has hers still available.

Julian is planning on selling a painting on which he expects to realise a gain of £5,800. By transferring the painting to Jackie for her to sell prior to 6 April 2024, the gain will be sheltered by Jackie’s annual exempt amount, so that no tax is payable.

Tax codes are fundamental to the operation of PAYE. If your tax code is correct, you should pay the right amount of tax on your PAYE income. However, if your tax code is not correct, PAYE will not work as intended and you may find that you have paid too much or too little tax. It is important, therefore, that you understand your tax code and also that you check that it is correct.

Your tax code will normally comprise letters and numbers; however, there are special codes which may not follow this format.

The number

If you have a suffix code, the number in the tax code will indicate the amount of tax-free income you can receive in the tax year. This will reflect both your allowances and any deductions from your allowances. The number is the net amount of allowances less deductions without the last digit.

For example, if you are entitled to the standard personal allowance of £12,570 and there are no deductions from your allowances, the number element will be 1257. Likewise, if you have received the marriage allowance from your spouse or civil partner so that your personal allowance has been increased to £13,830, the number element will be 1383.

Deductions

Amounts may be deducted from your personal allowance to allow tax on non-payrolled benefits in kind or untaxed interest or dividends to be collected through PAYE. Deductions may also be made from your tax code to collect underpayments of tax which may be the case if you have tax to pay under Self Assessment and you opted for this to be collected through PAYE via an adjustment to your tax code.

For example, if you are entitled to the standard personal allowance of £12,570 and have a company car with a cash equivalent value of £5,000, your net allowances are £7,570 (£12,570 – £5,000) and the number element of your tax code is 757.

Where you have a tax underpayment, the amount of the deduction is found by grossing up the tax that you owe at your marginal rate of tax (for example, if you owe £1,000 and pay tax at the higher rate, the deduction in your code would be £2,500 as 40% of £2,500 is £1,000).

The letters

The letters indicate your personal situation and how tax is to be deducted.

The following letters may be used on the tax codes of English and Northern Irish taxpayers.

Scottish and Welsh taxpayers

Scottish taxpayers have an ‘S’ in their code, for example, ‘SBR’, whereas Welsh taxpayers have a ‘C’, for example, CD0.

K codes

A K code is used where deductions exceed allowances. This may be the case if you do not receive a personal allowance because your income is more than £125,140 a year and you have deductions, for example, to tax benefits in kind.

For a K code, the number element represents ‘additional pay’ which is added to your actual pay to collect the correct amount of tax. Deductions are subject to an overriding limit of 50% of pay.

Emergency codes

PAYE is normally operated on a cumulative basis. However, there are certain situations where you may be given an emergency code which indicates that your tax is calculated non-cumulatively by reference only to your pay for that week or month. An emergency code will end in ‘W1’, ‘M1’ or ‘X’, for example, 1257L M1.

Check your code

To avoid nasty surprises at the end of the tax year it is important to check that your tax code looks correct, and that you tell HMRC if it is not. You can do this via the HMRC app.

Many in business will trade through the medium of a limited company and the directors will generally be remunerated by the payment of dividends or salary. The former are taxed on the recipient and must be paid out of profits subject to corporation tax, while the latter are subject to National Insurance contributions (NICs) as well as income tax.

So, are there more tax-efficient ways for owners to extract value from their companies?

1. Loans

The company could make a loan to the director. The company will incur a tax charge when the loan is made, which is repayable when the loan is repaid. The director does not incur an income tax or NICs liability on the amount loaned but is taxed on the benefit of an interest-free or low-interest loan, calculated by reference to HMRC’s ‘official rate’ of interest.

On the other hand, if the director (or indeed anyone else) has lent money to the company for business purposes, the company can pay a commercial rate of interest. This will potentially be subject to income tax but, unlike salary, there is no NICs charge. Of course, if the company can afford to repay the loan, this can be withdrawn free from income tax and NICs.

As well as money, the director may own assets (e.g., property or plant and machinery) that are loaned to the company for its use. If so, a commercial rent could be paid with a similar NICs saving.

2. Expenses

Directors will often incur expenses on behalf of the business. They should keep records and receipts and ensure that they are reimbursed for such costs rather than accepting that they are compensated by their salary.

The reimbursement would not be subject to tax or NICs.

3. Family members

Relatives may work for the business – perhaps a spouse or children; if so, they should be paid an appropriate salary. Not only will this ensure that minimum wage issues are avoided, but money may pass from the company to the family with lower liabilities than if a larger sum was paid to the controlling individual.

The wages must be commercially justifiable; if not, they could be disallowed in arriving at the company’s taxable profits, leading to effective double taxation.

Family members could also be given shares, enabling dividends to be paid to them. Advice is essential here, because as well as potential capital gains tax issues on the gift, there may be other implications.

4. Pension contributions

An individual can contribute to a pension scheme and receive tax relief at their marginal rate. However, they will probably have paid NICs (as will the company) on the salary from which those premiums are paid.

The company could instead pay the director’s premiums as employer’s contributions – and perhaps any other family employees.

5. Benefits

There is not enough space to examine this area in detail, but some benefits can be provided to a director and other employees that may have tax advantages.

For example, the provision of a mobile phone is taxexempt, as would be computer equipment if this is provided for work purposes and personal use is insignificant. Company cars, in general, may now not be as tax advantageous as they were, but electric cars and vans have relatively lower tax charges and may be worth investigating.

Conclusion

A limited company can have many advantages as a conduit for business, but its existence as a separate legal entity can result in additional tax and NICs charges. Professional advice will be essential in ensuring that those liabilities are minimised.

Practical tip

A review of working patterns and practices will be useful in determining whether tax-advantageous benefits or expenses payments may be provided by the company to its directors and employees. For example, with homeworking increasingly popular, an HMRC approved tax-free weekly amount can be paid in respect of the additional household costs.

The purpose and application of form R185.

If a trust beneficiary receives a Form R185 from a trustee, it is good news. It means they have been paid some income during the tax year.

The R185 shows the net income a beneficiary received from the trust, and the associated tax paid on their behalf by the trustee. The taxation system for trustees and beneficiaries in the UK is designed such that the beneficiary cannot fail to pay at least basic rate tax on the income received from the trust.

The system differs slightly if the trust is an interest in possession (IIP) to that of a discretionary trust (DT).

Interest in possession trust

There are two beneficiary parties in an IIP trust. The ‘remainderman’ beneficially owns the trust capital and is entitled to it at some time in the future - after the life tenant is no longer entitled to benefit from the trust.

