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TaxInsider Blog 1 - The difference between legal and illegal dividends

Blogs – Accounting Insight News

Dividends are a reward given to shareholders for taking the risk of investing in the company. Payment is not automatic and in the absence of any provision to the contrary, dividends must be paid in proportion to the shares held by each shareholder of each class of share.

A dividend is paid from retained profits made by the company therefore if no profit has been made over an accounting period or there are no undistributed profits brought forward from previous years, generally no dividend can be paid. Even if the bank account is in credit the company needs to have sufficient retained profits to cover the dividend at the date of payment. Any dividend paid in excess of this profit, or out of capital or when losses are made is ‘ultra vires’ and, in effect, ‘illegal’ (termed ‘unlawful dividends’ in the Companies Act 2006). Therefore, technically, every time a payment is made management accounts should be prepared to confirm that there is enough profit to support the payment.

The consequences of a dividend being designated as being 'illegal' will depend upon the status of the company. If the company goes into liquidation the liquidator or administrator reviews the past three years accounts and if it is found that a dividend has been paid ‘illegally’ then directors will be expected to personally repay the dividends payments made. If the liquidation is of a family or owner managed company it could be argued that the directors should have known or at least been aware (or had reasonable grounds to believe) that such a payment breached the conditions laid down by the Companies Act 2006 and Insolvency Act 1980. A director can also face liabilities for the breach of duty associated with authorising the payment of an unlawful dividend.

If the company is not in liquidation rather that HMRC are making enquiries into the validity of the dividend if they find that a dividend has been made 'illegally' then they will invariably try to reclassify the dividend as either salary or a loan to the shareholder. If reclassified as salary, then they will demand Income Tax and National Insurance payments on the amount each shareholder received. Conversely HMRC could take the stance that rather than being a dividend, the payment was in effect, a loan under s455 CTA 2007, the consequence being that the company would be charged 32.5% of the gross amount paid unless repaid within nine months and one day of the company’s year-end. After the original loan is repaid the s455 charge can be reclaimed but not interest.

If reclassified as a loan, not only does the amount become repayable but either interest will be paid on it by the shareholder, or they may be liable to income tax on the benefit-in-kind received should all loans received in the tax year total in excess of £10,000. The company will also be liable for employers National Insurance contributions. If all loans are less than £10,000 in the tax year, no benefit in kind charges apply.

If the shareholder is not a director in the company, they may only be required to repay an 'illegal dividend' if they know or have reasonable grounds for knowing that it was made illegally when the distribution was made.

Having 'illegal' dividends showing in the company accounts can make the company look insolvent having negative balances on the balance sheet which could affect the company’s ability to gain credit from a lender or suppliers and may breach current agreements with lenders or supplier.

by Rob Deighton

TaxInsider log 2 - Principal Private Residence – proving PPR

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The sale of any property is taxed under the capital gains tax (CGT) rules unless covered by exemption or subject to a specific tax relief. Private residence relief (PPR) is one of the better known and well used of such reliefs. However, we are so used to saying that the sale of a main residence is CGT-free that we are in danger of forgetting that there are two conditions that must be satisfied for a claim to succeed:

1. the property must not have been purchased for the sole reason of making a profit (note the word ‘sole’) and
2. the property must be an individual's only or main residence throughout the period of ownership (note the phrase ‘only or main’).

Legislation does not define exactly what constitutes a ‘residence’ but the courts are looking for “permanence, ... a degree of continuity and expectation of continuity to turn mere occupation into residence.” When considering whether a property is PPR exempt HMRC will not only look at the length of ownership but also what could be termed as 'quality' relying on the text in HMRC’s Capital Gains Tax Manual CG64441 which states that “occasional and short residence can make a residence; but the question is one of fact and degree.”  However, in practice, the longer the better does appear to be the rule. Recent tribunal cases reveal that HMRC are querying situations where a property is being renovated before sale and as such can only be lived in for a (relatively) short period.

However, that does not mean that living in the property for a short period denies relief as the case of David Morgan v HMRC (2013) shows. The taxpayer and his girlfriend were engaged and (importantly) both names were on the mortgage offer. The couple split up, but Mr Morgan continued with the purchase, moving into the flat for two weeks, specifically to prepare it for renting. The tribunal found that, notwithstanding the short period, he actually lived in the property and had intended to occupy it as a residence, the proof being that his girlfriend's name appeared on the mortgage deed.

