Thursday 9 February 2012

Salary sacrifices revisited

The tax and NIC savings of salary sacrifices have grown in popularity  as benefits providers have increased their products.  


Two recent cases underscore some key points to remember  to operate a "safe" salary sacrifice arrangement. 


Case 1 ( Reed Employment Plc v The Commissioners for HM Revenue and Customs - available to download here  . )


You should use the case to review your current salary sacrifice arrangements, making sure they are robust, but also consider additional areas where salary sacrifice could now be introduced with confidence.


The recent decision in the First-tier Tribunal  (FTT) case of Reed Employment plc (and other Reed Group companies) v The Commissioners for HM Revenue and Customs has now been issued. The case considered the employment tax treatment of a travel and subsistence arrangement that was purported to be a salary sacrifice arrangement.  Reed may well appeal against the ruling.



Reed made daily payments to cover lunch and commuting to around 500,000 temporary workers between 1998 and 2006, which they maintained was part of a salary sacrifice arrangement.  

The FTT found that the schemes operated did not constitute an effective salary sacrifice arrangement, as in reality no part of the salary was sacrificed.  The tribunal judges said “The salary was paid in full, even if there was a later manipulation”.  

In addition, it was ruled that the employed temps were engaged under a series of job-by-job contracts rather than under a continuing contract of employment.  Each assignment should therefore be treated as a separate engagement, and as a result the travel was therefore to a permanent workplace and the expenses were deemed to be ordinary commuting and non-deductible.

This decision turned on:
  • the contractual arrangements in place,
  • the clarity of the arrangement in place and
  • the fact that a salary sacrifice was found not to exist. 


The tax and NIC, along with interest, has been calculated at £158m. 

The contractual arrangements were much discussed and show the need to carefully draft a contract of employment and to ensure the terms of the contract are fully understood by all.  In the present case there was much made of the fact the employees could not understand their pay calculation
.

Comment The starting point for any successful arrangements is a correctly worded, understandable contract of employment which in this kind of an arrangement, to be acceptable to HMRC, should be an overarching contract of employment guaranteeing at least 336 hours.



The position put to the tribunal that a salary sacrifice existed was ultimately rejected partly on the basis of the confusing contractual arrangements in place but comment was also made on the small savings enjoyed by the workers as the arrangement was designed to deliver the bulk of the savings to the employer. 


The tribunal took the view that the employee could not understand what was happening to their pay from the payslip and that, in the tribunal view, a sacrifice by an employee should deliver a benefit to the employee.  


The tribunal went further to say that this purported sacrifice delivered no or little benefit to the worker and was an arithmetical exercise to deliver the maximum savings to Reed.


Comment In this case the tribunal reasoning that a salary sacrifice must deliver a benefit is potentially challengeable but the arrangement has to be transparent and to be understood and accepted by the employee if it is to be a valid sacrifice.  To avoid the view that ‘little or no’ benefit is made by the employee, an equitable sharing of the savings would also be advisable.


In this case the tribunal found that HMRC were entitled to issue a dispensation where they had a belief that no tax was payable (even if they were wrong).  However, as they found the expenses paid were a part of the employee’s wages, and there was no salary sacrifice in place, the expenses should have been subject to PAYE and NIC.  In addition, they considered the effect if a valid salary sacrifice was found to be in place but took a view that the assignments were all fixed term employments and as such the expense allowance would be taxable; that is, the employee did not travel to temporary workplaces which would attract relief from tax.


Comment When entering into these arrangements it is important not only to consider the contractual arrangements to be put in place but also important to ensure that the arrangement is communicated in a transparent way which demonstrates the worker was in agreement or had all the information to understand the arrangements affecting him/her.


The tribunal did not decide on the “Reed’s legitimate expectation” point as that will be left for any further proceedings at the Upper Tribunal.  However, the question they stated to be answered was “Can HMRC be required to apply a dispensation that Reed had a legitimate expectation was in place and covered the allowances paid, even where HMRC had no power to grant a dispensation”.  The tribunal commented that as the disclosures made did not provide the full facts to HMRC this helps support HMRC’s contention that Reed had no “legitimate expectation” as it did not fully disclose all relevant matters.