The life tenant is only eligible to the income from the capital, not to the capital itself. However, unlike a discretionary trust, the life tenant is entitled to all the income in the trust every year. The trustees have no discretion over this.

When the income is received in the trust, the trustees are charged to basic rate income tax. Form R185 shows the beneficiary how much tax the trustees have paid.

The beneficiary then adds the gross income received from the trust to their own income in the self-assessment tax return and pays tax at their personal applicable rate. They can offset, as a deduction, the tax already paid by the trustees.

If the beneficiary does not have income above the personal allowance (e.g., a school-aged beneficiary), they will receive a refund for the tax paid by the trustee. If they are a basic rate taxpayer, they will owe no more and no less on the trust income, and if they are a higher or additional rate taxpayer, they will have another 20% or 25% to pay to HMRC.

Discretionary trust

A DT only has one beneficiary (known as ‘the beneficiary pool’). The trustees have the ‘discretion’ to pay either the income or capital over to any, all, or none of the beneficiaries every year.

The beneficiaries therefore have only a ‘spes’ (Latin for ‘hope’) of receiving an amount from the trust. Because the trustees are not obliged to pay anything out to the beneficiaries they could, if they were minded, accumulate the income inside the trust.

With no chance of the income being distributed to a higher or additional-rate taxpayer, HMRC would only ever get basic rate income tax if the taxation system of the DT matched that of the IIP. For this reason, the taxation of the DT is at a much higher and punitive rate; in fact, the rate is equal to the additional rate of individual taxpayers. This shifts the cashflow advantage from the taxation of the accumulated income from the trustees to HMRC.

Once the trustees use their discretion to distribute income to a beneficiary, the R185 will show the income alongside a 45% tax credit, which can be offset against the beneficiary’s eventual tax liability. Unless the beneficiary is in the minority 5% of additional-rate UK taxpayers, they will get a refund from HMRC, bringing their rate down to 40%, 20% or 0%.

Practical tip Do not ignore the R185. Not only does it show the beneficiary the amount that is taxable, but it also highlights the amount of tax paid by the trustees on the beneficiary’s behalf. This amount can be offset or deducted against the beneficiary’s income tax liability, which in a DT will lead to a tax repayment from HMRC 95% of the time.

Some inheritance tax points to consider for parents wishing to help adult offspring manage their mortgage debts.

These are difficult times for most young people buying their first home, or for recent first-time buyers trying to keep up with their mortgage payments. Some offspring will need help from their parents to get (or stay) on the property ladder.

Cash lump sum

With some thought and planning, it can be possible for parents to help adult offspring in an inheritance tax (IHT) efficient manner. The most obvious way would be to give the children a lump sum to pay off all or part of the mortgage. A cash gift is a potentially exempt transfer (PET) for IHT purposes, which becomes exempt if the parent donor survives at least seven years.

Funding mortgage repayments

However, there are other possible ways for parents to help, which do not involve a seven-year waiting period for IHT purposes. These include taking advantage of the IHT exemption for ‘normal expenditure out of income’. An individual can benefit from this exemption to the extent that certain conditions are satisfied, i.e., broadly:

• the gift was part of the normal expenditure of the donor;
• it was made out of their income (taking one year with another); and
• the donor was left with sufficient income to maintain their usual standard of living.

For example, if the parents wished to make regular transfers of funds to help their offspring with mortgage payments, the IHT exemption may apply if the gifts satisfy the above conditions. There is then an immediate reduction in the donor’s estate; the seven-year waiting period does not apply (although HMRC might seek to establish whether the exemption conditions were satisfied if the donor dies within seven years and IHT is at stake).

Loans instead of gifts

Alternatively, the parents could (for example) make an interest-free loan to enable the children to buy their home, instead of making an outright cash gift. Whilst the loan remains part of the parents’ estates, the interest-free element of the loan should not constitute a PET, provided the loan is repayable on demand. If the parents later decide to convert the loan into a gift, care is needed to ensure that the loan release is effective in law (NB this article only focuses on English law). For example, if the release is made voluntarily and without consideration, it must be made by deed (Pinnel’s Case [1602] 5 Co. Rep 117a); this might be a signed agreement specifying that it is intended to be a deed. Otherwise, the debt remains an asset of the parents’ estate for IHT purposes. Accepting a lesser amount in repayment of the debt will not generally be effective either. However, there are certain exceptions, such as for early repayment at the parents’ acceptance Foakes v Beer [1884] UKHL1), or the acceptance of repayment in non-monetary form (e.g., the creditor “might take a horse, a canary, or a tomtit if he chose”; Couldery v Bartrum (1881) 19 Ch D 394). If the parents’ debt release is effective, there will still be a PET to the extent that their estates are reduced as a result.

Practical tip

Problems could arise if the parents later borrow back money they have gifted, due to anti-avoidance rules (FA 1986, s 103). Specialist professional advice should be sought, if necessary.

The tax implications of assets gifted or sold at an undervalue.

Surprising loved ones with a gift can potentially backfire on the donor, who may end up with a tax charge in exchange for giving up the asset.

Depending on the recipient, the nature of the asset and its value, a gift could lead to a capital gains tax (CGT) or inheritance tax (IHT) charge.

What is a ‘gift’?

Apart from outright gifts, a sale to a connected party at less than the asset’s market value is also considered a gift from the tax perspective.

In either case, the market value of the asset at the time of the transfer is treated as the proceeds of the transaction.

This is different from the normal CGT treatment of an asset being sold at a reduced price to make a quick sale.

Connected party

Excluding a spouse or civil partner (to whom any transfer is free from a CGT or IHT charge), a connected party for a donor can be any of the following:

•  • direct ancestors;
•  • direct descendants;
•  • siblings;
•  • spouse or civil partners of any of the above; and
•  • connections of spouse or civil partner.

Warning: clogged losses!

A loss arising from a transfer of an asset to a connected party can only be adjusted against any gain arising from a transfer to the same person.

CGT relief and exemptions

Although it may seem unfair that a gift could give rise to a gain, if planned effectively, the donor may get away with paying reduced or no CGT by utilising the annual exemption (£6,000 for 2023/24).

The donor may also be able to gift the gain to the recipient without a CGT charge if:

•  1. the transfer was of a business asset; and
•  2. both parties agreed to claiming gift relief on it.

The gain becomes taxable when the recipient sells the asset to a third party, effectively transferring the liability from the original donor to the recipient.

