Entrepreneurs’ Relief – Do you qualify ?

Entrepreneurs’ relief (ER) is widely misunderstood by people who don’t read the legislation. For ER to apply to a gain arising from the disposal of shares or securities, the company must be the individual’s personal company for a full 12 months ending with the disposal date, or the date the company ceases to trade (if earlier).

A company is the taxpayer’s personal company if he holds at least 5% of the ordinary share capital and at least 5% of the voting rights exercisable by virtue of that shareholding. This dual condition is relaxed if the shares were acquired by way of qualifying EMI options acquired on or after 6 April 2013.

A further relaxation is proposed where the shareholding is diluted below the 5% threshold as a result of issuing more shares to new investors on or after 6 April 2019. This change in the ER rules will be introduced by FA 2019.

The legal definition of ordinary share capital is: “all of a company’s issued share capital, except fixed dividend shares which have no other rights to share in the company’s profits,”. This definition means that the taxpayer must hold 5% of all the issued share capital (not just 5% of the ordinary shares), while ignoring any shares with a fixed dividend.

When the company has a complex share structure, working out exactly what proportion of the total issued share capital an individual holds can be tricky. HMRC has recently updated its view of ordinary share capital, to include more examples of situations where the position may be finely balanced. It is worth reading through those examples if  shares in a company with a complicated share structure.

The voting rights part of the condition must also be met. In the case of Dieno George the taxpayer did not hold enough voting rights for the full 12 month period to take his voting power up to 5%, and so his claim for entrepreneurs’ relief failed.

SEIS Qualifying Conditions

Seed Enterprise Investment Scheme (SEIS)

Click on this image to see more about SEIS and EIS Advisory

When you wish to use a venture capital scheme to allow equity investors to claim tax relief, you need to understand the conditions for the company to qualify before the investments are made. The best way to do this is to read the law, or approach us for advice. It’s a pity that HMRC didn’t do this before declining an application to use the SEIS by a small company in Oxford.

The Seed Enterprise Investment Scheme is specifically designed for young companies to raise relative small amounts of start-up capital. The company is permitted to raise up to £150,000 over a three year period, and the maximum investment per taxpayer is £100,000 per tax year. There is no minimum investment for either the company or for the equity investor.

Oxbotica Ltd, a spin-out company from Oxford University, applied to use SEIS for part of its initial equity capital. It was formed with £1000 of share capital and three individuals wanted SEIS relief on their share of this which amounted to just £316. In addition the company received a substantial loan from the University.

As with any risky venture, the investors were looking to the long term gain on the shares, so they were not very interested in 50% income tax relief on the investment, but they were attracted by 100% exemption from CGT once the shares had been held for three years.

HMRC declined the company’s application to use SEIS on these grounds:

  • The shares were subscriber shares – this is irrelevant as long as the shares are subscribed for in cash and are fully paid up.
  • The small amount of funding wasn’t of meaningful use to the business – this is an invented condition as there is no minimum investment requirement.
  • The real purpose of the share issue was to provide CGT relief to investors – irrelevant if the money is used for the business’ expenses – which it was.

The tax tribunal had no problem in agreeing with the taxpayer that SEIS was applicable, but it’s disappointing that the statutory review process didn’t reverse the initial HMRC decision, which was it was so clearly outside the law.

Oxbotica Ltd v HMRC TC06538

Disguised Remuneration – Avoidance

HMRC has updated the payment terms for settlement of disguised remuneration avoidance cases, which can be found on GOV.UK

Disguised remuneration tax avoidance schemes claim to avoid the need to pay Income Tax and National Insurance contributions. They normally involve a loan or other payment from a third-party which is unlikely to ever be repaid.

These schemes are used by employers and individuals. If they’re used by contractors, they’re often known as contractor loans.

If you’re in a disguised remuneration scheme, you should settle your tax affairs as soon as possible. If you don’t, the new loan charge announced at Budget 2016 will apply to all disguised remuneration loans outstanding on 5 April 2019.

Please contact us if you need help.

Reclaim SDLT and LBTT

Since 1 April 2016 a supplement of 3% SDLT has applied to purchases of second and additional homes in England, Wales and Northern Ireland. This supplement was copied in Scotland and became the additional dwelling supplement (ADS) for LBTT, also set at 3% of the entire consideration for properties costing £40,000 or more. A similar 3% supplement applies to LTT in Wales from 1 April 2018.

However, the rules for the SDLT supplement and the ADS for LBTT do not mirror each other, as there are different conditions for relief from the 3% supplement in each country.

Scotland has just amended its law to provide relief from ADS where a couple buy a home together to replace their main home, but their former home was held the sole name of one of the individuals. Taxpayers who fall into this category, and who purchased the replacement home on or after 1 April 2016, can now apply for a refund of the additional LBTT paid.

There are a number of circumstances in which refunds of the SLDT supplement can be reclaimed as set out in the SDLT manual under condition D. Unfortunately, the SDLT manual is not written in plain English and the convoluted conditions and exceptions are difficult to follow. We can help you with questions in this area.

It is worth checking if a refund of the SDLT supplement is due, as it must be claimed within 3 months of the sale of the previous main residence or within 12 months of the filing date of the land transaction return, whichever comes later. Another point to check is whether the property acquired is 100% residential, as the supplement only applies to residential property.

Revenue Scotland: relief from additional LBTT charge

SDLT supplement condition D

Claim refund of SDLT

Cash basis for landlords

A voluntary form of cash basis accounting was introduced from 6 April 2013, but only for unincorporated trading businesses with turnover under the VAT threshold. Until 6 April 2017 landlords were required to use accruals accounting for property income.

