Tax Notes - F6

Tax – F6 1.

Introduction to the UK tax system

1.1. The overall function and purpose of taxation in a modern economy − −

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UK Economy: Expenditure = injection, Tax = withdrawal Economic social and environmental factors may affect tax policies o Economic: Encourage and discourage certain activities, such as smoking, motoring. E.g. savings (ISAs), Charitable Donations (Gift aid), Entrepreneurs (Capital Gains), Marriage (Marriage Allowance) o Social: Redistribution of income and wealth. Direct taxes hit those that have resources (income tax/inheritance tax), Indirect taxes discourage spending (VAT), and Progressive taxes hit those that can afford to pay (Income tax). People argue tax should be equitable / fair. Efficient tax = cost of collection < tax paid. o Environmental: Deal with environmental concerns e.g. global warming. E.g. climate change levy (business proportion of energy consumption), landfill tax, and car taxes. Structure of the tax system o HM Treasury (Chancellor) – responsible for imposing and collecting tax o HMRC – administrative function for the collection of tax. o Officers of Revenue and Customs: Staff of HMRC are called officers are called officers of revenue and customs – responsible for the self-assessment regime o Crown Prosecution Services (CPS) - Provides legal advice and conducts criminal prosecutions o Tax tribunal – First tier (most cases), Upper Tier (complex cases). Tribunal tracks include:  Paper (simple and to hearing)  Basic (hearing and minimum exchange of documents)  Standard (management and formal hearing)  Complex (long and expensive)

1.2. Different types of taxes −

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Central government raises revenue through tax governed by statute law o Income Tax Direct Revenue Individuals & partners o National Insurance Direct Revenue Employers and employees o Corporation Direct Both UK Companies o Capital Gains Direct Capital Individuals & partners o Inheritance Direct Capital Individuals o VAT Indirect Both Companies Direct Tax: Income, wealth, gains collected from tax payer Indirect Tax: Paid by consumer to supplier Revenue: Charged on income Capital: Charged on capital gains or wealth Corporation: Income and capital gains

1.3. Principal sources of revenue law and practice −

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Sources of Revenue: Acts of parliament, statutory instruments, case law. HMRC issues: o Statement of Practice – how to apply law o Statutory Concessions o Explanatory Leaflets o Revenue and Customer Brief – Point of View o Internal Guidance o Agent Update A finance act is passed by Parliament each year to update the rules. Finance Act 16 governs tax year 16/17 Tax Year: 6 April – 5 April (period to submit returns and pay tax) Financial Year: 1 April – 31 March (Corporate tax returns) Jurisdictions: UK membership of EU impacts UK tax e.g. VAT. States joint enact laws known as directives provide a common code of tax in some areas e.g. VAT. Directive allows some flexibility e.g. rates of tax. Double Tax Agreements: Designed to protect risk of double tax where the same income / gains gets taxed in two countries

1.4. Tax avoidance and tax evasion

Tax – F6 − − − − − −

Tax Evasion: Illegal – misleading HMRC by supressing information / providing false information – fraud Tax Avoidance: Legal - using legislation to reduce your tax burden General Anti Abuse Rule (GAAR): Enables HMRC to counteract tax advantages arising from abusive tax arrangements Abusive Arrangements: Less income, profits / gains, greater deductions / losses Tax Advantage: Tax relief, avoidance of tax Ethical Approach: if a client makes an error / omission in a tax return or fails to file one and does not correct it when advised, accountant has to cease to act and inform HMRC – MLOR / NCA o Recommend client makes disclosure o If after reasonable time, notify and cease act o MLRO

Tax – F6

2.

