Archives for category: Technical tax matters

The government would be proud of us (that is the royal us, as in the royal we). We are living up to their marketing of the UK as the high tech centre of the European economy by inventing lots of stuff, or at least trying to.

A hugely impressive 1 in 10 UK resident adults looked into or applied for a patent in the past year, whilst 5% of 11 to 18 year olds did so too. Inventor-in-residence at London’s Science Museum Mark Champkins waxes lyrical on British inventiveness:

“This research shows the recession has sparked a real ‘can do’ attitude amongst ordinary people of all ages who are looking to make some extra cash – and it’s amazing to see that, as a nation, we are turning to science and engineering to make the impossible possible. Breakthroughs using science and technology hold the key to not only transforming individuals’ lives but the state of our country’s future economic growth”.

The research is connected with the Big Bang Young Scientists and Engineers Fair, which is encouraging young inventors and technologists to enter their ideas in the National Science and Engineering Competition, which offers top prizes worth over £50,000.

The government has nailed its colours very firmly to the invention and innovation mast by systematically introducing an extremely generous and flexible system of  enhanced tax relief on research and development expenditure, and even a cash back system on such expenditure for companies not yet paying corporation tax. It will add to this with the advent of the patent box in 2013, which will ultimately allow companies to enjoy a discounted corporation tax of 10% on all their patent-related income.

I was hugely impressed recently by a visit to the Fab Lab in Manchester. Those of us with children of relatively tender years associate Fab Lab with the C-Beebies series featuring a scientist dog and two research assistant pixies (no, I neither smoke or inject those kinds of material). However the Manchester version, pioneered by he Massachusetts Institute of Technology, offers budding North West inventors the chance to design, build and test prototypes using state-of-the-art machinery and technology during the week, and at the weekend throws open its doors for free to all comers interested in prototyping, of whatever age.

Given the dramatic surge in invention and innovation, therefore, I would expect Haydn Ilsley and his merry band at the Fab Lab to be extremely busy at the moment, and long may it continue. Who knows, perhaps Napoleon’s ‘nation of shopkeepers’ may be about to become a nation of inventors.

“If it isn’t broken, don’t fix it” is a rule of thumb that I have always tried to apply. My wife would tell you that this is because I am so impractical that there would be no chance of me fixing it whether it was broken or not, and might go on to quote her father’s excellent advice in his speech at our wedding:

“If at first you don’t succeed, do it the way she told you to”. Whilst I cannot vouch for the factual accuracy of Rex’s speech (at one point he described his wife Barbara as “The Marchioness of Budleigh Salterton”, a title which I cannot trace in Debrett’s Peerage) I can vouch for the sound common sense behind this suggestion.

Some things in government are clearly broken (the Child Support Agency springs irresistibly to mind) and some are clearly not (HMRC’s research and development unit in Manchester for one). On some the jury is out, and I would have included tax credits in that category. The system we have become used to is complex, and does not deal well with levels of income that vary from year to year; it also suffers from the classic government failing of giving with one hand and taking away with the other (see the child benefit tax charge). But after a number of years it is a sort of workable system, and people have pretty much got used to it. And one of the really good things about it is that HMRC administers it, so they have ready access to the necessary income details to check claims.

Now if modern governments have one besetting sin, for which I blame 24 hour rolling news channels, it is a constant need to be seen to be doing something. The other sin which goes along with this is a constant need to be saying something, which leads directly to comments like David Gauke’s about people paying tradesmen in cash. In government, as in so many other areas of life, less is often more. As W S Gilbert so memorably put it in Iolanthe:  

“The House of Lords throughout the war

Did nothing in particular

And did it very well.”

Modern governments have lost the art of doing ‘nothing in particular’, and we are the poorer for it.

Nowhere is this better illustrated than in the plans to replace tax credits, housing benefit, jobseeker’s allowance and several other benefits with Universal Credit. Sounds like a great idea, doesn’t it? Real simplification there. Well the trouble is great ideas need to be put into great practice, and what we have seen so far in this respect is not, to put it mildly, encouraging.

As I said above, one of the great things about tax credits is that HMRC administers them. So who shall we ask to administer Universal Credit? Yes, that’s right, the Department for Work and Pensions. Judging from their draft Universal Credit regulations, this may not have been a very good idea.

As I mentioned above, one of the recurring problems with tax credits was the mismatch between credit claims and income levels when the latter were subject to variation, whether as a result of getting a job, losing a job, getting a pay rise, getting promoted, changing jobs or simply being self-employed and thus earning a variable level of income. The tax credit system has recently been to base the initial assessment on the previous year’s income (oh happy memories of the pre-self assessment taxation of sole trades and partnerships) and to adjust this to a current year basis only if the claimant declares a drop in income.

This has been achieved by having a very large disregard for income increases (£25,000 from 2006-07 to 2010-11), which was a reaction to the furore in earlier years when the disregard was only £2,500 and lots of people had tax credits clawed back. We have already seen, in the light of the financial crisis,  a reaction to this deliberate policy of allowing people to receive what are effectively tax credit overpayments in the form of a reduction ion the disregard to £10,000, and it is due to fall to £5,000 for 2013-14, at which point Universal Credit will supersede tax credit.

The current government clearly hates the whole concept of the disregard, with its inevitable overpayments of credits, and thus the Universal Credit system has been designed to operate in real time. 10 out of 10 for ambition, but how is that going to work in practice?

From a PAYE perspective, it is going to work because of the introduction of Real-Time Information, currently being trialled for implementation in 2013-14. This will require employers to submit to HMRC details of all earnings paid to taxpayers at the time of payment, which is wonderful in theory, although the all-party parliamentary taxation group recently expressed doubts as to whether RTI could be delivered. Let’s just say we’re all going to have lots of problems if it can’t.

Assuming it can, this should make Universal Credit work for employees, provided HMRC tells the DWP all the income details (why is the DWP administering this, again?) Which just leaves the self-employed. As mentioned above, until 1996/97 it was felt necessary to have a prior year basis for taxation of the self-employed, who thus only moved onto an actual year basis of reporting 15 years ago, and are now to be expected to move onto a real time basis. See what I mean about ambition?

HMRC does not intend to obtain information from the self-employed about their taxable income other than via self-assessment, and VAT returns. So if you have a 30 April year end, you report your profits to HMRC 21 months thereafter. OK for income tax, but not great for a real time Universal Credit system.

So we need a monthly profit reporting system for the self-employed. But don’t small businesses constantly complain about increasing red tape and the growing burden of bureaucracy, and don’t we the government tell them that we’re cutting red tape and making their life easier? Yes to both of those, but let’s introduce a new requirement for them to tell the DWP (who they have nothing to do with at present) every month about their trading profits. Fantastic, they’ll really love that.

So this is going to be tricky; presumably every small business will be required to produce monthly management accounts, and it will be bonanza time for accountants? Well, no actually. Income will be reported on a ‘simplified cash income basis’, and apparently ‘these requirements have been designed to make it possible for claimants to report monthly without employing an accountant’.

At this point I would like to request a transfer to the parallel universe in which the author of the guidance lives, where self-employed taxpayers religiously keep their books up to date monthly and hand them to their accountant with a cheery smile as soon as their accounting period ends. Meanwhile, back in the real world that the rest of us have to inhabit…………..

The one compensation for small business owners faced with these monthly returns is that, once they have completed a year’s worth of them, they will be able to add them together (or give them to their accountant to add them together) and, hey presto, they will have their year end accounts for self assessment purposes. Whoopee, joined-up government! Except that they won’t be able to do that.

At the moment, self assessment returns of trading income are made on an accruals basis. In other words you account for what you have earned and expended, not what you have received and paid out. If you have bought stock and not sold it, you exclude it from your purchases for the year, and include it next year when you sell it. So for most businesses, other than those that literally buy and sell for cash with no time lags, accounts on a cash basis will bear no clear relation to accounts on an accruals basis, so they will need two sets of accounts, one for HMRC and one for the DWP.

Well, not necessarily. In a move not entirely unconnected with the impending introduction of Universal Credit, the government announced in the 2012 Budget a consultation on a cash basis of accounting for smaller businesses (being those with turnover below the current VAT registration threshold of £77,000). Thus, as the UC regulations state:

“the book-keeping a Universal Credit claimant who also reports his/her income for income tax has to maintain will be streamlined if the tax system is changed in line with this consultation.”

