Helpsheets ... continued 37 from homepage

The limitations of the form P45.

Employers complete PAYE form P45 for the leaving employee. In HMRC’s ideal world, a new employee presents their P45; the tax code, previous pay and tax and pay are then brought forward from the previous employment. P45 purpose fulfilled! Unfortunately, this Eldorado world and the real world are not aligned. Frequently, an employee does not give a P45; maybe it has not been issued by the previous employer in time for the first pay run. So, employers issue the ‘Starter Checklist’, or at least ask the employee to complete the checklist questions.

Matching employer, employee and HMRC expectations

There are two things employers, employees and HMRC want the first time information is submitted on the employer’s real-time information (RTI) full payment submission (FPS):

1. one employee on our payroll system matching one on HMRC’s systems, and

2. the correct tax code applied.

Employers must focus on point 1, as they do not want to submit data that may not match to an existing taxpayer on HMRC’s systems and maybe create a duplicate employment.

The RTI matching data

Five pieces of employee matching data must be reported on the first FPS:

 • National Insurance number (NINO);

 • full name;

 • address;

 • current gender; and

 • date of birth.

If a piece is missing, HMRC’s systems may not be able to perform the matching exercise and may create another taxpayer record (one taxpayer, but two on HMRC’s systems). Similarly, if the employer changes matching data in a subsequent FPS, HMRC’s systems may create another record. In April 2023’s Employer Bulletin, HMRC stressed the risks of incorrect data, not least for HMRC’s calculation of the monthly PAYE liability and issue of the tax code. Only the NINO is on the P45.

The correct tax code

Employers, employees and HMRC want the correct tax code applied as soon as possible, something the P45 allows providing this is presented in time to process the first payment. An employee starting without a P45 is given the Starter Checklist to complete or, at least, asked these questions (e.g., ‘this is my first job since leaving school’). The checklist estimates the tax code prior to HMRC confirmation.

Expectation conclusion?

Employers do not always get RTI matching data and tax code information correct in the first pay run. If both are important, I wonder if HMRC should be looking at processes in other countries. For example, the Republic of Ireland (ROI) also operates a PAYE system for income tax. Revenue Ireland (Revenue. ie.) abolished the P45 from 1 January 2019. Now, as part of real-time reporting (RTR, like RTI), before an employee is paid, employers must register employments. This additional reporting obligation requires employers to send employee details to Revenue.ie. who will, on receipt, send Revenue Payroll Notifications. This matching exercise tells the employer the tax code to operate. ROI said goodbye to the P45, performed the matching exercise and ensured the right tax code was used – so why can’t HMRC?

In summary

If the P45 is received after the first pay run, this can be used if it is in-date, although not if HMRC has sent a tax code. But it does not provide full matching information. In contrast, the Starter Checklist does provide matching data information. Members of HMRC’s Employment and Payroll Group suggested new starters should be required to complete the checklist. HMRC confirmed they are working to get tax code information to employers quicker. HMRC should look at RTR in the ROI. Coming after RTI in the UK, maybe this enabled Revenue.ie. to learn. The legacy form dustbin already holds forms P9, P14, P30, P35 and soon, P11D. I concede there is an additional reporting obligation on employers; however, let’s give the P45 the P45!

Practical tip

Obtain RTI matching data:

 1. NINO;

 2. full name;

 3. address;

 4. current gender; and

 5. date of birth.

The checklist is not mandatory, so employers can design their own. New employees manage to provide bank details for payday. Why not include the questions on the same form?

Partnerships and companies - which business model might be best.

A sole trader looking to expand their business might be weighing up the ‘pros’ and ‘cons’ of a partnership or a limited company. They are very different, with not only very different tax consequences, but functions as well.