Computation of taxable income and liability

2.1 Explain how the residence of an individual is determined − −

UK residents are liable to UK income tax on oversees and UK income. Non UK residents are only liable on UK income. Statutory test of residence: o Automatic Oversees Test  Time in UK < 16 days  Time in UK < 46 days and not a prior UK resident (3 years)  Work oversees and time in UK < 90 days (full time) o Automatic UK resident  Time in UK > 183 days  Home (only)  Full time work o Sufficient Ties Test (5)  Substantive work  Close family (partner / minor)  Home (used at least once in tax year)  In UK > 90 days in past 2 tax years  Spending time in UK > than any other country

2.2 Prepare a basic income tax computation involving different types of income and compute the income tax payable. Explain the treatment of ISAs and other tax exempt investments. −

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Types of Income: NSI (non-savings), Savings, Dividends. The following items are exempt: o Redundancy o Winnings o Scholarships o Damages for personal injury o Income from ISA’s (annual limit - £15,240, upon death their spouse is entitled to an additional allowance = to value held by deceased) o Local authority grant o National savings certificate Personal Allowance: £11,000pp. Tapering >£100,000 by £1 for every £2: Adjusted Net Income (Net Income – gross gift aid – personal pension contribution) - £100,000

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Pro-forma, Income Tax Computation: NSI Trading Income Less Loss Relief Employment Income Property Income Build / Bank Interest Loan Stock Interest Dividends Total income Deductible Income Loss Relief Net Income Personal Allowance Taxable Income

SI

DI

Total

X (X) X X X X X X X

X (X) (X) X (X) – NSI, SI, DI

X

2.3 Compute the amount of income tax payable − −

2

Tax Liability: Income tax on taxable income for year Tax Payable: Tax liability – tax paid (PAYE)

X

X

Tax – F6

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Starting Rate: SI – applies where it falls in the first £5k of income, if NSI is above £5k after PA, it does not apply Savings Income Nil Rate: o 0% for first £1000 for basic rate o 0% for first £500 for higher rate o 0% for £0 for additional rate Dividend Income Nil Rate: 0% for first £5000 for all taxpayers Marriage Personal Allowance: Where a partner does not use all of their PA, this may be transferred to a partner. Partner must be basic rate taxpayer. Transferable amount is 10% i.e. £110. This is gained by a reduction on the tax liability i.e. 20% = £220.

2.4 Explain the treatment of interest paid for a qualifying purpose −

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Interest paid gross on the following can be deducted from total income: o Loan to buy plant and machinery for use in partnership / employment o Loan to invest in partnership o Loan to buy interest in employee controlled company o Loan to invest in a co-operative Accrued Income Scheme: Issued by government to borrow money. Interest is paid in fixed amounts and dates. As the interest payment approaches the gilt will increase in price as the purchaser will receive the interest payment. o Usual rule: income tax is payable when received, however when nominal face value > £5k, and gilt is sold for price which includes interest:  Amount of interest accrued since last payment to sale date is taxed as income on seller  Interest is paid to new owner, relieved of tax by deducting old owner accrued income

2.5 Explain the treatment of gift aid donations −

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One off charitable donations qualify for tax relief. Payments are made NET of tax (basic rate). Charity claims aid from HMRC. o BRB: No additional tax relief o HRB: Additional 20% (40%-20%) o ARB: Additional 25% (45%-20%) Additional relief is given by increasing the basic rate limit and higher rate limit. o BRB: £32,000 + (payment * 100/80) o HRB: £150,000 + (payment * 100/80) GROSS gift aid is deducted from ANI for the purposes of tapering the PA.

2.6 The child benefit tax charge −

Income tax charge if ANI is between £50k and £60k – 1% is charged for every £100. Over £60k, no benefit is received.

2.7 Explain the treatment of jointly owned property by a married couple or civil partnership −

50:50 split unless declared to HMRC otherwise (written statement)

Tax – F6

3.

Employment Income

3.1 Recognise the factors that determine whether an employment is treated as employment or self-employment − −

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Employment: Contract of services (ongoing basis) Self-Employment: Contract for services. Advantages include the following (due to increased risk): o Client: No NI liability, no need to apply for PAYE, sick pay, holiday pay etc. o Worker: Income received gross – delay to pay tax, better deductibility of expenses, lower NI bill Factors which determine employment vs self-employment: o Provision of equipment = employment o Choose place of work, hours and method = self-employment o Choose whether to perform the work = self-employment o Integral position in company e.g. chairman = employment o Bears individual risk = self-employment o Employment rights = employment

3.2 Recognise the basis of assessment (RECIEPTS) − −

Employees are assessed on the amounts received in the current tax year. Received on the earlier of cash receipt or when the employee becomes entitled to payment. Directors receive on the earliest of the above, the amount credited in company accounts, end of period of account, time the amount is determined. Directors can manipulate dates, therefore more rules are established.

