Employee Share Gains: Income Or Capital?

The Court of Session has recently provided the final word on a long-running tax dispute on whether personal rights and rights outside the articles of association can be taken into account when calculating the market value of shares for employees.


Point at Issue


The significance of this is that if shares are acquired from employees for more than their market value (eg on a sale of a private equity company), then that excess amount is subject to income tax and National Insurance contributions (NICs) (which needs to be accounted for by the employer under PAYE) rather than the more favourable capital gains tax regime.


The Facts


In Grays Timber Products Ltd v HMRC, ( the case is available here ) an employee acquired shares in a company. 


A shareholders' agreement signed more or less simultaneously by the majority of the shareholders gave him a right to receive a disproportionately large amount of any sale proceeds if certain targets were met and he remained in employment. This was in contrast to his entitlement under the articles, which would just have given him a pro rata amount based on the number of shares he held compared with the number of shares other shareholders held. 


A sale duly occurred and the employee received the larger amount of proceeds.


HMRC subsequently challenged the tax treatment of his gain.


Argument


The employee repeatedly argued throughout all proceedings that his rights in the shareholders' agreement should be treated as if they attached to the shares and were included in the articles, and so contributed to the shares' market value. 


Decision


However, the Court of Session upheld the rulings of the lower courts in  agreeing that market value meant the value of the shares and rights which passed to a prospective buyer. External rights (in shareholders' agreements, for example) or personal rights, which did not affect the buyer or the intrinsic value of the shares, could not affect the market value of the shares. 


Accordingly, the shares' market value remained the pro rata amount the employee was entitled to under the articles (some £450,000) and not the enhanced amount (some £1.5 million).


This meant an income tax and NIC charge on the excess amount, which was payable under PAYE. 


In this case, the excess amount was over £1 million. Fortunately, however, the buyer of the company had operated a retention and so it was able to cover at least some of the amount sought by HMRC from that sum rather than having to go against the employee to recover its PAYE liability – which, as the sale occurred in late 2003, would now be difficult.


Comment


While not a surprising result, the case acts as a timely reminder, as capital gains tax schemes become more important, of the need for properly drafted arrangements to give employees additional rights on exit or achieving targets.


Crucially, these rights should be included in the articles rather than being expressed as personal rights. 


The downside of this can be that the employee shares can have a slightly higher value on acquisition than their pro rata value, but this is hope value and so should not normally amount to any significant premium. 


In the Grays Timber case, had the employee's full rights been included in the articles up-front, it is likely that, while he might have had to pay a little more to acquire his shares, his full £1.5 million would have been subject to capital gains tax after all and so he would have saved some £300,000 in tax.

UK: Charity Commission Re-defines Religion?

The Charity Commission's refusal in December 2009 to register The Gnostic Centre as a charity raises interesting issues about the Commission's criteria in defining religion and its apparent extension of existing legal boundaries. The decision can be read here.

The Commission considered that the Centre is not charitable as it:

• does not advance education because it promotes a specific point of view and encourages people to adopt a particular viewpoint
• does not promote the moral or spiritual welfare or improvement of the community since "there was no evidence of a clear and identifiable moral or ethical code or framework within Gnosticism" and so has no beneficial impact on the public
• does not advance religion, as it does not have an identifiable, positive, beneficial moral or ethical framework and confines its benefits to too few people 

This decision brings religious charities back into the spotlight raising issues about the Commission's regulation of this sub-sector. 

Although the Commission distances itself from matters of theology and doctrine where possible, it cannot avoid the issue where it is fundamental to registration. However, the extent to which it can, of its own volition, make judgements about theology and doctrine is likely to be controversial.

Two issues are of particular concern:

• 1. How the Commission decides what is and is not a religion. In this case the Commission has taken several leaps from the position stated in a 1931 case to stating that a religious charity must encourage "common standards, practices or codes of conduct as stipulated in particular scriptures and teachings" alongside "an identifiable positive, beneficial, moral or ethical framework".
• 2. The Commission's suggestion that it is only because of its "identifiable, positive, beneficial moral or ethical framework" that a religion impacts on society in a beneficial way. Any other benefit would seem now to be relevant only once the moral or ethical framework requirement is met.

Not only do religious organisations seeking charitable registration now have to meet a more rigorous standard than those previously registered had to, but the Commission's general policy on religious charities seems to have shifted. This will be of concern to new and existing charities. It also raises concerns about the extent to which the Commission is making, rather than interpreting, law.