The gift of a residential property owned and used by the donor may be completely exempt because of private residence relief.

IHT implications

Unlike CGT, cash gifts are relevant for IHT purposes. An asset gifted to another individual in the lifetime of the donor is treated as a potentially exempt transfer (PET). This means that no tax is payable at the time of the transfer and the asset has the potential to become completely exempt from IHT if the donor survives at least seven years after the transfer.

An IHT charge can arise where assets are transferred in the event of the death of the individual within the seven-year PET period.

As the value of the asset is expected to increase over time, transferring assets during the donor’s lifetime is encouraged. This is because if they do become taxable in the event of the donor dying within seven years, the value on which the tax charge applies will be lower than if the asset is part of the death estate.

IHT reliefs and exemptions

The value of lifetime transfers can be reduced by the annual exemption amount (£3,000 for 2023/24), and the tax charge on transfers on death may be reduced if taper relief is available.

If the value of the transfer is below £325,000 (i.e., the limit of the nil-rate band available to each UK-domiciled individual), the transfer could be completely free from IHT.

Gifts on the recipient’s marriage, depending upon the family relationship to the donor, can be exempt up to a maximum in some cases of £5,000.

Regular Christmas gifts, birthday presents, etc., are also exempt, provided the donor can maintain their usual standard of living after the transfer.

Practical tip

Keep the value of the total gifts to an individual in a tax year below £250 if possible, as this will be exempt from IHT.

How a company could benefit a business, and what directorship entails.

When deciding whether to incorporate a business, tax is clearly a major factor; but it is not the only one, as a company is a separate legal entity – a body corporate, and one which needs to be properly managed by its officers.

Rules and regulations

A limited company’s constitution is contained within its ‘articles of association’, which specify the operational rules and regulations and essentially acts as a contract between the company’s owners and its directors.

Company profits

The first thing which many sole traders or partners need to realise is that the company’s profits are the company’s and not theirs; they cannot take drawings at will.

The company’s profits are subject to a separate tax (corporation tax at 19% on profits below £50,000 and 25% above £250,000), and those same monies are only further subject to personal income tax when withdrawn from the company.

How are the profits withdrawn?

The company’s owners (shareholders) can receive dividends by virtue of their shareholding by approval of the directors; these dividends come from the company’s post-tax profits, which make up the distributable reserves. Often different classes of shares may be issued – often known as ‘alphabet shares’ – to allow the company to pay different shareholders varying rates of dividend.

However, the company’s officers (the directors and company secretary) are treated the same as employees for tax purposes, so they can receive a salary – normally a tax-deductible cost to the company and subject to PAYE and National Insurance contributions (NICs). Pension contributions can also be made, which are free from income tax and NICs on the recipients and tax-deductible for the company.

Officers can pay themselves an ex officio fee but may also have an employment contract, duties from which entitle them to a larger salary and pension. If the company uses any loan capital or land belonging to the shareholders and officers, the latter can receive interest or rent respectively from the company (NB basic rate income tax must be deducted at source from interest). Loans can also be made by the company to shareholders and officers, though benefit-in-kind income tax charges on loans of or above £10,000 will apply to officers, and a 32.5% deposit (widely known as a ‘section 455 charge’) will be payable by the company and repayable when the loan is repaid or written off.

Be aware that assets (e.g., land and buildings) owned by a shareholder but used by their trading company only attract 50% business property relief for inheritance tax purposes.

Who are these officers?

This is the term for directors and company secretaries, who are registered as such with Companies House (the executive agency of the UK government which creates and dissolves limited companies and maintains the register of companies and their shareholders and officers).

Directors manage (and are, effectively, agents for) the company; for smaller companies, they may also be shareholders. Besides common law duties, directors are subject to general duties under the Companies Act 2006 – these are enforceable statutory obligations to act within their powers; promote the success of the company; exercise independent judgment; exercise reasonable care, skill, and diligence; avoid conflicts of interests; not accept benefits from third parties; and declare interests in company transactions.

Private companies in the UK no longer require a company secretary, but when appointed, such officers are responsible for the administration of the company (e.g., maintaining statutory books, filing annual returns to Companies House, and arranging directors’ meetings).

Practical tip

Incorporating a company is not a decision to be made lightly; it is creating another legal person and exposing profits to another tax; this necessitates a new mindset with respect to tax and remuneration planning with the withdrawal of profits – no more helping oneself from the ATM at will! But more than tax, it involves the imposition of legal obligations on directors and more reporting and administration than sole trades or general partnerships.

Remuneration comes in many guises, usually as salaries, bonuses or benefits-in-kind, all being subject to tax and National Insurance contributions (NICs) unless the payment or benefit is specifically exempted (e.g., long-service awards).

Importantly, employees do not pay NICs on benefits-in-kind and one method whereby this point can be to an employee’s advantage is via the use of what HMRC terms ‘optional remuneration arrangements’ (OpRAs). You will usually find such ‘arrangements’ in ‘salary sacrifice schemes’, but others can come under this heading.

How do they work?

The main feature of such ‘arrangements’ is that an employee (which can include a director) gives up the right, or future right, to receive an amount of cash earnings in exchange for a benefit-in-kind. A salary sacrifice is, therefore, a reduction in pay rather than a deduction.

HMRC splits these arrangements into ‘Type A’ and ‘Type B’. A ‘Type A’ arrangement is usually a standard salary sacrifice-type offering, whereas a ‘Type B’ arrangement is one where employees choose between taking a benefit or receiving a cash allowance. Without the OpRA rules, employees would pay less income tax and NICs than they would have done if paid entirely in cash.

Most arrangements will fall within the rules whereby the benefit’s taxable value is calculated as the being the greater of the cash given up and the taxable value under the usual benefit-in-kind rules. The employee is taxed on this calculated amount, but does not pay NICs – the employer will pay NICs on the taxable value. Should the employee not have the right to choose, the OpRA rules will not apply, and the taxable value of the benefit will be as charged under the normal benefit rules.

However, there are exceptions to the OpRA rules, such that the only benefits that do not have to be valued or reported to HMRC under such arrangements are:

  • payments into pension schemes;

  • employer-provided pensions advice;

  • workplace nurseries;

  • childcare vouchers and directly contracted employer-provided childcare that started on or before 4 October 2018; and

  • bicycles and cycling safety equipment (including cycle to work).

