haysmacintyre: Is your structure fit for purpose? Property investment or trading

There are a number of factors to consider in determining whether a property is held as an investment or for trading but the starting point is the original intention when buying the property. The distinction is usually relatively straightforward: a person buying property to let out long term will be making a property investment, whereas someone buying a property to refurbish and sell will most likely be trading as a property trader.

The tax treatment can however sometimes be less clear in practice and, as there is no statutory definition of what constitutes a trade, it will be necessary to consider case law established by the Courts. HM Revenue & Customs use the ‘badges of trade’ to identify whether a trade exists. There are nine badges of trade that have developed from case law and it is important to look at these in the round. Some of the badges that carry greater weight for property businesses are profit seeking motive, frequency of transactions, length of ownership, nature and modification to the property and source of financing.

Why does it matter if the property is held as investment or trading?
  • For individuals – property traders will be liable to income tax and Class 4 national insurance (NIC) on profits arising on property disposals at an income tax rate of up to 45% (40% after April 2023) and NIC at 2% (from November 2022) for an additional rate taxpayer. An investor, on the other hand, will be subject to capital gains tax (‘CGT’) on the same disposal of the property at 20% or 28% depending on whether it is a residential property. Accordingly, there could be a considerable difference in the tax liability between the two
  • For companies – Although corporation tax applies at the same rate, which is currently 19%, on a chargeable gain arising on the disposal of an investment property or trading profits arising on the disposal of trading stock, the method of calculation of the chargeable gain or trading profits, utilisation of losses and reliefs available can lead to different tax outcomes
  • There are some favourable tax reliefs and exemptions that can apply on the sale of shares in a trading company, such as:
    • Substantial Shareholding Exemption (“SSE”), which can exempt a company from corporation tax on the chargeable gain arising on the disposal of an interest in a trading company; and
    • Business Asset Disposal Relief (“BADR”), which can reduce the CGT rate payable by an individual to 10% on the capital gain, up to a lifetime limit of £1m, arising on the disposal of shares in a trading company.

SSE and BADR only apply where certain conditions are met and will be covered in future articles in this series.

One key thing to do is to keep good documentary evidence (such as Board Minutes) as this is the clearest way of showing intent. Such evidence should be put in place at the time the property is acquired and every time there is a change in the circumstance which may lead or cause someone to question the nature of the activity. A change in the circumstance can, in some scenarios give rise to a tax charge e.g. where there is an appropriation of a property from trading stock to investment so it is important to obtain advice from your tax advisor.

Fiscal Statement – Growth Plan Full Summary

Reported as a “mini budget”, the Statement was neither a Budget nor mini, and with interest rates at their highest in 14 years and the Bank of England reporting that it believes the economy has already gone into recession, the Chancellor has set out his ambitious aim for 2.5% growth.  The Statement delivers the biggest package of tax cuts in 50 years, estimated at £45bn.

Our summary provides an overview of the key announcements arising from the Chancellor’s speech, and how they are likely to impact your business and personal finances.

Please get in touch with your usual haysmacintyre contact or any member of the Tax team, if you have any queries.

Fiscal Statement: The Growth Plan – changes to the Company Share Option Plan limit

The Chancellor announced as part of the Growth Plan that the Company Share Option Plan (CSOP) limit will be increased from £30k to £60k from April 2023. There will also be a reform on the rules around share classes eligible for CSOP from April 2023.

CSOP is a tax-advantaged employee share option plan. In many cases, it is an alternative plan for companies that are either too large or carrying out certain trades that would exclude them from granting Enterprise Management Incentive (EMI) options. The current £30k limit on the value of shares over which CSOP can be granted has often been viewed as prohibitive, with companies preferring other planning such as growth shares. The increased £60k limit will, however, make CSOP more capable of delivering meaningful sized awards to key employees.

Currently, CSOP eligibility can be complex where a company has multiple share classes. We shall await draft legislation regarding reform of these rules and hope to see them simplified, to allow more flexibility over share classes that can be used.

Fiscal Statement – The Growth Plan: Cancellation of Corporation Tax increase

The Chancellor has today confirmed the widely predicted cancellation of the increase in the main rate of Corporation Tax that was due to take effect from 1 April 2023.

