November 2006 Newsletter
This month we have information for shareholders lending money to their company, issues for property owners trading rather than investing, notes on tax and 50:50 ownership, and finally gifts and inheritance tax.
Don't forget to call if you need more information on any of the issues raised. The next newsletter will be published on Tuesday 5th December 2006.
Shareholder loans to company
There are certain circumstances
when it may be more expedient for a shareholder to lend money to the
company rather than the company borrow money from its bankers. The
shareholder could use his own savings or borrow funds to do this. If funds
are borrowed we have listed below some of the conditions that must be met
in order that the shareholder obtain tax relief on interest
paid.
1. The shareholder must own over 5% of the ordinary
share capital of the company, or have worked for the majority of their
time in the actual management of the company.
2. The company
must be a private company that meets specific criteria to qualify as a
"close" company, and be a trading concern or involved in the letting of
property to unconnected parties.
3. Tax relief will be denied
to the shareholder if he funds the loan to the company by means of an
overdraft. Interest is only allowed if charged to a loan
account.
4. In order to obtain full tax relief the
shareholder must have sufficient taxed income to cover the interest paid.
If the interest is more than total taxed income the excess cannot be
carried forwards to be set off in future years, or carried back to
previous tax years.
In the event that the company is unable
to repay the loan made by the shareholder the amount of the loss can be
claimed for capital gains tax purposes. (CGT relief will only be allowed
if the company applied the loan for the purposes of its trade.) This
relief is also available to guarantors. For instance if a shareholder
provided a personal guarantee to the company's bankers, which was called
upon, then the amount paid to the bank would qualify as a capital
loss.
If the shareholder is also a director care must be
taken when funds are withdrawn to reduce an existing director's loan. Tax
relief on the funding for the later shareholder loan may be reduced or
lost completely.
Trading with property
If you have bought property as a
long term investment, and have let accordingly, the rents received will be
treated as investment income subject to income tax, and when you sell the
property the gain will generally not attract business asset taper relief,
nor be available for rollover relief. (Furnished holiday lets property is
treated as being used in a trade and is an exception to this general rule
regarding taper relief.)
There is also a particular situation
where dealing in property can be considered a trade. The tax consequences
can be interesting!
Property
Developers
If you personally buy a property with the
sole intention of realising a quick profit HMRC are likely to consider
that you are a developer trading with property.
Negative tax
and national insurance issues:
a. Any profit you make will be
subject to income tax and you will lose the capital gains tax annual
exemption, currently £8,800 per person.
b. It is also
unlikely that HMRC would allow you to treat property bought and sold in
this way as your home (principal private residence), even if you "moved
in" for a few weeks while the property was refurbished.
c. To
avoid a £100 fine you will need to register this trade within 3 months of
commencement.
d. National insurance contributions will be due
on profits made. Class 2 and Class 4.
Positive tax
issues:
e. Losses made can be set off against other income.
(Rental losses cannot be set off in this way).
f. The value
of the business will attract 100% business property relief for inheritance
tax purposes.
g. Pension contributions can be paid out of
property development business profits and attract tax relief in the normal
way.
As you can see there is both good and bad news to
consider. Please call if you are considering this type of property deal,
we can work out the best tax strategy to apply based on your individual
needs. Leaving the call until after the event may well be too late!
Interesting tax consequences of a 50:50 split!
References in this article to husband and wife, also apply to partners
subject to the Civil Partnership Act.
Inheritance Tax
- Shares in Private Limited Company
The following
two paragraphs provide an interesting example where the taxable value of a
gift of shares may be less than the market value!
Consider a
small trading company that has been valued at £1m. There are two
shareholders Mr X and Mr Y who both own 50% of the issued share capital.
Common sense would indicate that their individual shareholdings are worth
£500,000. Whilst this would be the case should they actually sell the
business, different rules would apply if they considered gifting their
shares.
Inheritance tax looks to the value lost by the person
making the gift, not the value gained by the person receiving the gift. If
Mr X gifted his shares to his son, he would be transferring a minority
interest. (51% is needed to exert control.) For valuation purposes a
minority interest may be subject to a discount of between 20% to 30% of
the market value. So a gift could be made worth £500,000 and be treated by
the Revenue as valued at say £400,000 for inheritance tax purposes.