HMRC has specific valuation rules in relation to the benefit for supplying living accommodation. Under a ‘Type ‘B’ arrangement, the relevant amount to be treated as earnings reflects this calculation as being the greater of:

  • the ‘modified cash equivalent’ of the benefit; and

  • the amount of salary foregone.

Where the cost of providing is less than £75,000, the ‘modified cash equivalent’ is the rental value of the accommodation for the taxable period; where the cost of providing is more than £75,000, the benefit is calculated as (cost – £75,000) × official rate of interest at the start of the tax year - any rent paid or amount made good is not deducted from this final amount.

Importantly, a salary sacrifice arrangement must not reduce an employee’s cash earnings below the National Minimum Wage rate. Employers need to be aware of this and place a cap on any salary sacrifice deductions to ensure that these rates are maintained.

Practical tip

For an employee, swapping cash for a benefit can be beneficial in ways other than reducing their tax and employee’s NICs bill, e.g., it can enable employees earning just over £50,000 to reduce their salaries so as to continue to receive child benefit (which begins to be clawed back once one partner earns more than £50,000).

The VAT consequences of selling new commercial buildings and civil engineering works.

For VAT legislation purposes, a new commercial property or civil engineering work can be partly constructed or up to three years old and still count as being new.

VAT liability

Normally, the sale or leasing of commercial property is exempt from VAT unless the owner has opted to tax it. However, there is an exclusion from the exemption for new or partly completed commercial buildings and civil engineering works that removes them from the exemption so that they become subject to standard-rated VAT.

Standard rating does not just apply to the first sale but to any freehold sale within three years of completion. The only circumstances when the standard rating would not apply would be when the property could be zero-rated. Generally, this would only apply to the sale of a non-business charity building which can be zero-rated by certificate.

This is nothing to do with the option to tax. Therefore, there is no need for a developer to opt to tax a new commercial building or civil engineering work if it is intended to sell the freehold of the property. This means that input tax on the construction costs can be recovered in full.

Note that sale means a freehold sale. Do not confuse the sale of the freehold with the assignment of a lease at a premium! This is not standard-rated but exempt with the option to tax. If a business is going to grant a lease or rent a new commercial property or civil engineering work, it will need to opt to tax it if it wants to recover the input tax on its construction.

Over three years old

Once a building is over three years old, the sale is exempt unless the option to tax has been exercised. A building is completed when the architect issues a certificate of practical completion of the building or, if earlier, when it is first fully occupied.

A civil engineering work is complete when an engineer issues a certificate of completion, or, if earlier, when it is first fully used (VATA 1994, Sch 9, Gp 1, Notes (2), (4) and (5)).

What is a civil engineering work?

There is no definition of a civil engineering work in the VAT legislation. One might think that it would cover any structure which is not a building. However, in GKN Birwelco (MAN/82/74 No 1430), the tribunal suggested that the construction of an oil refinery was not a work of civil engineering.

In En-tout-cas Ltd ([1973] VATTR 101), the construction of a running track and a sports ground were held to be civil engineering works. Because of the degree of levelling, grading, and draining, the works were much more than landscaping. A similar conclusion was reached in St Aubyn’s School (Woodford Green) Trust Ltd (LON/82/260 No 1361), which concerned the conversion of an orchard into a playing field.

Where the land is primarily a new or partly completed civil engineering work, the freehold sale will be a single standard-rated supply. On the other hand, where the new or part-completed civil engineering works are only a minor element of the land, the supply is treated as a single exempt supply of land. An example of such a supply is the supply of a ‘serviced building plot’, where the vendor has installed the infrastructure for the provision of utilities (water, power, sewerage, etc.).

Practical tip

If a business is selling new commercial buildings or civil engineering works, they are automatically standard-rated, but this only applies to the freehold sale. If a business intends to lease or rent the property, it will need to opt to tax if it wants to recover the VAT on construction costs.

An outline of the construction industry scheme tax obligations placed on a contractor to withhold the correct amount of tax when paying a net registered subcontractor.

Contractors in the construction industry have big regular construction industry scheme (CIS) tax obligations and responsibilities. A contractor will have to get relevant financial and fiscal details regarding the subcontractor they plan to use to carry out construction work. The contractor will then have to ‘verify’ them. This means going online, submitting the appropriate details to HMRC, and waiting for a decision from HMRC as to how to pay them. HMRC will instruct the contractor to pay the subcontractor in one of three ways:

• gross;
• net of 20% CIS tax deducted if the subcontractor is ‘registered net’ with HMRC; or
• deduct 30% CIS tax if the subcontractor is not registered whatsoever with HMRC.

However, CIS tax is not deducted from everything! If the subcontractor splits up and analyses their fee, the following items can be paid gross when included within the fee rendered by the subcontractor:

• The direct cost of materials purchased and charged by the subcontractor.
• The hire of plant with no operator.

The amount for materials which can be paid gross is restricted to the direct cost to the subcontractor of the materials used in construction operations.

Materials

Materials include the costs of:

• paving slabs;
• bricks;
• piping; or
• fixings that a subcontractor supplies as part of the construction project.

HMRC treats materials as also including the cost of renting or hiring plant, equipment or scaffolding from a third party. The term ‘materials’ does not cover the cost of using plant or equipment owned by the subcontractor. However, consumables such as fuel for this plant or equipment can be claimed.

The subcontractor must indeed pay for the materials itself to obtain a CIS materials deduction. The cost of the materials must be incurred directly by the subcontractor. The figure of materials must represent the actual cost to the subcontractor of the materials (no mark-up). The contractor must check that the materials charge is ‘reasonable’. The amount shown for materials cannot be inflated. Materials cannot be a percentage of the overall invoice.

Plant hire

Payments for the hire of plant without an operator are outside the scope of CIS, but payments for the hire of plant with an operator are subject to CIS. Hire of plant without an operator would include:

1.  the hire of skips;
2.  the hire of concrete mixers; and
3.  the hire of pumps.

An example of plant with an operator would be when a crane is hired with an operator. This would be subject to CIS! Accordingly, when the contractor gets an invoice from a CIS net registered subcontractor, the contractor must deduct 20% CIS tax from the labour element, the profit on materials (if included in the fee by the subcontractor) and from any travel and subsistence included. If the subcontractor is not registered, HMRC will advise the contractor to deduct 30% CIS tax from certain parts of the invoice. The same CIS tax deduction principles must be used; however, CIS tax is deducted at a higher rate of 30%, not 20%.

Conclusion

Contractors must verify new CIS subcontractors they take on for the first time. HMRC will then notify the contractor as to whether to pay the subcontractor ‘gross’ or ‘net’.