Comment In this kind of arrangement all the facts should be on the table and HMRC and other parties should fully understand the arrangements in place with this being supported by clear employee communications. If this had been the case here it would have aided the case that a legitimate view was held that the dispensation made the payment of expenses exempt from PAYE and NIC even if that dispensation was later found to be wrong.


What should you do next? This case will have possibly have far reaching implications for all employers entering into salary sacrifice arrangements (salary sacrifice arrangements can cover pensions, cars, bicycles, child care vouchers, flexible benefit schemes and many others).  We suggest that all these arrangements are reviewed to ensure they are compliant and importantly that the workers fully understand the arrangement they have entered into.  The Reed case highlights the pitfalls of getting it wrong. The employment contractual arrangements are also as important as the tax considerations.


I have experience of successfully implementing these arrangements with the agreement of HMRC on a fully disclosed basis. Therefore do not be put off by this case if you are considering implementing a salary sacrifice as they can be implemented successfully. These arrangements can realise considerable savings for both the employer and worker.


Case 2 Astra Zeneca UK Limited (AZUL) v HMRC (the opinion of the Advocate General can be found here   )


It seems to me the decision in this case was correct within the meaning of both EC and UK VAT legislation, but  it could have a significant cost implication for those employers who have provided discounted retail vouchers to their employees without accounting for output tax over the years.
The decision was important because it confirmed the principle that where an employee gives up part of his cash remuneration in return for a supply of goods or services which in themselves are liable to VAT, this represents a supply by the employer to the employee for a consideration. It means that the employer can recover as input tax the VAT paid on the purchase of the goods or services concerned, but must account for output tax on the cash value of the salary “sacrifice”.
VAT and employee benefits VAT and employee benefits have always been a bone of contention between HMRC and businesses. Over the years, we’ve had potential issues arising from staff discounts and company cars. More recently, things have been more interesting as most large private sector employers have introduced different types of “flexible benefit” remuneration packages that enable employees to choose from a wide range of goods and, mostly, services.
The concept is simple – each employee has a remuneration “pot” which can be taken in form of a basic cash salary and minimum holiday entitlement, or varied to include a smaller cash salary and a range of other benefits, which are usually provided at a discounted “price”. These include various types of insurance, such as medical or dental insurance, childcare vouchers, goods such as bicycles, personal computers and various types of retail vouchers.
The AZUL judgement was very important in that it established, beyond any doubt, how VAT should be applied on transactions between employer and employee.
The facts AZUL provided such retail vouchers as part of their staff remuneration scheme. In the particular case, employees could opt to receive vouchers with a face value of £10, although the cost to the employer was between £9.25 and £9.55, representing a discount of between 4.5% and 7.5% to the employee.
Under normal VAT rules, businesses who buy and sell retail vouchers, can claim the VAT paid on their purchase but must account for output tax when the vouchers are “sold”. The sale of the vouchers is regarded as a supply of services as it entitles the purchaser, in this case the employee, the right to purchase goods for the face value of the voucher from the retailer concerned.
HMRC believed that AZUL could recover as input tax the VAT paid on the purchase of the voucher, but should have accounted for output tax on the supply to its employees. This would basically mean that the correct VAT accounting would be neutral for the company, ie the input tax and output tax would be equal.
What actually happened was that AZUL didn’t do either, but submitted a claim for input tax on the purchase of the vouchers, but didn’t account for output tax, arguing that giving the vouchers to staff weren’t liable to VAT as transactions between employers and employees don’t represent supplies for VAT purposes. Their position was that the provision of the vouchers to the employees meant that the vouchers were used for a business purpose so there was no liability to output tax.. In essence, that giving the vouchers to the staff in return for a salary sacrifice meant that the vouchers were “consumed” by the business and there was no supply to the employee.
The relationship between employer and employee and whether there is a supply for VAT purposes The key issue was that AZUL argued that the provision of employee benefits represented use by the business and therefore there was no liability to output tax. The ECJ judgement – which at just 6 pages is one of the shortest and most readable – dealt with the issue by answering the first in a list of questions which were referred by the Tribunal:
In the circumstances of this case, where an employee is entitled under the terms of his or her contract of employment to op to take part of his or her remuneration as a face value voucher, is Article 2 of the [Sixth Directive} ... to be interpreted such that the provision of that voucher by the employer to the employee constitutes a supply of services for consideration?
Article 2 deals with one of the most fundamental of VAT issues, ie it defines the term “supply” for VAT purposes, while Article 4 of the Directive defines the term “taxable person”.
Based on these fundamental principles, the ECJ had no hesitation in supporting HMRC’s view that the provision of the vouchers in return for a salary sacrifice represented a supply for a consideration which was liable to VAT. The vouchers were not used in the business, but represented a supply of services from AZUL to its employees for their personal use.
What it means for supplies by an employer to an employee AZUL confirms that when it comes to the provision of goods or services for personal use, the employer and employee are treated as separate legal entities.
It doesn't affect the employer/employee relationship in so far as the employee is contracted to provide services, ie whenever an employee enters into a contract of employment, the employee and the employer enter into a relationship whereby in return for a salary, the employee is paid by the employer for providing his time and presence working in the employer’s business. Paid employment is not a business activity, so the salary does not represent consideration for a supply by the employee to the employer.
However, the provision of goods and/or services by the employer to the employee for non-business, i.e. personal, use in return for a proportion of the salary does represent a supply for VAT purposes. Such transactions between the employer and employee are liable to VAT in the same way as transactions between any two separate entities.
The judgement of the ECJ  simply confirms HMRC’s longheld viewpoint that wherever a business puts taxable goods or services to non-business use, any consideration that is charged for such use is liable to VAT. 
The ruling doesn’t affect the position of those benefits which are either available to all employees for no “charge”, or the VAT treatment of benefits which are “purchased” but are exempt from VAT or zero-rated, such as health insurance or nursery vouchers. But employers are advised to review their employee remuneration packages to see if they have any liability on positive rated supplies made to employees that should be disclosed to HMRC.



