Making Tax Digital – common sense prevails

Making Tax Digital (MTD) is the government’s latest attempt to fully digitise the process of collecting data from taxpayers so they can speed up the process of calculating how much tax you owe.

Until last week, we were facing radical changes to the tax system to accommodate this objective. Businesses (including landlords) were to be required to upload summarised accounts data from their accounts software on a quarterly basis. This information, plus details of other income was to be collected in a personal tax account which would automatically calculate future tax liabilities.

The process was timed to commence April 2018 and be completed April 2020.

The accountancy profession was united in opposition to the undue haste of the implementation process and the obligation that all businesses with turnover more than £10,000 would be required to invest in acceptable accounts software and make quarterly uploads.

It would seem the government has listened. Last week they announced:

Mel Stride, Financial Secretary to the Treasury and Paymaster General said:

Businesses agree that digitising the tax system is the right direction of travel. However, many have been worried about the scope and pace of reforms.

We have listened very carefully to their concerns and are making changes so that we can bring the tax system into the digital age in a way that is right for all businesses.

Under the new timetable:

  • only businesses with a turnover above the VAT threshold (currently £85,000) will have to keep digital records and only for VAT purposes
  • they will only need to do so from 2019
  • businesses will not be asked to keep digital records, or to update HMRC quarterly, for other taxes until at least 2020

Making Tax Digital will be available on a voluntary basis for the smallest businesses, and for other taxes.

This means that businesses and landlords with a turnover below the VAT threshold will be able to choose when to move to the new digital system.

As VAT already requires quarterly returns, no business will need to provide information to HMRC more regularly during this initial phase than they do now.

It seems clear from this announcement that MTD is proceeding, but at a much more sensible pace.

VAT registered traders will need to have MTD compatible software in place by April 2019, and all businesses including property businesses with turnover above the VAT registration threshold (currently £85,000), will need to be ready to make the quarterly uploads of accounts data by April 2020.

Businesses with turnover below the VAT threshold will be under no obligation to use the MTD process, but can join in on a voluntary basis.

We will continue to work with clients to ensure they are ready to meet their obligations. It is gratifying to see the pace of change in this area slow down. This will give affected business owners and their advisors more time to implement the changes required and make more considered decisions about the software they will use to implement their links to HMRC’s MTD systems.

Tax payments due 31 July 2017

If you are self-employed, or registered for self-assessment, we are approaching “that” time of the year: your second instalment on account for 2016-17, is due for payment at the end of the month, 31 July 2017.

Any payment due will be based on your self-assessment liability for the previous tax year (2015-16) so it is worth underlining that this is a payment on account, and even though it is the second you will have made for 2016-17, it may not cover your total liability for this tax year.

There are two possibilities:

  1. That your income or profits have increased during 2016-17, and that as your payments on account (January and July 2017) were based on your previous year’s income, you may have underpaid tax and NIC. If this is so any balance outstanding will fall due for payment 31 January 2018.
  2. That your income and profits have fallen during 2016-17. In this case if we leave your payments on account with no change, you will likely have overpaid tax and be due a refund.

If the second option applies in your case, it may be worth calculating what your payments on account should be, based on your estimated, lower income for 2016-17. This may well reduce or perhaps eliminate any second payment on account due at the end of this month.

If you think your income or profits have decreased during 2016-17 (or the accounts ending in that tax year) please call so that we can deal with a formal application to have your payments of account reduced for 2016-17.

Life in the Cloud

There seems to be a trend supporting the movement of our computer software and data to the “cloud”. Not the fluffy white variety, but servers that are based off-site.

Even our tax system is pushing us in that direction. If and when the government’s objective to Make Tax Digital is finally realised, each of us registered to pay tax in the UK will have an online Personal Tax Account, and all our income sources and other details will be connected to it. So instead of waiting for us to submit an annual tax return to gather data, HMRC will receive everything it needs to know about our business and personal financial affairs via a direct, computer link.

Making Tax Digital for Business is just one aspect of that gradual change process.

Based on current plans, HMRC aim to require all businesses to link up their accounts data with its computer servers during the next three to four years. These data transfers will be required quarterly rather than annually. The aim is to provide you with an estimate of future tax payments based on real time data rather than prior year figures.

Although this process will eventually mean that annual tax return submissions are abandoned, the actual process of maintaining and checking records, and then making the data transfers, will create more work for business owners and their advisors, not less.

Initially, business owners (and this will include landlords) will have to consider how they are going to record their business transactions in a format that can link to HMRC’s computer networks. Most accounting software providers now offer a cloud based solution that will eventually have the functionality to cope with the demands of Making Tax Digital.

And there are other advantages to using cloud based software. For example, as advisors, it is a simple process for us to login to your software and help you with any queries you may have, or to keep an eye on your trading situation. This could be extended in due course to monitoring your accounts data before uploading summaries to HMRC.