Recently HMRC have been targeting self-build builders, questioning whether the property really has been built with the intention of being the main residence. If a self-builder repeats the process of building, moving in and moving on, rolling equity gains into subsequent houses each time they could avoiding CGT. HMRC may take the view that the self-build has become a business and seek to tax the gains as income particularly if no other sources of income can be demonstrated or the person actually doing the self-build is working in the building trade already.

HMRC will require proof that the property has actually been lived in as the PPR. The following are suggestions:

• Documentary evidence in particular utility bills in the owners' name at the property address. Other receipts for home insurance, telephone bills, DVLA records or credit reference agency records should be kept.
• The property address being on the electoral register in the owners' name.
• Receipts confirming purchase of furniture and so on for the property e.g. delivery confirmation proving delivery to the property address under the owners' name.
• Bank accounts registered at the address.
• Confirmation that the mortgage plan has reverted back to a standard plan and away from a ‘buy to let’ mortgage, if relevant.

A final suggestion is for the owner to introduce themselves to the neighbours to let people know who actually lives there.

by Rob Deighton

Drivers for change in an accountancy practice

Written by Greg Gillet: Many of us find change challenging.  We rationalise our caution by quoting the popular saying, “If it ain’t broke, don’t fix it”, which provides an easy justification for personal and organisational inertia.

But sometimes, change is unavoidable.  Here are the main drivers for change that affect modern accountancy practices.

The economy

There’s not a lot you can do to stop the economy nose-diving.  Or expanding, for that matter.  But there are things you can do to protect yourself against the worst effects of a slowdown and exploit the opportunities offered by an upturn.  New attitudes, new working practices and new technology should be an important part of your response.

Laws and regulations

Laws and regulations have a profound effect on how accountants work.  GDPR, Making Tax Digital and FRS 102 are just a few recent examples of this kind of change.  Be prepared to change the internal procedures and workflows within your practice together with your software and other IT systems in order to keep up.

Client demand

Over time, new clients will make new demands on you.  Even long-standing clients will expect you to offer them more services, or expect you to deliver those services differently.  Online accounting; mobile access to financial data; secure client portals; a social media presence…  What technology will you need to meet these demands?

Staff expectation

To be the best, you have to employ the best, so your practice needs to be able to hire and retain talent.  As well as flexible working, better work / life balance and a range of interesting and challenging assignments, staff these days want to be able to broaden and deepen their technical skills.  They also expect to have access to the latest technology to help them do their job.  Better make sure you’re providing it!

Self-development

Your staff, partners and managers aren’t the only people who may look for opportunities to extend their technical and other skills.  Over the course of a working life you will naturally look for new challenges, both to develop your career and to explore your own potential.  This kind of self-generated pressure can be an important driver of change.

Competitive pressure

Imitating your competitors is not always a winning strategy (“Tax returns for a fiver” anyone?) but neither is ignoring genuine competitive pressure.  How will you respond if another accountancy practice offers something that you don’t, or can’t?  These days, technology is often the key to unlocking new markets and opportunities and getting back your competitive edge.

Technology

As soon as any new technology becomes available, someone somewhere will exploit it to their advantage to do new things, or to do existing things better, more quickly, more cheaply or some combination of the three.  The most radical technologies reshape the way we see the world – the iPad, for example, grew from a desirable consumer novelty to become a valuable business tool.  What paradigm-shifting technologies await accountants in the near future?

Growing your practice

Even if you don’t want your practice to get any bigger, you need to continually take on new clients just to replace those you lose.  To expand, you’ll need to take on even more, perhaps by employing more staff or by working more efficiently.  To increase fee revenue, you’ll need to charge existing clients more for the work you already do, or get them to buy additional services from you.  Better software can help you pursue these growth strategies.

For tax and accounting professionals, change is a constant fact of life.  At some point – for any one of the reasons described above or a combination of many – the pressure for change in your accountancy practice will become irresistible.  Your best chance of success in periods of rapid transition is to find a technology partner who shares your vision of future success.