Tuesday 7 February 2012

Cycle and save tax and the environment!



Cycling could be just the thing help you keep fit, save money and be kind to the environment.
HMRC like cyclists too, so what do you need to do to qualify for tax savings.

First you will need to get your employer to participate in the scheme, they can do this either by setting up their own scheme or by using www.cyclescheme.co.uk or http://www.bike2workscheme.co.uk/ .

The basic rules are:

You must use the bike and/or safety equipment mainly (more than 50 per cent of the time) for ‘qualifying’ journeys. This means a journey or part of a journey:
  • between your home and workplace
  • between one workplace and another
  • to and from the train station to get to work
Taking part in the scheme means that you don’t have to pay a lump sum up front to buy a bike and/or safety equipment. Instead, you could borrow the bike and/or equipment from your employer, usually up to the value of £1,000.

Making loan repayments

Your employer may want to recover all or part of the cost of lending you the bike and/or safety equipment. If so, you would then make loan payments back to your employer over an agreed period (typically 12 to 18 months) to spread the cost.

The loan payments are usually taken out of your salary through a ‘salary sacrifice’ arrangement. This means you agree to accept a lower amount of salary in return for a benefit - the loan of a cycle and/or safety equipment. http://www.direct.gov.uk/en/TravelAndTransport/Cycling/DG_190101

Example of savings using Salary Sacrifice
              
Cost of bicycle:                                                                   £500
Cost of accessories                                                              £100
Total cost                                                                           £600
Income Tax 20%                                                                 £120
Employee National Insurance     12%                                       £72
Total Employee Saving                                                         £192
Your employer will save Employers National Insurance of 13.8%   on the salary sacrificed.

The Employee can buy the cycle from the company for a price set using the HMRC valuation table below
Age of cycleAcceptable disposal value percentage
Original price of the cycle less than £500Original price £500+
1 year18%25%
18 months16%21%
2 years13%17%
3 years8%12%
4 years3%7%
5 yearsNegligible2%
6 years &; overNegligibleNegligible

In addition you can claim an HMRC mileage allowance for Cycling of 20p per mile and if your employer doesn’t pay the allowance you can claim back the tax on the allowance using form P87 http://www.hmrc.gov.uk/forms/p87.pdf

If you have ‘Cycle to Work’ days your employer can provide free meals and refreshments for cyclists. http://www.hmrc.gov.uk/manuals/eimanual/eim21668.htm

So as the saying goes ‘get on your bike’


For UK residents it is one tax break that’s worth pursuing because the Cycle to Work scheme, can save you between 16 and 40 percent off the cost of a bike. 