3.3 Compute the income assessable −

Pro-forma, Employment Income: Employment Income

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Salary X Bonus X Commission / tips X Benefits X Allowable deductions (X) Employment Income (NSI) X - net taxable earnings Tax is collected via PAYE

3.4 Recognise the allowable deductions including travelling expenses − −

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General Rule: Expenses must be wholly, exclusively and necessarily be required to perform duties (no private benefit) Deductions: Limited and hard to obtain: o Contribution to a register occupational pension scheme o Fees and subscriptions to professional bodies o Travel expenses – performance of duties o Capital allowances on plant and machinery o Donations to charity under payroll giving scheme Travel Expenses: Not available for the normal commute, are available for: o Necessarily expended on travelling and subsistence to perform duties o Necessary attendance o Wholly, exclusively, necessarily o Travel to a temporary workplace < 40% time, < 2 years. Expenses deductive when a workplace becomes permanent Travelling appointments e.g. sky engineers, AA – expenses deductible from home

3.5 Discuss the use of the statutory approved mileage allowances

Tax – F6 −

Mileage Allowances: HMRC approved allowance may be received tax free – 45p/mile for first 10,000 miles, after this 25p / mile – this can be claimed as a deduction. Amount actually received (miles*reimbursed by employer) X Amount allowed to receive (miles*20/40p)

(X) X

Tax – F6 4.

Taxable and Exempt Benefits: The PAYE System

4.1 Explain and Compute the amounts of benefits assessable − − −

Benefit Definition: Perk provided by employer represents benefits taxable on employees Time Apportionment: If available for part the year, multiply by n/12 Employee Contributions: Any contributions for benefits provided are deductible from the taxable benefit, with the exception of fuel benefit (not wholly for business)

Accommodation −

General rule – use cost to employee. Employee who is provided with job related accommodation will not be taxed e.g. for security reasons, necessary for performance of role, customary and ensure better performance e.g. priest. If not, a taxable benefit arises. This is calculated as follows: o Greater of annual value vs rent paid by employer o Additional charge if the original cost of purchase (plus any improvements made before the start of the tax year) is greater than £75,000 (Cost – 75,000 * 3%) o If first made available > 6 years ago / after employer purchased property, use MV instead of cost

Accommodation Living Expenses −

Benefit arises if living expenses are paid by employer (house exempt, bills are taxable): o Job related – cost to employer, cannot exceed 10% of earnings o Not job related – cost to employer (taxed on full amount)

Use of Employer Assets −

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When an employee is provided with employer assets for private purposes, the employee will be assessed on the higher of: o 20% of value made available (MV) o Rental paid by employer If the asset is given to the employee, this will be taxed on the higher of: o MV when given o MV first used – amounts assessed as taxable benefit Furniture in accommodation is taxed this way. Mobile phones are exempt (one per employee). An additional phone is 20% at cost + running costs paid by employer.

Company Cars, Vans, Fuel −

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Employees are assessed on company cars but not pool cars (used by > 1 employee, only business use, at company residence). o Annual benefit: C02 % * list price of car o For cars over 95g: (Emissions – 95) / 5 (rounded down) + 16 + 3 (for diesel only) o Recap: C02 emission % * (list price – employee cont.) * n/12 = benefit for year1 Company cars = load baring capacity = standard benefit - £3,170. If only private use is getting to and from work = no benefit (£598 for private fuel). Car fuel for private monitoring: C02 % * list price = benefit for car, repairs, insurance etc. Fuel = same percentage * £22,200

Cheap / Interest free loans −

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Loans > £10,000 give rise to a benefit Average loan * 3% X Less interest paid (X) X Two methods to calculate the average loan. The average method (start + end) / 2 or the ‘strict’ method (amount outstanding * time). The taxpayer can choose – i.e. lower of two.