UK : Seconded and Casual Workers

United Kingdom: Secondment And Casual Workers 


Secondment


This is an arrangement where the original (or seconding) employer "lends" their employee (the secondee) to another employer (the host). The host  normally pays the original employer for the salary and other costs / expenses arising from the employment. The original employer may also charge a fee. 


The idea of a secondment is that the secondee will remain employed by the original employer for the duration of the secondment and will return to the original employer at the termination of the secondment. 


There can be benefits to all concerned in such arrangement – the original employer can (for a set period) reduce their salary costs and perhaps avoid / reduce redundancies. The secondee may gain valuable new experience and will preserve a number of benefits and entitlements e.g. continuity of employment with the original employer. The host can provide staff cover for e.g. short term projects / absenteeism. The arrangements can also build links between the original employer and the host.

The original employer would (unless there was a clause in their contract allowing secondment – which would be unusual) require the employee to agree to a secondment before this could happen without it being a breach of contract.


A written secondment agreement should be entered into so that all parities are clear what their rights and obligations are. 


The following issues would normally be required to be addressed or considered (and often many more depending on the precise nature of the secondment).


Who is the employer? 


Despite the intention of the original employer and the host the employee may in fact end up being an employee of the host. If the employee becomes an integrated part of the hosts' workforce and managed directly by the host the employee is likely to become an employee of the host. 


Therefore to seek to avoid this –

• The secondee should not owe any duties directly to the host but only to the original employer.
• The host should not owe any duties to the secondee.
• The original employer should retain overall control of the secondee.
• The original employer should continue to deal with any matters that involve the secondee (e.g. appraisals, disciplinary & grievance matters etc).
• The secondee should not become integrated into the host's organisation.

Even if the host was not the employer it is likely that the employee would be deemed to be a worker of the host. That would entitle the worker to a number of rights from the host e.g. holiday pay.


Discrimination: a worker may bring a range of unlawful discrimination claims against the host (age, sex, race, nationality, sexual orientation, religion and belief and disability).


What are the employee's duties going to be? Are these the same as the work they undertook for the original employer or will it be something else?
Management of the employee – how is this going to work? 


If the host employer takes on direct management of the secondee the host may become the employee's employer.


The employees' terms and conditions of employment will continue through the secondment but should the host wish the employee to be bound by particular rules and procedure, confidentially etc these should form part of the secondment agreement.


How is disciplinary / grievance procedures going to work?
What happens if the secondee is absent?
Who bears the costs relating to the liabilities to the secondee (e.g. health and safety) and acts of the secondee during employment? This together with appropriate indemnities should be recorded in the agreement. Is the appropriate insurance in place?
Duty of care – both the original employer and the host are likely to owe the employee a duty of care.
Vicarious liability – both the original employer and the host may be vicariously liable for the act of the secondee.
How is the agreement brought to an end? What notice does each party require to give the other?
Return to original employer – an employee considering a secondment is likely to want to know from the outset what will happen:

• If before the secondment is due to end, they serve notice to terminate their secondment and wish to return to their original employment.
• If, before the secondment is due to end, either the original employer or the host terminates the secondment.
• If, having served the full secondment anticipated by the parties, the secondment ends.

If the secondee is to return to the original employer, a number of questions arise:

• Will they return to their original or another post?
• What will happen if there is no post for them to return to?

Considering and providing for potential eventualities from the outset and setting these out in a clear secondment agreement (whatever form that may take) may avoid disputes once a secondment is commenced or completed.

Casual Workers / Bank Staff

Casual Workers

The term "Casual Workers" has no special legal meaning. However, it is generally used to describe a group of individuals who are engaged across a wide range of industries in many different circumstances. Casual Workers are used in businesses where the need for workers is not constant, for example, where the workflow is variable / seasonal or where it is impossible to predict demand due to external factors.


Casual Workers may be engaged in a number of ways:

• On a zero hours contract, under which the company does not guarantee to provide work and only pays for work done.
• As Bank Staff, where the employer can call on a pool of workers when work becomes available but there is no obligation on the worker to accept it (or for the company to offer it).
• Under an umbrella contract, where the worker is ostensibly engaged on a series of individual contracts but there is an over-arching contract (whether express or implied) that continues even when the worker is not working.

