CLIENT NEWSLETTER - WINTER 2007/8

“ACTIVE ACCOUNTING AND TAX”

INTRODUCTION

In my Autumn 2007 Newsletter, I commented that following the bringing forward of the pre-Budget report (PBR) to early October, there were a number of matters that had not been properly thought through at that time.

Whilst announcements were made regarding:-

• the simplification of Capital Gains Tax,
• “income shifting", overturning the Arctic Systems House of Lords decision,
• and non-domiciled individuals,

there was an immediate outcry against the effects of the first proposal and full details of the Chancellor's intentions on the second and third matters were not available. Since the PBR, further information has been issued only very slowly, the final proposals on non-domiciled individuals being issued in late January 2008.

Before looking at anything in detail, there is one important point on Capital Gains Tax, where it could be beneficial to take action before 5 April 2008.

Planning point: If you have owned any asset for a long time, particularly since before 1990, then this will have attracted both indexation relief for inflation (up to 1998) and then taper relief, under the new rules from that date. Both these reliefs will be lost for disposals after 5 April 2008, which could mean a substantial increase in the tax payable on a later disposal. To avoid this, it could be a good idea to trigger a disposal before that date, perhaps by transfer to another family member, to make sure these reliefs are retained.

This can only be reviewed on an asset by asset basis and we should be pleased to look at any assets that fall into this category, to see if a benefit could be obtained by your making a disposal under the current rules. Having said that, where the asset is land or buildings, the effect of Stamp Duty Land Tax will also have to be considered. If you would like us to review the tax consequences of any potential disposals, please do not hesitate to give Linda or me a call.

There has also been a further change in the VAT figures used for mileage claims and I will take the opportunity of this newsletter to comment on two other changes coming up in April 2008 - re Capital Allowances and fuel benefits, before looking ahead to future HMRC "compliance checks" and the 2008 Budget.
To find the information you need in this newsletter, please refer to the following headings:

1. Capital gains tax reform	5. Capital allowances from April 2008
2. Income shifting	6. Fuel benefits
3. Non-domiciled individuals	7. HMRC compliance checks
4. VAT and mileage rates	8. 2008 Budget

1. CAPITAL GAINS TAX REFORM

Essentially, the reforms announced in the pre-Budget report remain in place, but with one important exception – Entrepreneurs' Relief.

In response to what I described in my Autumn 2007 newsletter as previously unheard of anger from the business community, particularly from small business organisations, following the Chancellor’s announcements last October, from 6 April 2008, alongside the CGT reform programme, Entrepreneurs’ Relief will be available in respect of:-

• Gains made on the disposal of or all or part of a business or gains made on the disposal of assets following the cessation of a business, by
• certain individuals who are involved in the running of the business.

The first £1,000,000 of gains that qualify for this relief will be charged to Capital Gains Tax at an effective rate of 10%; gains in excess of £1,000,000 will be charged at the new 18% rate. An individual will be able to make claims for relief on more than one occasion, up to a lifetime total of £1,000,000 of gains qualifying for relief.

As with the proposals on income shifting, detailed legislation has yet to be unveiled and it is possible that there will be some further conditions, of which we are not currently aware. However, this does represent a significant “victory” for the small business organisations that lobbied the Chancellor following his original announcement. Indeed, the concession is even more generous than I hoped for in my Autumn newsletter – when I thought that any change would be an effective reintroduction of Retirement Relief, the new relief is more widespread than that and does not depend upon the retirement of the business owner.

As the full impact of the proposed changes to Capital Gains Tax have been digested by the professions, it has become clear that there are perhaps more losers than originally thought; this remains a tax raising measure, expected to bring in some £700 million in a full tax year.

Planning point: Because of this, should you do anything now? – in the circumstances set out in the planning point on the front of this newsletter - YES!!! – Please contact Linda or me for further advice.

2. “INCOME SHIFTING”

This is potentially one of the most fundamental changes to the UK taxation system for many years, but why has it arisen? Historically, up until the end of the 1980s, a married couple were always taxed as “one entity”, although there were some special provisions to avoid “double taxation” when both parties had their own earned income.

Following the abolition of this joint taxation basis, married couples are taxed as individuals, with one exception - the Tax Credits system, where “family” income is the basis for payment. When the change was made, it was recognised that some couples might rearrange there affairs such that, overall, they paid less tax. In the different tax avoidance climate of that time, when this was commented on in the debate in Parliament, it was not seen as a problem; how times change!

Having said that, there was a lot of comment in the professional press at that time regarding how the Inland Revenue, as it was then, might approach husband and wife partnerships, where it was clear that one party to the marriage "did all of the work", but the income was being shared between the two. There were “one or two” high profile cases (it was not possible to use a company in the same way as it is now for differing tax reasons – see below), but in practice, no particular action was taken by the Inland Revenue on this point.

The current use of a limited company for tax avoidance purposes was only made possible by changes to the tax regime for dividends, etc, introduced by the current Government in 1997. Practically, this increased the opportunities for tax avoidance and in the Arctic Systems case, which I have commented on in a considerable number of previous newsletters, HMRC sought to attack what had become relatively standard tax avoidance practice. When HMRC eventually lost this case in the House of Lords, last Summer, it was quickly announced they would change the law and the income shifting rules are the result.

