Capital Investment Appraisal, Tax and Depreciation – The Basics 23

How can you decide whether to buy a fixed asset or to rent it? How do you evaluate and compare capital expenditure requests?

There are 4 key techniques used:

1. Pay Back Period – how many years does it take to get back your initial investment in profits – for normal investments anything less than 3 years is considered good

2. Average Rate of Return (ARR) – this method of appraisal takes the average of the profits made over say a 3 year period (or the life of an asset) and shows the result as a % of the initial investment

3. Net Present Value/Discounted Cash Flow – this method of appraisal takes into account the time value of returns, its often considered the best and most precise way to assess returns, to calculate the Net Present Value you create a cash flow table year 0, shows the investment as a cost, then the net profits are shown in the subsequent years and a factor is applied to remove the effect of inflation, the higher the NPV the better the investment

4. Internal Rate of Return – this is also described as the effective interest rate, to calculate this we increase the Discount Rate in the DCF (3 above) until the NPV equals zero and that produces the return rate

Many businesses will seek to match the funding of the asset to its useful economic life through either a loan or lease, as the life of the asset will normally exceed the pay back period, this should lead to increased profits compared to renting the asset.

Assets are depreciated in the business accounts

Depreciation means the cost of the asset is spread, so it is written off against the profits of several years rather than just the year of purchase. Depreciation is not allowable for tax. Instead you may be able to claim the cost of some assets against taxable income as capital allowances.

The most common methods of Depreciation are Straight Line (depreciation is the same amount in each year) and Reducing Balance (the amount of depreciation decreases each year and is a percentage of the net book balance).

From April 2012 the rates of capital allowances will be reduced from (a) 20% to 18% and from on the Main Rate Pool (b) 10% to 8% for  ‘special rate’ expenditure respectively. At the same time the maximum amount of the Annual Investment Allowances (AIA) will be reduced to £25,000 a year (currently £100,000). So you might want to consider buying assets prior to April 2012 to take advantage of the current rates.

There will be a timing difference between Depreciation and Capital Allowances and the Tax on the difference in rates is calculated and shown in the accounts as a Provision for Deferred Tax.

steve@bicknells.net

Lend money to your company and get Interest 2

Many directors lend money to their businesses, especially during the start up phase.

But did you know the company can pay you interest net of 20% – the tax deducted at source is reported and paid each quarter using form CT61

Form CT61 cannot be downloaded or ordered online. To order a form, you need to phone the HMRC Accounts Office Shipley on Tel 01274 539 665.

Here is a link to the HMRC notes on Form CT61 http://www.hmrc.gov.uk/ctsa/ct61-notes-2010.pdf

If the loan is from a family member and they are a non taxpayer they won’t be able to use form R85 but they will still be able to claim the tax back either by contacting HMRC 0845 366 7850 or by filing a self assessment return

Interest payments are not subject to National Insurance and can be a tax efficient of recieving part of your income from your business.

The income will need to be reported on your self assessment return.

The interest charges will be tax deductable by the Company.

This will make the you ‘the lender’ a secured creditor but you may have to take a secondary position behind your bank or other lenders or if other lenders are already lending you may need their permission to register a charge.

steve@bicknells.net

Things you need to know about Dividends….. 1

It can be illegal to pay dividends if:

1. There are insufficient retained profits to cover the dividend payments

2. Dividend payments may be illegal if the relevant paperwork has not been completed

http://www.contractorcalculator.co.uk/declaring_dividends_paperwork.aspx

HMRC are increasingly contending dividends and arguing that they are in reality earnings under the s62 ITEPA 2003 (salary sacrifice) rules and to persuade them otherwise needs proof that a set procedure for the declaration of dividends has been followed.

An example of a board minute is as follows:

Minutes of a meeting of directors of bloggs limited Held at 14 the road, london, ir3 5nl On 31 march 2005

Present: J Bloggs – Director

It was resolved that the company pay a dividend of £9,000 per £1 ordinary share on 31 March 2005 to the shareholders registered on 31 March 2005.

……………………………………
J Bloggs – Director

http://www.ir35calc.co.uk/dividend_documentation.aspx

Companies pay you dividends out of profits on which they have already paid – or are due to pay – tax. The tax credit takes account of this and is available to the shareholder to offset against any Income Tax that may be due on their ‘dividend income’.

When adding up your overall taxable income you need to include the sum of the dividend(s) received and the tax credit(s). This income is called your ‘dividend income’.