A previous Chancellor had announced that the rate was to be increased from 19% to 25%, a change which was included in the Finance Act 2021.

The increased rate would have meant the return of two rates of Corporation Tax, as the 19% rate would have been retained for small profits, and the associated return of marginal relief calculations for profits between the small profits limit and the upper profits limit at which the main rate applies.

Aside from simplifying future Corporation Tax calculations the reversal will also have a significant impact on financial statements as deferred tax provisions have had to be included at 25% since the Finance Act 2021 was enacted.

In conjunction with the proposed increase in the main rate of Corporation Tax the then Chancellor also introduced enhanced capital allowances at a rate of 130% for the two years to 31 March 2023. This effectively gave tax relief at 25% for capital investment in those two years in advance of the increase.

The enhanced capital allowances are still expected to cease on 31 March 2023, but the Chancellor has also announced that the Annual Investment Allowance, which gives 100% relief for capital expenditure within the allowance, will remain at £1m permanently.

Fiscal Statement – Growth Plan: all change for employment taxes?

The Chancellor of the Exchequer, Kwasi Kwarteng, delivered his first Fiscal Statement today.

However, in an unprecedented move, the Chancellor announced the following yesterday, before the Statement to Parliament:

  • 1.25% increase in National Insurance (‘NI’) for both employer’s and employee’s NI that was introduced from April 2022 will be reversed from 6 November 2022 for the rest of the 2022-23 tax year. It will also cover Class 1A, Class 1B and Class 2 and 4 (self-employed) NI.
  • Additionally, Class 1A and Class 1B (PAYE Settlement Agreement) NI rate will be at 14.53% for the whole of the 2022/23 tax year
  • Most employees will see the increase in pay reflected in their November pay depending on their employer’s payroll software’s capabilities. We understand that most software developers have been updating their software in anticipation of this announcement.
  • The July 2022 uplift in NI thresholds will also be retained
  • In addition, the introduction of separate Health and Social Care Levy tax that was due to come into effect from April 2023 will also be repealed. The Chancellor has pledged that the repeal will not affect the funding of the health and social care services, which will be protected and remain at the same level (at around £13 billion), as if the levy was retained. The shortfall in revenue is expected to come from general taxation but without a tax increase.
  • The Government forecast that 30 million people will save an extra £500 and 920,000 businesses are set to save almost £10,000 on average next year due to the change

We assume the urgency of the NI announcement and approximately six week’s timeline is to allow for payroll software to be updated in time for the November reversal. The guidance relating to the Health and Social Levy calculator has been updated to state that it is now out of date due following yesterday’s announcement.

We are advised that the appropriate changes will take place automatically for employers who use HMRC basic PAYE tools.,

Various commentators have said that the reversal will benefit higher earners the most, handing back about £1,800 a year to top earners, while the lowest earners get about £7 a year. The government forecast translates to savings of £135 on average this year.

Other announcements

  • Bringing forward the reduction to the basic rate income tax by 1% to 19% from April 2023. 31 million will get £170 more per year
  • Additional rate of income tax 45% abolished from April 2023. “From April 2023 we will have a single higher rate of income tax of 40%. This will simplify the tax system and make Britain more competitive,” said Kwarteng.
  • IR35 Off payroll working rules introduced in 2017 and 2021 in the public and private sector respectively to be repealed. From April 2023, the original IR35 rules introduced in 2000 will apply. This means the contractors operating through their own Personal Service Company (‘PSC’) will be responsible for assessing their own employment status and operating PAYE, if applicable. This is big news! However, it should also be noted that this does not change the processes the employers should be following for those engaged directly, i.e. sole traders.
  • Setting up of investment zones. Each zone will offer tax cuts for businesses to help them create jobs and improve productivity. For those employers in these zones taking on new employees will pay no employers NI on earnings up to £50,270 per year (The Growth Plan 2022 – Factsheet on Investment Zones). This will be supported by less strict planning rules and reforms to environmental regulations to make building houses and commercial property easier.

