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Jon

A brief history of my time in tax

Image by alancleaver_2000 via Flickr

I am not going to tell you how long I have been working in tax, but suffice it to say I have a lot of experience. Things have changed so much that it seems to me that the public in general still entertains ideas about tax which are long outdated if indeed they were ever correct in the first place.

Once upon a time in the UK tax system, people did not get tax bills unless they actually sent in their income tax returns. In the distant past, there were two arms of the old Inland Revenue. One dealt with assessing tax at the standard rate (now called the basic rate) after deducting personal allowances, and the other charged the higher rates of tax which were due. This higher rate of tax was called surtax, only a small percentage of the population had income which went into the surtax bands, and the Revenue did not send out a tax bill until they had a Return; some were sent in very late for understandable reasons.

I am telling you this because strangely, some people still believe in a similar philosophy. If they delay sending in a tax return, they believe they won't have to pay the tax. That is not a good approach to modern taxation and at the very least will incur interest charges and statutory penalties as well as a wild guess by HMRC in terms of a tax demand in the absence or a return.

The biggest change to taxation in the UK in the last fifty years or so was the introduction of the Self Assessment process in the nineties. Effectively this is supposed to do what it says on the tin. The taxpayer has to work out his or her tax liability and pay it to HMRC. HMRC checks the figures using their software. Not surprisingly many taxpayers use agents such as my firm to do their tax returns for them and work out their tax positions. This huge shift of responsibility from HMRC to the taxpayer to calculate the tax due was a cost-saving measure in terms of the number of staff theoretically needed to be retained as HMRC Civil Servants. The costs saved by the Government were shifted to the taxpayer who either had to spend valuable time working out his or her tax position, or pay someone else to do it

The shifting of responsibility also shifted the burden of scrutiny, at least initially, to the taxpayer and the agent. Prior to Self Assessment, as long as there was full disclosure of the facts in a tax return, there was a tendency for taxpayers and sometimes for their agents to “try it on”.

For example, I remember a long time ago a science writer claiming in his accounts for a new and expensive pair of glasses (spectacles was the technical term) on the basis that he could not see to do his work without them. He insisted that my then firm put in for the deduction. We knew that a real person in an Inland Revenue office should look at the accounts and write us a letter saying why the expense had been disallowed, which would be on the basis that the client needed the glasses in the course of his everyday life, not just when he sat at his desk to write. As you might understand, a claim for some tax relief on a microscope would have been more in order. Actually the accounts went through unchallenged and the glasses got tax relief. This was felt to be acceptable in our office because the Revenue had not been misled but had not picked up on the deduction when they had the chance.

Now we have to do HMRC's job for them, and they are anyway far more aggressive in chasing down supposed errors and incorrect claims in the returns that they pick out for enquiry after we have done all the work for them. They will attempt to charge penalties for anything much beyond simple errors, and will certainly charge interest on tax paid late as a result of an amendment to a return.

Doing HMRC's job for them entails scrutiny of every item of expenditure and every allowance claimed. We have clients who will be very unhappy to accept our advice. As you will understand, especially in view of incidents such as the spectacles affair, many people still do not accept that the tax world has changed. We get comments along the lines of “in my old company we used to claim for our days at the races” even though this was either a benefit that never got charged to tax or was client entertainment which should have properly disallowed in the company tax computations even way back.

We have to be strict with claims for deduction of expenditure, we have to present as much information as we can about any unusual item and we have to follow strict accounting rules, which was not always the case. We have to report any uncorrected errors we pick up, and under the Money Laundering Regulations we as agents have to report any suspicions we have concerning possible dishonesty spotted in the course of our business; that of our clients (fair enough) and former clients but also other people's clients, and we must not tell the people reported that we have done so.

I have no problem reporting the dishonest of course. What is a worry is that I could be punished for not suspecting someone that a Government Agency thinks I should have.

Nowadays, we have to report any even mildly artificial scheme to avoid tax when making a tax return. We have to put up with bullying enquiries made by HMRC where they may be wrong, but the cost of going to the Tax Tribunal to appeal may be more than a client can afford in monetary terms in exceeding the extra tax which might be due. An appeal might be simply more than the client can stomach in terms of worry. HMRC is not always right. Their interpretation of the law is not always correct but they might have their way because if a taxpayer sees the leviathan coming for them that person may throw in the towel..

So, in summary, we cannot “get away” with a claim which would not stand proper scrutiny, our records must be good, and we must remember that taxpayers challenged by HMRC are guilty until proven innocent. Do not ask me to try anything on. I will make a claim for you if it has good merit and precedent because I have been round the block. I will do my best and might well know a quite legitimate relief that a taxpayer-client would not know about. Just don't tell me that you want to claim a deduction because someone at the club or on the checkout at the supermarket told you it was all right.

© Jon Stow 2010

What are golden hellos?