Practical tip

It is vital for contractors to make the correct and full CIS tax deductions when engaging and paying a net registered CIS subcontractor, who has performed ‘construction operations’. If insufficient CIS tax deductions have been made, HMRC will issue a ‘Regulation 13 determination’ on the contractor, seeking payment of the balance of any underpaid CIS tax.

An overview of whether it is best for a company to distribute or accumulate its profits.

With a sole trade or a partnership, whether to accumulate or withdraw profits is an irrelevant question – the profits are already the owner-partner’s; they are subject to income tax on those profits whatever happens to them.

By contrast, a limited company is a separate entity – the profits are the company’s and it is a matter of choice whether the taxed profits stay in the company or are distributed to the company’s owners – but the tax implications vary.

Keep it in the company

By keeping profits within the company and not declaring any dividends or paying any salaries, there are no further tax implications – corporation tax is paid on the company’s profits in a year and that’s it.

The potential issues that can arise relate to capital taxes – inheritance tax (IHT) and capital gains tax (CGT) – if the company’s shares are gifted, sold or bequeathed later on.

Excess cash

If a trading company has accumulated cash on the balance sheet which is not ‘working capital’, thus playing no part in the business, there is a potential danger of HMRC’s ceasing to regard the company as trading for CGT purposes – this would restrict gift holdover relief and deny business asset disposal relief (BADR) and rollover relief.

If a company is being used as a retirement moneybox with profits just rolled up until cessation of trading, BADR may not be available on liquidation. A company subject to these reliefs needs to be ‘substantially’ trading or professional (which HMRC defines as 80%+ with respect to the company’s activities).

As far as IHT is concerned, the availability of business property relief (BPR) could be restricted for the same reason – that ‘excess cash’ could be deemed as an ‘excepted asset’ and discounted from the relief.

Distributing the profits

Depending on how these profits are distributed, this may have no further implication on the company’s taxation – usually, most of the profits are taken as dividends which are paid post-tax, so they will only attract income tax for the individual shareholder.

However, salaries and pensions are tax deductible for the company (as is interest and rent, which could be paid to the shareholder if their capital or real property is being utilised), so these should be factored into the overall tax burden as well as the director shareholders’ personal tax positions; usually, most of the profits are extracted through a mixture of mainly dividends and some salary or pension.

However, if all or a majority of the profits are being extracted, the imposition of double taxation (i.e., profits subject to corporation tax and the same taxed again under income tax) may call for a limit on the amount of profits withdrawn. One trait of the limited company is that the extent of withdrawals and resulting personal tax liabilities can be controlled. If all profits are being withdrawn, it may be that trading as a sole trader, partnership or LLP is more beneficial from a tax perspective as all the profits are taxed solely under income tax – as opposed to both income and corporation taxes.

Practical tip

As usual with questions about what to do for the best, the circumstances need to be considered ‘in the round’ – the director shareholders’ personal situation and demands, their marginal income tax rates, their intentions for the business and succession planning, etc.

Keeping all the profits in the company and away from shareholders or directors will keep income tax to a minimum, but those individuals will want to benefit at some point, so having cash just sitting in a company may be of little use. However, too much profit withdrawal might make the double taxation rather expensive. Proper planning is required to ascertain whether to withdraw profits and if so, what the dividend or salary portions should be.

Most private companies start as sole owner-managers; roll on a few years and some will have grown such that family members may also work for the business, responsible for different departments or types of businesses, or grown such that there is more than one business under the company name. Family members may wish to take that department forward, separate from the others. Whatever the reason, a demerger may be under consideration, the aim being to undertake the procedure as tax efficiently as possible for the shareholders.

The two main methods by which a company may undertake a demerger without attracting an income tax charge for the shareholders are via an 'exempt' demerger (the 'statutory' form) or a liquidation demerger under the Insolvency Act 1986 (the 'non-statutory' form). Should either of these methods prove impossible or unattractive, a reduction in share capital or a share-for-share exchange may be possible to produce the same result.

Statutory demerger

As ever, there are a several conditions to be satisfied before any demerger can be deemed 'exempt' under the statutory rules, not least that the original company must remain a trading company and the intention must be to retain the demerged or successor company and not sell it. However, most demergers are undertaken to hive off one business and sell it, with the shareholders going their separate ways.

However, the demerger is structured by using either the ‘direct’ or ‘indirect’ methods, both constitute a distribution which would usually be taxable in the hands of the shareholders as income, taxed at dividend rates. Instead, the distribution is treated as a part-disposal of the shares in the distributing company subject to a capital gains tax (CGT) charge as there would be a receipt of shares. However, the transaction should be covered by the 'tax exempt distribution' provisions where the assets are transferred at 'no gain no loss'. At some time, the CGT base cost of the surrendering company will need to be apportioned between that company and the new one (usually on the first disposal of shares from either holding).

The 'direct' method is where the shares in the distributing company and the shares in the company being distributed together 'stand in the shoes' of the original shares. The 'indirect' method involves transferring trading activities to a new company which issues shares to the shareholders of the transferring company as consideration. Note that there may be stamp duty considerations, although reliefs may be available, providing the shareholdings of both companies mirror.

Liquidation demerger

Should it not be possible to comply with the conditions for a statutory demerger, another company or subsidiary will need to be incorporated and the trade  transferred to the 'new company'. The 'original company' is  then liquidated with the distribution of the relevant assets to the 'new ' being made by the liquidator.

Other methods

The 'reduction in capital' route is sometimes undertaken in preference to liquidation. The usual procedure is for a new holding company to be incorporated to own the shares of the split companies. Similar to the other methods, there will be no income tax implications for the shareholders and any CGT charge can be deferred. Assets transferred from one company to another will be covered under the transfer of business provisions.

'Share for share' exchanges may be possible where the intention is for the owners of one business to exchange their interests with another and receive shares in the new company as consideration. As long as no cash consideration is received and the values are the same so that no additional value is transferred, the transaction is effectively a swap of shares with no tax implications.

Practical point

The distributing company must make a return to HMRC within 30 days of making the distribution, which must include details of why it is believed to be exempt. Specific rules ensure that only legitimate 'business separation' takes place and that the distributions are not made as part of an arrangement to avoid paying VAT.

Two stamp duty land tax cases with similar facts but different outcomes in relation to residential property.