The term casual worker suggests an informal relationship between the parties, with little obligation on either side.


However, companies should not be lulled into a false sense of security, as in some cases, casual workers are employees with the full legal rights that this entails. To complicate matters the employment status of the casual worker can change over time, for example, if their working arrangements develop a regular pattern or they can establish that there is an umbrella contract of employment and so their employment continues during the periods when they are not working. 


There are a number of difficult issues in relation to casual workers that should be addressed when considering entering into such arrangement. These include:

• How to calculate continuity of service (this has a considerable bearing on the workers rights including redundancy pay, notice, holiday pay entitlement etc).

Status


It is important to establish the casual worker's employment status from the beginning of the relationship because this will determine their legal rights and protections and the obligations the employer owes them. There are three broad types of employment status: an individual may be:

• An employee.
• A worker.
• Self employed.

In any consideration of employment status, the main questions likely to be asked are:

• Is the individual required to provide their service personally?
• Is there an obligation on the company to provide work and an obligation on the individual to accept the work provided?
• Does the company exercise sufficient control over the way in which the individual carries out the work for the relationship to be properly regarded as an employment relationship?

Personal service, mutuality of obligation and sufficient control by the company is normally considered as the essential hallmarks of an employment relationship. Establishing whether there is mutuality of obligation is likely to be the key issue with causal workers. There will often be two key issues:

• Whether the workers are employees during the period when they are working.
• Whether the workers can link those periods together by establishing sufficient mutuality of obligation during the periods when they are not working.

Implications of status

I ndividuals who are employees enjoy the highest level of legal protection. For example employees:

• May not be unfairly dismissed.
• Are entitled to a statutory redundancy payment.
• Are entitled to maternity and other family leave and pay rights.

Casual Workers who are not employees may be workers if they provide services personally under a contract and the other party to the contract is not a client or customer of a business carried on by the individual. Workers enjoy lesser protection but still have valuable statutory entitlements, for example:

• To be paid the national minimum wage.
• To a minimum period of paid annual leave and other rights under the Working Time Regulations.

The genuinely self employed, those who are in business on their own account and have no obligation to render personal service, have few employment rights, although they may be protected against discrimination.


During any period of work, a casual worker may be an employee, a worker or self- employed. The issue will also need to be considered as to the status of Casual Workers between engagements. Casual work often involves workers being engaged on a number of short term contracts with gaps in between. A lack of mutuality of obligation during these periods is likely to be fatal to any argument that the casual worker is an employee.

Continuity of Employment

If a Casual Worker is able to establish they are an employee, they will be able to accrue continuous employment. This is important for many rights require an employee to have a qualifying period of employment (e.g. unfair dismissal, statutory redundancy payments etc). This can be straightforward when the engagement is continuous however what about when there are gaps? Whether a Casual Worker can establish that they have the relevant period of continuous service will depend on:

• Whether a global or umbrella contract of employment exists spanning both periods of work (and any absence).
• Whether any absences can be classed as a "temporary cessation of work" or whether an absence is by arrangement or custom regarded as continuing the employment of the employee.

Terms of engagement should be drawn up clearly setting out what the arrangements are and the status of the parties. This documentation will not be definitive and what actually happens in practice is taken into account in the assessment of the status of the worker.


Tax treatment of casual workers


The employment status of workers will determine the tax treatment of any payments made to them. 


Significant liabilities may follow for the company if they incorrectly take the view that the worker is not an employee and fails to deduct tax and national insurance through PAYE, so consideration at the outset of the relationship of any casual worker is required.


Casual workers should not be confused with temporary agency workers who might also be used by an engager to achieve flexibility. In this posting casual / bank workers describes individuals who are engaged directly by the company and not through a third party agency.


Conclusion
There are complex and wide ranging legal issues that arise from secondments and engaging Casual Workers. It is therefore important to have considered these issues in advance and have drawn up appropriate agreements and documentation at the outset clearly setting out what the arrangements are so as to avoid or at least reduce the scope for confusion and dispute later on.

UK: Extension Of Tax Reliefs To Certain European Charities

Until now charitable organisations registered outside the UK have been unable to claim the same charitable tax reliefs as those based in the UK.


Finance Act 2010 contains a new definition for organisations eligible for charitable tax reliefs which will include those based in the EU (including the UK), Norway or Iceland.