If you are still considering your software options, we would be happy to help. The old maxim “be prepared” is still relevant, in fact more so in this electronic age.

What is tax free these days

Surprisingly, there is quite a lot. As long as you are resident in the UK for tax purposes you will probably qualify for the following tax reliefs and allowances for the 2017-18 tax year:

  • The first £11,500 of your personal taxable income is free of income tax, although you will pay 12% NIC on earnings above £8,164 per year.
  • The first £5,000 of dividend income is tax free.
  • The first £11,300 of capital gains are also tax free.
  • There are various savings allowances that you may be able to claim.

Apart from these basic allowances, there are a number of income types and gains that are exempt from income tax and capital gains tax. Currently, they include:

Tax-free income:

Tax-free capital gains:

  • Gifts to your spouse, a civil partner or a charity
  • Gains when cashing in ISAs or PEPs.
  • Sale of government gilts and premium bonds
  • Betting lottery or pools winnings
  • Any profit on the sale of your car, unless you have used it in a business
  • Any personal assets that have a limited lifespan, less than 50 years, and the sale proceeds are below £6,000.
  • In most cases, the sale of your own home

Also, when you inherit an asset, any inheritance tax is usually paid by the estate. So you will get the use of the asset tax free, but you may have to pay capital gains tax if you subsequently sell it.

Tax Diary July/August 2017

1 July 2017 – Due date for Corporation Tax due for the year ended 30 September 2016.

6 July 2017 – Complete and submit forms P11D return of benefits and expenses and P11D(b) return of Class 1A NICs.

19 July 2017 – Pay Class 1A NICs (by the 22 July 2017 if paid electronically).

19 July 2017 – PAYE and NIC deductions due for month ended 5 July 2017. (If you pay your tax electronically the due date is 22 July 2017)

19 July 2017 – Filing deadline for the CIS300 monthly return for the month ended 5 July 2017.

19 July 2017 – CIS tax deducted for the month ended 5 July 2017 is payable by today.

1 August 2017 – Due date for Corporation Tax due for the year ended 31 October 2016.

19 August 2017 – PAYE and NIC deductions due for month ended 5 August 2017. (If you pay your tax electronically the due date is 22 August 2017)

19 August 2017 – Filing deadline for the CIS300 monthly return for the month ended 5 August 2017.

19 August 2017 – CIS tax deducted for the month ended 5 August 2017 is payable by today.

McLaren racing team lose tax appeal

It is a well-established feature of previous judgements that a fine imposed to punish an organisation should not be treated as tax deductible – the tax relief secured would effectively share out the burden of the punishment with the rest of the taxpaying community.

Which is why the First Tier Tribunal (FTT) decision, allowing McLaren racing to deduct a £32m fine for being in possession of documents belonging to Ferrari, was seemingly out of step with this point of view.

HMRC appealed the FTT ruling and the Upper Tribunal reversed the decision.

In some respects, this addresses issues of common sense as well as the law. If the FTT ruling had held, would we have seen footballers claiming tax relief on fines for bad behaviour? Or tennis players for swearing?

Landlords bear the brunt of recent tax changes

Recent budgets have done little to improve the financial position of landlords. One change stands out above the rest: the loss of higher rate tax relief on finance charges.

Many landlords have concentrated on growing their property portfolios in recent years and, taking advantage of the low interest rates, have borrowed heavily to maximise property acquisitions. In accountant speak, they are highly geared.

This strategy will come back and haunt many followers of this path as the tax relief for loan interest starts to reduce in the coming years. The changes will be:

  • From April 2017, 25% of finance charges will be disallowed and replaced with a basic rate tax credit.
  • From April 2018, 50% of finance charges will be disallowed and replaced with a basic rate tax credit.
  • From April 2019, 75% of finance charges will be disallowed and replaced with a basic rate tax credit.
  • From April 2020, only a basic rate tax credit will apply.

Landlords who only pay basic rate (20%) Income Tax on their property business may think these changes will have no effect on their tax bills, after all, the reduction in the deduction in finance charges is matched by a basic rate tax credit, but they may be mistaken. It all depends on the amount of loan or mortgage interest payments they presently pay and claim against their tax. Consider the following example:

Jo, whose rents for 2016-17 are £100,000 and loan interest is £80,000, will have taxable profits for the year of £20,000. Once the finance costs are fully disallowed, Jo’s taxable income will be £100,000 (not £20,000), Income Tax will be calculated accordingly and much will be taxed at higher rates. She will be able to deduct a tax credit, based on finance charges disallowed, but only at basic rate Income Tax.

If rental profits were her only income, and with no increase or decrease in her rental income and costs, Jo’s tax bill would increase from £1,800 for 2016-17, to £11,500 by the year 2020-21.

This sort of outcome would be disastrous for many landlords in a similar situation. They may be faced with selling property to reduce “leverage” and restore some sense of cash flow sanity to their tax affairs.