Readers will be aware that stamp taxes, whether stamp duty land tax (SDLT) or its devolved equivalents, are usually higher for residential property than non-residential or mixed-use property (although the current nil rate thresholds for SDLT, particularly for first-time buyers, mean that this is not always the case). ‘Second home supplement’ may also apply to residential property.

To be residential, the property must be a ‘dwelling’. Let’s compare two recent cases.

Mudan v HMRC ([2023] UKFTT 317 (TC))

In August 2019, the appellants bought a property in London for £1.755 million and submitted their SDLT return, paying SDLT (at residential rates) of £177,000. In July 2020, they amended their return on the basis that the property was not suitable for use as a dwelling and so was not a residential property.

Factors they used to support this claim included:

• the house was infested (and therefore not safe to live in) and needed rewiring;
• the boiler was detached from the wall;
• there was a hole in the roof letting in rainwater and the basement was flooded; and
• external doors and windows were broken.

The couple moved into the property with their family in May 2020, by which time the building work was partially completed. Having made a repayment of £99,750 to the appellants, HMRC later issued a closure notice confirming that the property was residential property and that the SDLT payable was the original sum paid over.

What does the legislation say?

Under FA 2003, Sch 4ZA, para 18, a building is a dwelling if it is:

• used or suitable for use as a single dwelling; or
• in the process of being constructed or adapted for such use.

Similar wording is found elsewhere in the tax code, for example, in:

• TCGA 1992, Sch 1B, which deals with the non UK resident CGT charge (where different rules apply for residential and non-residential property); and
• F(No2)A 2017, Sch 10, para 8, which covers the inheritance tax rules for ‘enveloped’ UK residential property interests.

So, a case such as this may be of significance for other taxes, not just SDLT.

First-tier Tribunal decision

The property had been used relatively recently as a dwelling and was structurally sound. The property was therefore a dwelling, as it had been recently used as a dwelling and, while empty, had not been adapted for another purpose.

With no structural issues, the property was capable of being used as a dwelling once more, once the repairs and renovation work had been carried out. None of this work was sufficiently fundamental to make it non-residential property at purchase.

P N Bewley Ltd v HMRC ([2019] UKFTT 65 (TC))

This case was similar, but with a different outcome. The property was a dilapidated bungalow in WestonSuper-Mare, which cost £200,000. ‘Second home’ supplement raised the SDLT from £1,500 to £7,500.

The property was in a very poor state of repair (e.g., radiators and pipework removed and the presence of significant amounts of asbestos). It was uninhabitable, unmortgageable and was to be demolished and replaced with a new dwelling.

On appeal, the FTT judges concluded that the bungalow was not suitable for use as a dwelling. It was treated as a non-residential property, and as a result, the SDLT liability was reduced to £1,000. The key distinction from the other case seems to be that this severely dilapidated property was not being repaired to become usable as a dwelling again.

Practical tip

If an existing dwelling is uninhabitable when purchased, expect to pay residential rates of SDLT if the intention is to make it habitable again.

Rising interest rates have forced many landlords to sell up. When selling an investment property, capital gains tax is payable at the residential rates to the extent that the gain is not sheltered by the annual exempt amount or available capital losses. Where the property has at some point been the landlord’s only or main residence, some private residence relief will also be available to reduce the chargeable gain.

The capital gain (or loss) is found by deducting the allowable costs from the disposal proceeds (or, where appropriate, the market value at the date of disposal).

Sale proceeds

The sale proceeds will usually be the amount for which the property was sold. However, in some cases, the computation of the gain is based on the market value at the date of disposal. This will be the case if you gave the property away or sold it for less than it was worth to help the buyer. You will also need to use the market value rather than the sale proceeds if the buyer is a connected person, such as a family member, even if they pay for the property.

Allowable costs

In calculating the capital gain, you can deduct allowable costs. These are:

• the purchase price;
• any incidental purchase costs;
• the cost of any improvements;
• any incidental costs of sale.

Purchase price

The purchase price will normally be what you paid for the property. However, there are exceptions to this rule.

If you inherited the property, the ‘cost’ will be the market value at the date of death.

The ‘cost’ will also be the market value at the date of acquisition if the property was acquired as a gift, unless it was a gift from a spouse or civil partner. The capital gains tax rules allow spouses and civil partners to transfer assets between themselves at a value that gives rise to neither a gain nor a loss. The upshot of this is that the allowable costs incurred by the transferor (original cost, incidental costs of acquisition and any subsequent improvement expenditure) are transferred to the transferee spouse or civil partner and deducted, along with any further allowable costs, when they dispose of the property.

If the property was acquired on or before 31 March 1982, it is rebased to its value at that date and the 31 March 1982 value is used to calculate the gain where it is higher than the original cost. There is no relief for inflationary gains since 1982.

Incidental purchase costs

Incidental acquisition costs can also be deducted in calculating the capital gain. This will include legal fees, surveyors’ fees, stamp duty and such like.

Improvement costs

The cost of any improvements made to the property can also be deducted when calculating the capital gain. This will include, for example, the costs of an extension or loft conversion. It is important to distinguish between improvement works, such as upgraded windows, and normal maintenance, such as replacing a few broken roof tiles or painting the walls. While the improvement expenditure can be deducted, maintenance costs cannot.

Incidental costs of sale

Any incidental costs of selling the property, such as estate agents’ fees and legal fees can also be deducted in calculating the gain.

Paying National Insurance contributions allows individuals to earn qualifying years, which in turn provides them with entitlement to the state pension and certain contributory benefits. Entitlement may also be provided by the award of National Insurance credits.

State pension entitlement

A person reaching state pension age on or after 6 April 2016 needs 35 qualifying years to benefit from the full state pension. A person who has less than 35 qualifying years but at least ten on reaching state pension age will receive a reduced state pension.

It is important to check your National Insurance record to see if you will qualify for the full state pension. This can be done online by visiting www.gov.uk/check-state-pension. Gaps can be filled in by paying voluntary contributions.

Class 3 voluntary contributions

Class 3 National Insurance contributions are voluntary contributions which can be paid to buy additional qualifying years to boost your state pension. Each additional qualifying year increases the state pension by 1/35th. At 2023/24 rates, each additional qualifying year up to the 35 qualifying year maximum increases the state pension by £5.82 a week (£302.86 a year).

For 2023/24, Class 3 contributions are payable at a rate of £17.45 a week. The rate is to remain at this level for 2024/25.