The proposed changes have been introduced to reflect the judgments of the European Court of Justice in Centro di Musicologia Walter Stauffer v Finanzamt München für Körperschaften (European Court of Justice, C386/04 - available here), which was delivered on 14 September 2006 and Hein Persche v Finanzamt Lüdenscheid (European Court of Justice, C318/07 - available here ), which was delivered on 27 January 2009.


Broadly, these cases held that it a breach of the EU Treaty for EU member states to distinguish for tax purposes between charities established under their own law, or within their own jurisdiction and those established under the law of, or within the jurisdiction of, another EU member state merely on the grounds that they were not indigenous. 


The Stauffer case had applied this principle to the income and gains of non-indigenous charities, while the Hein Persche case extended it to the tax treatment of gifts made to such non-indigenous charities. 

Organizations eligible for UK charitable relief

Under the proposed changes, organizations eligible to enjoy the same tax reliefs as charities and Community Amateur Sports Clubs ('CASCs') in the UK, will be those which:

• meet the England and Wales definition of a charity or CASC ;
• are located in a Member State of the EU, Norway or Iceland
• are regulated by a body in their home country which has an equivalent function to the Charity Commission or a similar regulator, as required by the law of the home country; 
• and is managed by 'fit and proper persons',

HMRC will decide if someone is a 'fit and proper person' for this purpose by considering, with reference to any records it has access to, whether that individual is likely to exploit the charitable reliefs for non-charitable purposes.

Charitable reliefs

Organisations meeting the above definition will be eligible for all HMRC 'charitable reliefs', including reliefs on income tax, capital gains tax, corporation tax, inheritance tax, and various stamp taxes.


They will also be able to enjoy the same VAT reliefs and exemptions as UK charities and CASCs, as well as the benefits of the Gift Aid scheme.


HMRC will be issuing guidance on its website about how organizations which meet the above requirements and wish to register for charitable relief should do so.


The relief may be available retrospectively to 27 January 2009 (the date of the Hein Persche judgment) but this will be considered by HMRC on a case-by-case basis and details of the process are not yet available.

The changes to do not apply to charities based outside the EU, Norway or Iceland.

UK: Enterprise Management Incentive Schemes (EMIS)

What is the "EMI"?


The Enterprise Management Incentives Scheme (the "EMI") was introduced by Finance Act 2000. It aims to assist small high-risk trading companies to attract and retain key employees and reward those employees for taking the risk of working for such companies.


The EMI allows a qualifying company to grant options over shares with a value of up to £120,000 per employee (up to a maximum of £3million) on very flexible terms. 


The EMI offers favourable tax treatment making it attractive to both companies and employees.


What companies qualify?


Broadly, the EMI is aimed at companies satisfying  conditions similar to those under the Enterprise Investment Scheme (EIS) and the Venture Capital Trusts (VCT) scheme.


The gross assets of the company (or the group of companies if a parent company) must not exceed £30million.


Gross assets broadly comprise all assets shown in the balance sheet when drawn up in accordance with standard accounting practice.


The company must have fewer than 250 employees.


The company must be independent and not under the control of any other
company. Control for these purposes is defined as the ability of a person to secure that a company acts according to his wishes, whether through share ownership or provisions in the Articles of Association of that company. Shares in a subsidiary cannot be used in an EMI option.


Companies may be quoted or unquoted.


There is no requirement that the company be resident or incorporated in the UK but the company's trading activities must be carried out wholly or mainly in the UK.


Group companies can offer the EMI to employees of both the parent and the subsidiary companies, provided that all of the subsidiaries in the group are qualifying subsidiaries. Broadly, this means that the parent (or another subsidiary) must own at least 75 per cent of the share capital and that no other person or entity should control (as defined above) that subsidiary.


Certain trades are excluded from the EMI. 


Excluded trades include:

• leasing,
• financial activities,
• property development, 
• shipbuilding, and 
• steel and coal producing companies. 

For a group, the activities of all group companies are treated as a single business. Any excluded trade which is merely incidental to the trade carried on by the company or the group of companies will be disregarded.


What employees qualify?


To qualify, employees must:

• work for the company (or, if relevant, any group company) for at least 25 hours a week or for at least 75 per cent of their working time (which includes time spent in self-employed work);
• not have a "material interest" in the company (or, if relevant, any group company) (defined very widely by reference to a holding of more than 30 per cent of that company).

