Tax year-end: limited companies' time to review

With the 2014 tax year-end closing in, contractor limited companies have an opportunity to launch a financial ‘spring clean,’ so their finances are shipshape enough to make a positive difference to their income, writes Gerry Brown, tax and trusts manger at Prudential.

This cleansing action shouldn’t just cover contractors’ staple financial arrangements, such as dividends, which if delayed from the current tax year to the next one can be beneficial to contractors if their income levels drop.

Indeed, tax-efficient investing options for the financially-shrewd small company owner extend to business premises; the Enterprise Investment Scheme, the Seed Enterprise Investment Scheme and Venture Capital Trusts.

These sometimes overlooked channels for investing tax-efficiently are ripe for consideration, alongside the more ubiquitous ones such as pension contributions, ISAs and Junior ISAs. But no tax year-end financial review for limited company IT contractors would be complete without an exploration of Capital Gains Tax and Inheritance Tax.

Income Tax – how to be tax-efficient

- Business Premises Renovation Allowance

Business Property Renovation Allowance (BPRA) was introduced by the Finance Act 2005 with the aim of encouraging the renovation of property in “Designated Development Areas.”

Although contractors might, until now, have only considered a business premises in relation to the IR35 Business Entity Tests, this allowance is not to be sniffed at, as 100% income tax relief is available in respect of conversion or renovation expenditure incurred on the premises, provided the following conditions are satisfied:

  1. the property must have last been used for the purposes of a trade or profession
  2. it must have been vacant for at least 12 months
  3. when renovated it must be brought back into use for the purposes of a trade or profession
  4. the property must never have been a dwelling

Note, the tax relief is clawed back if the property is disposed of within seven years of renovation.

- Enterprise Investment Scheme

The Enterprise Investment Scheme (EIS) offers a range of tax reliefs (income tax, capital gains tax and inheritance tax) to an individual acquiring new ordinary shares in a ‘small’ unquoted company carrying on a qualifying trade.

Investment can be directly into the company, or through an EIS Fund.

Income tax

Relief, at a rate of 30%, can now be claimed up to a maximum of £1,000,000 invested in such shares, giving a maximum tax reduction in any one year of £300,000. This depends on the individual having paid tax of at least £300,000. EIS income tax relief cannot be set off against dividend income as the tax credit attached to the dividend is not recoverable.

There is a 'carry back' facility which allows the all or part of the cost of shares acquired in one tax year to be treated as though those shares had been acquired in the preceding tax year. Relief is then given against the income tax liability of that preceding tax year. This is subject to the over-riding limit for relief for each year.

The shares must be held for a certain period or income tax relief will be withdrawn. This is usually three years from the date that the shares were issued. However if the qualifying trade started after the shares were issued, the period is three years from the date the trade actually started.

Capital gains tax (CGT)

The payment of tax on a capital gain can be deferred where the gain is invested in shares of an EIS qualifying company. The gain can arise from the disposal of any kind of asset, but the investment must be made within the period one year before or three years after the gain arose.

There are no minimum or maximum amounts for deferral and it does not matter whether the investor is connected with the company or not. Unconnected investors may claim both income tax and capital gains deferral relief.

There is no minimum period for which the shares must be held; the deferred capital gain is brought back into charge whenever the shares are disposed of, or are deemed to have been disposed of, under the EIS legislation.

Inheritance tax

Shares acquired under EIS will often qualify for inheritance tax business property relief.

- Seed Enterprise Investment Scheme (SEIS)

The Seed Enterprise Investment Scheme (SEIS) is intended to assist small, newly formed companies to raise equity.

Income tax

Income tax relief is available to individuals who subscribe for qualifying shares in a company which meets the SEIS requirements. The individual needs to have a UK tax liability against which to set the relief. Investors need not be UK resident. The relief is given by way of a reduction of tax liability. The relief cannot be set off against the notional tax credit on dividend income

If the SEIS shares are disposed of within a three year period, or if any of the qualifying conditions cease to be met during that period, relief will be withdrawn or reduced.