While this sounds great, it does beg some key questions, not least in what circumstances a UC claimant would not be reporting his or her income for income tax purposes, but let that pass. By ‘this consultation’, does it mean the HMRC consultation? If so, why do the UC regulations not simply adopt the proposals in the HMRC consultation as the measure of income for UC purposes, thus achieving consistency? You will have gathered from this that they don’t do so. Or does it mean the UC consultation, in which case the DWP appears to be approaching its aged grandmother HMRC and gently explaining to her how to suck eggs? On the basis that it means the former, there are three fundamental areas of mismatch between the proposed computation rules:

  1. 1.       Mixed use of assets

The UC regulations only permit the deduction of expenses incurred ‘wholly and exclusively’ for business purposes, whereas there is a long and honourable tradition of allowing the deduction of identifiable parts or proportions of expenditure which are incurred wholly or exclusively for the purposes of the trade. There are common flat rate deductions, but there are differences in the acceptable measures of use of home as office. Also, cash basis is to be optional for self assessment but mandatory for UC purposes.

  1. 2.       Exclusion of ‘unreasonable’ expenditure

No deduction will be allowed for UC purposes for any payment incurred ‘unreasonably’. What does this mean, given that there is no guidance In the regulations As there is also a wholly and exclusively test, it must be possible to incur expenditure wholly and exclusively for business purposes which is nonetheless incurred unreasonably. How exactly is this possible?

  1. 3.       Carry forward

In case you think I am splitting hairs, how about this example? The proposed cash accounting system for tax, based on a one year period, carries forward negative balances against future positive balances. The draft UC regulations treats them as zero. I am indebted to Taxation Magazine for the following example of the absurdity of this provision:

Wenlock and Mandeville sold Olympic merchandise, selling £5,000 per month each in May, June and July at a 50% profit margin. Wenlock bought all his stock in May, and Mandeville bought his at the start of the month in which he sold it.

  Wenlock Mandeville
     
May    
Sales £5,000 £5,000
Cost of stock purchased £7,500 £2,500
Deficit / surplus (£2,500) £2,500
Reportable for Universal Tax Credit £0 £2,500
     
June    
Sales £5,000 £5,000
Cost of stock purchased £0 £2,500
Reportable for Universal Credit £5,000 £2,500
     
July    
Sales £5,000 £5,000
Cost of stock purchased £0 £2,500
Reportable for Universal Credit £5,000 £2,500
     
Total income reportable for Universal Credit £10,000 £7,500

 

So despite having exactly the same trading results, Wenlock has to declare £2,500 more income for UC purposes than Mandeville, presumably as his punishment for stocking up in advance rather than buying to order. Clearly this is ridiculous and unacceptable, and some provision for carrying forward negative balances has to be made.

But it gets worse. You will note that the above example features no expenses other than cost of stock. On a cash basis expenses for a full year will often be included in the month they arise, such as annual subscriptions, insurance premiums etc. Also, rather bizarrely, the method of converting pre-tax income to post-tax income for UC purposes is to deduct tax payments like any other expense in the month they arise.

Thus, given that January is often a poor trading month as the country recovers financially from the annual Christmas over-spend, lots of businesses are going to show negative results for that month, given that they also pay their balancing payment and first payment on account for self assessment. So lots of inherently profitable businesses will be able to claim UC for January, and possibly also July due to the second payment on account. No doubt tax avoidance gurus are already plotting other ways to manipulate the system as we speak.

According to the regulations there appears to be no such thing as a partnership, but partners will need to provide details of their share of partnership income, which will be calculated on a different accounting basis, within 7 days of the month end for UC purposes. Hark, is that a pink thing with wings I see hovering over the office, saying “oink, oink”?

And what about companies? The regulations talk about ‘value extracted’ being the measure of income, at the point of extraction. But given that family company director / shareholders have full control over both means and timing of extraction, much planning will no doubt go into structuring dividends to make the majority of months eligible for a claim – indeed achieving this for 11 months should not be beyond the wit of an adept tax planner.

This will presumably be the trigger for a fundamental re-think of these regulations, even if the inconvenience and unfairness caused to business owners is not. There is no point in the advances made by government and HMRC against abusive tax avoidance if every Tom, Dick and Harriet can drive a coach and horses through the Universal Credit regulations and establish claims to which they are, by all that is right, not entitled. We are entitled to expect better than this from our government and civil service, and we should shout loudly and persistently until we get it.

 

Few aspects of the UK tax system have caused such problems in recent years as the issue of taxpayer residence. Given that this is an aspect that is utterly fundamental to the UK tax treatment of an individual, it is remarkable that there has been so little tax legislation on the subject for such an extended period of time. For many years the principal guidance on the question of residence came from two sources, namely the courts (which, given the haphazard nature of the cases which are litigated, could hardly provide comprehensive guidance) and HMRC’s booklet IR20, which offered extensive guidance on HMRC’s views of residence, but had no statutory authority.

This system held together remarkably well for a considerable period, but began to fall apart under the pressure of the changing transport possibilities in an increasingly mobile world. The opening of the Channel Tunnel and the widespread availability of cheap air fares, not to mention relaxed border controls between EU nations, meant that it became possible to be an international commuter even to an island nation such as ours. It is no coincidence that many of the recent tax cases on residence have featured airline pilots, who have particular scope to live their lives on a more international basis than could have been envisaged when the legislation and HMRC guidance was drafted.

As a result of the problems that this increased international mobility generated, HMRC gradually changed its stance on various of the views given in IR20, to the extent that it became a dead letter before it was formally withdrawn. This of course generated a large amount of uncertainty, which was a particular problem given the large amounts of tax that could be at stake depending on the residence of a particular taxpayer for a particular tax year.

This fairly quickly generated a consensus that more extensive legislation on residence was required, including a statutory residence test. What we now have on offer for consultation, in the form of something close to final draft legislation, has been ten years in the making. So is it worth the wait?

The stated aim of the statutory residence test is that it should be ‘transparent, objective and simple to use’. I will take you through it, and you can judge for yourself to what extent it meets these criteria.

The test is largely a series of tests, put together in what I would regard as a relatively complex structure, but one that is intended to be logical. I will attempt to follow these tests through in a logical order.

  1. A person is UK resident for a tax year if he or she satisfies either or both of two tests for that year, being the automatic residence test and the sufficient ties test (see below).
  2. If neither test is met for the relevant year then the individual is not UK resident.
  3. The automatic residence test is not satisfied if any of the automatic overseas tests are met.
  4. The automatic overseas tests are that an individual is not resident in the UK if any of the following apply:
    1. Where the taxpayer was resident in the UK for 1 or more of the 3 tax years preceding the relevant year and has spent less than 16 days in the UK in the relevant year.
    2. Where the taxpayer was not resident in the UK for 1 or more of the 3 tax years preceding the relevant year and has spent less than 46 days in the UK in the relevant year.
    3. Where the taxpayer leaves the UK to carry out full-time work abroad for at least one year, is present in the UK for less than 91 days in the relevant year and spends fewer than 21 days working in the UK in that year, a working day being defined as one on which 3 or more hours of work is carried out. Part of the consultation is as to whether the 21 days should become 26 and the 3 hours should become 5.

 

  1. If a taxpayer meets none of the overseas tests at 4 above, and meets one of four UK tests, he is automatically UK resident for the relevant tax year. The four UK tests are as follows:

 

  1. Day count

If an individual spends at least 183 days in the UK, the day count test is satisfied. Presence at midnight at the end of the day constitutes presence in the UK for that day, subject to 2 exceptions.

The first of these is where the taxpayer is in transit through the UK at midnight, and during his or her time in the UK does not engage in any activity unrelated to his or her passage through the UK. For example, if he or she merely sits in an airport terminal waiting for a connecting flight, this exception would apply.

The second exception is where the individual would not be in the UK at midnight on a particular day except for exceptional circumstances beyond his or her control that prevent him or her from leaving the UK, and he or she intends to leave the UK as soon as those circumstances permit.

 Examples given include national or local emergencies such as war, civil unrest or natural disasters (none of which the UK is fortunately prone to) and a sudden or life-threatening illness or injury. It is to be hoped that these are recognised as examples and not as a comprehensive list. Two examples that occur to me that would not be covered by the examples are the flight bans following the 9/11 attacks and as a result of the recent volcanic ash cloud.

There is a statutory limit of 60 days that can be regarded as not spent In the UK as a result of such exceptional circumstances, even a combination of two or more such circumstances. This is more than a little arbitrary; what if a taxpayer is in a coma, for instance?

I have a client who is resident in the Isle of Man but comes over to the UK to tend the family farm at lambing and harvest times. He broke his leg very badly on such a visit, and on the basis that he lives alone in the Isle of Man was advised not to return home until his leg had fully healed.

