It is important to know whether a worker is employed or self-employed as there are many differences in the way in which they will be taxed. Broadly, employees are taxed under the PAYE system with income tax and Class 1 national insurance contributions (NICs) being deducted from payments made to them. Class 1 NICs are also payable by employers. In contrast, the self-employed pay income tax and Class 4 NICs direct to HMRC, and are also currently liable to Class 2 NICs.
Some important differences are that:
Employment indicators The term ‘employment’ is broad in scope but is not exhaustively defined. The legislation lists three types of arrangement which indicate the central meaning of the term:
Firstly, the terms and conditions of the engagement need to be established – normally established from the contract between the worker and client/employer, whether written, oral or implied or a mixture of all three. Then any surrounding facts that may be relevant need to be considered – for example, whether the worker has other clients and a business organisation. Factors indicating employment include:
Workers’ rights If a worker is classed as an employee, there will automatically be entitled to certain employment rights, including the National Minimum Wage, statutory minimum levels of rest breaks and paid holiday, and protection against unlawful discrimination Employment status is not determined by any one single factor. In more complicated circumstances it will be necessary to build up a picture, taking into factors such as substitution, mutuality of obligation, control, pay structure and benefits, and the wording of any contracts in place. Partner note: ITEPA 2003, s 4; Check employment status for tax: https://www.gov.uk/guidance/check-employment-status-for-tax At some point, a landlord is likely to incur legal and professional fees in connection with the running of their property rental business. It is easy to fall into the trap of assuming that these costs can be computed in calculating taxable profits if they are incurred wholly and exclusively for the purposes of the business; however, this is only part of the story. The landlord must also determine whether the costs are revenue or capital in nature. The rules also differ depending upon whether the accounts are prepared on the cash basis or using traditional accounting under the accruals basis.
The rule The nature of the legal fees follow that of the matter to which they relate – so if the fees are incurred in relation to an item which is itself revenue in nature, the legal and professional fees are also revenue in nature. Likewise, legal fees that are incurred in connection with a matter that is capital in nature are also capital in nature. Legal fees that are revenue in nature would include, for example, fees incurred to recover unpaid rent, while legal fees that are capital in nature would include fees incurred in connection with the purchase of a property. Cash or accruals basis Revenue items are deductible in computing profits regardless of whether they are prepared under the cash or accruals basis, although the time at which the relief is given will differ. Under the cash basis, the deduction is given for the period to which the expenditure relates, for the cash basis the deduction is given for the period for which the expenditure is incurred. For capital expenditure different rules apply. No deduction is allowed for capital expenditure under the accrual basis, whereas under the cash basis, the treatment depends on the nature of the item – capital expenditure is deductible under the cash basis unless the expenditure is of a type for which a deduction is expressly forbidden. Items of the forbidden list include expenditure in or in connection with lease premiums and the provision, alteration or disposal of land (which includes property). Example of allowable revenue items A deduction for legal and professional fees will normally be allowed where they relate to:
Example of capital expenses The following are examples of legal and professional fees which are capital in nature:
Leases Leases can be tricky. The expenses incurred in connection with the first letting or subletting for more than one year are deemed to be capital and therefore not deductible – this would include the legal fees incurred in drawing up the lease, surveyors’ fees and commission. However, if the lease is for less than one year, the associated expenses can be deducted. Normal legal and professional fees on the renewal of a lease are also deductible if the lease is for less than 50 years; although any proportion of the fees that relate to the payment of a premium are not deductible. If a new lease closely follows the previous lease, a change of tenant will not render the associated fees non-deductible. However, if the property is put to other use between lets, or a long lease, say, replaces a short lease, the associated costs will be capital and non-deductible. Partner note: HMRC’s Property Income Manual PIM 2120 The dividend allowance is quite unusual in that it is available to everyone and everyone has the same allowance. For 2019/20 the allowance is set at £2,000. In common with many allowances, it is a case of use it or lose it.
As the end of the 2019/20 tax year draws closer, what can be done to ensure that the allowance is not wasted? Nature of the allowance Although termed the ‘dividend allowance’ its nature is really that of a nil rate band. Dividends which are sheltered by the allowance form part of band earnings, but the dividends that fall within that band are taxed at a zero rate. Example Harriet is a basic rate taxpayer. After taking account of her salary, she has £10,000 of her basic rate band remaining. She receives dividend income of £3,000. The first £2,000 of her dividend income is covered by her dividend allowance and is tax-free. The remaining £1,000 is taxed at the dividend ordinary rate of 7.5%. Harriet must therefore pay tax of £75 on her dividends. The dividend income uses up £3,000 of her remaining basic rate band. Family companies In a family company scenario, it is possible to organise the shareholdings so as to spread the dividend income around the family to reduce the combined tax bill and to take advantage of each member’s dividend allowance. This is particularly useful where the family member has no other shares and the allowance would otherwise be lost. As dividends must be declared in proportion to share holdings, the use of an alphabet share structure, whereby each person has their own class of share (e.g. A ordinary shares, B ordinary shares, etc.) preserves the flexibility to tailor dividend payments to shareholder’s circumstances. Example Andrew is the sole director of A Ltd. In 2019/20 the company has profits of £70,000 which Andrew wishes to withdraw as dividends. His wife Anne and his children Beth, Chris, Dawn and Emma all work outside the business. None has any other income from shares. Andrew also pays himself a salary of £8,628. To make use of each family member’s dividend allowance, an alphabet share structure is used, under which A ordinary shares are allocated to Anne, B ordinary shares are allocated to Beth, C ordinary shares are allocated to Chris, and so on. Each family member receives a dividend of £2,000. As this is sheltered by their dividend allowances, this enables £10,000 of dividends to be paid tax-free. Had Andrew received the dividends paid to family members, they would have been taxed at the dividend higher rate of 32.5%. Making use of the family’s dividend allowances reduces the overall tax bill by £3,250. Other opportunities Where one spouse or civil partner has substantial shareholdings and their partner does not hold any shares (with the result that their dividend allowance is unused) the shareholding partner could consider transferring shares to their spouse/civil partner (taking advantage of the ability to transfer the shares for capital gains tax purposes on a no gain/no loss basis). This will shift dividend income from one spouse/civil partner to the other and enable dividends that would otherwise be taxed to be received tax-free. Taxpayers with unused dividend allowances could also discuss their investment strategy with their financial adviser with a view to exploring whether it would be beneficial to hold shares – but remember not to let the tax tail wag the dog. 18/2/2017
Making Tax DigitalInteresting article from ICAS about developments in MTD. Another reason to get set up with Quickbooks so that you can meet the new proposed reporting requirements .....
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IntroSnippets of news and interesting facts from the financial world Archives
February 2020
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13/1/2020