Partnership

A partnership is essentially two or more sole traders coming together for a common venture. It is governed by the Partnership Act 1890, with the tax rules mostly contained within a Statement of Practice (SP D12, dated January 1975). Partnerships are transparent; they do not have their own legal identity, so the individual partners are subject to income tax on their own profit shares (irrespective of drawings, and with Class 4 National Insurance Contributions) and shares of capital profits or losses for CGT. The partnership does not pay tax; however, The partnership does report the business profits on its own tax return, with its own unique tax reference number, but the profits or losses are assigned to the individual partners who record their shares on their own tax returns. However, partnerships can have their own VAT and payroll numbers.

Besides a separate tax return, there are no other reporting requirements for general partnerships, there is no obligation to file accounts nor any reports with Companies House. Unlike with a limited company or a limited liability partnership (LLP; see below), nothing need be made public. One issue with partnerships, just like with sole traders, is that there is no protection from legal claims from third parties – the partnership itself is not sued; it is the individual partners who are subject to potentially unlimited joint and several liability.

Limited companies

A company is a separate entity from its owners (the shareholders); the business is conducted by the company and the profits or gains belong to this body corporate and are subject to corporation tax. Accounts must be submitted to HMRC and Companies House; and the register of shareholders or persons of significant control must be sent to the latter.

If the owners wish to get their hands on the profits, they must declare them through dividends, pay them as salaries or bonuses through a payroll, or perhaps charge the company for the use of personal assets – all of which will have personal tax consequences.

Dividends attract a lower rate of personal income tax (plus a £500 dividend allowance) but are not deductible for the company as they are paid out of taxed income through the company’s distributable reserves. As well as shareholders who own the company, the business is run by directors, who are often also shareholders with smaller businesses, but not necessarily. Directors can receive an officer’s fee, but also a larger salary via an employment contract. The tax impact should be considered between the individual shareholders or directors’ burden and that of the company. Personal tax is only incurred when profits are withdrawn, whereas for partnerships the profits are fully taxed, irrespective of what happens to them.

As well as this different tax treatment, a company offers protection to its owners. The company is a separate person and assumes the risks, sues, and gets sued and insulates the owners from any personal liability. The potential damage to them is ‘limited’ to their investment.

Best of both?

A limited liability partnership (LLP) is treated exactly the same as an ordinary partnership for tax purposes but is a separate legal entity, so it offers the protection of a limited company to its partners (or ‘members’, as they are properly known).

Practical tip

The two deciding factors between companies and partnerships are generally risk and profit extraction. If a business has an increased danger of third-party liabilities, a company or LLP might be a good option from which to operate it. However, for tax purposes, if the bulk of the profits are to be paid out to the owners, operating through a company will lead to double taxation with corporation tax on the profits and income tax on the dividends or salaries; but if the desired drawings are lower than the profits, a company might be preferable as partners are taxed on the profits regardless of what happens to them.

The amount of tax you pay on your salary depends on your tax code. If it’s wrong you’ll pay too much or too little. For many this can be a temporary issue, for others it can be permanent. What’s the problem and what can you do about it?

PAYE - The PAYE system celebrates its 80th birthday this year. Depending on your point of view that may or may not be a cause for celebration. Either way, the PAYE basics are the same today as they were when it was introduced. For example, your tax code tells your employer how much of your salary is tax free and the tables show the rates of tax that apply. The tax code is where trouble can start.

Codes and the end of year review - A key feature of the PAYE system is the end-of-year review carried out by HMRC. These days it’s done automatically by its National Insurance and PAYE Service (NPS) computer. It compares the tax you paid through PAYE with what it expects to see based on the tax code HMRC thinks should have been used. If there’s a discrepancy it marks your record for manual review. Conversely, if the code matches and the PAYE tax paid corresponds with it, the NPS calls it good and moves on even if your tax code was wrongly calculated.

NPS assumptions - The NPS assumes that HMRC officers have calculated your tax code correctly despite there being countless reasons why this might not be so. To be fair, incorrect codes are often not the fault of HMRC as it calculates your code from information about your income and tax-allowable outgoings provided by you and your employer. However, it’s not uncommon for HMRC officers to interpret information incorrectly or simply make a mistake that results in the wrong tax code. The frequency of errors has increased significantly in recent years.