At this stage, we have a consultation document, the consultation period ending on 28 February 2008. It is expected that following the end of this period, a further announcement will be made in the 2008 Budget and final legislation included in the Finance Bill 2008 to be effective in respect of income “distributed” to individuals from 6 April 2008.

Very broadly, the rules will apply where under “relevant arrangements” dividends or partnership profits are “shifted” from one individual to another. However, the rules will only apply where such a “shift” results in the movement of income from a higher to a lower rate taxpayer.

The rules will apply where all of the following conditions are met:-

1. Individual 1 (the earner) is party to or has power over the relevant arrangements,
2. Individual 1 forgoes income and the income forgone is individual 2's for the relevant tax year,
3. Individual 1 has the power to control the amount that is shifted,
4. The shifted income consists of distributions from a company (normally dividends) or the profits of a partnership.

Well, enough of the legalese, basically if one person "earns" the money, but when it comes to be taxed it is treated as not being all theirs, but part of it is “given away” to another person and tax is saved, please note there is no specific reference to married couples or civil partnerships here, the rules are drafted wider than that, then there could be a problem.

The talk in the professional press is that as well as targeting specific situations like that in the Arctic Systems case, many commercial arrangements will be caught. Because the proposals are drafted very widely, it is believed they will catch many owner managed businesses, not only just those involving husbands and wives, but also including other family members, for example siblings, or indeed friends. The difficulty will be working out whether you are caught by the definition of income shifting, or not, which will lead to yet more uncertainty.

The consultation document also defines “relevant arrangements” as being arrangements that are not genuinely commercial, where it would be reasonable to conclude that the purpose or one of the main purposes of the arrangement is the avoidance or reduction in the charge to tax. In this connection, genuine commercial arrangements are those that would exist between unconnected persons dealing at arms length.

What we are doing about the new rules: During February/March 2008, we will be reviewing all clients and looking at whether we believe there could be some difficulties under the new legislation; I anticipate there will be three different situations to consider:-

• Clients who are not affected by the proposals, because the income distributed as dividends or profits to those working is proportionate to the work each individual performs.
• Cases where although it might appear there is income shifting, more detailed consideration of the commerciality of the arrangements in place, may allow the contention to be rebutted.
• Situations that will definitely be caught under the proposed rules.

We will advise you which of these categories we feel you fall under and in the case of the second and third bullet points above, what action we believe should be taken, either to mitigate the effects of the proposals, or with regard to a change in the way in which dividends and profits are distributed, in order to comply.

If you have any queries before we write to you, of course please do not hesitate to give Linda, Kim or me a call.

In addition, if you know of anybody else, perhaps an unrepresented family member or friend, whom you feel may benefit from some professional advice on these matters, please ask them to give me a call.

3. NON-DOMICILED INDIVIDUALS – FLAT RATE TAX CHARGE

I gave quite a lot of information on the proposed changes in my Autumn 2007 newsletter and although further details are now available, they do not add significantly to the information I set out then – aside from confirming that the flat rate charge for non-domiciled individuals who have been in the UK for more than seven years and use the "remittance basis" in respect of overseas income will be £30,000.

What we are doing about the new rules: We have a number of non-domiciled individuals as clients and will be writing to each of you to explain how we believe the proposals are likely to affect you in the course of the next few months, however, the option for an individual to declare your worldwide income on a UK tax return form to avoid the charge remains possible. In such circumstances, double taxation relief to take account of tax already paid overseas, may be available.

One point that is “new” since last October, is that a number of tax barristers, now consider that the £30,000 charge in the UK would not be eligible for deduction under double taxation treaties in many other countries, including the USA, as it does not meet the definition of a tax charge contained in these treaties. This puts another political aspect on the decision to tax non-domiciled individuals in this way.

4. VAT IN MILEAGE PAYMENTS

As noted above, HMRC has reviewed the “company car” rates, as they are known, which represent the accepted figures for reimbursement of fuel costs to company car drivers for business mileage, assuming that there are no payments for fuel made other than in respect of business mileage claims. As previously, these rates are also able to be used as the gross of VAT rate on which VAT can be recovered as business input tax.

The latest table is to be used for business mileage travelled after 1 January 2008 (bold figures in the table below), but as there have been four different tables in the last 12 months, I thought it would be useful to show all of these, as below.

Engine size	Petrol cost (per mile)	Petrol cost (per mile)	Petrol cost (per mile)	Petrol cost (per mile)	Diesel cost (per mile)	Diesel cost (per mile)	Diesel cost (per mile)	Diesel cost (per mile)
		From	From			From	From
		1/2/07	1/8/07			1/2/07	1/8/07
	Up to	to	to	From	Up to	to	to	From
	31/1/07	31/7/07	31/12/07	1/1/08	31/1/07	31/7/07	31/12/07	1/1/08
1400 cc or less	11p	9p	10p	11p	10p	9p	10p	11p
1401-2000 cc	13p	11p	13p	13p	10p	9p	10p	11p
over 2000 cc	18p	16p	18p	19p	14p	12p	13p	14p

Separate figures are used for LPG vehicles; if you need these please give me a call.