This resulted in him spending a few months in the UK, and as a result of me obtaining a letter from his doctor confirming his instructions to my client, we were able to satisfy HMRC that he was here due to exceptional circumstances, and did not as a result become UK resident despite breaching the current day rules. That would not have been possible under the new regime, given that my client spent more than 60 days here due to the exceptional circumstances.

The government is considering introducing a specific rule to apply to people who regularly depart from the UK before midnight in an attempt to manipulate the ‘midnight rule’, and are thus present in the UK on a large number of days without being here at midnight.

I could see the need for such a rule if it were required in respect of international commuters, who for example commuted daily from, say, North Western France, the Channel Islands or the Isle of Man, but surely the days working in the UK rule would catch such people in any case. It is quite hard to see in what other circumstances it would be worth the trouble, expense and inconvenience of regular travel in and out of the UK in order to avoid UK residence. Maybe the government has in mind fabulously rich football club owners flying in to see their club play on a regular basis and out again before midnight?

  1. ii.                  Home in the UK

The UK home test is one of the more unsatisfactory aspects of the proposed regime. It is satisfied if an individual’s only home is in the UK or if he or she has more than one home, all of which are in the UK. It must be the individual’s home for at least 91 days, all or part of which fall within the relevant tax year, or if there are 2 separate periods within that year the periods must together add up to at least 91 days. Unhelpfully a home is not defined, although it can be ‘any place’, and can include a vehicle or a vessel, so my putative plan to live in a narrow boat on the Bridgewater Canal will have to be put on hold.

The individual need not have any legal interest in the home, but equally if he or she retains an interest in a property after moving out of it, it will not on that basis alone continue to be regarded as  the individual’s home. I would have thought that went without saying, but maybe this is to clarify the position for former homes which are commercially let. Apparently, ‘a holiday home, weekend home or temporary retreat’ will not count as a home for the purposes of this condition, which I would have thought adds a considerable degree of complexity to the matter in the absence of a general definition of a home.

Representations from professional bodies made it clear that the definition of a home had to be robust in order to avoid uncertainty for taxpayers, and quite frankly the government has ‘bottled’ this issue, or to quote the response to the consultation, has “concluded that it would be extremely difficult to provide a precise definition given the wide variety of living patterns adopted by individuals and their families.”

However, according to the paper, the government is “confident that the vast majority of people will know where their home is and whether that home is in the UK or overseas”. Two thoughts: firstly, presumably those people are expected to be more confident than the government was in failing to define a home, and secondly, it is not simply a matter of knowing where your home is, but also of convincing HMRC that you know, which is rather different. This looks like a recipe for lots of litigation, and to draft modern tax legislation on that basis is utterly unsatisfactory.

A ‘place’ is not defined in statute either – the dictionary definition is “a particular part or portion of space … whether occupied or not ….”, which is not particularly helpful in this context.

  1. iii.                Full-time work in the UK

This test is satisfied if an individual works full-time in the UK for a period of 276 days (there is consultation on extending this to 365 days) during which there are no significant breaks from work, all or part of that period falls in the relevant tax year and more than 75% of the total number of days in the relevant year when more than 3 hours work a day are done are days when that work is done in the UK. Working includes both employed and self-employed work.

A significant break from work is a period of 31 days or more where there is no day on which the individual does more than 3 hours’ work in the UK and the reason for absence is not annual leave or sick leave.

Full-time work is defined as 35 hours or more a week on average over the period, which may be reduced to take account of reasonable periods of leave and of sick leave when an individual cannot be reasonably expected to work because of injury or illness.

Working is doing something in the performance of the duties of an employment or a trade. Travelling time counts as working time if the costs can be deducted from earnings or profits (so not ‘ordinary commuting’) or if the individual carries out work during the course of the journey (e.g. work phone calls or e-mails).

The legislation delivers itself of the profoundly unhelpful statement that “work is done where it is actually done”, except where work is done in the course of travelling. Work done in the course of travel by sea, air or Tunnel from overseas to the UK or vice versa is assumed to be done overseas, and travel starts at the ‘embarkation point’. Whether that is arriving at the airport or boarding the plane is unclear, although logic suggests that passing through passport control (going airside) would be a sensible cut-off point.

  1. iv.                 Death during the year

Proof that the legislative draftsman is all heart comes from the final test, which is satisfied if the individual dies in the relevant year, had for each of the previous 3 tax years been resident in the UK because he had satisfied the automatic residence test, when he died his normal home was in the UK and the preceding tax year would not be a split year for the individual even on the assumption that he was not resident in the UK in the relevant tax year. Taxpayers should thus be advised to take great care over where and when they die.

The sufficient UK ties test applies where an individual meets neither any of the automatic UK tests nor the automatic overseas tests, and is met where the individual has sufficient UK ties. There are a variety of possible circumstances in this respect, depending on residence for the 3 previous tax years and the number of days spent in the UK in the relevant tax year. Still following this ‘simple to use’ system? Good. This is best illustrated by a table:

Days spent in the UK in the relevant tax year Number of ties that are sufficient where an individual has been UK resident in the 3 years preceding the relevant year Number of ties that are sufficient where an individual has not been UK resident in the 3 years preceding the relevant year
More than 15 but fewer than 46 At least four  
More than 45 but fewer than 91 At least three All four
More than 90 but fewer than 121 At least two At least three
More than 120 At least one At least two

 

Those of you who are still paying attention, and have not yet lost the will to live, will note that there are four possible UK ties for those who have not been UK resident in the 3 previous tax years, whilst I can tell you that there are 5 for those who have been so resident. Fortunately the 4 former ties overlap with 4 of the 5 latter, with an extra tie for the formerly UK resident.

The four common ties are as follows:

  1. i.                    Family tie

An individual has a family tie if there is a relevant relationship at any time between the individual and another person who is resident in the UK in the relevant tax year. Although the draft legislation appears to have been drafted by someone illiterate, it will apparently be amended to define a relevant relationship as one existing at any time between an individual and another person if:

  1. That other person is the individual’s husband, wife or civil partner and they are not separated;
  2. That other person is living with the individual as husband and wife or as civil partners; or
  3. That other person is a child of the individual aged under 18, where the individual sees the child in the UK at any point on more than 60 days in total in the relevant year.

For the purposes of test c, if the child is in full-time education in the UK and spends less than 21 days in the UK outside term time the child is treated as non UK-resident, and thus irrelevant for the purposes of this test.

It is not possible for the residence of spouses to be interdependent on each other, because the legislation specifically says so.

  1. ii.                  Accommodation tie

An individual has an accommodation tie in a relevant year if he has a place to live in the UK which is available to him for a continuous period of at least 91 days during that year and he spends at least one night at that place in that year.

‘A place to live in the UK’ includes a home, holiday home, weekend home, temporary retreat or something similar in the UK, or accommodation is otherwise available to him where he can live when he is in the UK. The individual need not have any legal interest in the property or have any legal right to occupy it. If fewer than 16 days elapse between the periods in which a particular place is available to the individual, that place is treated as being available to that individual for that period.

This should mean that short stays in hotels and guesthouses will not count unless the individual is careless enough to book a room for at least 91 days or the 16-day rule applies. In the latter case this can be avoided by using a different hotel for each separate stay within a 16 day period.

If the accommodation belongs to a parent, grandparent, brother, sister or adult child or grandchild of the individual, the requirement to spend one night is increased to a total of at least 16 nights at that place in that year. The problem with this is that if a friend is always willing to put up the individual the accommodation tie will be satisfied if the individual spends one night at the friend’s house. I can see myself drafting contracts between friends saying that on no account will non-resident friend be allowed to spend more than 15 nights per tax year in resident friend’s house. This could easily be solved by extending the15 night provision to any accommodation occupied for nil consideration.

One of the problems with all this harks back to my recent text about the child benefit tax claw-back “Too Much Information”. The’ living as husband and wife or civil partners’ test will require tax advisers to ask extremely personal questions of clients to whom the accommodation test is relevant, which I am not sure was ever part of my job description, or ever should be.

  1. iii.                Work tie

An individual has a work tie if he works in the UK for at least 40 days in the relevant tax year, work in this context being deemed to be more than 3 hours a day, although the government is consulting on increasing this to 5.

  1. iv.                 90-day tie

An individual has a 90-day tie for the relevant tax year if he has spent more than 90 days in the UK in either the tax year preceding the relevant year, the tax year preceding that year or each of those tax years.

  1. v.                   Country tie (NB only applicable to those resident in the UK in at least 1of the 3 tax years preceding the relevant year)

An individual has a country tie for a relevant year if the country in which he spends the greatest number of days in that year is in the UK. In the event that he spends the same number of days in 2 or more countries in a year and that number is the greatest number of days spent by him in any country, he will have a country tie if one of those countries is the UK.