Class 3 voluntary contributions must be paid within six years of the end of the tax year to which they relate, so by 5 April 2030 for 2023/24 contributions. However, unless the contribution relates to the either of the previous two tax years, it is payable at the rate in force when the contribution is made, rather than that applying for the missing year.

Individuals reaching state pension age on or after 6 April 2016 who have missing years between 6 April 2006 and 5 April 2016 (2006/07 to 2015/16) can benefit from an extended window in which to pay contributions for those years. Contributions must be paid by 5 April 2025 and can be paid at the 2022/23 rate of £15.85 per week.

Making voluntary contributions is only worthwhile if, after making the contributions, you have at least ten qualifying years. If you have missing years, but will secure 35 qualifying years by the time you reach state pension age, there is no point in making voluntary contributions.

Paying Class 2 contributions voluntarily

A self-employed earner whose earnings are below the small profits threshold does not benefit from the National Insurance credit available to those whose profits are between the small profits threshold and the lower profits threshold. However, they do have the option to pay Class 2 contributions voluntarily. Where this option is available, at £3.45 per week for 2023/24, this is a much cheaper option than paying Class 3 contributions.

Following the abolition of Class 2 contributions from 6 April 2024, self-employed earners will still be able to make voluntary contributions at the 2023/24 Class 2 rate of £3.45 per week.

Like Class 3, voluntary Class 2 contributions must be paid within six years from the end of the tax year to which they relate. The contribution is paid at the highest rate in force in the period from the year to which it relates to the year in which it was paid.

An extended deadline of 5 April 2025 applies by which to make contributions for missing years between 2006/07 and 2015/16 inclusive. These can be paid at the 2022/23 rate of £3.15 per week.

It is often said that inheritance tax (IHT) is a voluntary tax, and one that can be avoided if you give away sufficient assets at least seven years before you die so the value of your estate is sheltered by your available nil rate bands. This is not always practical – people do not generally know when they are going to die and they need somewhere to live and the ability to fund their life in the meantime. However, there are various IHT allowances and exemptions that allow lifetime gifts to be made free of inheritance tax, even if you die within seven years of making the gift.

Regular payments from income

Gifts that you make from your income do not count as part of your estate for IHT purposes as long as you can afford to make the payments after meeting your living costs and the payments are made out of your regular income. For example, if you have surplus income each month, you could help a child with their rent, pay school fees for a grandchild or provide financial assistance for a relative.

You can give away as much of your surplus regular income as you like, and also take advantage of various allowances and exemptions to make gifts from your capital free of IHT.

IHT annual exemption

The annual exemption allows you to make gifts of up to £3,000 a year without them being included in your estate for IHT purposes. Unlike many other annual exemptions and allowances, if the IHT annual exemption is not used in full for one tax year, the unused amount can be carried forward to the next tax year. However, the exemption for the current year must be used before any unused amount from the previous year.

If you did not use your 2022/23 annual exempt amount, you can make gifts of up to £6,000 before the end of the 2023/24 tax year without them being added to the value of your estate.

Small gift allowance

The small gift allowance means that you can make gifts of £250 a year to as many people as you like without the gifts counting as part of your estate. However, there is a catch – gifts to the same person cannot benefit from both the small gift allowance and another allowance or exemption.

Wedding and civil partnership gifts

The value of this exemption depends on the relationship between you and the recipient of the gift. For wedding and civil partnership gifts to a child, the exemption is £5,000, for a grandchild, it is £2,500 and for a wedding or civil partnership gift to any other person, the exemption is £1,000.

The same person can benefit from a wedding/civil partnership gift and other exemptions and allowances with the exception of the small gift allowance. For example, if you have not used your 2023/24 or 2022/23 annual exemption and your child marries before 6 April 2024, you could make a wedding gift of £11,000 free of IHT.

Gifts to spouses and civil partners

Gifts to spouses and civil partners can be made free of IHT without limit.

Other gifts

Exemptions also apply for certain gifts to charities or registered clubs, political parties, housing associations and to gifts for national purposes or public benefit.

A look at what ‘by reason of employment’ means and a Supreme Court decision highlighting its significance for tax purposes.

The UK tax system is full of potential surprises. For example, it sometimes treats certain situations and events as having occurred, which did not necessarily happen in the ‘real’ world.

Land of make believe

This ‘deeming’ can sometimes create a tax charge. The point was illustrated in Revenue and Customs v Vermilion Holdings Ltd (Scotland) [2023] UKSC 37 (see below). Shares and securities acquired in connection with employment generally fall within the scope of the employment related securities (ERS) tax regime. Within those provisions, the ‘securities options’ rules impose an income tax liability as employment income for gains on the exercise of an option if it is treated as an ERS option. ‘Securities’ includes shares in a company.

The rules apply to an option acquired by a person where the opportunity to acquire it is available ‘by reason of an employment of that person’ (ITEPA 2003, s 471(1)). A right or opportunity to acquire the option made available by a person’s employer (or connected person) is ‘to be regarded’ as available by reason of that person’s employment, unless the right or opportunity was made available by an individual in the normal course of their domestic, family, or personal relationships. This ‘by reason of employment’ treatment requires a causal link between a person’s employment and the grant of the option. However, if a person’s employer (or connected person) provides the employee with an option, that option is conclusively treated as having been made available by reason of their employment (subject to the domestic, family, or personal relationships exception). This ‘deeming’ rule can have unexpected and unfortunate consequences.

Investor or employee?

In Vermilion, in 2006 a company (VH) granted another company (Quest) owned by an individual (N) of which he was a director, an option to acquire shares in VH (the ‘2006 option’). However, VH underperformed, and a rescue funding package was formulated. N was appointed as a paid director of VH from 16 March 2007. In July 2007, VH and Quest entered into a new option agreement (the ‘2007 option’), for Quest to acquire shares in VH. The 2006 option expired. In 2016, Quest transferred the 2007 option to N, who exercised it.

VH was sold in November 2016. HM Revenue and Customs considered that the 2007 option was an ERS option, making N liable to income tax as employment income on exercise. The case reached the Supreme Court, which unanimously held that N was deemed to have acquired the securities option because of his employment as a director of Quest, and it was therefore subject to income tax.

A different outcome?

The Supreme Court’s decision indicates that the deeming provision (in ITEPA 2003, s 471(3)) takes precedence over the ‘by reason of employment’ test in section 471(1). This will potentially result in a larger number of income tax charges. The outcome in Vermilion might have been different had the option in 2006 (when N was only an investor) been varied instead of cancelled and a new option granted in 2007.