If the information HMRC has about your income and tax reliefs, e.g. job expenses, pension contributions, savings interest etc., is out of date your tax code is likely to be wrong. However, the NPS will not (cannot) identify this. It’s therefore up to you take the lead and notify HMRC of changes needed to your code.

If you’re in self-assessment you needn’t worry too much about tax code errors. These are superseded by your self-assessment tax calculation which will pick up any over or underpayments of PAYE tax. However, it’s sensible to notify HMRC of any significant errors in your code.

HMRC delays - Sadly, over the years HMRC has reduced its number of properly trained officers. The effect is that even if you notify HMRC that you are owed tax or that you owe it, you’ll be told that there is no need for a manual review of your tax and it will be done automatically by the NPS later in the year. This usually takes place in August and September. Frankly, this isn’t acceptable. If you’ve overpaid tax why should you wait months to obtain a refund? What’s more, as we’ve already mentioned, the NPS can’t definitively check if your code is right, consequently it will not pick up over or underpayments caused by coding errors.

Take action - The lesson here is that unless you complete a self-assessment tax return you need to pay special attention to checking your tax code and notify HMRC of any changes needed. If you don’t you might miss out on a tax refund or find yourself landed with an unexpected tax bill.

HMRC officers frequently make mistakes when calculating tax codes. HMRC’s automated annual review system can’t detect these without information provided by you. Always check your code for out of date or unwarranted adjustments and notify HMRC as soon as possible. Use our tax code guide to help identify errors.

You’re making substantial repairs and improvements to your buy-to-let property. You’ve borrowed from the bank to finance the repairs and these loans will wipe out the profit for a few years. What tax relief are you entitled to and how can you claim it?

Repairs and improvements - The basic rules for calculating the taxable profit on a property rental business are straightforward and logical; it’s simply income less expenses. However, things get trickier where the expense relates to repairs, improvements and finance costs. A tax deduction from profit is allowed for the first category but not the others.Where repairs are substantial HMRC may argue that they are in effect improvements. Generally, a like-for-like repair or replacement using similar materials (or more modern equivalents) is deductible from income. This applies to structural work and to equipment that’s fixed to the property such as boilers and water systems.

Finance costs - Tax relief for finance costs is also problematic. When calculating profit or loss on the letting of residential property you’re not allowed a tax deduction for finance costs, e.g. loan interest. Instead, you’re entitled to a limited tax credit (sometimes referred to as a tax reducer). The rules for working out the credit aren’t simple.

Example - In 2023/24 Janelle’s rental income net of tax-deductible expenses was £8,000. Janelle paid financial costs (mortgage interest) of £5,800. She is a higher rate taxpayer and the tax on the rental income is therefore £3,200 (£8,000 x 40%) ignoring the tax credit for the finance costs. The tax credit allowed is the lesser of 20% of:

• the finance costs, in this case £5,800
• the rental profit, in this example £8,000
• Janelle’s adjusted total income.

If your tax-deductible expenses exceed your rental income for the year, i.e. you make a loss, you aren’t entitled to a credit for any finance costs but the good news is that both the loss and the excess tax credit can be carried forward and used to reduce tax on the rental income for later years. The excess tax credit is the difference between 20% of the total finance costs and the amount calculated and the amount allowed for the year.

What finance costs are affected? - A finance cost for the purpose of the restriction doesn’t just mean interest on loans, it includes costs incurred in connection with loans etc. such as arrangement fees and other types of financing, such as overdraft and interest charges etc.

Excess expenses and finance costs - Having worked out your net rental income and the tax credit, the figures will need to be included on your self-assessment tax return on the “UK Property” or the “Foreign” pages, whichever is applicable. Both include spaces specifically to record losses where expenses exceed rental income and excess finance costs.Tip.It’s important to enter the amount of any losses and unused tax credits in the correct place on your tax return. Failing to do so risks losing the right to claim them after four tax years have elapsed.

