When does a hobby become a trade

An example may illustrate the answer to this question.

Harry updates his iPad and decides to sell his old one – he does not use the iPad for his employment or any business, it’s used purely for recreational purposes. He sets up an account on eBay and manages to sell for a reasonable price. Encouraged, he sells a number of other, no longer used, personal items on the same eBay account.

At this point, it would be difficult for the tax office to argue that Harry was engaged in a trade.

Harry then has an opportunity to buy an iPad from a friend, and the price his friend wants is reasonable, so reasonable that Harry is tempted to purchase and resell on eBay for a quick profit. This he does. With a small profit in the bank Harry starts to consider that he may be onto a good thing and plans to buy and sell more items online.

Buying with an anticipation of selling in order to make a profit is a so-called “badge of trade”, and if Harry continued with this activity he may need to register his online trade with HMRC and submit a tax return.

The criteria that HMRC will apply to decide if a hobby (sometime described as an adventure in the nature of a trade) is a trade are listed below. These are the badges of trade that will be considered by HMRC together with any relevant case law:

  • profit seeking motive
  • the number of transactions
  • the nature of the asset
  • existence of similar trading transactions or interests
  • changes to the asset
  • the way the sale was carried out
  • the source of finance
  • interval of time between purchase and sale
  • method of acquisition.

We are waiting to see if a new Trading Allowance of £1,000 will be reintroduced after the election this month, if it is, Harry would not pay tax as long as the income from his eBay account did not exceed £1,000.

We would be happy to discuss this issue with any readers who are unsure of their present status. You should be aware that there may be penalties if you do not register a business activity with HMRC, file a tax return and pay any tax due.

What happens if you can’t pay your tax on time

Following on from the previous article, we thought readers might be interested in the consequences if they fail to pay their Self Assessment tax on time.

If you are facing cash-flow issues, and cannot see how you can afford to settle part, or all of your tax payment due 31 July 2017, what is the best strategy to avoid confrontation with HMRC and minimise any penalties and interest charges?

Firstly, let’s take a look at penalties. The trigger dates for penalties are 30 days, 6 months and 12 months after the tax became due for payment. On each of these trigger dates you will be charged a 5% penalty based on the amount of tax outstanding.

The current interest charge on unpaid tax is 2.75%.

If you are concerned that you may not be able to meet your liabilities as they fall due, and in particular, any payment due 31 July 2017, we recommend a two-pronged approach.

  • Firstly, make a realistic estimate of when you can settle amounts due. This may be instalments or payment in full at a time after the due date.
  • Secondly, call HMRC’s Business Payment Support Service on 0300 200 3835, and agree an extended payment scheme with them. Generally speaking, they will agree as long as your suggested scheme clears any outstanding liability before your next liabilities become due for payment. They will also exhort you to gather funds such that you can settle future tax on the due dates.

What is inadvisable, is to bury your head in the sand and wait for the brown envelopes, telephone calls and debt collectors at your front door. Call the help line before the tax falls due and keep to your agreed settlement plan.

Tax due next month

Are you self-employed? If you are, you may need to make your second payment on account for 2016-17, due date for payment is 31 July 2017.

This second payment on account will have been based on 50% of your combined Self Assessment tax and Class 4 NIC liability for 2015-16. Which raises an interesting question.

What if your actual Self Assessment liability for 2016-17 is higher or lower than the liability for 2015-16? From a cash flow perspective, the outcome is win-win in both cases. Let’s consider the two options in more detail:

2016-17 liability is higher than 2015-16

In this case your taxable profits will have increased, year on year, and after your January and July 2017 payments on account have been deducted, there will be a balance owing to HMRC. At present there is no legal requirement to add this underpayment to your July 2017 payment, in fact HMRC will not ask for any balance owed until 31 January 2018.

2016-17 liability is lower than 2015-16

In this case your taxable profits will have reduced, year on year, and if you make your January and July 2017 payments on account (based on the 2015-16 results) you will have overpaid HMRC. Again, there is no legal requirement to change your July 2017 payment, and HMRC would no doubt be happy to make use of your overpayment until they would be required to offer a possible refund on 31 January 2018.

However, if you find yourself in this position, you can make a formal application to reduce your 31 July 2017 payment.

Our advice, if you have a realistic expectation that your accounts on which your 2016-17 liability will be based (usually the accounts ending in the tax year to 5 April 2017) are lower than the previous year, then we should calculate the effect on your Self Assessment liabilities for 2016-17 and lodge a formal request to reduce your July 2017 payment on account, if appropriate.

Are you missing out on a �662 tax rebate

Apparently, over 4 million tax payers are eligible to claim the new marriage allowance, but only 2 million have done so. If our math is correct, this add up to £1.3bn in unclaimed tax refunds.