by Rob Deighton

More career advice for the newly qualified accountant Scott Lowes Levitate

Candidate pool and competition for jobs

As external audit is a specialist area, accountancy firms are unable to hire just any qualified accountant. They need people that have relevant experience in audit within certain sectors and people that have years of experience in working with a range of reporting standards. Since the day I started recruiting in practice (over 10 years ago) there has always been a shortage of experienced auditors both in the UK & overseas, which means there is a great opportunity for you to capitalise on this and push on into a more senior role.Within industry, this is a totally different scenario! Yes, there are roles available for NQs to secure but the competition for these roles is extremely high. You will be up against people from all different backgrounds that have worked in different firm environments and within different sectors. Many of the larger FTSE firms will have some criteria based on the career path they have followed and will generally seek out Big 4 trained professionals or those with a specific sector background.You will also find you are not only up against newly qualified individuals from practice but a much larger candidate pool of people that have either trained in industry or those that have already made the move and now have industry experience. As an employer looking to make the best hire, it is much easier to take a safer bet and employ someone that already has industry experience and is settled in that environment rather that a practice first time mover who hasn’t had this experience and may require some further on the job training.Touching on the point above: Remaining with your current employer where you have built a legacy and proven loyalty will generally be respected and rewarded. If you are making a move into industry with a new employer then building loyalty and trust is back to the start.Moving to another practice firm For some of the people we speak with about their next step, it needs to be totally different. They need a change as they really do not enjoy the area of accountancy they are working in. Some leave accountancy all together as they realised early on that it wasn’t for them but didn’t wish to lose the time they had invested in working towards the qualification. Others that need a change will often work out that it’s not the work that is making them unhappy and clambering for change but the environment they are working in or the people they are surrounded by. Some are unable to work this out for themselves so it is important that you take time to consider the pros and cons of your role so that you can understand what it is that makes you unsettled. If you are struggling with this then speak with a specialist recruiter who can assist you to break down what you do and don’t enjoy.A move to a new firm and role provides a new start and is often viewed as an opportunity for you to shine and progress. As an experienced consultant, We will always advise everyone we speak with to sit down and speak with their current firm about their career path and what is on offer as it’s impossible to make an educated decision if this hasn’t been explored. If we are being totally honest, it’s also a way of protecting our time as firms do not wish to lose employees and 9 times out of 10 will sit down with their employee after they have tendered resignation to work out what they can do keep them before providing a counter offer to keep them. It is always the first place to start when considering options but we will also advise people to at least consider speaking with other firms at the same time so that they can get a better view of what else is on offer and how this compares to what is available within their current firm. Those that do this can then confidently move forward in their career knowing they have researched and considered all options before making a commitment.Working OverseasAchieving ACA or ACCA status means you can literally work anywhere in the world that recruit’s accountants. Most of the major International cities will have the same Top accountancy firms you would expect to see in the UK. If they don’t then there will most certainly be some kind of affiliation to one that you know. As in the UK, qualified accountants from a practice background are always in high demand and there is no better time to make an international move than at newly qualified stage as this is when you are viewed as being ‘the most flexible’. Moving at a later stage in your career is still possible but there will always be less opportunities to consider. We also find that the older someone gets then the less likely an International move will be as their situation changes and can sometimes dictate available options.Making an International move in industry is possible but is less likely if you do not have prior industry experience. As a recruiter that has assisted people to move all over the world to places such as Australia, New Zealand, The Caribbean, Canada, Luxembourg, Switzerland and South Africa, we have never once spoken with a newly qualified accountant from practice that has successfully made this international move without travelling over to work in a practice firm first. My advice is to make a move for a minimum of 12 months in a similar practice role and then make the move into industry. This way, you will have more locations & opportunities to consider, the move will be smoother as you are doing something you know and you will also have a chance to gain understanding of any differences there are in accounting rules and processes whilst working with a wide range of specialist accountants.As a specialist recruiter for accountancy practice roles, we will of course lean towards remaining in practice as a great option. We have seen the benefits of further training and career progression and witnessed people progress from newly qualified to Director and Partner level. Whilst this is the case, Industry also offers people great opportunities and we have also seen many people make great moves where they have progressed to FD and even CEO.If you are unsure about your next step then we are always here to assist and provide advice. It may be that you want to consider both options and if this is the case then the best option is to also speak with recruiters that specialist in industry roles and try to meet with several firms that can offer you a different outlook on how your career can progress and develop. If you do your research and take your time then hopefully whichever way you go will be the right direction for you.

by Rob Deighton

Inheritance tax : timing is everything

Mark McLaughlin points out that inheritance tax business property relief can easily be lost due to the timing of certain transactions

Business property relief (BPR) is a potentially generous form of inheritance tax (IHT) relief, which can reduce transfers of ‘relevant business property’ (e.g. shares in an unquoted company) during lifetime or upon death at rates of up to 100% (or alternatively 50%), if certain conditions are satisfied (IHTA 1984, ss 103-114).