I am intrigued by the wording of this part of the legislation, specifically:

“if the country in which he spends the greatest number of days in that year is in the UK” (my emboldened italics). Note that it does not say “is the UK”. The implication of this is that the separate parts of the UK will be treated as separate countries for this purpose (perhaps in anticipation of the Scottish independence referendum?). Thus there may be opportunities for judicious planning for taxpayers to divide their time in the UK between the four constituent countries in order to avoid meeting this test. On that basis I can see the Welsh and Scottish borders becoming very popular under the new residence regime.

In summary, anything would be better than the chaos that is UK tax residence, so the new regime will be an improvement. But what a missed opportunity to clarify the position beyond all doubt, to give absolute certainty to taxpayers on their residence status. The legislation is complex, involves subjective concepts (notably “home”) which have not been defined, adequately or indeed at all. It is profoundly unsatisfactory that modern tax legislation should be drafted on such a basis, particularly as there are models, such as the US weighted average day count test, which could give such certainty. “Could do better” has to be the verdict on this draft legislation.

From April 2013 it will be possible for income attributable to patent rights to be subject to corporation tax at a special rate, ultimately falling to 10%. Whilst no doubt the large pharmaceutical companies of this world will have all of the accounting systems necessary to isolate all relevant income at the touch of a button, how is the smaller company patent holder likely to compute the level of relevant income?

The patent box is the technical name for the amount of profit eligible for the 10% rate. In order to determine the amount of that profit, it is necessary to distinguish it from routine return and marketing asset return on patents or products containing them, as well as from non-patent income.

The patent box comes into effect on 1 April 2013, and for that purpose company accounting periods overlapping that date will be divided into two. In 2013 60% of patent box profits will be eligible for the 10% rate, increasing to 70% in 2014, 80% in 2015, 90% in 2016 and 100% for 2017 and subsequent financial years.

The types of income eligible for the special rate are:

  1. Income from sale of patented items, those that incorporate a patent somewhere, or the sale of spares in respect of such items;
  2. Licensed-in patent rights; and
  3. Compensation for infringement of patent rights

This income is determined by stripping out profits considered routine (i.e. those that would be made regardless of the patent) and profits attributable to the brand value of the item. For smaller companies there is a formulaic approach to permit this exercise to be carried out without a detailed accounting system to generate all the required figures in detail.

There are various conditions to satisfy in order for profits to get into the patent box:

  1. The organisation must be a company, not a sole trade, partnership or LLP.
  2. The company must hold a patent or a countrywide exclusive licence to exploit one. This includes a variety of industry-specific rights similar to patents, specified in the legislation.
  3. The patent must be granted by the UK patent office, the European patent office or the patent office of one of 13 specified European countries.
  4. The company must have actively developed the patent or a product incorporating it.
  5. In the case of a group of companies, where a specific company holds all intellectual property, its income will only qualify for the patent box if it takes an active role in managing the IP portfolio. The definition of a group includes associated companies as well as subsidiaries.
  6. The company must elect into the regime.
  7. Although the patent box only applies from the date of grant of a patent, it is possible for a company to bring into the patent box all relevant profits that have accrued while the patent is pending, which will happen as of the date of grant (see below for details).For this to happen the company must have had the patent box election in force for all earlier accounting periods from which profits are re-allocated, and must be a qualifying company for such periods.
  8. Companies may go back for this purpose to the later of the date on which the patent was filed or 6 years prior to the date of grant. In this respect the current lag time for a UK patent is around 2 years, and for a European Patent Office patent 5 years.
  9. The deadline for an election is two years from the end of the company’s accounting period.
  10. An election may be revoked at any time, on the basis of the same deadline. Once a company has left the patent box, it may not re-enter for at least 5 years.

There are 3 main steps to identifying the patent box profits for the smaller company without detailed data to separately identify:

Step 1 – Identify the profit in the box

The first part of this step is to apportion turnover between that derived from patents and that which is not, identifying the patent box profits as a percentage of total turnover.

The second part is to apply that percentage to all costs, and hence to the profits.

Step 2 – Strip out the routine return

The legislation assumes that companies would enjoy a 10% mark up on all routine expenses; this mark up is apportioned as above and stripped out of the patent box profit. As a yet further incentive to take advantage of the UK’s extremely generous research and development tax relief regime, salaries forming part of an R & D claim are not included in this cost plus calculation.

Step 3 – deduct a marketing asset return

For companies with a qualifying residual profit (i.e. what is in the patent box after step 2) of less than £1 million, or in some cases £3 million divided by the number of associates, it is possible to elect for ‘small claims treatment’. This involved deducting 25% of the qualifying residual profit to take account of the brand element. As this article is dealing with the regime as it will apply to smaller companies, I will not consider the more complex alternative approach.

For profitable companies, it would be pointless to delay entering the patent box. However, if there are patent box losses, they can only be relieved at the 10% rate, and can thus only be carried forward against future patent box profits or group relieved against profits of other group patent box companies. Thus loss-making companies will wish to remain outside the patent box until they have relieved any losses that would be patent box losses.

Thus companies that benefit from exploitation of patents will need to consider whether, and at what stage, they should elect into the patent box, remembering the risk of premature election should it prove necessary to withdraw the election at some future stage. Those with patents pending will face particular urgency, not to mention difficulty. In taking this decision. Nonetheless this is a regime that will complement the research and development tax regime in establishing a tax regime under which it is attractive to develop and exploit new products in the UK.

 

 

A couple of months ago, I pointed out that HMRC had gone on record as suggesting that Olympic torch relay runners who sold their torches (which they could purchase from LOCOG for £215) would be regarded by HMRC as generating a capital gain. I doubted the validity of that advice, initially on the basis that in my view the torches would be chattels that were wasting assets (i.e. they have a useful life not exceeding 50 years), and thus exempt from capital gains tax.

Since then the plot has thickened in two respects. Firstly, I am now informed that aluminium, the base metal from which the torches are made, does not have the same propensity to rust as, say, iron, and that it is thus likely that, properly cared for, the body of a torch is perfectly capable of surviving for 50 years. Thus, if bought as a souvenir or memento of the Olympics, or indeed the torch relay, it may be that a torch body is not in fact a wasting chattel.

This does not, however, mean that HMRC’s advice is necessarily correct. The next question to ask is whether the torch is a machine, as plant and machinery is always regarded for capital gains tax purposes as having a predictable life of less than 50 years.

I feel like I am on firmer ground here, as I saw the torch relay in Whitefield, Manchester (twice) and Old Trafford, including three handovers between torchbearers, so I have a reasonable idea of the workings of the torches. Apparently they have a burner mechanism which draws a mixture of liquid propane and butane from a canister , evaporates it through a heated coil and ignites it, producing heat and light. Think hot air balloon burner and you will get the basic idea. All that heat was the reason why the torch body was needed, to protect the user from the heat produced and the flame from the elements to ensure that it remained lit.

Policemen with special Allen keys were on hand at each exchange to turn on the gas supply to the burner, after which the torch was lit from the flame of the previous runner’s torch. That torch then had its gas supply turned off with the same key, the gas canister was removed and the tube between canister and burner was severed.

All of that sounds awfully like a machine to me; it converts liquid to gas and gas to heat for visual effect, and a key is used to turn on the gas supply to the burner mechanism, which evaporates and ignites the gas, forcing it out of the top of the torch by a process of gasification and expansion. The question that then arises is whether, once the torch is disabled, it remains a machine or becomes something different? I think it remains a machine,  because the disablement process, involving as it does the turning off of the gas supply with a key, is both temporary and readily reversible, so the torch could fairly readily be made usable once again if so desired. There are many examples of machines that operate on a similar basis; a car perhaps being the most obvious example.

So my reasons may have changed, but I still think HMRC is talking rubbish when it says that CGT could arise on the sale of an Olympic torch.

 

 

University is a wonderful place, even if you are reading for an accounting degree. One of the aspects of my taxation course that I remember most vividly was being asked to design a tax system from scratch, with no preconceptions and no existing tax legislation. What a wonderfully liberating exercise that was, and how straightforward were the systems that our young minds devised. And then we were let loose on the real UK tax system, and life was never the same again.

My previous post summarised a symposium organised by the Institute of Chartered Accountants in England and Wales, on the subject “Is Tax Simplification Possible?”. The general conclusion, even from a discussion which featured a major contribution from the director of the Office of Tax Simplification, was “no”.

