Month: August 2021

New Multiple Penalties for MTD ITSA and VAT!

The new HMRC penalties cover late submission, late payment and interest harmonisation and unlike the old penalties you will now get points and penalties even if you owe no tax or are due a refund! there will be no soft landing period.

The new penalties take effect:

  • for VAT taxpayers for their first VAT return period starting on or after 1st April 2022
  • for ITSA (Income tax and self assessment) taxpayers within income over £10k subject to Making Tax Digital (MTD) for their first tax year or accounting period starting on or after 6th April 2023
  • for ITSA taxpayers with income below £10k starting 6th April 2024

In theory the penalties are fairer but they can work out more expensive than the current penalties.

The new system is based on points, each late return gets a penalty point which expire after 24 months.

The points only apply to VAT and ITSA (not to other taxes at the moment)

Once the penalty threshold is reached there is a fixed penalty of £200 for each missed return, there is an appeals process.

Submission FrequencyPenalty Theshold
Annual2 points
Quarterly 4 points
Monthly 5 points

Total points will only be reset to zero once when the following 2 conditions are met

  1. A period of compliance based on their submission frequency
  2. All submissions that were due within the preceding 24 months have been submitted
Submission FrequencyPeriod of Compliance
Annual24 months
Quarterly12 months
Monthly6 months

Late Payment Penalty

Late Payment could potentially mean you get two penalties depending on when you pay!

The first penalty will be levied 31 days after the payemnt due date and will be based on a set percentage of the balance outstanding.

The second penalty will be calculated on amounts outstanding from day 31 until the principle balance is paid in full or a payment plan agreed.

Time to Pay Payment plans suspend penalties.

HMRC will notify the penalties separately.

PenaltyDays after payment due datePenalty charge
First Penalty0 to 15No penalty payable
16 to 29Penalty calculated at 2% of what was outstanding at day 15
30Penalty calculated at 2% of what was outstanding at day 15

Plus 2% of what is still outstanding at day 30
Second PenaltyDay 31 plusPenalty calculated as a daily rate of 4% on APR for the duration of the outstanding balance

There will be a ‘period of familiarisation’ for the first year which is based on 30 days.

Interest Harmonisation

The VAT interest rules will change to be inline with ITSA

  • When an amount is not paid by the due date, late payment interest will be charged to the taxpayer from the date that the tax becomes overdue until the date payment is received
  • VAT Repayment Supplement will be replaced with Repayment Interest. Repayment Interest will be paid from the later of:
    • the due date of the return
    • the date the return is submitted

If HMRC owe you interest it will be paid at the Bank of England Base Rate -1% but if you owe HMRC interest its at the Bank of England base rate +2%.

Other things to note

  • The Gateway will tell you how many points you have
  • The Gateway will tell how penalties have been calculated
  • Agents will not be able to pay the penalties
  • When appealing you will need to say who was to blame for missing the deadline
  • When claiming the deadline was missed due to a health issue a declaration of honesty is required

steve@bicknells.net

Making Tax Digital Income Tax (MTD ITSA) registration starting soon!

MTD ITSA is at best going to be challenging for tax payers and accountants, but we love a challenge, don’t we?!

In the MTD ITSA there are

  • 900,000 Landlords
  • 2.5 Million Self Employed
  • 400,000 Partnerships

Over 130,000 probably need to change their year end and when MTD ITSA starts a single self assessment will be become 6 returns.

HMRC announced in August in there Agent Communications

Making Tax Digital for Income Tax Self Assessment (MTD ITSA) — Agents can sign-up customers in advance of April 2023

It has been confirmed that a bulk sign-up facility for MTD ITSA will not be possible due to several factors including each individual customer having different details to be input.

It is recognised that data will need to be input during the sign up process for each customer. It is accepted that this could be time consuming if all this had to be done at once, especially if it coincided with other peak demands such as the tax year end or VAT filing for example.

Following discussion with agents, HMRC is working to deploy a solution which will help flatten this workload. Agents will be able to sign up mandated MTD ITSA customers from 6 April 2022. This will not activate MTD obligations but will give agents the opportunity to spread the load of sign-up work across a 12-month period.

The back-end process is being worked on and further information will be issued. HMRC reaffirms, this will only come into effect from 6 April 2022 and that any sign-ups made before that date would be for the active pilot.