Having talked about golden handshakes I ought to mention the “golden hello”, which is a payment made to a future director or employee. It is just possible (only just!)that a payment received from someone other than the new employer – a third party - could be construed as non-taxable.

Where a lump sum payment is made to a prospective new employee, it will be taxed as advance pay for future services unless it represents compensation for some right or asset given up on taking up the employment. An example going back to the 1950s was where an amateur rugby player gave up that status upon turning professional. In those days there was no turning back to amateur status and therefore to return to Rugby Union from the professional Rugby League. His payment was held not to be taxable. In modern times the case for a payment escaping tax would be hard to sustain given the general attitude of HMRC where even a perfectly arguable situation would fall in the face of the expense of defending it.

Usually a payment to a prospective employee about to join will be an emolument of his or her employment and therefore subject to tax and NIC. Effectively it is a signing-on fee similar to that offered to former England goalkeeper Peter Shilton upon his transfer from Nottingham Forest to Southampton (Shilton v Wilmshurst (64TC78) 1991). Lord Templeman explained “An emolument 'from employment' means an emolument 'from being or becoming an employee.' The authorities are consistent with this analysis and are concerned to distinguish in each case between an emolument which is derived 'from being or becoming an employee' on the one hand, and an emolument which is attributable to something else on the other hand.'”

Peter Shilton's payment was found to be taxable in full and almost always this will be the rule for payments made to employees prior to or upon their starting a new job.

© Jon Stow 2010

What are golden handshakes?

Golden handshakes are payments to an individual upon termination of employment and may also be known as lump sum payments.

There are cases where such payments are not taxed at all, which are those post-death when an employee has died in service, and in some cases payments due to disability may qualify for exemption. Those are outside the norm.

For the most part termination payments are taxable under special rules. The first £30,000 of a leaving payment will be exempt from tax if it is an ex-gratia payment and therefore non-contractual. One may have to make the case to HMRC that the payment is not for services rendered and that there was no obligation on behalf of the employer.

Otherwise, payments in lieu of notice (PILONs- how we love these acronyms) are taxable if contractual in the sense that the employee's contract specifies that the employer will make a PILON if the employee is asked not to work notice.

If the contract does not specify this, being silent on the position where the employee is asked to leave without working notice, then the first £30,000 may qualify for the tax exemption because it then represents “damages” for breach of contract. However, if the employer habitually follows the practice of paying terminated employees in lieu of notice even though the contract does not specify this then HMRC may take the view that the first £30,000 is taxable because an employee would have the expectation and the employer probably the intention from the outset.

A true redundancy payment should qualify for the £30,000 exemption, but must be supportable as genuine on the evidence available.

If you are starting to think this whole area of leaving payments is a minefield, you would be right. If you are an employer planning on letting some of your workers go, you should get professional advice.

If you are an employee on the receiving end of both your notice and a proposed payment, you would also be wise to get professional advice before the agreement, and also in completing your Self Assessment Tax Return later. The level of taxation on any non-exempt amount might also depend on what level of income you have in the year you receive your payment, and often if you are not seeking further work you will benefit by having your termination payment at the beginning of a tax year in April or May so that it will not be aggregated with a whole year's pay.

The golden rule for golden handshakes is to seek professional advice.

© Jon Stow 2010

Budget 2010 - I am not going to say “me too”

One usually annual problem for tax practitioners is that we are expected to have instant knowledge of every bit of information announced in the Budget almost straight away. There was in fact very little of substance in the March Budget of 2010, which is not surprising given that we are having a General Election probably on 6th May, and what Chancellor would announce anything unpleasant and painful in such a situation?

There is no point in publishing here a commentary on the Budget announcements. The newspapers have covered what there was in depth, and for a more insightful examination of the Budget scraps I recommend AccountingWeb.

The real Budget will be from the post-election administration in May. It is going to hurt, whoever delivers it, but we will have more certainty that measures already announced will actually come in, and will know about those new ones as yet unannounced. That is all!

Weighing up whether your workers are employed or self-employed

There was an interesting tax case before the First Tier Tax Tribunal in respect of which the decision was announced in February. It was much reported in the tax press and tax circles, but also in the national broadsheets. The case involved a very well known company, Weight Watchers Limited, which is a subsidiary of Weight Watchers International.

The case was not remarkable in the sense that many people treated as self-employed have subsequently been found to be employed, and it was unremarkable also in that the usual tests were applied, which are in respect of the amount of control the provider of work has over its workers. The remarkable element is that Weight Watchers have gone so long in the UK without HMRC having mounted a challenge. I suppose they would have been taking advice from their accountants over a number of years.

In this case the tribunal determined that there were a number of indicators that WW leaders, those who run the classes around the country, were employees and that the wordings and requirements of their contracts made them so. These included:

1.WW could replace a leader if they did not feel the leader was representing WW correctly in a contract which existed between the company and the member, not between the leader and the member.