However, BPR will generally be denied if there is a ‘binding contract for sale’ of the business property at the time of its transfer (IHTA 1984, s 113). This is an anti-avoidance provision. The underlying principle of BPR is that relief should be available in respect of relevant business property, but not cash.

For example, if a chargeable lifetime gift of unquoted shares (on which BPR is claimed) was followed shortly afterwards by a sale of the company, it might be argued that the gift was effectively a transfer of part of the company’s sale price. HMRC may seek to apply the anti-avoidance rule in such circumstances (see below).

Not ‘caught’

There are two specific exceptions to the anti-avoidance rule on contracts for sale. The first exception can apply to some business incorporations, i.e. if the binding contract is for the sale of a business (or business interest) to a company which is to carry on that business, where the consideration is wholly or mainly the company’s shares or securities. It should be noted that an incorporation in the form of a business sale wholly or mainly for cash is not within this exception.

The second exception relates to company shares or securities, where the sale is made for the purpose of reconstruction or amalgamation (IHTA 1984, s 113(a), (b)).

Lifetime transfers shortly before sale

HMRC is alert to BPR planning such as chargeable gifts of business property made shortly before its sale to a third party (See HMRC’s Inheritance Tax manual at IHTM25291).

In the above example of a chargeable lifetime gift of unquoted shares followed by a sale of the company, the BPR position might be “carefully checked” by HMRC to see if there was a binding contract for sale at the date of transfer. If there was a binding contract, BPR will generally be denied. HMRC guidance (in its Shares and Assets Valuation manual at SVM111120) suggests that the following cases will be subject to close scrutiny:

Lifetime transfers where a sale of the company (or of part of the share capital including the transferred shares) occurred within six months following the transfer; and

Any other such case where a sale occurred outside the six months period, but the circumstances suggest that the sale may have been in prospect at the time of the lifetime transfer.

In those circumstances, HMRC is likely to request any paperwork relating to the original transfer of the shares, together with the subsequent sale of the company, to determine whether a binding contract for sale existed at the time of the original transfer.

Look ahead?

The binding contract for sale provisions were not in point in Swain Mason and others v Mills & Reeve (A Firm) [2012] EWCA Civ 498 as the share disposal in question had already taken place, but the case highlights the importance of considering the timing of business sales for BPR purposes in the particular circumstances. In that case, the claimants were executors of their late father’s estate. The deceased (CS) was the managing director and majority shareholder of a company, which was the subject of a management buyout (MBO) completed on 31 January 2007. CS had a history of ill-health, and he sadly died in February 2007 shortly after being admitted to hospital for a heart procedure.

The proceeds from the sale of the deceased’s shares became liable to IHT, whereas if CS had died while still owning the shares, no IHT liability would have arisen due to BPR. A claim of professional negligence was made against the defendant firm on the basis that, if due advice had been given, completion of the MBO would have been deferred until after the heart procedure. However, the court held (among other things) that the defendant firm had not been asked for advice on the potential tax consequences of CS’s death in the light of his forthcoming heart procedure. The claim was dismissed.

No binding contract

HMRC accepts that, in certain specific circumstances (which are not considered in this article), particular types of agreement (e.g. options to purchase) may not constitute binding contracts for sale so as to prevent relevant business property from qualifying for BPR under the anti-avoidance provisions in s 113 (see HMRC’s Shares and Assets Valuation manual at SVM111120). However, care is needed, and expert professional advice should be sought if necessary.

• Mark McLaughlin CTA (Fellow) ATT TEP is a co-founder of www.taxationweb.co.uk – see www.markmclaughlin.co.uk. This article was first published in Tax Insider (www.taxinsider.co.uk)

by Rob Deighton

Transferring property into a trust – tax implications TaxAssist

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Trusts are created for a number of reasons but with reference to property that reason is invariably for protection.

The beneficiary may become unable to manage the property themselves or become mentally incapable of doing so or be a minor who is unable, as yet, to take on responsibility for the property themselves; the donor may wish for the property to remain within the family which might not necessarily be the case should the beneficiary become bankrupt or divorce.

Whatever the reason there are capital gains tax (CGT) tax implications on the transfer of property into the trust because the settlor is treated as having disposed of the property as a gift at ‘market value’ at the date of transfer. The ‘market value’ rule applies because the settlor and trust are deemed to be ‘connected’.