Where your tax-deductible expenses exceed your rental income, the excess (the loss) is carried forward and used to reduce future profits. No deduction from profit is allowed for interest and finance costs; instead any tax payable of the rental income profit is reduced by a maximum of 20% of the finance cost. Losses and unused finance cost credits must be claimed on your self-assessment tax return or you risk losing them.

The tax implications of shares in a family company being awarded or gifted to family members of employees.

The employment-related securities legislation deals with arrangements involving shares and securities provided by reason of employment where the full value of the employment reward provided to the employee is not included in the salary package and is charged to tax.

The basic rule is that should an employee or director be given shares for free or pay less than the market value of the shares at the time of the award, a charge to income tax (and possibly National Insurance contributions (NICs)) will arise (under ITEPA 2003, s 62). The tax charge will be the difference between the market value and the price paid by the employee.

However, various tax-efficient share option schemes are available, which are intended to encourage employees and directors to participate in their employment companies. Such schemes permit shares to be awarded income tax-free and sometimes capital gains tax-free.

Anti-avoidance

There are wide-ranging anti-avoidance provisions relevant to these arrangements, which encompass when shares and other securities are awarded not just to employees, but also to what HMRC terms ‘associates’. Associated persons include persons connected with the employee and members of the same household as the employee.

The rules broadly state that even if the person receiving the shares is not an employee, they are deemed to be in certain circumstances. For example, should a company issue shares to an employee who requests the shares be given to their spouse instead, the spouse would have acquired the shares from an ‘opportunity made available by reason of the employee’s employment’ (ITEPA 2003, s 471(1)). The shares would be deemed employment-related securities, and any tax would be chargeable to the employee’s spouse.

Should the employee wish the spouse to take ownership of the shares, the shares will have to be registered in the employee’s name first, taxed on the value and then transferred under the interspousal rules. Transfers of assets between spouses are normally at a no gain, no loss value for capital gains tax purposes.

Exception to the rule

There is supposedly an exception from the tax charge where the shares are acquired for family reasons. ITEPA 2003, s 471 states that there will be no tax charge where:

‘A right or opportunity to acquire securities or an interest in securities made available by a person’s employer, or by a person connected with a person’s employer, is to be regarded ... as available by reason of an employment of that person unless -

 a. the person by whom the right or opportunity is made available is an individual, and

 b. the right or opportunity is made available in the normal course of the domestic, family or personal relationships of that person.’

This is confirmed in HMRC’s Employment Related Securities Manual at ERSM20220 (‘Employmentrelated securities and options: ‘by reason of employment’ – exception for family or personal relationships’), which states:

‘We take a common-sense view of this exception. It would clearly apply if a father, on reaching retirement, hands over all the shares in his family company to his son and daughter simply because they are his children, even if they are both also employees of the family company’.

Practical tip

In most cases, the transfer of shares to a family member who works in the family company will be covered by this exception, but it would be more difficult to prove where the individual concerned is an unrelated close friend or ‘associate’. If a company owner wishes to give shares to a child who does not work in the company as part of any succession planning, this should be undertaken by way of a gift.

If you’re a sole trader or in partnership you may need to show extra information when completing your 2023/24 tax return. What’s required and how might it affect your self-assessment payment due on 31 July?

Transitional year - 2023/24 is the basis period transition year for businesses operating as sole traders and partnerships (including LLPs). Depending on your business accounting period end date this may require you to use different self-assessment pages to report your profits.

If your accounting period for 2022/23 ended between 31 March and 5 April 2023 (inclusive) you aren’t affected by the transitional changes and can therefore complete your tax return as usual.