Time the dividends from your company carefully

You have overdrawn your director's loan account (DLA).  This can land both you and your company with an unexpected tax bill. Your golf club chump(s)  suggest the company pays a dividend after the end of the company's financial year. Does this work? Is there a better option? 


Targeting loan accounts One of the first things HMRC does when checking the accounts of an owner-managed company, is to examine the directors' loan accounts (DLA) closely.


Your accountant should do the same thing when preparing the annual accounts. If he finds you owe the company money, he will usually suggest crediting your DLA with a bonus or dividend (more tax efficient) to balance the books. By the time HMRC see the figures everything appears to be in order. But is it?


Two problems - only one fix There are two tax charges which can bite from an overdrawn DLA:



  • Your company will have to pay tax amounting to 25% of the amount you owe it;
  • You can be taxed on a benefit-in-kind (BiK).

You can avoid the tax on your company by simply paying a bonus or dividend to clear the amount you owe. Provided you do this within nine months of your company year end , HMRC will be happy and the company will not have to pay tax on your loan. 


However, you may still have a personal tax charge on the BiK and there is yet a further potential trap.


TRAP 1 A taxable BiK arises where, you owe your company more than £5,000 even if only for just one day. Paying a post-year-end bonus or dividend will not remove the BiK charge.


TRAP 2 If you were not aware of the BiK problem, you will almost certainly have failed to declare it on your P11d form (return of benefits and expenses). This can attract a substantial penalty.



Incorrect P11D and P11D(b)returns:


Penalties are based on a percentage of tax that is due and might be uncollected as a result of the errors in the form. The percentage varies according to the circumstances and seriousness of the error:



  • 0% (for a genuine mistake made having taken reasonable care to complete the form correctly)
  • 30% (careless error)
  • 70% (deliberate error but not concealed from HMRC)
  • 100% (deliberate and concealed error).



Late submission



  • Form P11D: £300 per return plus £60 per day until sent in
  • Form P11D(b): £100 per 50 employees per month.  

Toolkit help HMRC warn of both these traps in their Director's Loan Account Toolkit which can be found here . This hows they are aware of the problem and gives you less excuse for ignoring it. So what is the fix?

Forestalling Obviously keep close track of your loan account balance and if it's likely to go over £5,000 clear ut immediately with a bonus or dividend.  Preferably, don't leave it until your year end.





Declaring and paying dividends


A dividend can be declared at any time by a company but will only be valid where it is made in accordance with company law - see s.829 to s.853 Companies Act 2006. Essentially these rules say that a dividend should be paid only from the company’s profit accumulated at the time the dividend is declared.

Where you intend to declare a dividend on the first day, or soon after the start, of an accounting period you won’t know for sure the results of the financial year just ended, but you will probably have a good idea. Producing regular management accounts, say quarterly, will help you keep tabs. Even without these you may know that the company has substantial profits built up over the years in which case declaring a dividend at the start of a year won’t be a problem. If, however, the level of profit is predictable you should estimate it before working out how much dividend can be paid.

It’s advisable to be cautious and not declare a dividend that exceeds profits. Where this happens and the recipient is a material shareholder, this usually means they own 5% or more of the ordinary share capital, they will be required to repay the dividend. And if the proper paperwork isn’t kept (see below) HMRC might argue that the excess is taxed and subject to NI as additional salary.

Paying a dividend


Declaring a dividend is the formal step needed before actually paying it. A declaration is just a statement that says how much and when the dividend will be paid. There’s no reason declaration and payment can’t happen on the same day.

The director/shareholders loan account can only be credited with a dividend on the date it’s payable - and not the date of the declaration.

Paperwork


Where the timing of a dividend is critical this makes the need to keep accurate documentation and records equally so. Companies should record the date the dividend is declared. This might be in the form of a minute of a board meeting, or for a single director company just a note kept with the company’s statutory records (company register etc.).

Other shareholders


A dividend declared will be payable to every holder of the same type of share. This can cause trouble if one shareholder wants a dividend paid early in the financial year while another wants to wait. To get round this problem you can issue additional classes of share for each director/shareholder in addition to their ordinary shares. This will allow you to declare dividends at different dates. It’s advisable to take professional advice before going down this route.






Sunday 5 February 2012

New tax investigation initiatives

HMRC are now taking a much harder stance in cases of fraud. Is that you?