Agent Update: issue 87 – GOV.UK (www.gov.uk)

Since HMRC know all about tax payers (because they get annual Self Assessment Returns) and they know all about agents (because we have agent service accounts with HMRC that list our clients), why is it necessary to have a signing up process.

MTD ITSA is compulsory, so why aren’t the relevant tax payers automatically registered by HMRC?

Let’s hope HMRC can find a back-end process that will save us from manually enrolling millions of tax payers.

steve@bicknells.net

What is the Tax Treatment of Abortive Property Investment Costs?

Most investors, whether personal landlords or companies, will have suffered some abortive costs for deals that failed.

The nature of the costs will be capital for investors.

BIM35325 – Capital/revenue divide: general themes: abortive expenditure

Expenditure that would have been capital had it been successful does not change its character merely because in the event it is abortive. ECC Quarries Ltd v Watkis [1975] 51TC153 was concerned with costs incurred in an unsuccessful planning application.

If the application had succeeded the expenditure would have been capital. In the event the application failed; no asset was acquired or modified (and the company did not rid itself of any disadvantageous asset).

What this means is that property investors don’t get any tax relief for abortive fees.

This can be extremely bad news as the case of Hardy v Revenue & Customs [2015] UKFTT 250 (TC) a 10% deposit was paid and the outcome was that HMRC disallowed the claim for relief, the taxpayer appealed and the appeal was dismissed.

It seems unfair but the seller who receives the deposit treats it as a capital gain and pays tax on it.

If a property trader/developer had suffered the loss of the deposit and the costs was ‘wholly and exclusively’ for the purpose of the trade, the expenditure might be an allowable deduction from profits.

steve@bicknells.net

  

What is a Family Investment Company/SMART Company? What do HMRC think about them?

Companies can have multiple classes of shares and the shares can have different rights. These rights cover:

  • Voting
  • Capital Growth
  • Income via Dividends

This can be of particular benefit to families.

Family Investment Companies (FICs), sometimes called Smart Companies, are particularly useful for Inheritance Tax (IHT) and have been used for over a decade as an estate planning tool.

In its simplest form parents lend money to the company and the company is owned by their adult children, but FIC’s can be structured to go beyond that with different assets and share classes.

They are a great alternative to partnerships which are taxed at income tax rates allowing faster growth as Corporation Tax starts at 19% (25% top rate) and income tax can be as high as 45%.

Capital Gains Tax is paid at Corporation Tax Rates (19%/25%) and they don’t suffer from 10 year anniversary or exit charges that are applied to Trusts.

The only slight downside is that extracting profits from a company will incur tax for the individual.

Over a period of time the income and capital shares will be moved to younger members of the family and the older members will retain the voting rights.

HMRC Family Investment Companies Unit

HMRC have been investigating FICs since 2019 and have now stopped, their findings are published in the meeting minutes 13th May 2021

In the research we undertook there was no evidence to suggest that there was a correlation between those who establish a FIC structure and non-compliant behaviours. As with any analysis of a taxpaying population, the same broad range of tax-compliance behaviours were observed, with no evidence to suggest those using FICs were more inclined towards avoidance.


Tax risks related to FICs
The key findings in relation to the tax risks associated with FICs are outlined below:
• The use of FICs appears to be a planning strategy, often with the primary objective generational wealth transfer and mitigation of Inheritance Tax.
• There is some diversity in the way that a FIC is structured and managed, creating tax risks and compliance activity across a variety of tax regimes, including Inheritance Tax, Capital Gains Tax, Stamp Duty Land Tax and Corporation Tax.


Conclusions
The team have been subsumed into WMBC and FICs are now looked at as business as usual rather than having a dedicated team

steve@bicknells.net

What are Assets and how does depreciation work?

What is a Fixed Asset?

Fixed Assets generally include Buildings, Computers, Office Furniture, Plant, Equipment, and Vehicles. The Accounting Standards generally refer them as ‘Property, Plant and Equipment’ and in Published Accounts Assets are often called ‘Tangible Fixed Assets’.

Most business set a rule for what value an item has to be before its treated as a fixed asset, for example it might be items costing more than £200, below that value the items might be expensed in the P&L.