The dividend you are paid represents 90 per cent of your ‘dividend income’. The remaining 10 per cent of the dividend income is made up of the tax credit. Put another way, the tax credit represents 10 per cent of the ‘dividend income’.

Dividend tax rates 2011-12

Dividend income in relation to the basic rate or higher rate tax bands Tax rate applied after deduction of Personal Allowance and any Blind Person’s Allowance
Dividend income at or below the £35,000 basic rate tax limit 10%
Dividend income at or below the £150,000 higher rate tax limit 32.5%
Dividend income above the higher rate tax limit 42.5%

So the 10% tax credit offsets the 10% basic rate tax

Dividends are not subject to National Insurance.

Can you claim the tax credit if you don’t normally pay tax?

No. You can’t claim the 10 per cent tax credit, even if your taxable income is less than your Personal Allowance and you don’t pay tax. This is because Income Tax hasn’t been deducted from the dividend paid to you – you have simply been given a 10 per cent credit against any Income Tax due.

http://www.hmrc.gov.uk/taxon/uk.htm#5

Declaring dividend income on your Self Assessment tax return

If you normally complete a tax return you’ll need to show the dividend income on it. See income boxes 3 and 4 http://www.hmrc.gov.uk/forms/sa100.pdf

If you don’’t complete a tax return, but you have higher rate of tax to pay on your dividend income, you should contact HMRC.

steve@bicknells.net

Pay off your Directors Loan and reclaim Corporation Tax 3

If you’re a company director or ‘participator’ and take money out of your company that’s not a salary or a dividend – over and above any money you’ve put in – you’re classed as having received the benefit of a director’s loan.

If your director’s loan account is not paid off in full within nine months after the end of your company’s accounting period:

• You must include details of the loan in your Company Tax Return.
• Your company must pay Corporation Tax on the loan – the current tax rate for directors’ loans is 25 per cent of the loan.

http://www.hmrc.gov.uk/ct/managing/director-loan.htm#5

The good news is that you can reclaim the tax when the loan is repaid (often by paying a Dividend to clear the balance outstanding).

How you do this depends on timing:

• if your claim is made within 24 months of the end of that accounting period you can amend and resubmit an amended Company Tax Return for that previous accounting period
• if your claim is made more than 24 months after the end of the previous accounting period you can make a separate claim by writing to HMRC at the same time as you file your Company Tax Return for your most recent accounting period

The Claim was previously known as a S419 claim (S419 ICTA 1988) but its now covered by S455 and S458 Corporation Tax Act 2010

When writing to HMRC makesure you give them as much information as you can for example:

UTR – Unique Taxpayer Reference

Company Name and Details

Amount being reclaimed

Details of the relevant Corporation Tax Returns on which the Directors Loans are shown

Your Bank Account Details for the Refund

You would be surprised at how many businesses never reclaim the S419 tax! makesure you don’t miss out

steve@bicknells.net

By the time you actually start trading, you may have spent thousands of pounds on research and setting up the business.

Provided you have formally notified HM Revenue & Customs that you have started up a business, most of these costs are usually allowable as business expenses in the first year.

Income Tax (Trading and Other Income) Act 2005

(1)This section applies if a person incurs expenses for the purposes of a trade before (but not more than 7 years before) the date on which the person starts to carry on the trade (“the start date”).
(2)If, in calculating the profits of the trade—
(a)no deduction would otherwise be allowed for the expenses, but
(b)a deduction would be allowed for them if they were incurred on the start date,
the expenses are treated as if they were incurred on the start date (and therefore a deduction is allowed for them).

http://www.legislation.gov.uk/ukpga/2005/5/section/57

http://www.hmrc.gov.uk/manuals/bimmanual/bim46355.htm

VAT Paid Before VAT Registration

You can reclaim any VAT you are charged on goods or services that you use to set up your business.

Normally, this will include:
• VAT on goods you bought for your business within the last 4 years and which you have not yet sold.
• VAT on services, which you received not more than 6 months before your date of registration.

You should include this VAT on your first VAT return. (Notice 700/1 April 2010 4.2)

http://customs.hmrc.gov.uk/channelsPortalWebApp/channelsPortalWebApp.portal?_nfpb=true&_pageLabel=pageExcise_ShowContent&id=HMCE_CL_000086&propertyType=document#P331_32574

steve@bicknells.net

When you are Self Employed your pay tax in advance in January and July, but Companies pay tax 9 months after their financial year end.

So if you formed a Company and it started trading in April 2011, its year would end 31st March  2012 and Corporation Tax would be due in December 2012.