'Hold over’ relief may be available which effectively allows a chargeable gain to be deferred (‘held over') and passed to the recipient of the gift (in this case, the trust itself) until either the property is sold or transferred out of the trust or the trust ceases. The charge is on the increase in value from the date of transfer into the trust and the final sale proceeds as usual, but the CGT ‘hold over’ amount is added to the final amount payable. Broadly, where trusts are involved, ‘hold-over’ relief is only available on a transfer that gives rise to an inheritance tax (IHT) liability (such as a gift of property into a 'discretionary' trust) or on the transfer of business assets. The settlor must be UK resident for this relief to be claimed.

Should CGT be charged the calculation is after deduction of the annual exempt amount for trusts, taxed at 18 per cent (20 per cent if the transfer is of residential property).

No CGT is charged on the transfer of property into a trust created on death (a 'Will Trust'). In addition, for the purposes of any later CGT liability, the acquisition cost by the trust is deemed to be the value at the date of death, thereby creating a ‘tax-free uplift’ in the base cost of the asset.

'Will Trusts' are treated as being a disposal of part of the estate’s assets subject to the Nil Rate Band and seven-year rules. In addition, any estate which includes a property that at some time during its period of ownership had been occupied by the deceased as a main residence, downsized to a less valuable home, sold, or given away after 8 July 2015, qualifies for an additional allowance named the Residence Nil Rate Band' ('RNRB) so long as the residence is transferred into a specific type of will trust; e.g. an IPDI trust for a lineal descendant (or their spouse/civil partner).

HS295 Relief for gifts and similar transactions (2015); TCGA 1992, s 165

by Rob Deighton

'Anti phoenix' companies - HMRC clarify the rules Tax Assist

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Payments made to shareholders are deemed to be distributions and taxed as income. Payments made to shareholders under liquidation are not distributions rather being taxed as a capital gains tax disposal of an interest in shares. This will be the case so long as the company has been liquidated for genuine commercial reasons (e.g. cessation of the business or following the sale of the trade and assets to another entity that is under substantially different control) and particularly where the liquidation is not motivated for tax reasons.

However in recent years, the beneficial CGT treatment has led to an increased use of tax-driven 'phoenix' arrangements whereby a company is liquidated, shareholders withdraw profits receiving a capital distribution (often enabling a claim to CGT entrepreneurs’ relief taking the tax rate down to 10%) and then the shareholder sets up another company in a similar field and the process is repeated.

The Finance Bill 2016 introduced the Targeted Anti Avoidance Rules (TAAR) to counter this practice and tax the distribution as income rather than a capital gain should four conditions apply:

• Condition A: the shareholder held at least 5% of the shares in the company immediately before the liquidation
• Condition B: the company was a close company at some point during the two years ending with the liquidation
• Condition C: the shareholder continues or is involved with, the carrying on of the same or a similar trade within two years following the date of the distribution
• Condition D: it is reasonable to assume that the main purpose (or one of the main purposes) of the winding up was the avoidance or reduction of income tax

Condition D is assessed by reference to intentions at the time that the decision was made to wind up the company. HMRC will also treat events occurring after the winding up as evidence and will want to look at all available evidence when assessing the main purpose.

Condition C has proved to be the main restricting condition not least due to the lack of clarity from HMRC. However, HMRC have become aware of schemes that have been devised whereby promoters claim to counter Condition C and in the past year have issued updates to its guidance on the TAAR in its Company Taxation Manual and last month published "Spotlight 47" entitled "Attempts to avoid an Income Tax charge when a company is wound up". "Spotlight 47" acknowledges that such schemes claim to circumvent the TAAR legislation by artificially modifying those arrangements which the rules target. An example would involve the selling of a company to a third-party company rather than liquidating. The third-party company pays for the target company by receiving a dividend from the target company; the individual shareholder carries on trading but using a different vehicle. The idea is supposed to work on the basis that no liquidation has taken place (and therefore 'phoenixing legislation' is not in point) and also because the transactions in securities legislation does not apply because the sale is to a third party.

HMRC consider that these schemes do not work, and as well as quoting the TAAR rules have confirmed that they will consider whether the General Anti-Abuse Rules apply, which could result in a 60% penalty. "Spotlight" states that for arrangements entered into on or after 16 November 2017, HMRC will also consider whether an 'enablers' penalty could be applied to anyone who has enabled the use of this type of scheme. The penalty amount will be equal to the amount of consideration received for enabling the arrangements. The user of the scheme may also be subject to penalties for filing an inaccurate return, with penalties of up to 100% of the undeclared tax.

by Rob Deighton