Relief is available at 50 % of the cost of the shares, with a maximum annual investment of £100,000.

There is a 'carry-back' facility which allows all or part of the cost of shares acquired in one tax year to be treated as if they had been acquired in the previous year. The SEIS rate for the earlier year is applied and relief given for the earlier year. This is subject to the over-riding limit for relief each year.

Capital gains tax

If income tax relief (which has not subsequently been withdrawn) has been received, and the shares are disposed of after having been held for at least three years, any gain is CGT free.

Inheritance tax

Shares acquired under EIS will often qualify for inheritance tax business property relief.

- Venture Capital Trusts (VCTs)

VCTs offer tax reliefs to investors as follows:

Income tax relief

Individual shareholders (aged 18 or over) can claim income tax relief at the rate of 30% per cent for up to £200,000 annual investment, provided the shares are held for at least five years.

Dividends

Dividends received from VCT ordinary shares are income tax free.

Capital gains tax

Disposals by individuals of ordinary shares in VCTs are not subject to CGT.

Capital Gains Tax – how to be tax-efficient

There are three key elements in tax year-end CGT planning:

  • realising losses
  • ensuring use of the annual exempt amount
  • making negligible value claims

There is a considerable degree of interaction between the first two. The objective should be to increase the effective exempt amount by supplementing it with realised losses.

While anti-avoidance legislation restricts the use of ‘bed and breakfasting,’ it does not prevent it if the 30-day reinvestment limit is satisfied.

Other reinvestment options include:

  • ‘bed and ISA’
  • ‘bed and spouse’
  • ‘bed and pension contribution’

The advantages of exempt inter-spouse transfers in ensuring that both spouses’ annual exempt amount should be fully utilised, where possible.

When it can be agreed with HM Revenue & Customs that shares are of negligible value, the loss arising is treated as a realised loss and is available for set-off against gains.

In certain circumstances losses on unquoted trading companies can be set against income and income relief obtained.

Inheritance Tax – how to be tax-efficient

Inheritance tax (IHT) planning (largely, but not exclusively) revolves around reducing an individual’s estate by giving away assets. This giving can be ‘controlled’ with the involvement of trustees and the inheritance tax code offers a range of exemptions, some of which are time sensitive e.g.:

  • Annual £3,000 exemption
  • Small gifts exemption (£250)

There is also a number of inheritance tax planning strategies that should be undertaken sooner rather than later, for which you should consider taking, tailored advice from a independent financial adviser before proceeding.

Within the context of ‘giving’, gifts should be made as soon as possible so that the ‘seven year clock’ starts ticking. These include ‘Potentially Exempt Transfers’ (PETs) and ‘Chargeable Lifetime Transfers’ (CLTs).

Consideration could been given to starting a pattern of gifts which would qualify for exemption under the ‘normal expenditure from income exemption’? Pension contributions for children or grandchildren could be useful in this context. As well as reducing the donor’s ‘estate,’ the contributions will generate tax relief for the recipients.

There are also inheritance tax claims or actions that are time sensitive:

  • A claim to benefit from a ‘transferable nil rate band’
  • A claim to vary the IHT effects of Will (a ‘variation’)

At a more strategic level, three further areas to consider are:

  • Ensuring that ‘protection’ life policies are in a trust. An amazingly high proportion are not. Without a suitable trust, the policy proceeds will fall into the IHT ‘net’.
  • ‘Estate equalisation’ with a marriage or civil partnership
  • As spring is the season of romance, couples in a stable long-term relationships could consider marriage. Marriage offers many advantages - not all of which are financial!

Final thoughts

January saw contractors have to rush to get their self-assessment forms in, but February and March are now demanding that these busy professionals turn their attention to year-end tax planning.

For the typical contractor, the prospect of operating their personal and/or business finances more tax-efficiently in the next tax year will be enough to spur them into action. But as to the inert in need of further motivation, it is essential that you play your part in helping the UK make the most of the recovery it has embarked on, by minimising your liabilities and maximising your income and, in turn, your growth prospects.

Tuesday 4th March 2014