This month we have information for shareholders lending
money to their company, issues for property owners trading rather
than investing, notes on tax and 50:50 ownership, and finally
gifts and inheritance tax.
Don't forget to call if you need more information on any of
the issues raised. The next newsletter will be published on
Tuesday 5th December 2006.
Shareholder loans to company
There are certain circumstances when it may be more expedient
for a shareholder to lend money to the company rather than the
company borrow money from its bankers. The shareholder could
use his own savings or borrow funds to do this. If funds are
borrowed we have listed below some of the conditions that must
be met in order that the shareholder obtain tax relief on interest
paid.
1. The shareholder must own over 5% of the ordinary share capital
of the company, or have worked for the majority of their time
in the actual management of the company.
2. The company must be a private company that meets specific
criteria to qualify as a "close" company, and be a trading concern
or involved in the letting of property to unconnected parties.
3. Tax relief will be denied to the shareholder if he funds
the loan to the company by means of an overdraft. Interest is
only allowed if charged to a loan account.
4. In order to obtain full tax relief the shareholder must have
sufficient taxed income to cover the interest paid. If the interest
is more than total taxed income the excess cannot be carried
forwards to be set off in future years, or carried back to previous
tax years.
In the event that the company is unable to repay the loan made
by the shareholder the amount of the loss can be claimed for
capital gains tax purposes. (CGT relief will only be allowed
if the company applied the loan for the purposes of its trade.)
This relief is also available to guarantors. For instance if
a shareholder provided a personal guarantee to the company's
bankers, which was called upon, then the amount paid to the
bank would qualify as a capital loss.
If the shareholder is also a director care must be taken when
funds are withdrawn to reduce an existing director's loan. Tax
relief on the funding for the later shareholder loan may be
reduced or lost completely.
Trading with property
If you have bought property as a long term investment, and have
let accordingly, the rents received will be treated as investment
income subject to income tax, and when you sell the property
the gain will generally not attract business asset taper relief,
nor be available for rollover relief. (Furnished holiday lets
property is treated as being used in a trade and is an exception
to this general rule regarding taper relief.)
There is also a particular situation where dealing in property
can be considered a trade. The tax consequences can be interesting!
Property Developers
If you personally buy a property with the sole intention of
realising a quick profit HMRC are likely to consider that you
are a developer trading with property.
Negative tax and national insurance issues:
a. Any profit you make will be subject to income tax and you
will lose the capital gains tax annual exemption, currently
£8,800 per person.
b. It is also unlikely that HMRC would allow you to treat property
bought and sold in this way as your home (principal private
residence), even if you "moved in" for a few weeks while the
property was refurbished.
c. To avoid a £100 fine you will need to register this trade
within 3 months of commencement.
d. National insurance contributions will be due on profits made.
Class 2 and Class 4.
Positive tax issues:
e. Losses made can be set off against other income. (Rental
losses cannot be set off in this way).
f. The value of the business will attract 100% business property
relief for inheritance tax purposes.
g. Pension contributions can be paid out of property development
business profits and attract tax relief in the normal way.
As you can see there is both good and bad news to consider.
Please call if you are considering this type of property deal,
we can work out the best tax strategy to apply based on your
individual needs. Leaving the call until after the event may
well be too late!
Interesting tax consequences of a 50:50 split!
References in this article to husband and wife, also apply to
partners subject to the Civil Partnership Act.
Inheritance Tax - Shares in Private Limited Company
The following two paragraphs provide an interesting example
where the taxable value of a gift of shares may be less than
the market value!
Consider a small trading company that has been valued at £1m.
There are two shareholders Mr X and Mr Y who both own 50% of
the issued share capital. Common sense would indicate that their
individual shareholdings are worth £500,000. Whilst this would
be the case should they actually sell the business, different
rules would apply if they considered gifting their shares.
Inheritance tax looks to the value lost by the person making
the gift, not the value gained by the person receiving the gift.
If Mr X gifted his shares to his son, he would be transferring
a minority interest. (51% is needed to exert control.) For valuation
purposes a minority interest may be subject to a discount of
between 20% to 30% of the market value. So a gift could be made
worth £500,000 and be treated by the Revenue as valued at say
£400,000 for inheritance tax purposes.
Income Tax - Property ownership and rental income
Should a property be owned by more than one person it is normal
practice to agree the percentage share owned when the property
is bought.