Employees may hold options over shares under a savings-related share option scheme and under a Company Share Option Plan (CSOP) in addition to EMI options. However, CSOP options are taken into account in determining the limit of £120,000 per employee.


Are there any restrictions on the grant of options?


Each employee can only hold a maximum of unexercised options worth
£120,000 in any 3 year period under the EMI. 


Any further options granted to an employee over and above this sum would not qualify for EMI relief. 


The 3 year period will begin to run from the date of the grant of the last ption that took the total holding to £120,000.


Companies are free to set their own option period, but options must only be capable of exercise within 10 years of being granted and be exercised within that period. 


After 10 years have elapsed the tax benefits of EMI no longer apply to the exercise of any outstanding options.


Companies are also free to set the option price which may be more or less than the market value of the shares on the date the option is granted.


The shares over which options are granted must be fully paid up ordinary shares. It is not possible to grant an EMI option over redeemable or convertible shares.


How is the EMI operated?


A separate agreement will be required in respect of each option granted to an employee. This enables the company to tailor each grant of an option to the particular employee.


Does HM Revenue & Customs (HMRC)supervise the operation of the EMI?


There is no need for prior approval of the EMI from HMRC - the company must simply notify HMRC within 92 days of granting an option.


A company can seek advance informal assurance from HMRC that it is a qualifying company.


HMRC has a period of 12 months from the expiry of the 92 day notification period in which to check whether the grant is within the EMI rules. The company has a right of appeal against any HMRC decision that this is not the case.


HMRC may require the company to provide it with information to enable it to carry out an investigation into the grant of options.


Any valuation of shares in connection with the EMI will need to be agreed with the Shares Valuation Division of HMRC. 




Companies who grant EMI options need to make a return to HMRC within three months of the end of each tax year.


What other requirements are there?

• The employee must be prohibited under the terms of the grant of the option from transferring any of his rights under the option.
• If the option is capable of being exercised after the employee's death, it must not be capable of being exercised more than one year after his death.

There are provisions in the legislation for dealing with the EMI options if the company which granted them is the target of a successful take-over. In certain circumstances the holder of the option can agree with the acquiring company to surrender his option in return for a replacement option to acquire shares in the acquiring company.


What are the tax advantages of EMI options?

• No income tax or national insurance contributions (NICs) are payable on the grant of an EMI option.
• Where the option price is equal or greater than the market value of shares on the date that the option is granted, then no income tax or NICs (including employer's NICs, currently at 12.8 per cent) are payable on the exercise of the option.
• Companies may set the option price at a discount (or even at nil).

However, where this is the case then, on exercise of the option, income tax will be payable on the discount (the excess of the market price of the shares on the date the option is granted over the exercise price paid by the employee). 


Where the shares can be readily converted into cash when the option is exercised, any such income tax must be accounted for under PAYE and NICs (employer and employee) will also be payable on the taxable amounts.
When shares obtained on exercise are eventually sold the employee will
be liable for capital gains tax (CGT) but the shares will qualify as
"business assets" for the purposes of entrepreneur relief. 


This means that an EMI compliant option exercised and shares sold two
years from grant will give rise to no income tax charge and capital
gains tax of only 10% on the gain to the employee. In addition the
annual CGT exemption will be available.


The costs of setting up and administering the EMI will be deductible expenses for the company when calculating its profits for the purposes of corporation tax.


Can the tax advantages be lost?


If at any time prior to the exercise of an option a "disqualifying event" occurs then, on a subsequent exercise of the option, an employee will be subject to income tax in the usual way as on the exercise of an unapproved share option.


However, the gain will be calculated by reference to the market value of the shares on the date of the disqualifying event. 


Examples of disqualifying events include:

• the employee ceasing to be a qualifying employee;
• the company ceasing to be a qualifying company.

Salary Sacrifice Pension Scheme - Winner?

Providing employees with a salary sacrifice scheme can  save them and the business money. 'Just getting by' is becoming more and more difficult. Employers are trying to reduce their costs and employees' take-home pay is being squeezed. At the same time, we are constantly reminded of the need to save more for our retirement. For employers and members of their pension scheme, a salary sacrifice scheme may provide a neat solution.