The allowance has been available since 6 April 2015 and is worth £212 for 2015-16, £220 for 2016-17 and £230 for 2017-18; a cumulative tax rebate of £662. The allowance is only available to the following couples:

  • Couples must be married or in a formal civil partnership, living together does not qualify.
  • One spouse/partner needs to be a non-tax payer. i.e. their income must be below the personal tax allowance. (£10,600 for 2015-16, £11,000 for 2016-17, and £11,500 for 2017-18).
  • The other spouse/partner needs to be a basic rate (20%) taxpayer. Higher rate taxpayers cannot receive any benefit from the Marriage Allowance.

The spouse/partner that has the spare personal allowance needs to make the claim, and once made, the relief should automatically be given in subsequent years. You will need to advise HMRC if your circumstances change.

The allowance is simple to claim, just visit the Gov.uk website at https://www.gov.uk/apply-marriage-allownce. And don’t forget, it is the spouse partner who pays no tax (with an unused, or partially unused, personal allowance) that needs to make the claim.

Before making the application you will need to have you and your partner’s National Insurance numbers. You will also need a way to prove your identity. This can be one of the following:

You’ll get an email from HMRC confirming your application.

Possible bonus when you register for VAT

Businesses are required to register for VAT purposes when their annual taxable turnover exceeds £85,000 (this limit applies from 1 April 2017). You will not have to account for VAT on your taxable sales up to the date you are required to register, but interestingly, you may be able to claim back VAT you have paid out on purchases of goods, services and equipment, prior to the VAT registration date.

 

Accordingly, if you started a new business and were not required to register for VAT straight away, the first thing you should do when you do register is to explore the possibility that you can recover VAT you have paid on past purchases.

There’s a time limit for backdating claims for VAT paid before registration. From your date of registration, the time limit is:

  • 4 years for goods you still have, or that were used to make other goods you still have
  • 6 months for services

You can only reclaim VAT on purchases for the business now registered for VAT. They must relate to your ‘business purpose’. This means they must relate to VAT taxable goods or services that you supply.

Complications can arise if you have acquired assets prior to registration. There is an argument that any attempt to recover VAT on the purchase of equipment, vans etc. prior to VAT registration, should be restricted for any contribution the assets will have made to sales prior to registration, but it is not impossible to recover a proportion of the VAT charged.

You should make a claim on your first VAT Return (add them to your Box 4 figure) and keep records including:

  • invoices and receipts
  • a description and purchase dates
  • information about how they relate to your business now

If your pre-registration purchases and other costs are significant, this facility can produce a reasonable cash flow benefit. Please call if you would like our help to assess any possible claim you could make, in particular, the recovery of VAT paid on the purchase of pre-registration equipment. We can also advise how to make the correct entries in your accounts software, if you use this to file your VAT return.

Do you use your car for business purposes

Many employees use their own cars to undertake journeys for their employers. In most cases, employers will pay for this. Generally, they will pay a rate per mile.

HMRC consider this type of mileage payment as tax exempt as long as the rate per mile paid does not exceed a certain amount. Currently, the tax-free rates for cars are:

  • 45p per mile for the first 10,000 business miles in a tax year, and
  • 25p per mile for any additional miles in excess of 10,000.

The same rates per mile apply if you use your own van for business travel.

It is also possible to claim up to 24p per mile for the use of a motorbike and 20p per mile for the use of a bicycle. In both these cases there is no break point at 10,000 miles – you can claim these rates however many business miles you undertake.

Complications arise if you are paid more or less than these agreed rates per mile.

Are you paid more than the approved rates?

If you are paid more, any excess will be treated as a benefit and you will have to pay tax on the difference. Generally, this will be adjusted on the tax code that your employer uses to work out your weekly/monthly tax deduction from salary/wages.

Are you paid less than the approved rates?

If you are paid less than the approved rates per mile, you can claim the difference as a deduction from your taxable income. It’s called Mileage Allowance Relief (MAR).

Consider Jane, who undertook 2,000 business miles for her employer, but was only paid 35p per mile. She can claim 2,000 times 10p (45p – 35p) or £200 against her taxable income.

You will need to advise HMRC of any claim in order to get your tax reduced. If you pay no tax (if your income is below the current personal allowance – £11,000 for 2016-17) there is no tax to recover so a claim is inappropriate.

Your employer can also pay you up to 5p per mile if you carry a passenger as part of your business trip. Again, any payment in excess of this rate will be taxable, but payments of less than 5p per mile cannot be claimed as tax relief.

Changes to taxable benefits from April 2017

The good news, the way in which benefits in kind are taxed – company cars, mobile phones, etc. – is unchanged for the tax year just ended, to 5 April 2017. Consequently, you can expect your tax position regarding any benefits you enjoy to be unchanged for 2016-17; as long as the benefits themselves have not changed.

Unfortunately, from April 2017, the taxman is tightening his grip, and many tax-free benefits will be taxed as if they were part of your salary – this will increase the combined income tax and National Insurance charges in many cases.

A number of benefits are not affected, and will continue to be classified as tax exempt. They are:

  • Cars with emissions between 0 and 75g CO2 per kilometre.
  • Childcare vouchers.
  • Workplace nurseries.
  • Employer pension contributions and pensions advice.
  • Cycles and safety equipment under the cycle to work scheme.
  • Intangible benefits that are not taxed, such as additional annual leave or flexible working hours.
  • Counselling and other outplacement services on termination.
  • Retraining courses.

