February Newsletter
{clientname} Monthly Business Roundup February 2008
Tax changes for small businesses
Welcome to the February 2008 newsletter. Given the wide ranging changes that the Chancellor is looking to introduce in the next couple of months, this newsletter is somewhat longer than normal. In addition, as the final position relating to the detailed changes in respect of the treatment of taxation of non domiciled individuals and offshore trusts has not been clarified we will cover this in a separate newsletter.
Change and more change!
The Government's proposals for tax change have really come to a head in early 2008, and the implications for smaller businesses and their owners are of concern. There are three main aspects which have caused concern, the issue of income splitting, or income shifting as it is now called, Capital Gains Tax changes and Capital Allowances.
Capital Gains Tax
Mr Darling announced a radical reform of CGT in his October pre-Budget report. This was followed almost immediately by an outcry from various sectors, but most concerned of all were those owning businesses who had hoped to benefit from Business Asset Taper Relief on the sale of their interest, bringing the effective rate of tax on any gain to only ten per cent. They were now facing an 80 per cent hike in their tax bill with a new flat rate of 18 per cent on all disposals.
Late January has eventually brought news on this, with the introduction of a new entrepreneurs' relief. This is a new relief, modelled quite noticeably on the old CGT Retirement Relief which was abolished in 1998 when the last CGT reforms were introduced. The announcement means that the original October 2007 proposals will be implemented in full, with the abolition of indexation on older assets and taper relief on both business and non business assets, but those selling a business or shares in a company will benefit from a reduction in their tax rate to 10 per cent on up to 1 million of gains. Unlike retirement relief there will be no minimum age for disposal, and business owners will only need to have owned the business or the asset for one year to benefit. However, the 1 million will be a lifetime limit, applying to all disposals from April 2008. Once the limit has been used up, no further relief will be available (unless the limit is subsequently increased). Also, the restrictions for those owning shares means that the relief will only be available to those who are an officer or employee of the company in which they own at least 5 per cent of the shares (or another company in the group). This means that pure investors who are neither employees nor directors of the company they own will not benefit from the relief.
Many taxpayers will now have to consider carefully whether to make disposals before 5 April 2008 to benefit from the current regime or to delay a sale so that only 18 per cent tax is chargeable on the disposal. What the late announcement means for many is that the owner of very small businesses, with likely gains of up to a few hundred thousand pounds, need do nothing precipitate as his position has been protected by the latest announcement.
Income Shifting
What has gone unnoticed in all the discussions regarding Capital Gains Tax is that despite losing the Arctic Systems case new legislation is being put in place to prevent the sort of tax planning we have seen for many years in small companies. The owners of these smaller businesses need to think very carefully about the way in which dividends or profit shares are allocated in their businesses. The new legislation is intended to prevent businesses run by couples from sharing their income in the most tax efficient manner and is likely to be a significant worry for the businesses and their owners for the next couple of years, until we are used to the new rules.
The new income shifting rules require that where the profits in a partnership or dividends in a company are "transferred" from one person to another the tax benefit that such an arrangement produces will be ignored. There are various technical aspects which determine whether income shifting has taken place or not, but there are several points which are important to note about this new legislation :
First, it applies to "one individual" and a "second individual". Although the problem the legislation seeks to resolve is the sharing of profits or dividends between married couples, the new legislation affects all income shifting whether between related or unrelated parties. Of course, it is less likely that income would be shifted to an unrelated party as this would be uncommercial.
Second, the rules consider whether one individual has "forgone income". This means that to be sure that the profit shares or dividends paid do not fall foul of the new rules, businesses will need to document carefully the roles of each individual in running the business. The time spent and the nature of the work done will help to determine the appropriate share of profit or dividend for each participant, and thus defend taxpayers where HMRC raise an enquiry.
Although technically the new rules apply to any situation, clearly husband and wife businesses, and those run by civil partners, are likely to attract most attention in compliance terms, so these businesses should take care to consider the new approach carefully. The new rules apply to partnership profits declared as income and dividends drawn after 5 April 2008, irrespective of when the income was generated by the company.
Capital Allowances
As noted there are radical changes, affecting all businesses that will be made to the system of capital allowances for plant and machinery from April. The aim of this article is to summarise information about the proposed changes; and to offer a few indicators about decisions that may need to be taken at this stage.
The changes described here apply from 1 April for companies or 6 April for businesses paying income tax and relate to expenditure or plant and machinery, unless clearly stated otherwise. Various other capital allowances (for example those given for industrial or agricultural buildings) are also in a state of flux at present.
At present, capital allowances are given at a variety of rates (typically 6, 10, 25, 40, 50 or 100 per cent) depending mainly on the nature of the expense and on the size of the business. The proposal is to change this as below.
First-year allowances
First-year allowances (FYAs) currently given at 40 or 50 per cent are to be abolished.
FYAs for expenditure on certain ‘green technologies’ (environmentally beneficial plant, etc.) will be retained at 100 per cent.
Writing-down allowances
Writing-down allowances (WDAs) are for the most part to be given at a reduced rate of 20 per cent (rather than 25 per cent as now).
WDAs at ten per cent will be given for long-life assets (currently at six per cent) and also to certain assets that do not currently attract any tax relief (such as general lighting, ordinary electrical wiring and cold water systems). Expenditure on ‘active facades’ (essentially smart windows with changeable thermal properties that adapt to short-term energy needs) will also qualify for relief, albeit at the lower ten per cent rate.