Income Tax - Property ownership and rental
income
Should a property be owned by more than one
person it is normal practice to agree the percentage share owned when the
property is bought.
If our Mr X and Mr Y also jointly owned a
rental property it would suggest that not only would they split the profit
or loss on sale of the property equally, but would also share rental
income arising from the ownership in the same
proportion.
However the Revenue will accept a split of rental
income at variance with the ownership of the property as long as all
parties agree. So Mr X could be allocated 90% of the rental income and Mr
Y 10%. This is a useful strategy to consider but it does not apply to a
husband and wife who own a rental property.
In husband and
wife situations it may be sensible for one party to receive the bulk of
the rental income and pay tax at lower rates - thus creating an overall
increase in post tax income for the family. But to gain the Revenue's
approval the couple must own the property as tenants in common, and the
percentage owned by each party has to be the same as the division of
rental profits. So if Mr A and Mrs A own a rental property as tenants in
common, 90% owned by Mrs A and 10% by Mr A, rental income and profits can
only be split 90:10.
Income Tax - Husband and
wife owned businesses
If a husband and wife team run
a small limited company, or trading partnership, and each own 50% of the
shares or rights to share of profits, they need to be mindful of the
"settlements legislation" particularly where there are few assets in the
business.
If Mr X owns 50% of the business but does 90% of
the work in the business, the Revenue can use existing legislation to
restore a commercial balance to the situation. In this example the Revenue
could argue that as Mr X does 90% of the work then he should receive 90%
of the dividends/share of profits distributed by the business.
This area of tax law is currently being tested by the Arctic
Systems case, a House of Lords decision is pending. But as current
legislation could be applied, shares of business income between husband
and wife need to reflect the underlying commercial reality. A 50:50 split
on paper does not prevent a challenge by the Revenue that other divisions
should be applied.
Gifts and Inheritance Tax
Most taxpayers are aware of the
term PET as applied to inheritance tax. (A Potentially Exempt Transfer.)
If a gift is made from one individual to another as long as the person
making the gift lives 7 years after making the gift, no inheritance tax is
payable.
But what happens if the person making the gift
retains some "enjoyment" of the gift made? We will need to consider the
Gifts With Reservation of Benefits rules - otherwise known as
"GWROB's".
When a person dies who has made a GWROB the value
of the asset gifted will still form part of their estate for inheritance
tax purposes. A classic example is where an elderly parent gifts their
property to the children, but continues to live there. A GWROB can be
avoided in this type of situation if the donor pays full market rent for
the use of the asset gifted.
A PET can also be affected by
further anti-avoidance legislation called POAT - "Pre Owned Assets Tax".
Although the underlying legislation was enacted to counter complex
avoidance strategies, the Pre Owned Assets Tax can also be applied to
quite innocent situations. It generally applies to gifts that are
converted to other assets which are subsequently used by the original
donor - POAT can also be applied to transactions that were set up some
time ago! For instance an elderly parent could gift cash to son who buys a
house in his name. The parent then occupies the house rent free. A POAT is
not an inheritance tax charge - it is a charge to income tax for the use
of an asset.
The legislation for both GWROB's and
POAT's are incredibly complex. However a gift can only be classified as a
GWROB or subject to the POAT rules - not both.
We suggest
that if you have unwittingly stepped into a GWROB or POAT type transaction
that you call us to discuss the tax consequences without delay!
Tax Diary November/December 2006
1 November 2006 -
Corporation tax due for companies with a tax liability for the trading
year ending 31 January 2006.
19 November
2006 - PAYE and NIC deductions due for month ending 5 November
2006. (If you pay your tax electronically the due date is 22 November
2006)
1 December 2006 - Corporation tax due
for companies with a tax liability for the trading year ending 28 February
2006.
19 December 2006 - PAYE and NIC
deductions due for month ending 5 December 2006. (If you pay your tax
electronically the due date is 22 December 2006)
30
December 2006 - If you file your 2006 Tax Return via the Internet
you must send it back by this date if you want the Revenue to consider
collection of outstanding tax for the year through your tax code. This
will only be possible where you owe less than £2,000.