Practical tip

A comforting note of judicial caution about ‘deeming’ provisions was expressed in Fowler v Revenue and Customs [2020] UKSC 22: “A deeming provision should not be applied so far as to produce unjust, absurd or anomalous results, unless the court is compelled to do so by clear language.”

An overview of how salary sacrifice can still be used for employees. As well as providing their employees with a salary, many employers wish to offer other benefits-in-kind (BIKs) as a means of further incentivisation or simply out of care for one’s workers.

That benevolence may be a little more affordable if an employee was able to make a contribution by having the cost deducted from their wages; by deducting the cost before tax and lowering the salary subject to income tax and National Insurance contributions (NICs), the employee will enjoy some savings too. If the salary is reduced below £100,000, income tax savings can be even greater with the personal allowance being restored; below £60,000, one’s child benefit might be restored too.

How did salary sacrifice work?

Before 6 April 2017, the employee would agree to the salary within their employment contract being lowered for at least 12 months (except for pension contributions) and in return, a BIK would be provided, with the employee being subject to income tax (with only NICs for the employer) on its value. Ideally, the BIK will be exempt from income tax, but even if the tax on that BIK is simply less than that of the salary foregone, the exercise was still worthwhile.

A common example of salary sacrifice being employed is with pension contributions; as well as the employer making their contributions directly to the employee’s pension pot, they will pay the employee’s contribution on their behalf after deducting it from their gross salary. As pension contributions are tax-free, the tax saving is given to the employee through the reduction in their taxable salary. Other common examples include provision of extra holiday or childcare vouchers (tax-free), medical or dental insurance and company cars (both taxable).

For example, £1,000 of salary is subject to income tax at (say) 20% (i.e., £200) and NICs at 12% (i.e., £120); if a salary is reduced by £1,000, that tax is saved. If the salary is replaced by £1,000 pension contributions, then equivalent benefit is received, but with no tax.

What happened in 2017?

Instead of income tax being subject to the (lower) value of the BIK which substituted the salary reduction, HMRC will subject to income tax the higher of the BIK and the sacrificed income; in other words, for income purposes, the benefits are totally negated. The only employee saving now is with the NICs, as that remains unaffected by these changes.

Using the same example as above, if someone signs up for a £1,000 salary reduction in return for a tax-free BIK, the income tax will be on the £1,000 reduction, as that reduction is higher than its replacement (zero). The income tax position will be exactly the same; the only saving remaining intact is the £120 NICs.

An important exception to this change is that if the BIK consists of pension contributions (and advice), provisions of ultra-low emission (i.e., less than 50g/km) company cars, childcare vouchers, workplace childcare, or cycle-to-work bicycles, the pre-2017 regime stays in place. In the example above of pension contributions being given in lieu of £1,000 salary, the income tax savings would still stand.

What are the pitfalls?

With salary sacrifice, an employee’s contract has been amended, the salary has been reduced and that new figure will appear on someone’s form P60. These documents will be necessary for mortgage and other loan applications; entering salary sacrifice does mean taking an official pay cut with all the consequences involved to one’s lifestyle, as well as benefit or tax credit entitlements.

Practical tip

Any employee should give careful thought as to the consequences of taking a reduction in salary as part of receiving a BIK. Income tax savings are no longer available, except for the provision of a few benefits; the NICs savings may be useful otherwise, but the potential wider consequences to lifestyle changes, loan applications and benefits claims cannot be ignored.

When businesses purchase assets, they invariably use some form of finance on the pretext that it is better to conserve cash, because once it’s gone – it’s gone!

Different methods have different tax implications depending on the type of asset involved, contract entered into, and whether the business calculates its profits on a cash or accruals basis. Capital expenditure is not usually deducted in calculating taxable profits; capital allowances are claimed instead. The exception is where accounts are prepared using the cash basis, when relief is given against profits unless the asset is of a type that is specifically disallowed (e.g., cars). Where accounts are prepared using the accruals basis, a deduction is not given for capital expenditure as such but under the capital allowances (CAs) regime instead.

Examples of finance methods and the tax implications include:

 • Hire purchase

Under a hire purchase agreement, a lump sum payment is made at the start, followed by smaller payments. Technically, the asset is being hired for the agreement term with an option to buy at the end. Typically, a small additional charge is added to the last payment, being the fee for exercising the purchase option and the transfer of legal ownership. For tax purposes, the purchase is treated as being made at the beginning, which has the advantage of providing tax relief via the CAs regime at the invoice date rather than the date of payment. As well as claiming CAs, tax deductions are generally available for interest charges under the agreement.

The value of such an arrangement is that VAT is recoverable at the outset, with the VAT invoice or finance agreement showing the VAT as the ‘lump sum’ amount paid upfront. In practice, a small deposit is paid (usually covering road tax) but no lump sum payment is made. The monthly payment is net of VAT; however, should a VAT-registered business reclaim the VAT and subsequently sell the asset, VAT is accounted for on the selling price. Should the asset be given away, the claimed VAT must be repaid.

 • Finance lease

Under an agreement with a term of seven years or less, there is no option to buy at the end of the contract. The lessor retains ownership, so no CAs can be claimed by the business lessee making payment.

However, the lease payments are generally tax deductible and the VAT charged on each payment is reclaimable.

 • Personal contract purchase

This is similar to a finance lease – but more flexible. Such agreements are commonly associated with car financing and are intended to minimise the cash impact, with a small deposit and low monthly repayments offset by a large final ‘balloon’ payment at the end should the lessee keep the asset. The financing is on the vehicle’s depreciation based on a guaranteed minimum future value (GMFV). Again, the lease payments are tax-deductible and any VAT on each payment is reclaimable.

Should the ‘balloon’ payment be set at or above the anticipated market value (i.e., the GMFV) of the asset at the time the option is to be exercised, the contract will be a deemed supply of leasing services. VAT must be accounted for on the full value of each instalment spread over the contract’s term. However, if the final optional payment is set below the anticipated market value, such that a customer would choose to buy the asset when they exercise the option, the contract will be deemed a supply of goods with a separate supply of finance. VAT will be due on the supply of goods at the beginning of the contract and the finance element is exempt from VAT.

Practical tip

The maximum claimable under the annual investment allowance (AIA) for CAs purposes is £1m per year or accounting period. Qualifying expenditure on plant and machinery (not cars) to the maximum AIA attracts 100% relief. Any higher amount enters the 18% or 6% Cas pool (depending on the type of asset), attracting a writing-down allowance at the appropriate rate.