Fiscal Statement – Growth Plan Highlights

The new Chancellor of the Exchequer, Kwasi Kwarteng, delivered his Fiscal Statement (the Statement), also known as ‘The Growth Plan’ this morning. Reported as a “mini budget”, the Statement was neither a Budget nor mini, and with interest rates at their highest in 14 years and the Bank of England reporting that it believes the economy has already gone into recession, the Chancellor has set out his ambitious aim for 2.5% growth.

In advance of the Statement, the Chancellor announced yesterday that the National Insurance (NI) rate increase (1.25%), implemented from April 2022, would be reversed in November 2022. In addition, the Health and Social Care Levy, due to be implemented from April 2023, will be cancelled, and the increase to dividend tax rates will be reversed from April 2023.

The tax announcements include:

  • Income Tax:
    • From the original Fiscal Statement on 23 September, the additional rate (45%) was set to be abolished from April 2023. However, on 3 October the Chancellor has announced that the 45% rate will not be abolished.
    • The basic rate (currently 20%) will be reduced to 19%, from April 2023
  • National Insurance:
    • The 1.25% increase in NI for both employer’s and employee’s, introduced from April 2022, will be reversed from 6 November 2022 for the rest of the 2022-23 tax year. It will also cover Class 1A, Class 1B and Class 2 and 4 (self-employed) NI.
    • Additionally, Class 1A and Class 1B (PAYE Settlement Agreement) NI rate will be set at 14.53% for the whole of the 2022/23 tax year
    • Most employees will see the increase in pay reflected in their November pay, depending on their employer’s payroll software’s capabilities. We understand that most software developers have been updating their software in anticipation of this announcement.
    • The July 2022 uplift in NI thresholds will also be retained
  • Health and Social Care Levy: due to come into effect from April 2023, but will be repealed
  • Dividend tax rates: the 1.25% increase to the dividend tax rates will be reversed from April 2023, returning the rates to 7.5% and 32.5%. From the original Fiscal Statement on 23 September, the additional rate (38.1%) was set to be abolished. However, on 3 October the Chancellor announced that the 38.1% additional rate will not be abolished.
  • Corporation Tax: the proposed rate increase to 25% from April 2023 has been cancelled. The rate will remain at 19%.
  • Stamp Duty Land Tax (SDLT) changes from today:
    • The threshold for all (currently £125k) for SDLT will increase to £250k
    • The threshold for first time buyers (currently £300k) will increase to £425k
    • First-Time Buyer Stamp Duty Relief available on properties up to £625k (currently £500k)
  • Investment zones: creation of new zones with tax reliefs for businesses, including business rates, SDLT and NI
  • Annual Investment Allowance: will remain at £1m, permanently
  • Office of Tax Simplification to be wound down, with all of HMRC to focus on simplification
  • A promise to simplify IR35 rules for off payroll workers, repealing the 2017 and 2021 changes
  • Seed EIS will be extended to £250k per year and the age limit increased to three years
  • Introduction of digital VAT free shopping for visitors to the UK
  • Duty rates for wines, spirits and beer: RPI increase will be cancelled

Further details to follow in our full summary.

Please contact Katharine Arthur, Partner and Head of Private Client, with any queries.

 

 

UK Reporting Funds

Offshore Fund reporting

If you plan to market your offshore Fund to UK investors, then this is relevant to you.

UK individuals would prefer to pay tax at UK capital gains tax rates (generally 20%) rather than income tax rates (up to 45%).

To ensure a Fund can offer UK investors this comfort then the Fund must have Reporting Fund Status (RFS) (with such funds often referred to as ‘Reporting Funds’). UK investors can then pay UK capital gains tax rates on any disposals, providing they pay income tax on their share of any income in the Fund, even if this income is not paid out.

There are a few hoops to jump through to get a Fund registered for RFS, as well as ongoing compliance requirements but given the value RFS provides then these are obstacles worth tackling.

Registration

Registering for RFS is straight forward. An application form, which asks questions about the Fund, would need to be completed and submitted to HMRC alongside other documents for example the Fund’s prospectus.

The application must be made before the end of the accounting period for which the Fund requires RFS eg. for a 31 December 2022 year end, the application must be submitted by 31 December 2022.

A similar application will also be required for any share classes that require RFS that are launched later.