Fixed Assets must have a life beyond the current accounting year, for example a computer might have a life of 3 years or more.

The reason we capitalise the items and turn them into a fixed asset is so that we can apportion/spread the cost of the asset over its useful economic life. This means the accounts get a fair allocation of cost each year.

This is not the same as the tax treatment, many assets qualify for Capital Allowances and of those many might qualify for the Annual Investment Allowance. The Annual Investment Allowance gives 100% tax relief immediately.

How are Assets Depreciated?

There are several methods of depreciating assets Straight Line, Reducing Balance, Units of Production and others too. The most commonly used ones are Straight Line and Reducing Balance.

You need to use your judgement to decide the rate of depreciation, for example to depreciate straight line over 4 years you would choose 25%. Rates are normally set for an entire asset class for example Computers as a whole.

Reducing balance works by taking the net asset value and apply the depreciation %

Original Value

Less Depreciation to date (accumulated depreciation)

Net Book Value

Apply Reducing Balance Depreciation %

Every year the current year depreciation is added to the accumulated depreciation the cycle repeats each year.

Depreciation is disallowed as a tax deduction, because you claim Capital Allowances instead.

Business should maintain a Fixed Asset Register listing every asset and its Original Value, Accumulated Depreciation and Net Book Value.

When an asset is sold the value from the asset register need to be used to remove its value from the accounts, any profit or loss on disposal is posted to the P&L.

When an asset is sold there may also be a tax adjustment known as a Balancing Charge, its the difference between the Tax Written Down Value and Fixed Asset Register Written Down Value.

steve@bicknells.net

Are you missing out on Qualifying Interest Relief?

If you pay interest on a personal loan then you used to lend money to your limited company then you can probably claim tax relief on the interest that you pay on your personal loan.

Here are the rules from HS340 – You may be able to claim relief for interest paid or for alternative finance payments where the loan or alternative finance arrangement is used to:

  • buy ordinary shares in, or lend money to, a close company in which you own more than 5% of the ordinary share capital on your own or with associates
  • buy ordinary shares in, or lend money to, a close company in which you own any part of the share capital and work for the greater part of your time in the management and conduct of the company’s business, or that of an associated company
  • acquire ordinary share capital in an employee controlled company if you are a full-time employee – we regard you as a full-time employee if you work for the greater part of your time as a director or employee of the company or of a subsidiary in which the company has an interest of 51% or more
  • acquire a share or shares in, or to lend money to, a co-operative which is used wholly and exclusively for the purposes of its business
  • acquire an interest in a trading or professional partnership (including a limited liability partnership constituted under the Limited Liability Partnership Act 2000, other than an investment limited liability partnership)
  • to provide a partnership, including an limited liability partnership, with funds by way of capital or premium or in advancing money, where the money contributed or advanced is used wholly for the partnership’s business – if the partnership is a property letting partnership, read information about the residential property finance costs restriction
  • buy equipment or machinery for use in your work for your employer, or by a partnership (unless you’ve already deducted the interest as a business expense) – relief is only available if you, or the partnership, were entitled to claim capital allowances on the item(s) in question – if the equipment or machinery was used only partly for your employment, or only partly for the partnership business, only the business proportion of the loan interest or alternative finance payments qualifies for relief)

You cannot claim relief for interest on overdrafts or credit cards.

The limit on Income Tax reliefs restricts the total amount of qualifying loan interest relief and certain other reliefs in each year to the greater of £50,000 and 25% of ‘adjusted total income’.

To claim the tax relief you enter the amount of interest paid on your self assessment return under Additional Information SA101 ‘Qualifying Loan Interest Paid in the Year’.

This could be useful for Property Investors who invest via a limited company. Here is an example

Fred Smith owns his own home worth £500k without a mortgage

He borrows 75% £375k against his home and lends it to his limited company, the interest rate from his broker is 2% cheaper than borrowing in his limited company.

So he could save £7,500 a year interest

He also gets tax relief on the interest that he has paid.

steve@bicknells.net

What are Basis Periods and what will be the impact of Government Proposals to reset them? – Making Tax Digital (MTD ITSA)

Here is an example of how Basis periods work and how they create overlap periods taken from our blog What is Overlap Profit? – Steve J Bicknell Tel 01202 025252

A business commences on 1 October 2010. The first accounts are made up for the 12 months to 30 September 2011 and show a profit of £45,000.