New strategy Last summer HMRC carried out a consultation on the way investigations are settled. They have now published a revised Code of Practice (COP9) which can be read here . Pleasant bed-time reading it is not! 


What is tax fraud? Usually - you think of fraud in terms of large sums of money but it can - and does - mean gaining any advantage, usually financial, by deception . HMRC will now categorise those who underpay tax into those who make mistakes and those who commit fraud with no middle ground.


Confession time If HMRC suspect deliberate, unfair tax avoidance, a COP9 will be issued. This includes a "contractual disclosure facility" (CDF) form where you confess all instances where you have unfairly dodged tax. If they are satisfied with your response, they will not prosecute you. If you don't make a full confession, they will be much harsher.


It will be some time before we know how HMRC will apply this new strategy . Will COP9 be automatically issued in every tax enquiry? 


TRAP If you receive a COP9, don't ignore it. If you don't rely within 60 days, HMRC will treat this as non-co-operation. Contact me or your tax adviser immediately.


TIP Don't let HMRC bully you into signing a COP9. If you do, you will be admitting deliberate, unfair tax avoidance and HMRC will automatically charge higher enalties if you have underpaid tax. 



Friday 3 February 2012

Tax Relief for pre-trading expenses







By the time you actually start trading, you may have spent thousands of pounds on research and setting up the business.
Provided you have formally notified HM Revenue and Customs that you have started up a business, most of these costs are usually allowable as business expenses in the first year (some may not be - see below for the most common of these exceptions).
Income Tax (Trading and Other Income) Act 2005
Pre-trading expenses



Relief under ICTA88/S401 for pre-trading expenditure is only available to the person who incurred the expenditure and commences the trade. 

From the moment you decide to go into business, start keeping a record (with matching receipts, invoices and bank statements) of all your business expenditure. Best of all set up a separate bank account to make this easier. 
Expenses and costs incurred by small businesses and companies before they  begin business can be offset against their sales in the first accounting year if they can prove the pre-trading expense was incurred within seven years from their first day of trading and would have been deductible as a business expense if it had been incurred after the business started trading.

Such pre-trading expenditure may commonly include:

  • advertising costs, 
  • wages, 
  • rent, 
  • rates, 
  • insurance, 
  • bank charges and interest, 
  • lease rentals on plant and machinery, computers equipment, office furniture and accountancy fees.

Where business assets are bought before commencement of trade, they are introduced into the business at their current market value and treated as if  purchased on the first day of business. The business is also entitled to claim capital allowance on the tangible asset.



  • Some costs are not allowable.

  • For example, training courses are only an allowable expense once you have officially commenced trading.

  • If you form a limited company, the formation costs incurred are not allowable.

    VAT Paid Before VAT Registration
    You can reclaim any VAT you are charged on goods or services that you use to set up your business.
    Normally, this will include:


    • VAT on goods you bought for your business within the last 4 years and which you have not yet sold.
    • VAT on services, which you received not more than 6 months before your date of registration.
    You should include this VAT on your first VAT return. 



    To able to make this claim, the following conditions have to be met:-

    •the goods were bought by you as the entity (for example, the individual, business or organisation) that is now registered for VAT

    •the goods are for your VAT taxable business purposes, which means they must relate to VAT taxable goods or services that you supply

    •the goods are still held by you or they have been used to make other goods you still hold

    For example, prior to registering for VAT the business purchased 10,000 widgets and sold 3,000 of these products. The business can, therefore, claim back VAT on the remaining 7,000 items in stock at time of registering for VAT. 

    Deregistration and Reregistration  On deregistration a trader must account for output tax in respect of assets on hand if the liability exceeds £1,000. If the trader later reregisters for VAT and the assets in question (or some of them) are again to be used in the business, the output tax previously charged on deregistration (or the respective part of it) is potentially deductible input tax of the newly reregistered business.

    However, the trader will not have a valid tax invoice, having merely accounted for output tax on deregistration. HMRC used to allow deduction of this input tax only by concession but now accepts that if the trader can demonstrate having accounted for output tax in respect of the assets in question on previous deregistration, that is adequate alternative evidence of having incurred the input tax. A tax invoice is not, therefore, strictly necessary and the concession is, accordingly, not necessary either and has been withdrawn. The effective position thus remains unchanged but HMRC's rationale for allowing the claim has been updated.




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