However, the co-organisers of the 2020 Tax Commission, The TaxPayers’ Alliance and the Institute of Directors, would beg to differ. Their report “The Single Income Tax” proposes a dramatic and far-reaching simplification of the UK tax system, and is therefore worthy of some serious consideration.

The basic idea is that the vast majority of UK taxes would be swept away, including the following old favourites:

National insurance (“almost indistinguishable from income tax”)

Capital gains tax (“an additional income tax on dividends”)

Corporation tax (“penalises some combination of labour and capital based on the economic efficiency of the company concerned”)

Stamp duty and stamp duty land tax (“transaction taxes have little relation to the ability of individuals to pay”)

Inheritance tax (“hits families again on the same money they have already paid tax on, just because someone has died”)

Instead there would be a single income tax, levied at a single rate. The Commission calculates that, at 2011-12 prices, with a £10,000 personal allowance the rate of this single tax would need to be 30% to make government tax revenues account for 33% of national income (like Australia),  allowing for an abolition of air passenger duty (fails my green test then) and a fuel duty cut of 5p per litre (definitely fails my green test).

Setting aside the desirability of basing our tax system on that of a country which won less than a quarter as many Olympic gold medals as us and has not won an Ashes series in this country since 2001 (petty I know, but I enjoyed it), this is a very interesting proposal indeed, if rather bleak for my future business and employment prospects. I quote:

“A large and sustained rise in the number of (tax) advisers is surely a symptom of an over-complicated and worsening tax code as much as of an industry becoming more successful in promoting the benefits it offers. Membership of the Chartered Institute of taxation has grown every year from 10,115 in 1996 to 15,400 in 2011”. I was one of each of those numbers, but will try not to let my instinct for self-preservation in any way influence my thoughts on this proposal, that threatens to steal the very bread from the mouths of my young children.

The report makes a compelling case for a 21st century Nirvana where tax liability is determined purely by ability to pay, regardless of the form in which income is received, and  tax avoidance is a thing of the past, although whether Nirvana would feature a significant increase in air and road traffic is a more complex question. It does also recognise that merely saying “let tax be 30%” is actually too simple for a modern tax system, and that there is a requirement for some element of greater complexity.

This would primarily  take the form of a tax on income from capital, deducting the entire liability (comprising net distributions to holders of capital) at source. UK companies would pay tax on dividend and interest payments less dividend and interest income, whilst share subscriptions, buybacks and loan principal amounts would also be taxed or eligible  for credit, depending on the direction of flow of funds.

There is also recognition (of sorts) of issues relating to national insurance / state benefits and also pensions. The political direction from which this report is coming is made clear by an unintentionally hilarious line about state benefits:

“The government’s state pension proposals will remove all but a relatively tiny link in the benefits system with national insurance (query the definition of ‘relatively tiny’ to cover 30 years’ national insurance contributions as the basis for a full state pension).The remaining contributory benefits can easily be reformed. Some of those losing out will be eligible for non-contributory benefits, while benefits for the others could either be abolished or linked to tax payments instead.”

Here is the clearest possible hint that the authors have lost contact with the real world in pursuing their hazy dream of tax paradise. Let’s take people on contributory benefits and just abolish those benefits, or link them to tax payments, which with a personal allowance of £10,000 are unlikely to feature large in the day to day life experience of the benefit claimant. ‘So let’s just let them starve’ might be a fairer way of putting this, I think.

The report also has an intriguing insight into the possible mechanism for abolishing employers’ national insurance, prefaced by the remark that “a key issue is to inform employed taxpayers that they already pay employer’s national insurance”. Well, no they don’t actually. That remark is predicated on the basis that employers fix salary levels on the basis of 112.8% of their employees’ salaries, which is not in my experience how the process works at all.

What the proposal is actually intended to achieve is to mislead employees into believing that their tax liability is being increased, before making them feel good by misleading them into believing that they have enjoyed a corresponding reduction. This becomes clear from the following description:

“An initial step would compel employers to state employer’s national insurance on payslips, add a line called ‘total salary’ that included employer’s national insurance, and rename it ‘income tax (payroll charge).”

An interesting way of reducing complexity by baffling the hell out of the majority of employees; if a proposal requires that to work then it seems to me to be fundamentally flawed.

Protection of pensioners would require further complexity, either allowing them to effectively opt out of the new regime or artificially inflating annuity rates. I am reminded of the comment directed at my grandfather on Rawtenstall market following the introduction of decimalisation:

“I don’t know why they didn’t wait until all of us old ones had died”.

Indeed, given my close association with Wigan, I should also quote the other classic remark directed at my grandfather on that occasion:

“Don’t bother me with that rubbish; I’m moving to Wigan next week”.

So as ever in tax, simplicity implies its own form of complexity. But the real flaw in this plan, the massive elephant not so much lurking in the room as stomping all over the furniture, is VAT. How can a proposal to radically simplify the UK tax system just ignore a massive revenue-raising tax such as VAT? Well of course it has to, because VAT does not fit into the simple world view that it is necessary to adopt in order to imagine that the single income tax system has a snowball in hell’s chance of working in practice.

There are two fundamental problems with VAT in this respect. The first is that it is a tax, not on ability to pay (the cornerstone of the proposed brave new world) but on consumption. Anathema to the authors of the report, because the need (or indeed the desire) to consume resources is not necessarily linked to ability to pay for them. But then any report authors who can airily suggest that contributory benefits ‘could be abolished’ are not going to worry about a little detail like that.

The truth is that VAT is potentially a massively regressive tax, whose worst features in that respect are ameliorated in the UK only by extensive zero-rating of essential items such as food, water, sewerage, new residential buildings, children’s clothing and footwear, dispensing of drugs, public transport and certain specific reliefs for people with disabilities and charities, and by the use of the 5% reduced rate for other items, such as domestic power, to which the EU no longer allows us to apply zero-rating.

Oops, and there goes the other massive complication to the happy world of the single income tax, namely the EU. VAT is a tax largely regulated by the EU, subject to the collective decisions of the members on its main principles and levied at a rate set within fairly narrow bands by the European Commission. So how exactly are we going to deal with VAT in the brave new world? Are we going to abandon our cherished zero-rating schedule and start adding 20% to the prices of food, water and children’s clothes in the name of simplicity? Or are we going to declare UDI and abolish VAT altogether; surely not even the IoD are advocating such a ‘scorched earth policy’ with regard to the EU? Well, apparently, it isn’t important enough to mention. So much for the simplicity of the proposed new tax system.

And then of course we have those taxpayer behaviours that governments see fit to encourage, with resulting complexity in the tax system. Charitable donations, anyone? Investment in riskier unquoted companies? Investment in green technologies in transport or construction projects? All presumably to go by the board, although silence reigns on these issues too.

The reality is that the brave new world would be a nightmare, just like Aldous Huxley’s original version. Let’s face it, the ICAEW symposium had it right, tax will never be simple, just (hopefully) simpler. And anyone who tries to tell you otherwise could be either a fool or a charlatan, or just possibly both. 

 

 

 

 

A stellar cast of tax luminaries was let loose last month in Chartered Accountants’ Hall to discuss whether tax simplification was achievable. The conclusion of the majority of the audience, both before and after the symposium, was that it is not.

As a great advocate of the ‘Keep it Simple, Stupid’ principle, I guess I should be depressed by that conclusion, but whilst I might be depressed I am not surprised. I have after all gone on record as saying that whenever a Chancellor says he has simplified the tax system, it has invariably just got more complicated. So what are the reasons for the symposium’s conclusions?

I think these were neatly summed up as fourfold by Robert Maas, veteran tax lecturer and practitioner:

  1. 1.       Chancellors like to introduce legislation

Sad but apparently true. All of the Finance Acts of the 1950s (I am guessing 10 in number) came to 625 pages in total. This year’s Finance Act alone is 687 pages. All of the Finance Acts of the 1960s came to 1,262 pages (which covered the introduction of three whole new taxes in corporation tax, capital gains tax and capital transfer tax). The current government has produced 1,219 pages in two and a bit Finance Acts to date.

  1. 2.       It is cheaper and easier to introduce new legislation than to enforce the old

If the IR35 legislation worked as intended, we would have no need for the proposed  personal service company legislation.

  1. 3.       Provisions are rarely removed once on the statute book
  2. 4.       Parliament patches poor legislation rather than withdrawing and replacing it with effective provisions

And it thus becomes disjointed and hard to follow.

Robert Maas also made the point that Chancellors use the tax system to influence taxpayer behaviour by introducing deductions and reliefs, which again makes it more complicated. I think I would have made the more general point that Chancellors ‘play politics’ with the tax system, which means that many ‘temporary’ changes are introduced over time, which are subsequently replaced by further, slightly different legislation.