The basis periods for the first three tax years are:

2010-2011Year 11 October 2010 to 5 April 2011
2011-2012Year 212 months to 30 September 2011
2012-2013Year 312 months to 30 September 2012

The period from 1 October 2010 to 5 April 2011 (187 days) is an `overlap period’.

It is a complicated and confusing process and the overlap profit is effectively taxed twice and given back later as tax relief.

There are two ways to gain access to your overlap relief: cease trading or change your accounting date.

The Proposal

The HMRC proposal affects the self-employed, partnerships, trusts, and estates with trading income. The proposal affects unincorporated businesses that do not draw up annual accounts to 31 March or 5 April, and those that are in the early years of trade.

Having carried out a short informal consultation with a range of businesses and tax experts, the government intends to implement the proposed reform ahead of the mandation of Making Tax Digital for Income Tax in April 2023.

The consultation period end on 31st August 2021.

Example

A business draws up accounts to 30 June every year.

Currently, income tax for 2023 to 2024 would be based on the profits in the business’s accounts for the year ended 30 June 2023. Part of the accounts are outside of the tax year, and part of the tax year is not included in profits taxed.

The proposed reform would mean the income tax for 2023 to 2024 would be based on:

3/12 of the income for the year ended 30 June 2023, plus 9/12 of the income for the year ended 30 June 24.

Basis periods are straightforward for the estimated 93% of sole traders and 67% of trading partnerships that draw up their accounts to 5 April or 31 March every year. But if a different accounting date is chosen then the rules are more complex and can be confusing for businesses to understand and apply. The rules can be particularly challenging for new or unrepresented businesses, leading to errors and mistakes in tax returns.

Aligning the basis of assessment for trading income with other forms of income enables wider, simpler reforms to be considered in the future. In particular, transitioning to the tax year basis in the tax year 2022 to 2023 will simplify the introduction and experience of Making Tax Digital for Income Tax. For simplicity, the government proposes a one year transition period, with an option to spread any excess profit arising in that transition period over five years.

The transition tax year would introduce the equivalence rule. This means that businesses can treat the end of the tax year for their tax year basis as any date between 31 March and 5 April.

Alongside this transition, the proposals would mandate that all overlap relief must be claimed in the transition tax year, including any historic transitional overlap relief, or overlap relief generated during the new transition year. No overlap relief would be carried forwards into the new tax year basis, and no new overlap relief would be generated after the transition year.

According to an article in the Law Society Gazzette 13th August

The new rule, proposed by HM Revenue & Customs under the guise of simplification, could generate a badly needed windfall of more than £1bn for the Treasury next year. 

Aligning the reporting date with the tax year would mean that profits that arise in each reporting year would be allocated to that tax year. Currently, profits are taxed for the year in which the business’s accounting period ends. Many partnerships thus end their accounting period on 30 April, allowing them 11 months’ grace. 

In summary

  • The basis period reform will apply from 2023-24.
  • There will be a transition period in 2022-23.
  • Accounting periods that end between 31 March and 4 April inclusive will be treated as ending on 5 April.
  • In the 2022-23 transition year, business profits will be reported from the end of the previous period assessed in 2021-22 up to 5 April 2023. 
    • Businesses with a 31 March 2023 accounting date will report business profits up to that date. This will be deemed to be 5 April 2023.
    • The subsequent accounting period will be deemed to start on 6 April 2023.

steve@bicknells.net

Making Tax Digital (MTD ITSA) – what will you have to do?

Making Tax Digital (which some have dubbed ‘Making Tax Difficult’) is coming.

Self-employed businesses and landlords with annual business or property income above £10,000 will need to follow the rules for MTD for Income Tax from their next accounting period starting on or after 6th April 2023. However, its expected that HMRC will encourage businesses to start from 6th April 2022 to gain experience in the process before it becomes compulsory.