As a director of your own company you will be paid as an employee (PAYE) and get paid dividends as a Shareholder. Dividends are paid out of taxed profits.

What this means is that a Director taking a minimal salary, will probably have a tax break of 12 plus 9 = 21 Months.

In addition the company will buy the assets of the sole trader and it may be possible to include a value for goodwill.

steve@bicknells.net

Self Employed Tax Allowances 3

Basically when you are self employed you spend money on 3 types of expense:

1. Capital Expenditure – Equipment & Vehicles

2. Business Expenditure – stock, wages, premises

3. Private Expenditure – day to day living expenses – mostly not allowed but some types of cost may still count as business expenses

In general its types 1 and 3 where sole traders and partnerships miss out on tax allowances.

For example, you could claim capital allowances on your car,

Example: If you are self-employed, you pay Income Tax and your accounts are drawn up for the year to 5 April 2011 and you spent £20,000 on a car that you use 100 per cent for your business that has CO2 emissions of 165g/km, the calculation is as follows:

Cost of car = £20,000
Writing-down allowance deducted (£20,000 x 10 per cent) = £2,000
Value to carry forward = £18,000
Capital allowance you can claim = £2,000

If you use your car partly for private and partly for business you simply disallow a % for private use.

On other assets there is an Annual Investment Allowance which is currently £100,000 per year but will drop to £25000 in April 2012.

For most business that will cover all their capital expenditure, but there are further allowances available too.

With regard to private expenditure, there are tax reliefs available for working from home

http://www.hmrc.gov.uk/incometax/relief-household.htm

If you have to spend money on tools or specialist clothing for your job you may be entitled to either:

• tax relief for the actual amounts you spend
• a ‘flat rate deduction’

http://www.hmrc.gov.uk/manuals/eimanual/eim32712.htm

steve@bicknells.net

How to claim tax relief for employment expenses 4

As an employee you can claim tax relief for expenses incurred in doing your job, for example business mileage, cycling on business, hotels, meals, business phone calls, in fact anything as long as its business related

If your claim is less than £2500 you can make your claim using Form P87 http://www.hmrc.gov.uk/forms/p87.pdf if its more than £2500 you will need to complete a Self Assessment Return (you need to phone HMRC to request a Self Assessment Return – contact details below), if you know your UTR number you can register and file your Self Assessment Return on line.

steve@bicknells.net

Telephone

Self Assessment

Help and advice for customers completing their tax return and supplementary pages, or who need general advice about Self Assessment
Please have your Unique Taxpayer Reference number with you when you phone
Opening hours
8.00 am to 8.00 pm, Monday to Friday
8.00 am to 4.00 pm Saturday
Closed Sundays, Christmas Day, Boxing Day and New Year’s Day
0845 900 0444

Tax Refund for Business Mileage 5

Many employers pay their employees expenses for business mileage, but often the amount they pay is below the HMRC approved rates shown below.

If your employer pays at rates below the HMRC Approved Rates you can claim tax relief on the difference, this can add up to a lot of money particularly for site based staff who can count travel to temporary places of work as business travel or for workers who’s place of work is their home.

You can claim the tax relief via your self assessment return or by writing to HMRC.

steve@bicknells.net

Travel – mileage and fuel allowances

Approved mileage rates
From 2002/03 to 2010/11 First 10,000 business miles in the tax year Each business mile over 10,000 in the tax year
Cars and vans 40p 25p
Motor cycles 24p 24p
Bicycles 20p 20p
Approved mileage rates
From 2011/12 First 10,000 business miles in the tax year Each business mile over 10,000 in the tax year
Cars and vans 45p 25p
Motor cycles 24p 24p
Bicycles 20p 20p

Cash Accounting is a VAT scheme and it will improve your cashflow if your customers pay more slowly than you pay your suppliers and other costs. For example if your clients pay on 60 to 90 day terms and you pay suppliers on 30 days then VAT Cash Accounting should work in your favour. When you use Cash Accounting you pay VAT based on money received and money paid (so you exclude customers who havent paid).

You can use the Cash Accounting Scheme if your estimated VAT taxable turnover during the next tax year is not more than £1.35 million.

Once you start to use cash accounting, you can continue to do so until your VAT taxable turnover reaches £1.6 million.

You can use Cash Accounting with other VAT Schemes, for example the Flat Rate Scheme.

You do not need to complete an application form or advise HM Revenue & Customs (HMRC) to start using the Cash Accounting Scheme.

You can start using the Cash Accounting Scheme at the beginning of any VAT period if you are already registered for VAT

Why pay VAT before you need to?

steve@bicknells.net