Other Assessable Benefits − −

Medical insurance (cost to employer) General allowances (random cash)

Exempt benefits 1.

Childcare: Tax free up to a certain weekly limit: o BRB: £55/pw exempt

Tax – F6

2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18.

o HRB: £28/pw exempt (20/40*55) o ARB: £25/pw exempt (20/45*55) Removal Expenses: Up to 8k Car Park for work Employer cont. to approved pension scheme Sports facilities for staff Counselling to employees: Made redundant after > 2 years Bikes: 20p per business mile £4/pw: Home working Entertainment: Provided by 3rd parties (vouchers included) Gifts / goods: £5k taxable Assets used for work Course: £15,480 paid for at least a year (20 weeks) Work related training Air miles Work buses Trivial benefits: £150k have a reduced allowance (£1 for every £2). Minimum allowance - £10,000 for this with income > £210k o Adjusted Income = net income + employee contributions to occupational pension + employer contribution to pension o If gross contributions exceeds the annual allowance, the excess will be taxed as a charge for the tax year in which contribution is paid. Charge is included in total income and taxed at marginal rates. Pension Benefits: Individuals can start to receive pension at 55 with complete flexibility. o Tax free lump sum of 25%, rest is reinvested. Balance can be withdrawn as income, taxed as NSI. o Lifetime allowance is £1m total value of pension. Where this is exceeded, there will be an additional tax charge when funds are withdrawn.

Tax – F6 6.

Property Income

6.1 Compute property business profits − −

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Property Income: Profits from property business is calculated on an accruals basis. Income from land / buildings are NSI. Rents and lease premiums receivable on lets in the UK. A landlord is assessed on rent accruing in the current tax year. Allowable Deductions: o All expenses wholly and exclusively for the purpose of the letting business o If the landlord has borrowed money, the interest is deductible o No capital allowances are available, however relief for the cost of replacing furniture and other items are available Replacement of furniture and other domestic items: o No relief is given for the initial cost, just the replacement. Items include furniture, furnishings, appliances and kitchenware. It does NOT include fixtures such as boilers, radiators etc. o The amount of relief is the expenditure on the replacement – proceeds of sale. Only the cost of an equivalent asset is available for relief.

6.2 Understand how relief for a property business loss is given −

Pro-forma, Property Losses: Rental Income (accruals) Less expenses (accruals) Advertising Agent fees (X) Repairs Property Income P/L X/(X)

X (X) (X) If X, taxable in the current year, if (X) cfwd to deduct from property Y in the future

6.3 Explain the treatment of furnished holiday lettings (FHL) −

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FHL: Accommodation counts as FHL if: o Available for commercial letting for 210 or more days a year o Actually let for at least 105 days o Tennant stays for less than 31 days, can be longer if it does not take more than 155 days in a tax year o Located in EEA FHL income is taxable as property income but treated as a business, therefore FHL gets capital allowances on furniture instead of replacement relief. The landlord must keep details of income separate to other property income. Losses can only be offset against future profits of FHL. The advantages of FHL are: o Capital allowances are available o Treated as relevant employment income for pension contributions o Capital gains tax rollover relief, entrepreneurs relief and gift relief are available on any subsequent sale of the property

6.4 Compute the amount assessable when a premium is received for the grant of a short lease ( 130gs 15%disallowed Expenditure not wholly & exclusively for trade Add any non-trading expenditure

X

X X X X X X X X X X X X

Deduct: Items not taxed as trading income Income assessable under other categories (X) Non-taxable income (X) (X) Adjusted profits Less capital allowances e.g. P&M Trading Income

X (X) X

*Except items < £50, not food/drink/tobacco, bear a company logo 7.3 Recognise the relief that can be obtained for pre-trading expenditure −

Pre-trading expenditure within 7 years of commencing trading is treated as a trading expense incurred on the first day as long as it is allowable.