Where members are required to pay a contribution into their employer pension scheme, a salary sacrifice scheme can: 

• reduce the employer's NI cost,
• increase the member's take-home pay, and
• increase contributions to the member's pension scheme.

How Does It Work? If a member currently pays a contribution of 5%, he/she takes a 5% salary reduction and stops paying the personal contribution. The 5% salary reduction is paid as an employer contribution to the pension scheme.

The member's take-home pay increases by the saving in employee NI on the lower salary (11% on earnings up to £43,888, 1% thereafter).


The employer's costs are reduced by the NI saving (12.8%) on the salary reduction.


Pension contributions are increased by the employer adding some of his/her national insurance saving to the 5% employer pension contribution.


A further benefit is that higher rate taxpayers effectively obtain higher rate tax relief on pension contributions at source, rather than having to claim additional higher rate relief on personal contributions through their end of year tax return.

• The scheme must be well documented, and there are HMRC requirements to be observed. 
• It needs to be flexible enough to cater for changes to individual employee circumstances. 
• Employers will also need to consider how the scheme is communicated to staff.

An Illustration Consider an employee earning £25,000 who wishes to pay 5% per annum, or £1,250 per annum gross, into a pension plan. The company contribution is also 5% per annum or £1,250 per annum. The table illustrates the various savings and increases afforded by the scheme.

	Without Salary Sacrifice £	With Salary Sacrifice £
Salary	25,000	23,750
Personal Allowance	6,475	6,475
Taxable income	18,525	17,275
Tax payable	3,705	3,455
NI	2,121	1,983
Net salary (gross earnings less tax and NI)	19,174	18,311
Deduct employee pension contribution (net)	1,000	0
Net disposable Income	18,174	18,311
Net Effect To The Employer
Salary	25,000	23,750
NI	2,468	2,308
Employer pension contribution	1,250	2,580
Total	28,718	28,638
Saving in employer costs	0	80
Net Effect To The Individual
Effective pension contribution	2,500	2,580
Increase in spendable income	0	137
Increase in pension contribution	0	80

A Note Of Caution For Prospective Sacrificers 

A salary sacrifice is a permanent reduction in your salary and you do not have the right to revert to your previous salary unless there are special circumstances. 


Your previous gross salary will be used as the yardstick for things such as annual salary increases or salary-related benefits.


Making a salary sacrifice could affect entitlement to state benefits, such as the state second pension and tax credits. It may also affect contribution based benefits, such as incapacity benefit and job seekers allowance, and mortgage arrangements as you are reducing your annual salary.


For comment on the latest cases (as at 9 February 2012) on salary sacrifice arrangements, go here .

All Rights Reserved

Tax treatment of payments to reduce contractual redundancy rights

The recent case of Colquhoun v HM Revenue & Customs ("HMRC") suggests a payment to reduce an employee's future contractual redundancy rights can potentially be entirely tax-free and does not count towards the £30,000 exemption available on any future termination of employment.
Facts
Mr Colquhoun was employed by his employer from 1973 until 2005, when he was made redundant.  In 1997 he was offered a payment to reduce his rights to enhanced redundancy payments if he were to be made redundant in the future.  He accepted the offer and received £33,000.  Mr Colquhoun was subsequently made redundant 8 years later in 2005, when he received a smaller redundancy package than he would have done had he not accepted a variation in the terms of the scheme in 1997.
 
Mr Colquhoun sought to shelter this 2005 payment from tax by using the £30,000 tax exemption available for redundancy and certain other payments, claiming that the 1997 payment could not have been on account of redundancy as his employment had not then ended. HMRC argued the £30,000 tax exemption, which is only available once during the course of a particular employment, had already been used to shelter the 1997 payment and so the whole 2005 redundancy payment was taxable.
Decision

The Tax Tribunal agreed with Mr Colquhoun, holding that the 1997 payment was not a termination payment and did not, therefore, use up the tax-free exemption as it was not a termination payment in the first place. The exemption was therefore still fully available for the actual redundancy payment in 2005.  In reaching its decision, the Tax Tribunal considered that what is popularly known as the termination payment legislation only covers three areas:

• Termination of employment;
  
• Change in the duties of employment; and
  
• Change in the earnings of the employment.