Another curse of the modern world is the desire to be seen to be innovative, or put more simply, to be seen to be doing something, almost regardless of what that is. Thus we see constant government initiatives, not least in the area of tax, which require legislation to put them into effect. They grab headlines and suggest dynamic action, but they do not simplify the tax system.

Finally, Robert suggested that the Office for Tax Simplification (see below) should address more strategic issues such as the structure of the law in particular areas to see whether the objectives of the current law could be met in a simpler way. At the moment it concentrates on looking at reliefs that might be removed from statute.

Appropriately in view of this reference, Robert was followed by John Whiting, technical director of the Office for Tax Simplification (OTS). Presumably we would have considered that we were indeed in trouble if John did not think that tax simplification was possible in view of his role! However, he did say that he did not think a simple tax system was possible, and regarded his Office’s role as making it simpler. He approached this task on two bases, that of technical simplification and practical administrative simplification, the latter being arguably the more important. Simplicity to deal with is perhaps the key feature of a tax system.

The constraints on the work of the OTS were scarce government resources, Treasury nervousness about fundamental changes to the tax system and unintended consequences thereof (I would agree in passing that the Treasury is not good at anticipating such consequences) and the current state of the economy, with no money to compensate ‘losers’ from such changes.

There were big questions about how the OTS should operate, as follows:

  1. Should it go for relative tinkering, or take a more profound look at a particular part of the system? The latter for me.
  2. Is the current way of making tax legislation sustainable, with its aim of precision, or should we opt for principles based legislation instead? I would say no to the first part of the question and yes to the second. Our current method of making tax legislation is flawed, both because the Treasury is so bad at identifying unintended consequences (which is an invitation to aggressive tax avoidance) and because Parliament devotes shockingly little time to scrutiny of the legislation, mainly presumably because there is so damn much of it. Our tax system badly needs guiding principles, which are a feature of a number of other first world tax systems. The advent of the General Anti-Abuse Rule is a first hopeful sign that this may be happening.

The final speaker was David Heaton, another luminary of the tax lecture circuit. He had a simple message, which was that constant change is a bad thing, and that his manifesto was “stop it”. Stop making endless changes to the existing tax system, so that people get used to the rules and can comply with them. Never introduce a law with which taxpayers cannot comply – witness the high income child benefit tax charge. Always consult fully on tax changes in advance – witness the proposed changes on granny, pasty and caravan taxes, all highly controversial, two of them withdrawn, and none of them subject to consultation.

So there you have it. We will never have a simple tax system, but we need a period of stability in tax, to use the expertise of the tax profession to identify in advance those unintended consequences that the Treasury can never predict and to direct the attention of the OTS sequentially to tidying up the legislation in a variety of complex areas of taxation. Do those three things and we might get somewhere in making the tax system simpler, even if never simple.

 

 

 

 

Set out below is the text of questions posed by a journalist and answers given by me in respect of the issue of taxation and non-domiciles:

1)     How does one qualify for non-dom status?

 

Domicile is a legal rather than a tax concept, is rather akin to nationality than residence, and works as follows:

 

A child is born with the existing domicile of its father (or its mother is father is unknown) – this is known as a domicile of dependency. Until the child reaches age 18 (or marries below that age) its domicile follows the relevant parent’s domicile. At the age of 18 a person is capable of establishing their own domicile – their birth domicile is now known as a domicile of origin, and any subsequently acquired domicile of dependency becomes a domicile of choice.

 

A domicile of origin is hard to change – it requires both a cutting of ties with that domicile and an establishing of ties with a specific new domicile of choice. It is easier to change a domicile of choice by cutting ties with that domicile and acquiring ties with a new domicile of choice. If a domicile of choice lapses without a new domicile of choice being acquired, the person reverts to their domicile of origin.

 

When I refer to ties above I mean a variety of connections to a particular country, such as social, financial and economic ties. It can also be important in this respect where a person has made their will and where they have chosen to be buried or cremated.

 

It is implicit in non-domiciled status that a taxpayer is resident in theUKfor tax purposes; if they were not they would be taxable here only onUKsource income.

 

 

2)     Will people go to extraordinary lengths to remain a non-dom? Egs?

 

Yes. I will give a classic example of a client of mine. His parents were Jewish, and fled Nazi persecution in their Polish homeland, leaving behind residential and business property. He was born in theUKjust after World War 2, and has lived here all his life. In the 1980s he acquired a holiday home inIsrael, where he spends around 6 weeks a year.

 

In the early 1990s, after the fall of the Berlin Wall, he established his claims to his family’s property interests inPoland(his father having died), which were sold in the late 1990s, cutting all family ties withPoland.

 

I was able to establish Polish domicile for my client on the following basis:

 

1. His father’s domicile of origin was inPoland, and it was fairly clear that his parents would have returned toPolandhad World War 2 and then the communist occupation permitted them to do so.

 

2. His own domicile of origin was thus also inPoland.

 

3. The family retained substantial property interests inPolandthroughout the communist period, although they were unable to legally establish them at that time.

 

4. Those property interests passed to my client under his father’s will in the 1980s, and were successfully asserted by him in the 1990s.

 

5.  By the time my client sold his Polish property interests and thus cut his ties withPoland, it was unclear whether his domicile of choice wasEngland(one is domiciled inEnglandorScotland, not theUK) orIsrael, as he had property and spent time in both countries. Thus his Polish domicile of origin persisted.

 

It is not uncommon for people to be able to establish domicile in countries with which they have had little or no contact for many years.

 

3)     How complex are the rules governing non-dom status? Changes required? If so, what?

 

I have given an idea of the complexity of the rules above. They are difficult to change because they are matters of general law rather than simply tax law. Thus when the Government wished to increase the burden of tax on non-domiciles, rather than seeking to change the law of domicile they introduced a flat rate tax charge on non-domiciles who benefit in tax terms from their non-domiciled status (see below for further details)

 

4)     What are the benefits/ drawbacks of being a non-dom?

 

The main benefit is that a non-domiciled taxpayer is entitled, if it is to his or her advantage, to use what is called the remittance basis of taxation in theUK. This means that a non-domicile is only taxed in theUKon income and gains arising outside this country if he or she brings them to theUK.

 

In recent years an annual charge has been introduced for non-domiciles wishing to use the remittance basis, unless they have been resident here for less than 7 of the last 9 tax years, or the amount of income concerned is less than £2,000 in a particular year. The charge is £30,000 for those who have been resident here for at least 7 of the last 9 tax years, and £50,000 for those who have been resident here for at least 12 of the last 14 tax years.

 

If they do not wish to pay the charge they are taxed on the arising basis; that is to say they are taxed in theUKon worldwide income. Thus a calculation needs to be made each year to decide if it is worthwhile for a taxpayer to pay the remittance basis charge.

 

Of course the issue with a flat rate charge is that those with modest non-UK income will never choose to pay it, but for those with very large non-UK income it is a drop in the ocean. Many of us thus consider the remittance basis charge to be unfair and inequitable as between taxpayers.

 

Another key advantage of being a non-domicile relates to inheritance tax. Once a taxpayer has been resident here for 17 of the last 20 tax years, he or she is deemed domiciled here for inheritance tax purposes, but prior to that it is possible for them o place all of their non-UK assets into a non-UK  (offshore) trust, from which they can benefit, and thus keep all of those assets outside the UK inheritance tax net, even once they are deemed domiciled here, which would usually mean they were subject to inheritance tax on worldwide assets.

 

The main drawback is complexity of financial affairs, as it is necessary to ensure that income and gains are, so far as possible, not brought to theUK. Thus it is common practice to have separate income, capital and capital gains bank accounts, and to remit money only from the capital account. This can be expensive in terms of bank charges, as can operating an offshore trust (which is in fact extremely expensive).

 

5)     What recent events have had a big impact on non-doms?

 

Apart from the increase in the annual remittance basis charge from £30,000 to £50,000 mentioned above, the other significant change is legislation allowing non-domiciles to bring income and gains into the country without triggering a remittance basis charge in order to provide equity or loan finance to a UK-based trading company, including a company which they control.

 

The idea is to stimulate the UK economy with an influx of funds from abroad, and this appears to be a positive change, probably designed to achieve the same objective as the limited remittance basis charge for the seriously wealthy, but much better targeted in that respect.


 

6)     ICAS has set up a taskforce to produce a set of principles for accountants on tax avoidance following media storm over tax avoiders – will this also cover non-doms?

 

That is a good question, to which the answer is complex, and is probably yes and no! To explain what I mean, I need to outline the distinctions between various types of tax mitigation and tax avoidance.