From 6 April 2017 the tables are turned as smaller unincorporated property businesses are required to use a form of cash basis accounting. The landlord can opt to use the cash basis for one property business and not for another different and separate property business. Say he has some property let as furnished holiday lettings, and other property let as normal residential lettings, the FHL accounts could be drawn up on an accruals basis and the other lettings on the cash basis.

The following unincorporated landlords are not permitted to use the cash basis:

  • those with annual turnover exceeding £150,000;
  • where business premises renovation allowance has been claimed and there is a balancing adjustment in the year;
  • LLPs, trustees, personal representatives or partnerships including a corporate member;
  • where the property is jointly held by spouses/ civil partners and one person does not use the cash basis.

If the landlord doesn’t fall into one of the exemptions listed above, he can opt to use accruals accounting by electing in his tax return for the relevant tax year, or by the deadline for amending that return: 31 January 2020 for the 2017/18 returns.

The cash basis for property business differs from the cash basis for trading businesses on these points:

  • security deposits are not counted as income while the funds are available to be returned to the tenant.
  • the cost of replacing domestic items in residential properties may be deducted, but not the cost of the original items.
  • interest and finance costs are not capped at £500 per year.

Finance costs are capped under the cash basis for property businesses, but the disallowed charges are based on the portion of loans which exceed the value of the let properties when they were first let by that landlord. This cap applies before, and in addition to, the restriction of deductions for finance charges relating to letting of residential property, which is phased in from 6 April 2017.

Guidance on the cash basis for landlords

Incorporating a property portfolio business

There is now huge pressure on indebted landlords to incorporate their property businesses, to avoid the restriction on the deduction of interest and other finance charges which has applied since 6 April 2017.

Where an actively-managed property portfolio is transferred to a company the gains arising maybe rolled into the value of the shares received, using incorporation relief (TCGA 1992, s 162), if it can be shown that the letting activity is a “business”. This was the essence of the EM Ramsey case, as decided by the Upper Tribunal in 2013. Following that case HMRC amended the guidance in its Capital Gains manual (para CG65715).

The new guidance sets out the reasoning of the judge in the EM Ramsey case, and HMRC believes that should be sufficient for any taxpayer to make a judgment on whether their business constitutes a “business” for incorporation relief. HMRC has also stated that it will no longer give a ruling on this point under the non-statutory clearance service.

We can help you decide whether the business you are planning to incorporate does fall within the boundaries of “business” for incorporation relief, and guide you through the other conditions required for that relief.

EM Ramsey v HMRC [2013] UKUTT 0226(TCC)

HMRC guidance on what is a business CG65715

Trading and property allowances

These £1,000 annual allowances were introduced by F(no 2)A 2017, and backdated to apply from 6 April 2017. However, the detailed guidance on exactly how each allowance works has only just been published in HMRC’s Business Income Manual (BIM) and the Property Income Manual (PIM).

The trading allowance and miscellaneous income allowance (TMIA), and the Property Income Allowance (PIA) operate in a similar fashion, but on different categories of income received by individuals. The PIA can’t apply to rental income which qualifies for rent a room relief. Also neither allowance can be set against income from a connected party, such as a close company in which the taxpayer is a participator or an associate of a participator, or a partnership in which he is a partner or connected with a partner.

Where the qualifying income, before deduction of expenses, is no more than £1000 per year, he will automatically be given full relief, and the trading or property income is treated as nil. The taxpayer also is relieved from having to report that income to HMRC.

If the taxpayer doesn’t want the allowance to be set against his qualifying income, he must make an election for it not to apply. This may be the desired outcome where the taxpayer has made a loss, after deduction of expenses, which he wishes to set against his other income (for a trade), or carry the loss forward or back.

If the taxpayer’s gross qualifying income is more than £1,000 he can opt in to be given partial relief and not deduct any expenses, or not elect for the allowance not to apply at all and then deduct all allowable expenses as normal.

These elections are made as part of the taxpayer’s SA return, so you need to watch out for the opting out and opting in elections when completing the 2017/18 returns.

Trading income allowance guidance

Property income allowance guidance

EMI Schemes under threat

The enterprise management incentive (EMI) scheme is the most popular share option scheme, as it is designed for companies that have gross assets of no more than £30 million.

On 4 April 2018 HMRC announced that the EU State Aid approval for the EMI scheme was due to run out on 6 April, as it hadn’t been renewed in time. This means that any EMI share options issued from 7 April 2018 onwards won’t qualify for tax relief.

It is not clear whether the tax relief for any existing EMI share options continues to apply where those options have not been exercised. HMRC has said that it will continue to apply its current guidance and practice regarding existing EMI options, so it will consider those options to be approved share options for now.

The UK Government is trying to negotiate the reinstatement of State Aid approval for the EMI scheme, but no one knows whether this approval will be backdated to 7 April 2018. Tax relief for the EMI scheme may only apply from the date the approval is reinstated or from a date to be specified in the future. It is possible that the State Aid approval may not be renewed for the EMI scheme before the UK leaves the EU on 29 March 2019.

The implications for employers are not pretty. Any share options granted which do not qualify for tax relief are a benefit in kind subject to PAYE and NIC. The company would normally be able to claim a deduction for corporation tax purposes of the cost of granting the options, but this deduction doesn’t apply if the options are part of an unapproved share scheme.

Shares acquired through an EMI scheme also carry an entitlement to entrepreneurs’ relief on disposal, where the qualifying option was granted at least one year before the disposal of the shares. The employee is not required to hold 5% or more of the ordinary share capital for such EMI-derived shares.

We can help with any questions you may have concerning the EMI scheme, the implications of issuing unapproved options and other opportunities such as the CSOP scheme.