The Tax Tribunal concluded that none of these factors were relevant to the 1997 payment for changing redundancy rights.  Mr Colquhoun had in 1997 remained in employment with the same employer, had not changed his duties and had not suffered any change in his earnings.  As the payment was not a termination payment , the £30,000 exemption had not needed to be used and so was still available to shelter the 2005 payment.  Other than to say the £30,000 tax exemption had not been used, which was the only relevant point in the proceedings, the Tax Tribunal did not analyse in any great depth the issue of how the 1997 payment should have been taxed on the basis it was too late to consider any alternative tax treatment.
Planning points

Further guidance is now required from HMRC (who may still appeal this case) outlining how they will treat payments to buy-out enhanced redundancy rights. 

Meanwhile, employers need to ensure they take appropriate advice before negotiating and making any such payments, but, for those employers considering reducing the value of their redundancy programmes and making a payment for doing so, there does at least seem the potential to make tax-free payments and to claw back tax where they treated these payments as taxable if the payments were more than £30,000.  

However, if there were a proposal to make employees redundant shortly after the payment or incentivise employees in this or some other way, great care would be needed as the payment could be taxable on other grounds and HMRC would be likely to raise these points.

For a link to the Tax Tribunal case report please click here.

UK VAT - Minor Change With Major Consequences

It has long been the case for some specific categories of VATable service that the place of 'supply' has been deemed to be where the recipient belongs.

As of 1 January of this year this is also be the case in many situations where previously the point of supply was treated as the place where the supplier belongs.

Why does it matter?

The new rules mean that VATable supplies may now occur where payments are made by UK entities to entities outside the UK, which would include making payments to 'parent' entities based overseas.


Whereas historically there was usually no VAT attributable to a supply because the supplier belonged outside the UK, a VAT charge may now be incurred in the UK. This could be a costly difference to a UK entity, especially if the supply originates outside the EU or in an EU country with lower VAT rates than the UK's.

Who will it affect?

No business - no problem


The rules only apply to those organisations that are engaged in a 'business'. 


Charities which are not registered for VAT and which do not engage in business of any kind eg a charity whose sole activity is to give grants will not be affected by this change.


However, if a charity is in fact registered for VAT then this new rule will apply whether or not a particular service relates to the business part of the charity's overall activities.


No cross-border supplies - no change


Entities which are not making or receiving cross-border supplies also should have no cause for concern as their VAT status is unlikely to be affected.


Overseas suppliers/recipients - watch out


Entities that do receive supplies from outside the UK (and particularly from outside the EU) may, however, be affected.


Where an entity in this situation is already registered for VAT it should have been given plenty of warning about this change via its existing VAT compliance activities but they should ensure that, after 1 January 2010, they are not still being charged any non-UK VAT by an EU supplier.


Clearly, this change is more of a concern to entities which do make or receive cross-border supplies but which are not currently registered for VAT as they are below the UK VAT threshold. This change in the rules may mean that an entity is inadvertently pushed over the threshold for VAT because of the change in status of its foreign-source supplies.

Recovering UK VAT on M&A costs: Opportunities in the light of the BAA case

BAA has recently won a significant victory in the Tax Tribunal, allowing it to recover millions of pounds of VAT incurred as part of its 2006 takeover by Ferrovial.


Businesses should carefully consider their VAT position in relation to M&A costs: this case highlights some opportunities to increase the amount of input tax recovered.


NB I understand  HMRC have  appealed against this decision to the Upper Tribunal, so there might be a change in the outcome. 


Background


Ferrovial formed a new company, ADIL, to bid for BAA in 2006.  That company incurred significant VAT-bearing fees in relation to the bid, primarily for investment banking advice from Macquarie and for legal and other services.  After the successful takeover, ADIL actually joined BAA's VAT group, and the representative member of the group sought to recover the bid company's pre-acquisition input tax.  HMRC – taking a restrictive view of deal fee VAT recovery – refused the claim, saying that ADIL had never made onward supplies, nor had it traded nor conducted economic activity.


Decision of the Tribunal


The Tribunal allowed BAA's appeal.  Even though ADIL never made actual taxable output supplies for VAT purposes, it did carry on an economic activity, and once it joined the BAA VAT group it was part of a group that made taxable supplies.  The fact that it subsequently joined the BAA VAT group meant that ADIL was a "taxable person" for VAT purposes even at the time it incurred the pre-acquisition costs.