The lower WDA rate will also apply, however, to some assets that are currently relieved at the full WDA rate. This will particularly effect:
¨ Lifts, escalators and moving walkways
¨ Air conditioning, ventilation and heating systems;
Toilet and kitchen facilities, which were considered as possible candidates for the reduced rate of WDA, continue to attract full WDAs, albeit at the new lower rate of 20 per cent.
The term ‘integral features’ is to be given to those assets (excluding long-life assets) that will attract relief at the ten per cent rate for the first time.
Annual investment allowances
Businesses will obtain immediate 100 per cent relief, by way of a new ‘annual investment allowance’ (AIA) for up to £50,000 of new expenditure (though this £50,000 figure is to be phased in over the 12 months from April, depending on the accounting date, as illustrated in the example below).
The AIA expenditure can include those items that would otherwise attract relief at just ten per cent, as described above. Indeed, the business will be free to allocate the AIA as it wishes.
General exclusions
Many of the existing ‘general exclusions’ applying for the purposes of FYAs are adopted (and adapted) as new AIA provisions. So, for example, no AIA will be available:
¨ For the chargeable period in which the qualifying activity is permanently discontinued;
¨ For cars;
Interaction of FYAs, AIAs and WDAs
The date from which the changes apply is 1 April 2008 for companies and 6 April 2008 for unincorporated businesses that are subject to income tax. To avoid undue repetition, the rules are explained below as they apply to companies.
Expenditure incurred before 1 April 2008 will be subject to the rules for FYAs as they apply before the changes are introduced. After deducting the amount of the allowance, any balance can be carried forward to the following chargeable period.
Expenditure incurred from 1 April 2008 onwards will no longer attract FYAs (subject to the special rules for environmentally beneficial plant, etc.). Instead, the new AIA will be available. The amount of the AIA will depend on the length of the chargeable
Period and (as a one-off transitional rule) on the year-end. For a company with a 31 December year-end, for instance, the maximum AIA available for the year to 31 December 2008 will be £37,500, as there are nine months within the 12-month accounting period that fall in the period beginning on 1 April 2008.
To the extent that the expenditure is incurred after 31 March 2008 and exceeds the amount on which AIAs can be claimed, the balance is available for WDAs in the same period. WDAs in a period spanning 1 April will be given at a hybrid rate, calculated according to the length of the period falling before and after that date. For a company with a 31 December year-end, for example, the hybrid rate will be 21.25 per cent, based on three months at the old rate of 25 per cent and nine months at the new rate of 20 per cent.
The ten per cent pool will work slightly differently. Long-life expenditure currently attracting allowances of six per cent will be subject to a hybrid WDA rate, calculated using the same principles above. Expenditure incurred from 1 (or 6) April, on both long-life assets and new integral features, will receive the full ten per cent allowance, with no transitional restrictions.
What does this mean
Winners
For the businesses that rarely, or never, incur more than £50,000 of capital expenditure, the changes will represent a welcome acceleration of tax relief (though such businesses will often be small companies that will be hit by higher corporation tax rates, rising from 19 per cent at the start of last year to 22 per cent, from April next year).
For such businesses, the changes will also bring considerable simplification – future expenditure will simply be written off in the year in which it is incurred, whether by way of a 100 per cent FYA for expenditure on green technology or by way of an AIA. As such, there will be no need to calculate WDAs. The exception may be for expenditure brought forward at the time the new rules are introduced. As currently proposed, such expenditure would sit indefinitely in a pool wherein the value would reduce year by year.
Losers
At the other end of the scale, businesses incurring large amounts of capital expenditure will be worse off as the £50,000 will be of relatively little value, and such businesses will suffer from the reduced rate of WDA.
A single company carrying on more than one qualifying activity will, at least, have complete freedom to choose how to allocate the AIA. However, groups of companies will be entitled only to a single AIA (albeit split as they choose). Indeed, proposed regulations provide a depressingly long set of new anti-avoidance provisions relating to groups of companies, other companies under common control, qualifying activities under common control, and so on.
Too close to call
Businesses that spend considerable amounts on buying, constructing or refurbishing property will have a more complex web of gains and losses compared with the system currently applying. As always, time spent on reviewing fixture claims can be very profitable, all the more so now that cold water systems and electrical and lighting systems will qualify for relief.
Deciding what to do next
Deciding what action to take in anticipation of the proposed changes will require individual consideration in most cases. It is possible, however, to pick out a few general principles:
¨ Businesses should defer any expenditure on electrical systems, on lighting or on cold water systems until after 1 or 6 April, as such expenditure will not currently attract tax relief (unless the assets in question are closely related to the nature of the trade) but will do so from April. The same principle applies to so-called ‘active facades’.
¨ They should also consider deferring other modest amounts of capital expenditure until April if that means that such expenditure will attract full relief immediately, but depending on the amount of the expenditure and on the business year-end.
¨ On the other hand, some businesses would be well to bring forward any significant expenditure on heating, air conditioning, lifts and escalators if doing so will give relief more quickly than would be available for expenditure incurred from April.
Cars
The Chancellor is planning to alter the way tax relief is given for cars, especially for those costing more that £12,000. We do not yet have details but it is likely that changes will again be introduced from April.
The new rules are likely to penalise cars with high emissions but to give relief faster than at present for those vehicles that cost more than £12,000 but that have low emission levels.
The 100 per cent FYA currently given to cares with very low carbon dioxide emissions is in any case due to end on 1 April 2008.
Key Tax Dates for February
http://{virtualhost}/content/taxcentre_budget/tax_calendar.html
Health and Safety:Working at Home
The rules governing health and safety for people who work from home
http://{virtualhost}/common/personal_corner/health_safety.html