 

It seems to me that there are probably 4 types of what might be loosely termed tax avoidance or tax mitigation:

 

  1. Behaviour that is encouraged by tax legislation. This would include investments under Enterprise Investment Schemes and donations to charity (which is why George Osborne’s proposed cap in this respect was so controversial). It is entirely possible to construct an argument that says that the tax legislation lays out a framework for the taxation of non-domiciles, and that if they choose to take advantage of that framework by structuring their financial affairs in a particular manner, that is entirely their decision.

 

  1. What HMRC’s Consultation Document on a General Anti-Abuse Rule refers to as ‘the centre ground of tax planning’.  What they appear to mean by this is planning that legitimately takes advantages of options granted to taxpayers by the tax legislation, without resorting to artificial transactions or transactions that have no commercial justification other than saving tax. I would put Sir Chris Hoy’s arrangements in this category, to give some context.

 

  1. The grey area between the centre ground of tax planning and         

          what HMRC refers to as abusive tax planning. This is

          inhabited by schemes such as the Icebreaker scheme in           

which Gary Barlow has invested. This has commercial substance, in that it genuinely supports the dissemination ofUKmusic andUKtechnology into overseas markets, but it is also structured in such a way as to give a very large amount of upfront tax relief to investors.

 

  1. Schemes that are clearly abusive, in that they are

artificially designed with no commercial merit other than the tax saving they achieve. Jimmy Carr’s K2 scheme would fall into this category, as no-one would make an arms-length decision to give their income to a trust which might lend it back to them if the trustees see fit to do so.

 

So the answer to the question is that taking advantage of non-domicile status by structuring one’s financial affairs in the commercial manner that best suits the current system would generally be regarded as acceptable, but straying into artificial arrangements to take advantage of the legislation would not be. So I suspect the ICAS task force will not look at non-domiciles per se, but may consider some of the tax arrangements they use where these appear potentially abusive.

 

7)     Recent budgets worked for or against non-doms? In what way?

 

I would say recent Budgets have very much worked against non-domiciles, certainly those who have been resident here for at least 7 years. Until 6 April 2008 there was no remittance basis charge, so arguably payingUKtax on non-UK income and gains was voluntary for non-domiciles, and certainly it was relatively straightforward to structure a non-domicile’s tax affairs so as to minimise income tax, capital gains tax and inheritance tax charges on non-UK income and assets.

 

The remittance basis charge has effectively restricted the significant tax advantages of non-domicile status to those who have not resided in the UK for 7 years and those whose UK tax liability on unremitted income and gains would exceed £30,000 (now £50,000 for those who have lived here for at least 12 years), which means of course the better-off non-domiciles, to some of whom such tax figures are a drop in the ocean.

 

The above changes have to some extent been mitigated by the introduction of the relief from the remittance basis for money brought into theUKto fund trading companies, which is the one positive change for non-domiciles in recent tax legislation.

 

8)     Any new legislation had an influence? Will have an influence?

 

I think I have answered this at 7 above.

 

9)     Big court cases? Impact?

 

Not in general an area of law that generates high profile court cases, because the domicile status of an individual is a matter of fact rather than law, and as such to be determined by the first tier Tax Tribunal and not capable of being appealed to a higher court. We have not yet seen any significant cases on the remittance basis charge, and other legislation is too new to have generated cases as yet.

 

10)  How are non-doms generally perceived by government and public at large? Will the recent adverse publicity against tax avoiders tarnish non-doms too? Likely effect of this?

 

As a tax expert, I have found the vast majority of media coverage of the tax avoidance issue to be facile, sensationalist and frankly confusing for the general public (probably a feeling shared by any expert whose field suddenly becomes of interest to the mass media!) Certainly I know of significant donors to charity who have either curtailed their giving or been the subject of ill-informed criticism on the basis that they were engaging in tax avoidance.

 

Thus it appears likely that adverse publicity about tax avoiders will tarnish non-domiciles, because of the favourable tax regime that they (or at least the richer of them) enjoy. And if this results in a change to the current regime, which actually gives (to my mind) unfair tax advantages to mega-rich non-domiciles, then all the better from my perspective. Better by far, it seems to me, to seek to tax the worldwide income of non-domiciles and then give relief for funds used to invest inUKbusiness.

 

The government perspective on this is quite different, I perceive. The presence of extremely rich foreign citizens in theUKis regarded by government as a positive factor, on the basis that they spend significant sums of money in theUKand thus generate tax revenue in that way, even if HMRC does not get its hands on tax on their worldwide income or assets. And of course some of them do invest inUKbusinesses (either their own or others’) and generate economic benefits in that way also. I assume that is why the tax system is deliberately skewed in favour of the richest non-domiciles, to the extent that those who find it worthwhile to pay the remittance basis charge are almost certainly paying a lower rate ofUKtax on their foreign income than less wealthy non-doms who have to pay tax on their full worldwide income. This is a unique situation in theUKtax system, and frankly not one with which I am at all comfortable.

 

I think the public perception of non-domiciles is in general negative, unless they happen to have invested heavily in one’s football club! They are associated with tax avoidance and ‘not paying their fair share’ of the tax burden, and also perhaps seen as wishing to remain ‘semi-detached’ from theUKby not adoptingUKcitizenship and thus effectively renouncing their non-UK domicile.

 

Looking forward, I would like to see tax reliefs for non-doms tied firmly to business investment in theUK, but I believe that the government will wish to continue to attract wealthy non-doms to live here, and will thus stick to the current system, which appears to have cross-party support (it was introduced by the Labour government). I also look forward to an informed debate on the nuances of tax mitigation and tax avoidance activity, but I am not necessarily holding my breath!

If there is one comment from a Chancellor guaranteed to get the tax profession excited, it is a proposal that he describes (when ARE we going to have a female Chancellor, by the way) as a simplification of the tax system. This is because history and experience have taught that this usually means that the tax system is going to get more complicated, at least in the short to medium term. And in the long term, as John Maynard Keynes so rightly said, we are all dead.

 

So when George Osborne, in his March 2012 Budget speech, said that the government was going to consult on a simpler system of taxation for micro businesses, it may be fair to see that there was a degree of cynicism within the tax profession. So was it justified, and what is proposed?

 

HM Revenue & Customs has just concluded the consultation exercise, so it is interesting to review their consultation document to see what they have in mind for the future tax treatment of micro businesses.

 

Currently 6 out of 7 sole traders in theUK(some 3 million people in total) have a turnover below the £77,000 VAT threshold. The requirements of accounting practice are the same for them as for the largest of multinationals, at least in the sense that the accounts that they submit to HMRC have to be prepared in accordance with Generally Accepted Accounting Practice (“GAAP”), which means for example using the accruals basis, requiring accounts to be prepared on the basis of revenue earned and costs incurred rather than on the basis of money received and expended.

 

There used to be some exceptions to this rule, but they were based on the nature of the business rather than its size. Solicitors and barristers were those to benefit from the last vestiges of the so-called cash basis, but even they are now required to accrue for unpaid bills and recognise non-contingent work in progress.

 

The cash basis lives on in the form of the VAT cash accounting scheme for smaller businesses, but the consultation document suggests it may also be going to make an income tax comeback for smaller sole traders. Apart from being allowed to account on the basis of cash receipts and payments, the proposal is also to allow them to use standardised expenses in some cases rather than requiring them to specifically identify and account for every pound spent.

 

The proposal is to introduce the new regime from April 2013. Originally the Office for Tax Simplification proposed that it be available to sole traders and partnerships turning over up to £30,000, but the Document suggests that a more appropriate turnover threshold might be the VAT registration threshold of £77,000, with businesses allowed to use the scheme until their turnover exceeds £150,000. If VAT registered, using the cash accounting scheme would be a (logical) requirement Farmers with averaging claims or using the herd basis would also be excluded from the scheme.

 

The attractions of the system are that there would no longer be a requirement to keep records of stock, debtors and creditors, although clearly there is a business requirement to keep such records to ensure that money is collected and paid out on a timely basis, and that purchasing is kept under control, and that records of some expenses would no longer need to be kept, although again for business purposes it would appear to be wise to do so. So quite how much simpler the new system would be in practice is extremely questionable. Its use would be voluntary for taxpayers.

 

One expense that would cease to be allowable would be interest in cash borrowings, which appears harsh. Another complication would be that if it was necessary, or desired, to join or leave the cash basis, adjustments would be required to allow for the transition between bases. So not necessarily looking that much simpler then.