Compliance

Once the initial application has been made, the Fund must provide annual reporting to HMRC and its investors within 6 months of its year end eg. for 31 December 2022, reporting is due before 30 June 2023.

This report will include a calculation of the Fund’s Excess Reportable Income (ERI) on a share class by share class basis. ERI is essentially the income in the Fund that has not been distributed and UK investors need this figure to include on their tax return.

A timeline of the relevant dates and requirements is shown below.

 

Top tips

  • Don’t miss the deadline! HMRC will not take late applications and it is no fun explaining to UK investors that they will pay income tax on some of their ‘investment’
  • Although the initial application can include all share classes, any new share classes must be registered separately if RFS is required. Don’t miss this deadline either!

 

How we can help you

We can help Funds to obtain RFS and undertake the annual reporting. 

This document is designed to give a high-level overview of RFS however we are on hand to help with the more technical aspects of this regime. Advising on:

  • Whether a Fund meets the definition of an ‘Offshore Fund’
  • Bond Funds and how income streams may differ when UK investors invest in these vehicles
  • Corporate considerations of investing into an offshore Fund eg. how a UK corporate investor will be taxed depending on whether the Fund has RFS or not
  • Fund of Funds and computational requirements
  • Converting a non-reporting Fund into a Reporting Fund and advising on relevant UK investor elections to ensure that any uplift moving forward can be taxed at capital gains tax rates
  • How to reflect the mechanics of this regime in a Fund’s prospectus when marketing the Fund

Corporate and Private Client eNews

The latest edition of our Corporate and Private Client eNews is now available and covers the following topics:

  • Her Majesty Queen Elizabeth II
  • Referees’ tax: entering extra time
  • FRC reviews EPS
  • HMRC hails 4,000 taxi drivers
  • Scotland announces rent freeze
  • FRC researches the PIE audit market
  • Mini Budget expected this week
  • And finally…Companies House encouraging
    online filing

Click the button below to download this week’s edition, or read our previous editions here.

Corporate and Private Client eNews

The latest edition of our Corporate and Private Client eNews is now available and covers the following topics:

  • Prospects of a September Budget?
  • Fuel advisory rates increase
  • Companies House to extend web filing
  • OTS reviewing working practices
  • ICAEW finds business confidence falling
  • MTD guidance issued
  • Naming and shaming tax avoiders
  • And finally… send accountants to jail

Click the button below to download this week’s edition, or read our previous editions here.

High Court ruling on private companies with a sole director

In the case of Hashmi V Lorimer-Wing (2022), inconsistencies have been highlighted for private companies who operate under the Model Articles with a sole director, and it has been questioned if the Model Articles are adequate to allow directors to make decisions solely. The High Court determined that private limited companies who operate under the Model Articles must have a minimum of two directors, and therefore the Model Articles are required to be amended in permitting a single director to make decisions on behalf of the company.

Prior to the ruling, the Model Articles (Article 7(2)) interprets that if a company has a sole director and the articles do not require them to have more than one director and the general rules do not apply, then the director may make decisions without regard to any of the provisions of the articles relating to directors’ decision making. Article 11(2) states that the quorum for directors’ meetings must never be less than two and unless otherwise fixed, it is two.. It therefore appears that there is a conflict between Article 7(2) and Article 11(2).

As a result of the ruling in this case, decisions previously made by a sole director may be called into question. This will apply to companies who are operating under Model Articles or articles that also include equivalent articles to the Model Articles in relation to directors’ decision making.

Following the High Court’s decision, it is anticipated that the Government will review and amend Articles 7 and 11 of the Model Articles to be less conflicting.

Consideration for companies with a sole director

Given that Model Articles were viewed as being sufficient enough in permitting a sole director to act on behalf of the company, the High Court’s decision will most likely have implications with the potential of affecting a large number of companies.

Therefore, sole director companies who are operating under Model Articles or similar should expedite the required amendments to specifically permit a sole director to carry out the company’s day to day business decisions. Additionally, they should confirm that if a company only has one director then the quorum for such decisions shall be one. Alternatively, the company can appoint at least one additional director to ensure that the minimum requirement for quorum will be met.  You should also consider the company passing a resolution to ratify past decisions of the sole director.

 

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