Small Business - Tax planning in a recession

Do we call the current economic crisis a “recession” or go as far as “depression”? Whatever the title, we must ensure tax planning aids the survival of the small UK business.

A simple tax planning checklist is as follows:

1) Finance Act 2009

Carry back of tax losses for three years (normally only one year)

The key points are to identify and claim the tax loss as soon as possible. Accounting matters to be considered include bad debt provisions (specific or general and adequacy - where possible make specific), claim for repairs (chargeable to P/L account and tax allowable) as opposed to improvements (balance sheet items and unlikely to attract tax relief), the correct treatment of capital allowances and the write down of balance sheet items where appropriate.ng.

2) Date of Approval of Accounts

Assess the position at the date the accounts are signed.

A few weeks either side may change the accounting and tax treatment of balance sheet values and provisions.

The cut off point can be critical when considering prudent accounting treatment resulting in an insolvent balance sheet but establishes tax losses to utilise. Factors surrounding the collection of debts change on a daily basis and so too can the solvency of the company and the tax loss to take advantage of.

3) Net Realisable Value (NRV) and Stock

A clear example of tax planning is that stock should be valued at the lower of cost and net realisable value. How does the owner of the business arrive at net realisable value? A key element here must be the need for a professional valuation and the protection that can be achieved by so doing.

a) Farming Stock and Tillages

An example of tax planning and NRV is farming stock and tillages under BEN 19 where a percentage of market value is used. How complex is market value for farming? Pretty straightforward. There are markets for comparison and livestock and corn prices have stayed steady but what of the bloodstock market?

b) The Equine Market

Stock is valued on an item by item basis at the lower of cost and net realisable value. There is great scope to value each item at the low values currently being seen in the sales ring.What is market value and how can it be ascertained?

Trading tax losses created by a fall in stock values can of course be carried back against profits of the last three years and a tax refund claimed.

4) Legal Claims

In a recession there will be greater attempts at civil litigation against small businesses and the correct accounting and tax treatment will have to be considered.

Those running the business will ultimately be making the accounting and tax decisions. What is the role of the professional adviser?

Reliance on tax advisers, accountants and auditors could give greater opportunity for civil actions against professionals – the guardians of true and fair and accurate accounting. The real shame for all concerned is that honesty, proactivity and genuine client care by professionals could result in greater exposure to litigation.

5) Professional Negligence Claims

Professional life is full of irony and one such example is that professionals who try to help clients suffering under the recession may be MORE likely to be subject to a professional negligence claim. The duty of care owed to the client needs to be defined as will the evidence of requisite skill and care involved in any work carried out. The claimant will have to show actual loss suffered. Great care must be taken and will be needed in defining terms of engagement.

6) Engagement Letters for one-off specialist survival work

When clients contact professional advisers for help it would be reassuring to think that the first matter the professional considers is self-protection. After giving due consideration to the problems raised by the client the next matter to consider is risk management of the work 0required. The starting point is to clearly define that the terms of the engagement and the risks involved should be clearly assessed. To whom is the duty of care owed and what is the size of the financial risk?

7) Trading whilst Insolvent – unlawful dividends

For the limited company one of the first safety checks is : are there enough profits built up in the company to allow the directors to authorise payment of dividend when the business is not trading profitably?

Directors must carry out safety checks on solvency on an ongoing basis. The desire to maximise a tax loss to carry back under the new three year provisions must be carefully reviewed as must genuine legal claims and resulting provisions against the company.

If restructuring is needed will there be a “change of ownership” that can have tax disadvantages regarding the use of losses?

8) “Change of Ownership” and restructuring

“Change of ownership” arising from restructuring to help a struggling company has to be given due consideration. The tax restructuring of struggling companies has to be planned carefully.

Rules that prevent an investment company’s use of its non-trading losses (expenses of management, non-trade loan relationship deficits, or charges) if, after a change of ownership, there is a significant increase in the company’s capital (TA 1988 s 768B(1)(a)) need to be considered, as well as the perhaps better known provisions for losses in trading companies where there is a change in ownership. As the number of companies that are incapable of servicing their debt rises, a fair number of these will have significant interest losses.

A “change of ownership” is defined within TA 1988 s 769 as the acquisition by one or more persons of over half of a company’s ordinary share capital. If this is in fact by more than one person, each must acquire at least 5%. The change of ownership is calculated by comparing any two points in time over a period of three years.

Assuming there has been a change of ownership of a company, there also needs to be an increase in its capital in order for it to lose the benefit of its tax losses going forward. To determine whether this has occurred, it is important to look at TA 1988 Sch 28A.

A company in hardship forced into a debt for equity swap by its banks as a condition of avoiding a winding-up process, on HMRC’s interpretation faces the prospect of losing the benefit of its tax losses – tax losses that could potentially be of enormous value to the company’s survival. The company replaces a non-capital item (bank debt) with a capital item (shares).

The company law implications of those actions (including some thought about the directors’ fiduciary duties and the possibility of financial assistance issues) may need further consideration.

Summary

Proactive tax planning can help reduce tax liabilities and even result in tax refunds for the small business at a critical time. However, the complexity of solvency, change of ownership and protection for the tax planner must also be considered.