 

Businesses would have a choice whether to claim a deduction for the cost of purchase of a van, or claim the fixed mileage rates available for business mileage. There would be a restriction on the cost of the van claimable in accordance with the level (if any) of private use of the vehicle.

 

Rather confusingly, if the business was VAT registered, VAT paid to HMRC would be an allowable expense, and VAT recovered would be taxable as a receipt, with receipts and payments treated as VAT inclusive. This achieves the correct result, but in a rather roundabout and less than simple way.

 

It is also proposed that losses on cash basis businesses would not be allowable against other income of the year of loss, but only to carry forward. Again this is a restriction that would make the cash basis much less attractive to many businesses.

 

The following simplified expenses, based on flat rate figures, would be available as an alternative to actual costs incurred:

 

Standard mileage rates for business use of cars (which is actually fairly common, if not strictly permitted by legislation, at present). Currently 45p per mile for the first 10,000 miles and 25p thereafter, these rates are proposed to continue.

 

Flat rate expenses for business use of home. The proposals are:

 

25 – 50 hours per month                                   £8 per month

 

51 – 100 hours per month                                 £16 per month

 

101 or more hours per month                            £24 per month

 

I suggest this is less than generous in many cases compared to a detailed apportionment of actual costs.

 

Flat rate adjustment for personal use of business premises (e.g. living in a flat above a shop). This would operate on the basis of all costs being claimed and then an adjustment applied, as follows:

 

1 person occupying                   £350 per month

2 people occupying                   £500 per month

 

3+ people occupying                £650 per month

 

 

There is also discussion of ignoring incidental private use of telephone and internet services and allowing clams for stationery on a unit costs basis (e.g. per business letter).

 

I am not fond of these proposals. To have a proper idea of how even a small business is performing it is necessary to know the value of stock, how much is owing from customers and how much is owed to suppliers and others. Even more so is it necessary to keep records of how much is being spent on motor expenses.

 

I can see the logic of the £30,000 limit proposed by the OTS, because such businesses really are micro businesses, but to apply these rules to business up to 5 times the size is unrealistic. I could see the logic of allowing only businesses below the VAT threshold and not voluntarily registered to use the scheme, but anything beyond that appears ridiculous.

 

This therefore sounds good, but in practice could present some major problems, and should thus be restricted to the very smallest of businesses.

 

 

Few pieces of tax legislation have been as controversial, as much derided and as unsuccessful as IR35. Famous for causing HMRC to change the way they numbered their press releases, IR35 seeks to create a legal fiction for tax purposes, by lifting the corporate veil (as my company law lecturer used to say, investing it in my view with quite unwarranted sexual connotations, possibly inspired by the story of Herod, Salome and the head of John the Baptist) and seeking to tax an underlying employment relationship despite the presence of a corporate (or partnership) intermediary.

Despite its chequered past, HMRC is still determined to make IR35 or some variant thereof, work, as two recent developments have demonstrated. I will deal with the first today, and the next later in the week.

For a long time HMRC has offered on its website an Employment Indicator Tool, devoted to the highly dubious concept that it is possible to determine someone’s employed or self-employed status by answering a few questions on a computer. The have now adapted this idea with an update to their IR35 guidelines, introducing a points system to identify the risk of a commercial arrangement falling within IR35. Now this is irresistible for a statistics addict like me (I told you in a previous post you would never guess what I was addicted to) so I had to look more closely.

The idea is that the guide poses a series of questions, to which yes answers generate points (in one case negative points). And what do points make, as Bruce Forsyth used to ask on Play Your Cards Right? No, not prizes in this case, but a low risk of IR35 applying to your contract.

I can tell you are dying to know, so here are the questions and the point allocations. Less than 10 puts you at high risk of IR35 applying.10 to 20 is medium risk (incidentally what does that mean? You are either within IR35 or not) and more than 20 is low risk.

  1. Does your business own or rent separate business premises that are separate from your home and client’s premises? (10)   

  

  1. Do you need professional indemnity insurance? (2)   
  1. Has your business had the opportunity in the last 24 months to increase your business income by working more efficiently e.g. by finishing the work/project earlier than projected but still receiving the full agreed payment? (10)
  1. Does your business engage one or more workers who generate at least 25% of your business turnover annually? (35)
  1. Have you been engaged on PAYE employment terms by your current client / end user within the last financial year with no significant changes to your working arrangements? (-15)
  1. Has your business invested over £1,200 on advertising, excluding entertainment in the last 12 months (2)
  1. Does your business have a business plan with cash flow forecast, that is regularly updated, and a business bank account that is separate from your personal account and identified as a business bank account by the bank? (1)
  1. Would your business have to bear the cost of having to rectify any mistakes? (4)
  1. Has your business been unable to recover payment for work done during the last 24 months in excess of 10% of annual turnover? (10)
  1. Do you invoice for work carried out prior to being paid and negotiate payment terms? (2)
  1. Does your business have the right to send a substitute? (2)
  1. Has your business hired anyone in the last 24 months to do the contracted work you have taken on? This could be demonstrated by sending a substitute in your place or by sub-contracting, but in both cases your business remains responsible for the work and for paying the substitute or sub-contractor. You can still pass this test if you had to notify the end user of the name of the individual you sent as a substitute. (20)

This is clearly intended only as a guide, and neither HMRC nor taxpayer is going to be bound by the results. But there are some bizarre inclusions and exclusions here, which make me wonder how much practical use this will prove to be:

1 – this would be completely unnecessary in a number of businesses, which can quite happily and efficiently be conducted from an office or workshop at home.

2 – this is also completely unnecessary in many businesses.

5 – this begs the question what is a significant change? I used to be guaranteed work now I am not – is that a significant change? (see below).

6 – this assumes that advertising works, which is a big assumption in my experience.

7 – an awful lot of business don’t have a business plan and cash flow forecasts.

9 – that’s an awfully big bad debt, which would be sufficient to cripple many small businesses.

11/12 – #11is only worth 2? A requirement for personal service is a prerequisite for an employment to exist, or for IR35 to apply. My first, and often only, question to an engager wishing to treat someone as self-employed is “do you require them to do the work themselves?” If the answer is yes, I tell them that the person in question is an employee. If the answer is no, I tell them to put a substitution clause in the contract, along the lines outlined in #12. There is an implication in the point allocation for this question that the terms of a commercial contract are effectively meaningless, which is absolute rubbish. A substitution clause gives the right to supply a substitute, and that is that.

A sensible engager will insist upon the substitute being appropriately qualified, experienced, knowledgeable etc, but that is just commercial common sense. And of course they will want to know who is coming to their premises; I haven’t been let into any HMRC offices lately without identifying myself and normally passing through a scanner, and I assume they don’t expect businesses to be less careful about access to their premises?

Giving 20 for #12 just emphasises the inadequacy of the point allocation for #11. It is sheer chance whether it is necessary for a contractor to send a substitute at any point in the contractual relationship, or whether the parties can work around holidays, illness etc without that being required. And should the application of IR35 be established by sheer chance? I think not.

Should I be advising clients to make sure they send a substitute at least once at the start of a working relationship to clear them for IR35 purposes, and if so does that not encourage a degree of cynicism in applying the guidelines? What if the contractor is anxious not to send a substitute in case the client prefers the substitute? Is that a legitimate reason to apply IR35 to the contractor? Again I think not – it has to be the legal right of substitution that matters, not whether it happens to have occurred in practice.

And what about the number of customers a contractor has? Does having multiple customers rather than 1 not give a greater indication of true self-employed status? And what about mutual obligations, which employment tribunals have found to be a critical factor time and again in determining employment status? Does it not matter if the engager is required to provide work, or the contractor to accept it? Of course it does, very much.

The addition to the guidelines is a good idea, but the checklist is incomplete, in places irrelevant and the point allocations are ill thought-out. The idea that one could establish one’s status under IR35 by applying this checklist is frankly laughable, and it is dangerously misleading for HMRC to give taxpayers the impression that they can.

Lemexie commented on this post:

“Your recent excellent analysis on IR35 and Tax Avoidance could maybe be combined when considering the case of a Ltd Company providing an interim FD to a failing NHS Trust (in the press yesterday) at £3,000 per day.       Questions arising might be (a) ethics of the day rate fee from NHS funds (especially give the announcement in effect said the organisation was insolvent) and (b) whether being an interim FD meets the new HMRC tests of IR35.”

I suspect Lemexie of being clairvoyant, as he was anticipating my post yesterday about the consultation document on controlling persons, which I suspect is intended to cover precisely the type of situation he illustrates. From this I think we might deduce that the government is concerned that IR35 might indeed not cover the FD in question. I am right with him on the ethical issue too.