If our Mr X and Mr Y also jointly owned a rental property it
would suggest that not only would they split the profit or loss
on sale of the property equally, but would also share rental
income arising from the ownership in the same proportion.
However the Revenue will accept a split of rental income at
variance with the ownership of the property as long as all parties
agree. So Mr X could be allocated 90% of the rental income and
Mr Y 10%. This is a useful strategy to consider but it does
not apply to a husband and wife who own a rental property.
In husband and wife situations it may be sensible for one party
to receive the bulk of the rental income and pay tax at lower
rates - thus creating an overall increase in post tax income
for the family. But to gain the Revenue's approval the couple
must own the property as tenants in common, and the percentage
owned by each party has to be the same as the division of rental
profits. So if Mr A and Mrs A own a rental property as tenants
in common, 90% owned by Mrs A and 10% by Mr A, rental income
and profits can only be split 90:10.
Income Tax - Husband and wife owned businesses
If a husband and wife team run a small limited company, or trading
partnership, and each own 50% of the shares or rights to share
of profits, they need to be mindful of the "settlements legislation"
particularly where there are few assets in the business.
If Mr X owns 50% of the business but does 90% of the work in
the business, the Revenue can use existing legislation to restore
a commercial balance to the situation. In this example the Revenue
could argue that as Mr X does 90% of the work then he should
receive 90% of the dividends/share of profits distributed by
the business.
This area of tax law is currently being tested by the Artic
Systems case, a House of Lords decision is pending. But as current
legislation could be applied, shares of business income between
husband and wife need to reflect the underlying commercial reality.
A 50:50 split on paper does not prevent a challenge by the Revenue
that other divisions should be applied.
Gifts and Inheritance Tax
Most taxpayers are aware of the term PET as applied to inheritance
tax. (A Potentially Exempt Transfer.) If a gift is made from
one individual to another as long as the person making the gift
lives 7 years after making the gift, no inheritance tax is payable.
But what happens if the person making the gift retains some
"enjoyment" of the gift made? We will need to consider the Gifts
With Reservation of Benefits rules - otherwise known as "GWROB's".
When a person dies who has made a GWROB the value of the asset
gifted will still form part of their estate for inheritance
tax purposes. A classic example is where an elderly parent gifts
their property to the children, but continues to live there.
A GWROB can be avoided in this type of situation if the donor
pays full market rent for the use of the asset gifted.
A PET can also be affected by further anti-avoidance legislation
called POAT - "Pre Owned Assets Tax". Although the underlying
legislation was enacted to counter complex avoidance strategies,
the Pre Owned Assets Tax can also be applied to quite innocent
situations. It generally applies to gifts that are converted
to other assets which are subsequently used by the original
donor - POAT can also be applied to transactions that were set
up some time ago! For instance an elderly parent could gift
cash to son who buys a house in his name. The parent then occupies
the house rent free. A POAT is not an inheritance tax charge
- it is a charge to income tax for the use of an asset.
The legislation for both GWROB's and POAT's are incredibly complex.
However a gift can only be classified as a GWROB or subject
to the POAT rules - not both.
We suggest that if you have unwittingly stepped into a GWROB
or POAT type transaction that you call us to discuss the tax
consequences without delay!
Tax Diary November/December 2006
1 November 2006 - Corporation tax due for companies
with a tax liability for the trading year ending 31 January
2006.
19 November 2006 - PAYE and NIC deductions
due for month ending 5 November 2006. (If you pay your tax electronically
the due date is 22 November 2006)
1 December 2006 - Corporation tax due for companies
with a tax liability for the trading year ending 28 February
2006.
19 December 2006 - PAYE and NIC deductions
due for month ending 5 December 2006. (If you pay your tax electronically
the due date is 22 December 2006)
30 December 2006 - If you file your 2006 Tax
Return via the Internet you must send it back by this date if
you want the Revenue to consider collection of outstanding tax
for the year through your tax code. This will only be possible
where you owe less than £2,000.
DISCLAIMER - PLEASE NOTE: The ideas shared
with you in this email are intended to inform rather than advise.
Taxpayers circumstances do vary and if you feel that tax strategies
we have outlined may be beneficial it is important that you
contact us before implementation. If you do or do not take action
as a result of reading this newsletter, before receiving our
written endorsement, we will accept no responsibility for any
financial loss incurred.
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