Reporting profits - There are two versions of the self-employment and partnership pages which can be used to report your business profits. The short versions are SA103S and SA104S respectively for sole traders and partnerships, and the full versions SA103F and SA104F. If the transitional rule applies to your business, you must use the full version even if you’ve used the short version previously.

Additional information - When completing the SA103F or SA104F you need to enter details of the transitional profit and how you want it to be taxed (it can be spread over five years). Also, if you changed the end date of your accounting period in 2023/24 you’ll need to enter the details of this and may need to complete a second SA103F or SA104F depending on your new accounting date.

July payment - The second self-assessment payment on account (POA) is due on 31 July 2024. The standard amount payable is equal to 50% of your 2022/23 self-assessment tax. If your 2023/24 tax is greater, the POA due on 31 July won’t change. However, if it’s lower you can ask HMRC to reduce your POA. If you’ve already done so you should review whether the reduced amount is now sufficient taking account of the tax on your transitional profits.

If the basis period transition rules apply you must use the full version of the self-employed or partnership pages of your 2023/24 tax return. Include the tax on transition profits when checking if you can reduce your 31 July payment.

You’re a shareholder and director of three companies. You currently take a low salary from each company topped up with dividends. But is this really the most tax-efficient option?

Salary plus dividends - As a rule of thumb, the most tax-efficient strategy for taking income from a company is a modest salary plus dividends. Generally, salary should be no more than either £9,100 (the NI secondary threshold) or £12,570 (the NI primary threshold). Which of these is best depends on whether your company is entitled to reduce its NI bill with the employment allowance (EA).

If it’s not possible or desirable to pay dividends or you have directorships with more than one company, a salary of more than £9,100 can be marginally more tax efficient.

Usually, a separate NI primary and secondary threshold applies for each directorship. This means a director can earn £9,100 from numerous companies without any NI being payable. However, there’s a potential catch.

For NI purposes companies that are related share one secondary NI threshold and the directors, one primary.

Example - Ava is a director of three companies. She’s paid a salary of £9,100 from each. If the companies are not related no NI is payable on any of the £27,300 earnings. By contrast, if the companies are related only £9,100 is NI free. The NI payable on the balance is £2,512 (£18,200 x 13.8%) for the companies plus £1,178 ((£27,300 - £12,570) x 8%) for Ava.

Advantages of benefits - By taking benefits in kind instead of some salary,Ava can reduce the overall NI liability while keeping the same advantages of salary. This is possible because employees, including directors, don’t have to pay NI on benefits in kind.

Example - Jane is a director of three related companies. In 2024/25 between them they pay her a salary of £9,100. This means there’s no employers’ or employees’ Class 1 NI payable. The companies also contract for and pay for Jane’s health club membership, various streaming entertainment services and a range of other perks that she would normally pay from her net income. The total cost of these benefits is £13,000; the Class 1A NI is £1,794 (£13,000 x 13.8%). Had the £13,000 been paid as salary, Jane would have had to pay £1,040 (£13,000 x 8%) NI, but as a benefit in kind she pays nothing.

Remuneration planning with benefits - The same strategy that’s typically used for maximising tax and NI efficiency when paying a combination of salary and dividends should be used for salary and benefits. That’s to say, you should take a salary at least equal to the secondary threshold (£9,100 for 2024/25) divided between your various directorships however you see fit. Additional remuneration is taken as benefits.

Example - If Gill takes all her income from her three directorships, say £27,000, as benefits in kind, the companies would pay Class 1A NI at 13.8%, i.e. £3,726 (£27,000 x 13.8%). Instead, the companies should between them pay Gill a salary of £9,100, plus benefits of up to £17,900. There’s no Class 1 NI for the companies or Gill to pay on the salary but the Class 1A NI bill is £2,470.

If you have multiple directorships, taking a salary up to the secondary NI threshold (£9,100 for 2024/25) from each is slightly more tax efficient than dividends. However, if the companies are related for NI purposes then take a salary up to the secondary NI threshold and top up with benefits in kind.