2.The Company decided on the timings and places of meetings indicating a degree of control.

3.Most of the guidance to help the leader hold successful meetings given by WW was 'mandatory rather than aspirational'.

4.WW required certain targets of the leaders including maintaining their weight within their 'gold goal weights'.

5.The takings collected in meetings were insured by Company and had to be paid over within 24 hours of being collected for them.

There are other rules concerning the taking of holidays, regular supervisory observers being sent to classes by the company and so on, which appear to indicate that the company is very much “hands-on” when it comes to controlling their workers in the field.

To be self-employed and to borrow from HMRC's booklet ES/FS2, one needs to ask:

• Can the worker hire someone to do the work, or take on helpers at their own expense?

• Can the worker decide where to provide the services of the job, when to work, how to work and what to do?

• Can the worker make a loss as well as a profit?

• Does the worker agree to do a job for a fixed price regardless of how long the job may take?

I have no argument with these and if a worker does not satisfy these basic principles then he or she is probably an employee.

Of course no two cases are exactly the same. The Company is going to appeal against the tribunal decision and they may make a good case for all I know, but it does indicate for every business that before deciding a worker is self-employed they need to look at the facts on their merits.

As a result of the defeat of the company by HM Revenue & Customs, £23M has been provided in the company accounts as a liability which may have to be met, and this would be in respect of the PAYE tax and Employer's and Employee's National Insurance Contributions over a number of years for which they may now find themselves responsible. The possible tax hit has been shown as $37M in the international group's accounts.

I am not sure whether this sum is related to the full PAYE liability or if the Company is assuming that they can take into account tax already self-assessed and paid by their workers on their hitherto presumed self-employed basis. Guidance from HMRC following a fairly recent case, Demibourne Ltd v HMRC SpC 486, says HMRC will effectively allow credit for such tax assessed on a self-employed basis in these cases. Where the worker has not paid tax self-assessed, the Company will not have a remedy.

We await the appeal with interest, but remember that if you tell a worker when to turn up and how to do the job and that person has to ask for time off and holidays, he or she is probably an employee, whether an engineer, a bar person or an office cleaner.

© Jon Stow 2010

Late, late tax planning

The 2009 Pre-Budget Report in December signalled a significant number of tax increases in the UK designed to make up the significant Budget deficit following the banking crisis. For many or our clients there will be a significant impact on their finances.
-Income tax rates to rise and personal allowances to reduce for wealthier clients.
-Future changes to rates applicable for dividends, trusts and NICs.
-New 50% income tax band.

There are further complicated rules for pension relief restriction and the end of well-established tax breaks for furnished holiday lettings (currently enjoying business tax advantages). There is speculation about an increase in capital gains tax and I have heard different forecasts from various commentators.

We have about three weeks to do some quick planning which may mitigate in some part the higher tax payable on income receivable after 5th April 2010. It might be slightly less if restrictions are brought in with the 2010 Budget, for which we still await a date.

From 6 April 2010 there are higher rates of tax and fewer reliefs. Those earning in excess of £150,000 will be subject to a ‘super-tax’ of 50% on income over that threshold.

Furthermore, personal allowances will be restricted for those earning more than £100,000, at the rate of £1 for every £2 of income above that figure. As the current personal allowance is being frozen at £6,475 this means the full allowance will be extinguished at an income level of £112,950.

The gradual tapering of the allowance – within the narrow banding of £100,000 to £112,950 – means that where income falls within these limits, the effective rate of income tax is 60%.

In the current fiscal year ending in April it may be possible to convert income chargeable at 50% to gains chargeable at 18% or even an effective 10%. It would really depend on the circumstances of course, so no idle promises.

From 6 April 2010 there will be three rates of tax on dividend income. Where income falls within the basic rate band, the 10% tax credit will extinguish any liability, as before. The equivalent rate for 40% taxpayers remains at 32.5%, but a new rate of 42.5% will be introduced where income will be taxed at the new rate of 50%.

National Insurance contributions (NICs) are due to rise from April 2011 (a further year on), but if these go ahead as planned they will add another 1% to the rate, which is a significant uplift and may be a very sobering thought as people look ahead. Businesses could consider paying themselves in advance through salary or dividends, or paying their employees early bonuses but these are tough times from the point of view of cash flow. Still, any available option should be considered.

Our clients' finances and tax positions need to be looked at in the round; taxation of small businesses is inextricably linked to the reward and taxation of their owners and their families. Whilst high earners will bear the brunt of the initial increases, every taxpayer will feel the effect. These are tough times and tough decisions need to be made, although not to the long-term detriment of the businesses themselves. In addition, with a General Election in the offing we can only plan in the short term based on what we know now.

If you know anyone who may be affected make sure that their accountants and tax advisers are reviewing their tax positions in these next few weeks. Of course you may wish to talk to me about how I can help. Not everyone will have the flexibility to adjust their financial strategy, but it is worth checking.