Clearly, there is a need to re-examine your investment strategy if your property business is similar to the above example. We can help. There may be possible changes you could make short of outright disposal. The key is to consider your options now.

Self-employed combined liability

Whether you pay Income Tax or National Insurance, the effect on your cash flow is the same. The payments are a necessary part of our obligation to fund the activities of State, but the self-employed are often surprised that their bi-annual tax payments cover Income Tax and National Insurance.

The weekly Class 2 contribution is included, presently £2.85 per week, and also Class 4 contributions: these amount to 9% of taxable income in excess of £8,164 and up to £45,000, and 2% on earnings above £45,000.

Accordingly, the combined rate of State dues on self-employed earnings in excess of £8,164 is potentially 29% – 20% basic income plus 9% Class 4 NIC – and over £45,000 a combined rate of 42%. Although in practice some of the income over £8,164 may be covered by other personal tax allowances, these combined rates illustrate the true impact of Income Tax and National Insurance to be paid.

The lower Class 2 contribution is due to be withdrawn from April 2018.

In his first stab at a budget in March this year, Philip Hammond wanted to increase the Class 4 NIC rates from 9% to 10% (April 2018) and from 10% to 11% (April 2019). These increases were subsequently withdrawn. Whether the new, minority government will seek to re-introduce these changes remains to be seen.

Self-employed traders with significant taxable earnings should therefore expect to pay more than the usual rates of Income Tax when they contemplate settlement of their annual Self Assessment bill, and have funds in reserve to meet these combined liabilities.

Making Tax Digital – are we making progress

There is evidence that HMRC’s Making Tax Digital (MTD) implementation team are working with advisors and their clients to beta test the computer systems that will drive the quarterly upload process when it is timed to begin April 2018.

For those readers who may have missed our previous updates on this topic, MTD aims to have taxpayers’ income and other relevant details uploaded to a personal digital account. When completed, this new system will eventually remove the necessity of a formal tax return each year.

Banks, employers, pension providers and business owners (including landlords) will have an obligation to upload data to HMRC. The information gathered will allow for the estimation of future tax liabilities in real time.

For business owners and landlords this is quite a change from the present annual tax return. At various implementation dates they will be required to make quarterly, summarised uploads of their accounts data and undertake an annual online check.

At present, HMRC is not providing direct access to taxpayers to comply with their MTD obligations; instead, business owners will need to use accounting or other software that is authorised for this purpose.

The present timetable, when businesses will need to start uploading data, is:

  • April 2018 – the self-employed, including landlords, with turnover in excess of the VAT registration threshold, presently £85,000.
  • April 2019 – the self-employed, including landlords, with turnover below the VAT registration threshold.
  • April 2019 – submission of VAT returns
  • April 2020 – companies and other organisations subject to Corporation Tax.

Businesses with income below £10,000 will be excluded from the MTD quarterly upload processes.

Incredibly, the legislation setting out the rules and regulations for MTD has still not reached the statute books. It was included in the Finance Bill 2017, but the relevant sections and schedules dealing with MTD were deferred for consideration until after the recent election. Professional advisors, software providers, and the business community looks forward to some progress in this area. Presumably, the deferred legislation will reappear in a summer Finance Bill. The intention, we would assume, is to tidy up these loose ends before members of parliament break for their summer recess.

Sole trader or limited company

We are often asked to judge whether it’s better for a business to be run as a sole trader, or incorporated as a limited company.

The risk argument is fairly straight forward. If your trade or service provided involves risk, and a risk that it is difficult to fully insure, then the limited company is the best route. The only assets at risk will be those owned by your company. Your personal assets will be safeguarded.

If there is no significant risk, the next criteria to test is taxation. Which option generates the lower tax and NIC bill and provides you with more take home pay?

At the lower end of the spectrum, say taxable profits up to £20,000, it is probably better to be a sole trader, as any perceived tax benefit will likely be eliminated by the increased costs of running a limited company.

In the mid-range, profits between £20,000 and £200,000, you will save tax and NIC by being limited. Above £200,000 you may be better off being a sole trader.

However, these assumptions only apply if you withdraw everything you earn from your business. If you want to retain profits in your business, then the picture changes dramatically.

For example, if your company made £200,000 trading profit and you drew out £50,000 in salary and dividends and paid any corporation tax due, the company would be able to retain £114,000. This is cash that the company would be able to use to invest in the business. The combined take home pay and retained funds in the business would now be some £42,000 more than if you had paid tax and NIC as a self-employed person. The reason; as a self-employed sole trader you would pay tax at income tax rates on all your profits, even those you left in the business, whereas the company would only pay corporation tax at the lower 19% rate (2017-18).

There is no substitute for looking at this number crunching process on a case by case basis. If you are contemplating a new business venture and you are unsure what structure you should choose, please call so we can look at the options taking all of the above options into account.