Improving VAT recovery


In effect, the Tribunal looked forward to ADIL's subsequent position as part of a VAT group, rather than considering its pre-acquisition circumstances in isolation.  As there was no "chain breaking" exempt transaction intervening, the cost components incurred by ADIL to achieve the acquisition were sufficiently linked to the output transactions of BAA.  Moreover, the principle of fiscal neutrality allowed the taxable activities of the BAA VAT group to be imputed to ADIL. That principle allows deduction of VAT in full by businesses performing taxable transactions whatever the purpose or results, so that the VAT system does not distort competition between different business structures carrying out similar economic activities.


The Tribunal's analysis serves as a reminder to businesses that where HMRC's criteria for recovery cannot precisely be met, there may be scope for arguing that the principle of neutrality of taxation nonetheless allows for recovery.  As this case shows, it can be particularly important in relation to M&A activity, where HMRC have historically taken a restrictive view on recovery of input tax.


Due to the difficulty in attributing ADIL's input tax to specific output supplies, the Tribunal found a link to the general overheads of the representative member of the VAT group.  For businesses that are only partially taxable (for example in the financial sector) this may have a knock on effect on the rate of recovery.  Within a VAT group, savings may be possible through an efficient allocation of costs.


A further key point to consider in relation to M&A costs is whether the other parties involved, such as an investment bank, are making VAT-bearing taxable supplies.  Where these supplies are exempt, for example where they relate to negotiating an issue, sale or purchase of shares, any such exempt supplies would break the chain for recovery of input tax (and the principle of fiscal neutrality would not repair the link).  All services provided in relation to corporate finance merit a careful analysis to ensure they are structured to achieve maximum VAT efficiency.


The full case can be found at BAA Ltd v HMRC [2010] UKFTT 43 (TC)

Tax Relief on Repairs before first letting?

Many buy to let landlords think the cost of repairs to a newly-purchased property cannot be claimed before it is first let out. This isn't always the case.

Allowable Expenses


Such repairs are an allowable expense if certain conditions are met, and if allowable, they are treated as if incurred on the first day the property is occupied.

The important distinction is between work on the property which is "capital expenditure" - effectively, part of the cost of acquiring the property and making it fit for use in the letting business, and expenditure which is no more than routine maintenance – even if that maintenance is quite extensive as a result of the previous owner's neglect.

The Test


The crucial test is : was the property fit to be let before the repairs were carried out? If it was, then the repairs are an allowable expense against the rent once the property is let.

The law on this subject is derived from two tax cases which were heard shortly after the end of the Second World War.

A Cinema


In one case, Odeon Cinemas claimed the cost of repairs to various cinemas (principally the Odeon, Edgware Road) they had bought up after the end of the war and refurbished before opening them to the public again.

Although the cinemas in question were in a poor state of repair, the Court was satisfied that they were nevertheless usable and in use. Odeon were simply carrying out routine maintenance which had been neglected during the war. They were also satisfied that the price Odeon paid for the cinemas was not significantly lower as a result of the condition they were in.

A Ship


The other case concerned a ship which was also bought just after the end of the war. It too was in a poor state of repair, to the extent that it was classified as not being seaworthy having failed its full Lloyds certificate. Given the times, a temporary certificate of seaworthiness was granted provided the ship was sailed straight to a port where it could be extensively repaired.

When the claim for these repairs came to court, the verdict went against the ship-owners. This was because it was clear that (despite the temporary certificate granted because of the post-war shortage of ships) the ship was not fit for use and the repairs were necessary before it could be used for the owner's trade.

It was also the case that the price paid for the ship reflected the fact that it was unseaworthy. The cost of the repairs was therefore capital expenditure, being part of the cost of acquiring the ship as a useable asset for the trade, in contrast to the Odeon cinemas, which were already useable when purchased, and simply needed their neglected routine maintenance brought up to date.

Practical Tip 


This distinction between capital expenditure and repairs applies to any work carried out on a property, at any stage in its ownership, and there is nothing special about work carried out before the first letting. The same rules apply, and expenditure on normal maintenance is an allowable expense whether the property has already been let or it has only just been purchased.

That is why a landlord should look at the property he has just bought for his letting business and consider whether it is more like a rather tatty cinema, or an unseaworthy ship!

If you have difficulty believing this is the correct view, go to HM Revenue and Customs' website, and look at PIM2020 in their Property Income Manual under "Repairs etc after a property is acquired" by clicking here.