7.4 Explain and compute the assessable profits using the cash basis for small businesses −

If an unincorporated business has revenue < £83,000 (VAT threshold), the cash basis can be used instead of accruals

Tax – F6 −

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A business can continue to use this basis until: o Receipts in the prior tax year are 2* £83,000 o AND receipts for that year exceed £83,000 This means certain expenses can be calculated on a flat basis as follows: o Approved millage allowance to compute deduction for business miles o If a business premises is used partly for private purposes the private use adjustment can be made on the number of occupants If the above is a loss, this can be carried forward against the loss against future trading profits

Tax – F6 8.

Capital Allowances

8.1 Define plant and machinery for capital allowances − −

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Allowances are given against adjusted trading profits in respect of the fall in value due to business use of qualifying assets (replaces depreciation). To qualify, assets must be owned at the end of the accounting period. Allowances are treated as an allowable expense, and balancing charges are added. Capital expenditure on P&M qualifies and both unincorporated businesses and companies are entities. If using cash basis, not available. Expenditure is deemed to be incurred when the obligation to pay becomes unconditional e.g. delivery date. Plant and Machinery: Qualifies for all capital allowances if used for qualifying activity. This includes all additions and disposals in the accounting period, it does not matter when in the year. The following items are excluded: o Buildings o Structured o Land o Integral Features o Computer Software

8.2 Compute writing down allowances, first year allowances and the annual investment allowance − − − − −

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Allowances are available if the P&M performs a function rather than provide a setting Main Pool: Expenditure is pooled, on which allowances may be claimed. Writing Down Allowanced (WDA) are given at 18%p.a. on the Tax Written Down Value (TWDV) after adding the current period additions and taking current period. Annual Investment Allowance (AIA): Given to all businesses up to £200,000 pf P&M per year. There is no AIA on cars, adjustments are made if not 12 months and should be first allocated to additions qualifying for WDA at the lower rate. Small Balance on Main Pool: Where the balance on the main pool is < £1,000 this can be written down with a nil balance Private Use Assets: Some assets with a private use are in their own pool (single asset pool). Allowances are calculated on full cost, however only the business proportion can be deducted. A separate calculation has to be performed for each asset. The whole WDA is deducted from TWDV, however only the business proportion is claimed as an allowance. Closing Years: No WDA / FYA / AIA can be claimed for final year of account. Additions are brought in, and then disposal proceeds (cost), are deducted from the qualifying expenditure. o If proceeds > TWDV = charge o If proceeds < TWDV = allowance

8.3 Compute writing down allowances for motor cars and recognise treatment of assets in the special rate pool −

Special Rate Pool: Expenditure on long life assets > 25 years are added to the special rate poll, this only happens when more than £100,000 is spent in the accounting period, cars > 130gsm, P&M integral to the building e.g. lifts, ventilation, water, lighting, water systems etc. The WDA to this pool is 8%. The taxpayer can decide where to allocate the AIA, it is more efficient to set it against the special rate pool. o Cars with C02 < 75g gain a 100% First Year Allowance (FYA) o Cars with C02 75g – 130g are in the main pool, 18% o Cars with C02 > 130g are in the special pool, 8%

8.4 Compute balancing allowances and charges −

Charges: Proceeds (purchase cost) are deducted from TWDV, if proceeds from disposal are > TWDV, a charge arises. A balancing allowance can only arise on the pool on ceasing trade (below £1000).

8.5 Recognise the treatment of short life assets −

Normally main pool assets which have an expected life < 8 years e.g. a computer. Balancing allowances cannot normally be claimed on assets in the main pool. However, P&M (not cars), may be depooled in to a separate column. If sold for less than TWDV, a balancing allowance may be claimed. Special treatment is lost at the 8th anniversary in which the asset was acquired, at this point it automatically returns to the main pool at TWDV.

Tax – F6

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Pro-forma, Capital Allowances: TWDV b.f Additions Disposals (proceeds) AIA Transfer to MP/SRP FYA WDA 18% WDA 8% TWDV c.f

AIA

FYA

X

X

MP

SRP

SLA

PUA

X X (X) X

X X (X) X

X X (X) X

X X (X) X

X

X

(X)

Allowances

X (X) X X

X X

X

X *40%

X

X

X X X X

Tax – F6 9.