It is fine for employers to continue providing other benefits after 5 April 2017, but there will no longer be any tax or National Insurance benefit in doing so – in other words, the benefits will be treated as if they were part of salary.

As always, when these changes occur there are transitional arrangements, a delay in the date on which the full tax and National Insurance charges will apply from. Where an arrangement is already in place on 6 April 2017, existing legislation will continue until the sooner of:

  • When the arrangements are varied, renegotiated, revised or renewed (including auto-renewal), and
  • 6 April 2021 for cars, vans, fuel, accommodation or school fees, or
  • 6 April 2018 for any other benefit.

Damage limitation

The phrase “in-limbo” comes to mind when describing the present outlook for businesses in the UK. What will be the outcome of the June election? What will be the outcome of the withdrawal from the EU?

We will all likely be affected. If not directly involved in trade with Europe, we are possibly part of the downward supply chain.

What to do?

First of all, damage limitation planning may be appropriate. If part of your export sales are with Europe, or with firms who supply goods or services to Europe, there is an increased risk that your future prospects may be negatively affected post Brexit. Accordingly, you could:

  • See what opportunities there are to seek out new markets outside the EU.
  • Collaborate with customers who are dependent on EU sales to make joint approaches to non-EU markets.
  • What government assistance is available?
  • Take a fresh look at investment decisions to see if it would be more prudent to retain liquidity, or reduce borrowings to meet any future financial challenges.

It would also be illuminating to prepare realistic financial forecasts based on various what-if criteria.

There are compelling reasons for being prepared and the present hiatus may be that quiet period before the storm that gives us the space to do just that. Businesses that have concerns should face their anxieties head-on, and we can help.

What is the current tax position when dividends are taken

One of the most useful ways for owner directors of small companies to reduce their overall tax and NIC costs is to pay themselves a reduced salary – just enough to maintain their State benefits entitlements – and take any balance of remuneration in the form of tax efficient benefits and dividends.

Government has changed the rules regarding the sacrifice of salary in exchange for benefits, so this particular tax planning strategy has shorter legs, however, the advantages of dividends as a tax efficient remuneration strategy remains; albeit with reducing benefits in future tax years.

Why is this?

Dividends are not a cost. They don’t reduce the amount of profit assessable to corporation tax. Rather, dividends are a distribution of profits after corporation tax has been deducted. Presently, company reserves available for distribution in this way have already suffered a potential 19% corporation tax charge. Accordingly, only 81% remains. This can be retained to finance future investment, or accumulated as a rainy-day fund to see you through more difficult trading periods, or it is available to distribute to shareholders as dividends.

Consequently, the withdrawal of dividends creates no tax consequences for the company, but it can create income tax bills for shareholders.

For 2017-18, the following rules apply. Shareholders will pay:

  • No tax on the first £5,000 of dividends received from all sources.
  • 7.5% tax on any dividends that form part of their basic rate band.
  • 32.5% tax on any dividends that form part of their higher rate band, and
  • 38.1% tax on any dividends that form part of their additional rate band.

If the missing parts of the Finance Bill 2017 are reintroduced after the June election, the £5,000 tax-free allowance is being reduced to £2,000 from April 2018.

The arguments in favour of the low salary high dividend approach for owner directors of small companies is well known and in most cases, an appropriate, and acceptable, tax planning strategy. Unfortunately, every person’s tax affairs are unique, and whilst the generalisations made above hold good for most shareholder directors, what is less clear – and should not be generalised – is the best-fit strategy to suit your particular circumstances.

The tax regime for dividends looks to be hardening in future years, so if you haven’t discussed your options recently, a conversation is probably overdue; and of course, we can help.

The new Criminal Finances Bill

New legislation to increase the powers of law enforcement received Royal Assent 27 April 2017.

The Criminal Finances Act 2017 will give law enforcement agencies and partners, further capabilities and powers to recover the proceeds of crime, tackle money laundering, tax evasion and corruption, and combat the financing of terrorism.

The act:

  • creates unexplained wealth orders which can require those suspected of serious crime or corruption to explain the sources of their wealth
  • creates new criminal offences for corporations who fail to prevent their staff from facilitating tax evasion
  • enables the seizure and forfeiture of proceeds of crime and terrorist money stored in bank accounts and certain personal or moveable items
  • provides legal protections for the sharing of information between regulated companies and extends the time period granted to law enforcement agencies to investigate suspicious transactions
  • extends disclosure orders to cover money laundering and terrorist finance investigations
  • extends the existing civil recovery regime in the Proceeds of Crime Act to allow for the recovery of the proceeds of gross human rights abuses or violations overseas

These changes are the biggest extension of asset confiscation and the money laundering legislation since the Proceeds of Crime Act was passed in 2002.

 

The legislation will need to be considered, and with some care, as this new act has extended liability in sensitive areas, not least new criminal offences for corporations who fail to prevent their staff from facilitating tax evasion.