Its compulsory! failure to comply will result in penalties – you will have 30 days from the end of the quarter in which to file

When it starts the key issues will be

  1. You will basically have 2 returns to file at the same time one for the previous year and new quarterly reporting
  2. The basis periods are expected to be re-aligned so that all the self employed and landlords start at the same time – 6th April 2023
  3. A single annual self assessment will become at least 6 new filings – 4 quarters, end of period and a new self assessment return

The primary legislation for Making Tax Digital relating to VAT and Income Tax is contained in the Finance (No.2) Act 2017.

Business will have to use HMRC approved accounting software, for example

Xero

Sage

Freeagent – free if your business banks with NatWest/RBS

Quickbooks

When we refer to MTD-compatible software, we mean software that can integrate with HMRC systems to send updates to HMRC.

HMRC is not offering its own software products but has provided the Application Programming Interfaces (APIs) that commercial software developers are using to develop a range of applications that enable businesses to keep their records digitally and integrate with HMRC systems. An API is software that links 2 or more software programmes together, allowing them to exchange data.

So there won’t be a Government Gateway where you can enter the information, you have to use commercial software approved by HMRC.

You have to have all your self employed and property businesses in a single piece of software but be able to report the information separately for each business in the following formats

Furnished Holiday Lets

Income
Accounting Basis (Traditional or Cash)
Rent paid, repairs, insurance and costs of services provided
Loan Interest and other financial costs
Legal, management and other professional fees
Other allowable property expenses
Private use adjustment
Profit or Loss

Residential Property Income

Total Rents and other income from property
Accounting Basis (Traditional or Cash)
Rent, rates, insurance and ground rents
Property repairs and maintenance
Non-residential property finance costs
Legal, management and other professional fees
Costs of services provided, including wages
Other allowable property expenses
Profit or Loss
Private use adjustment
Residential property finance costs

Self Employed

If the turnover is below £85,000 only Turnover and Total Expenses need to be reported otherwise you will need

Turnover
Accounting Basis (Traditional or Cash)
Costs of goods bought for re-sale
Car, van and travel expenses
Wages, salaries and other staff costs
Rent, rates, power and insurance costs
Repairs and maintenance of property and equipment
Accountancy, legal and other professional fees
Interest and bank and credit card etc financial charges
Telephone, fax, stationery and other office costs
Other allowable business expenses
Profit or Loss

What is the process?

Stage One – Sign Up and Software

  • Business that fall within the scope of MTD ITSA (Income Tax Self Assessment ) will need to be signed up before April 2023
  • ‘Digital Records’ need to kept on approved HMRC software
  • The minimum amount of information will be Date, Amount and Tax Category
  • The information needs to be summarised in the format noted above
  • Each property and business activity will need its own reports

Stage Two – Quarterly Reporting

  • An electronic submission of summary totals for specified categories from digital records of each business on a quarterly basis (obligation period) from software to HMRC needs to be made
  • The first submission will include designatory data
  • Updates are due from 10 days before to one month after the quarter end date
  • The update does not need to include a statement that the data is complete and accurate
  • HMRC will return a calculation of the tax liability based on the information sent but payment will due on the current pre-MTD dates (or at least for now)

Stage Three – End of Period Statement

  • Process to finalise the taxable profit or allowable loss for any one source of business income
  • The process will pull together the quarterly submissions and allow you to claim allowances and reliefs
  • You will be able to exclude disallowable expenses
  • This submission does require a declaration that the information is complete and correct
  • HMRC will then calculate the tax due

Stage Four – Final Declaration (New Self Assessment Return)

  • Referred to as crystallisation
  • It will take into account all sources of income and gains not just those from Self Employment or Property
  • Its a replacement for the SA100 tax return
  • The deadline will be 31st January
  • HMRC will provide a Submission Interface

steve@bicknells.net

What is Cash Accounting? Accrual Accounting? Traditional Accounting?

Cash Basis Accounting

Under Cash Accounting you only report Sales when you are paid and Expenses when you pay them. This can be particularly useful if your clients take longer to pay you than you take to pay your suppliers.

Its referred to as the ‘Cash Basis’ for Income Tax and ‘Cash Accounting’ for VAT.

The ‘Cash Basis’ for the Self Employed was introduced in April 2013.

You can use Cash Basis if you:

  • run a small self-employed business, for example sole trader or partnership
  • have a turnover of £150,000 or less a year

If you have more than one business, you must use cash basis for all your businesses. The combined turnover from your businesses must be less than £150,000.