Assessable Trading Income

9.1 Recognise the basis of assessment for self-employment income −

Traders are assess on a current year basis (CYB) i.e. on profits for the period ending in the year of assessment. If a trader makes accounts to 31 December each year, his 2016/2017 assessment will be based on profits ending 31 December 2016.

9.2 Communicate the assessable profits on commencement and cessation −

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Opening Rules: There are special rules in the opening three fiscal years of trade. Opening year rules: o First Year: Take trading profit from the date trade commences to the following 5 April and identify which tax year this falls in to (5 April should be the end of the tax year). The first year will generally be less than 12 months. o Second Year: Must tax 12 months. Firstly identify which accounting period ends in the second tax year, then see how long it is.  12 months – tax these profits – third year will then be taxed on profits of 12 months to accounting period date  < 12 months – tax profits of first 12 months of trade – CYB thereafter  > 12 months – tax profits of 12 months to accounting period date – CYB thereafter o There may be a double assessment of profits, where there is an overlap, relief is available on ceasing trade or a change of accounting date. Closing Rules: Penultimate tax year is charged on a CYB basis. The final year is what is left – overlap profits.

9.3 Recognise the factors that will influence the choice of accounting date − −

If profits are expected to rise, a date early in the tax year, for example 30 April will delay the time when those increasing profits will be taxed. An accounting date of 30 April gives the greatest time between earning the profits and paying tax. A 31 March / 5 April year end is more straightforward and avoids overlap of profits. Knowing profit in advance of the end of the tax year makes tax planning easier.

Tax – F6 10. Trading Losses −

XXX

Tax – F6 11. Partnerships and Limited Liability Partnerships 11.1 Explain and compute how a partnership is assessed to tax −

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A partnership will have to split income amongst partners for tax purposes. The following needs to be dealt with: o Allocation of trading profits o Effect of a change in the profit share ratio o Effect of a change in membership of a partnership Trading Profits: These are allocated in accordance with share arrangement during the account period. Salary, interest on capital, then residue (in agreed ratio). Pro-forma, Trading Profits: Net profit of partnership X Add: Disallowed expenditure X Less: Income taxed elsewhere (X) Capital allowances (X) Partnership Trading Income X - this is split according to agreement and treated as sole traders Trading Profits: These are allocated in accordance with share arrangement during the account period. Salary, interest on capital, then residue (in agreed ratio). Trading Losses: These are allocated using the same method as for profits, each partner will decide on how to use their share of the loss.

11.2 Explain and compute the assessable profits for each partner following a change in the sharing ratio −

Assessable profits will be apportioned for the period as per the rules, where a change has occurred in the sharing ratio, the change will be implemented on this date.

11.3 Explain and compute the assessable profits for each partner following a change in the membership of partners −

The partnership is always treated as continuing, however for: o Outgoing Partner: Use cessation rules for evaluating share of profits o Existing Partner: Use CYB rules o New Partner: Use open rules to evaluate share of profits. Deemed to commence from date of joining, making up accounts to the partnerships year end.

11.4 Explain the alternative loss relief claims that are available to partners − −

Limited Liability Partnerships: These are taxed virtually on the same basis as normal partnerships New Partnerships: Profits and losses are allocated on the basis of the arrangement in force for the accounting period with the profit or loss arose: o Profits: These will be assessed under CYB rules. o Losses: Losses can be relieved in the fiscal year in which the period ended and/or the previous fiscal year. Opening years – loss of the period will be carried back to the three fiscal years prior to the year when the loss making period ended – set loss against first available future trading profits.

Tax – F6 12. National Insurance Contributions 12.1 Explain and compute how a partnership is assessed to tax −

A partnership will have to split income amongst partners for tax purposes. The following needs to be dealt with: o Allocation of trading profits o Effect of a change in the profit share ratio o Effect of a change in membership of a partnership