Planning point: The VAT fraction is currently 7/47, this being the amount of VAT contained in an amount including VAT. Accordingly 7/47 of each of the above figures, for example 2.83p per mile in respect of the 19p rate above, is the officially sanctioned amount of VAT that can be reclaimed per mile in respect of business mileage expenses. This can amount to a significant figure and we strongly recommend that you consider reclaiming VAT on this basis if you have not previously done so.

5. CAPITAL ALLOWANCE CHANGES

As stated in both my Spring and Autumn 2007 Newsletters, there are very big changes to Capital Allowances for business assets coming in respect of purchases after 31 March/5 April 2008.

Planning point: If you are considering making major purchases of fixed assets during the first half of 2008, you could end up with significantly different quantities of allowances for tax purposes dependant on whether you purchase these before or after 31 March/5 April. If you would like us to review the effect of the purchase date for fixed assets, particularly fixed assets costing more than £50,000, please do not hesitate to give Kim, Linda, or me a call.

6. FUEL BENEFIT IN KIND

Having remained unchanged for a number of years, the figure on which the benefit of private fuel supplied to an employee is based is being increased to £16,900, up from £14,400, with effect from 5 April 2008 – an increase of over 17%.

Where fuel for private journeys is provided, this figure is multiplied by the percentage charge based on the CO2 emissions of the vehicle to give the taxable benefit in kind. Based on a 1,400 to 2,000 cc vehicle with a 22% CO2 charge, I calculate a 40% taxpayer you would need to do 11,440 private miles a year after 5 April 2008 to be better off! (£16,900 X 22% ÷ .13 (from VAT table above) X 40% = 11,440).

Planning point: The mileage figure at which this benefit is cost effective is now so high, it is unlikely to be an incentive in almost all cases. If you are in receipt of this benefit or are aware of anyone who is, I recommend an alternative be negotiated.

7. HMRC COMPLIANCE CHECKS

Spurred on by the success of their 2007 "campaign" against undeclared overseas bank interest, HMRC have announced that in 2008 they intend to perform detailed compliance checks in the following areas:

• Property income
• Higher rate tax payable on interest with basic rate deducted at source
• Bank, National Savings and other interest received gross with no tax deducted
• High levels (over £2,000) of unidentified "other" expenses claimed against any form of income
• Construction Industry Scheme discrepancies
• SSP – checks on employers who have claimed this back
• Incentive award schemes – the checks will be on employers and third parties who provide these
• UK Chargeable events, these can occur with certain payments from bonds or life assurances and whilst basic rate tax is deducted at source, higher rate tax may be payable.

The fact that there are problems over higher rate tax is largely of the Government's own making from stopping the requirement for all higher rate taxpayers to complete a self-assessment return, owing to there being so many more higher rate taxpayers for some reason! However, notwithstanding this, HMRC is now attempting to crack down by checking on potential non-compliance in the above areas.

Over the last few months, HMRC have been collating third party information they have obtained from a variety of sources – for example Stamp Duty Land Tax returns relating to the purchase of properties that are not the recorded address of the taxpayer. This will give them a database of properties that are potentially rented out and they will be making initially informal contact with some of the taxpayers involved, to confirm or deny rental income is being received. I understand letters on this will start to go out in the week commencing 18 February 2008; work in the other areas being programmed over the period up to June 2008.

Planning point; Because of the source of their information on these matters, whilst they should always send us, as your agent, a copy of anything they send to you, this might not happen if you are picked for one of these checks. Please let us know as soon as possible, if you receive a letter, however informally it may be worded, looking into one of these, or indeed any other matter.

If you know someone who does not have a tax adviser, who receives a letter on one of these or indeed any other matter, I strongly recommend you urge them to take professional advice, particularly in the case of income from property. The detailed legislation on the calculation of property income runs to many pages and whilst HMRC can help to put some basic figures together, the relatively junior officials they often use to do this, may not realise the correct position and all of the expenses that might be claimed.

8. BUDGET 2008

As mentioned above, the next budget will be on 12 March 2008. On this occasion, the tax bands for 2008/09 and other "annual" figures will be announced, but I hope very much that there will no other substantial changes. What we need now is some stability in the tax system and for the considerable number of changes to virtually every single tax, announced over the last couple of years to be given the opportunity to bed down and work properly.

Copies of previous newsletters can be found on our website at www.paulahill.co.uk

PAUL HILL

This newsletter is prepared for the general information of clients and contacts of Paul A. Hill & Co only. No liability can be taken in respect of any action taken or not taken because of relying on the information contained in this newsletter alone. Only the general position can be stated here and there are often qualifying conditions or other criteria that affect the way in which tax relief is given or other proposals will affect you or your business. You should always take individual advice based on the exact circumstances that you have before taking any form of action, or indeed refraining from any action. If you would like to follow up on any of the points in this newsletter, please do not hesitate to contact me, or any of the practice staff.

© Paul Hill and Paul A. Hill & Co. – February 2008