Limited companies and limited liability partnerships cannot use cash basis.

From the 6th April 2017, the Finance Bill 2017 made the Cash Basis the default basis for Landlords which means on Self Assessment returns Landlords have to tick a box to use Traditional Accounting.

HMRC believe that Cash Accounting/Cash Basis is a simpler way to prepare accounts for tax returns, in reality, I am not convinced as it can be confusing where there are management fees, rent arrears, costs covering more than a year and mortgage interest.

Joint Ownership can add to the confusion because both owners are free to make their own choice as to whether to use the Cash Basis or Traditional Accounting. The exception to this rule is married couples and civil partners who have to adopt the same approach.

VAT Cash Accounting

VAT Cash Accounting is open to all business types.

Usually, the amount of VAT you pay HM Revenue and Customs (HMRC) is the difference between your sales invoices and purchase invoices. You have to report these figures and pay any money to HMRC even if the invoices have not been paid.

With the Cash Accounting Scheme you:

  • pay VAT on your sales when your customers pay you
  • reclaim VAT on your purchases when you have paid your supplier

To join the scheme your VAT taxable turnover must be £1.35 million or less.

You must leave Cash Accounting when your Turnover hots £1.6 million.

Accrual Accounting and Traditional Accounting

These are the same thing.

The Accruals Method essential follows the principle of matching revenue and expenses in the same period.

Companies must use this method for their published accounts.

S396 Companies Act 2006 (CA 2006) (S404 for group accounts) specifies that the directors of every company have to prepare a balance sheet and a profit and loss account every financial year and that the balance sheet must give a true and fair view of the state of affairs of the company as at the end of the financial year, and the profit and loss account must give a true and fair view of the profit or loss of the company for the financial year.

In order to comply with this Directors need to enter all sales and purchases in the accounts, not just the ones that have been paid.

Accruals refers to including liabilities that you have incurred but not paid for example accountancy fees to prepare the accounts.

There could also be prepayments for things paid in advance such as insurance.

The accounts will also included items such as depreciation.

To give a True and Fair view Company Accounts are prepared to accountings standards such as FRS105 and FRS102 and UK GAAP.

steve@bicknells.net

Are you a Property Developer or Investor for CIS Tax purposes?

Property developers

Property developers are included within the meaning of mainstream contractors for the Construction Industry Scheme (CIS) because their business activity is the creation of new buildings, or the renovation or conversion of existing buildings, or other civil engineering works. The same is true of a speculative builder.

Property investment businesses

A ‘property investment business’ is not the same thing as a ‘property developer’. A property investment business acquires and disposes of buildings for capital gain or uses the buildings for rental; it need not be involved in the construction, alteration or extension of buildings. Even so, if its property estate is substantial enough, its expenditure on construction operations may well cause it to fall within the meaning of a ‘deemed contractor’ (see CISR12050).

The Badges of Trade

There are also we established indicators which help determine whether you are an investor or a developer (trading), the factors below would indicate that you are a developer (which includes property flipping)

  • Profit Motive – did you buy the property with the selling it quickly for a profit
  • Property Finance – developers have loans and development finance (not long term mortgages)
  • Frequency – a company regularly buying and selling properties is likely to be trading and to be classed as developer
  • Duration – it the period between buying and selling is short that would indicate that you are not an investor
  • Work Carried Out – If major works are undertaken with a view to sale that sounds like a developer
  • Agreements – have you asked agents for sale prices or rental

Example from CISR12080 – Construction Industry Scheme Reform Manual – HMRC internal manual – GOV.UK (www.gov.uk)

A property investment business acquires a number of properties which it intends to let, but before letting, minor refurbishment is required to bring the properties up to a suitable standard to be able to let them. For CIS purposes we would see this as the normal activities of a property investor, and where the expenditure on such activities exceeds £3million in a rolling 12 month period then CIS applies.

The property investment business then acquires a large dilapidated hotel to add to its portfolio, and decides to convert the building into a series of flats which it will then individually let out. As a result, substantial development is required to the property to change the building to its new use. In respect of this particular development and contract we would regard the property investment business as having taken on the mantle of a mainstream contractor as its business activity is now that of construction operations.

steve@bicknells.net