Share Schemes – Annual Reporting Requirement

All employee share schemes need to be registered with HMRC in order to qualify for the tax advantages, and an annual return must be submitted to HMRC for each registered share scheme by 6 July following the tax year end.

This annual return must be submitted online through the ERS system, even if there is no activity in the scheme during the tax year. The penalties for not submitting the ERS annual return are similar to those for a late SA return: £100 for missing the deadline and £300 if the return is still outstanding after three months. 

In the case of Talkative Ltd v HMRC the Company registered two employee share schemes in January and March 2018, but failed to submit the annual returns for these schemes by 6 July 2018. The £100 penalty notices were issued on 17 July 2018. As neither annual return had been submitted by 6 October 2018, further £300 penalties were issued for both schemes.

At the FTT the company’s accountant claimed he wasn’t aware that annual returns were required. He also said that no return was filed because no notice to file was received. Neither of these arguments was well received by the FTT, which upheld the penalties.

Unlike for SA returns, a notice to file is not required to be issued to trigger an obligation to file an ERS return. The adviser should have been aware of the need to file the ERS returns for the share schemes which were only registered a few months earlier.

If you have registered employee share schemes, make sure the ERS returns are submitted on time. If the share scheme is no longer needed, deregister it by following the steps set out in the link below.

Talkative Ltd v HMRC TC07172

How to deregister a share scheme 

Entrepreneurs’ relief changes

FA 2019, Schedule 16 has introduced four changes to entrepreneurs’ relief (ER). The new conditions for an individual’s shareholding in their personal company to qualify for ER took effect from 28 October 2018. The three other changes to ER take effect for disposals made after 5 April 2019.

Qualification period

For disposals after 5 April 2019 all the qualifying conditions for ER must be in place for at least 24 months to the date of disposal, or to the date the business ceases to trade.

Look through incorporation

Where a business incorporates the qualification clock for the ER conditions is set back to zero on the issue of the shares, or on date the on which the company starts trading, whichever is the later. Where the shareholders receive an offer for the company shortly after incorporation, they will be denied ER as they won’t have built up full qualification period of share ownership.

For disposals after 5 April 2019 the qualification period for ER can look through the incorporation and include the period during which the unincorporated business was owned by the current shareholders. This look-through only applies if the shares were acquired wholly or partly in exchange for the transfer of the business as a going concern, and all the assets of the business, other than cash, must have been transferred to the company. These are the conditions under which incorporation relief applies.

If it is planned to incorporate the business, make sure that incorporation relief does apply as an insurance policy against a quick sale of the company.

Dilution of shareholding

Where equity investment is raised from outside investors, it can dilute the holdings of existing shareholders to below 5% of ordinary share capital, stripping away their rights to ER.

For new share issues made from 6 April 2019, the existing shareholders can preserve their ER by making two elections . The first election creates a deemed sale and reacquisition of their shares, crystallising the gain on which ER can be claimed, and the second election defers the CGT due until their shares are sold. These elections must be made by the first anniversary of 31 January following the tax year in which the additional shares are issued.

What tax is paid on winding up a company?

In 2016 a targeted anti-avoidance rule (TAAR) was introduced to prevent individuals from winding-up their close company, taking out the retained cash at capital gains tax rates and then continuing the same business in another vehicle.

In HMRC Spotlight 47 HMRC declare that schemes designed to step around this TAAR, which involve selling the company to a third party rather than winding it up, don’t work, so the TAAR would apply with the result that the withdrawn cash would be subject to tax at income tax rates.

HMRC’s view is misleading to say the least.

The TAAR only applies if a company is wound-up, it can not apply if the company is sold to a third party. If a business owner decides to sell their cash-rich company to a third party in order to release the funds, and within two years (the period defined in the TAAR), starts a similar trade or activity, the income tax charge imposed by the TAAR cannot apply. It is disingenuous for HMRC to imply that it could.

What’s more HMRC say that the general anti-abuse rule (GAAR) would apply in these circumstances if the TAAR doesn’t apply. This is also nonsense, as it was not the intention of Parliament for the TAAR to apply on the sale of a company to a third party.

Clearly if there is a non commercial arrangement with a third party undertaken with the primary aim of sidestepping the TAAR then it is to be expected that the transaction will come under scrutiny.  

HMRC is trying to frighten people away from using tax avoidance schemes, which is a good thing, but it needs to use this power in a responsible way. 

You can read Spotlight 47 here

‘Living’ in a property for PRR purposes

Private residence relief provides relief from capital gains tax arising on the disposal of a property which has been the taxpayer’s only or main residence.

In the recent tribunal decision of Hezi Yechiel TC06829, consideration was given as to whether, for the purposes of the legislation, Mr Yechiel occupied the property in question, 6 Beaufort Drive, as his only or main residence.

In determining whether the property was occupied as a main residence, the Tribunal considered the ordinary English meaning of ‘reside’ which is ‘to dwell permanently or for a considerable period of time, to have one’s usual or settled abode, to live in a particular place’.

In determining whether a property qualifies as a `residence’, the nature, quality, length and circumstance of the occupation are taken into account. Weight is also given to the taxpayer’s intention – in this case to have a ‘bolt hole’ to escape the stress of his divorce and for it to be a long-term home.

The tribunal considered what Mr Yechiel did in the house. It had a working kitchen and bedroom and (the Tribunal presumed) a bathroom. While Mr Yechiel slept there, he did not cook there or do his washing there; when he ate there, it was mainly take-way food. He brought only a bed and a side table for the property. During the period Mr Yechiel spent a significant amount of time at his parents’ house, eating there and doing his laundry there.

The Tribunal dismissed Mr Yechiel’s appeal. They found his occupation lacked sufficient quality of occupation, concluding ‘that to have a quality of residence, the occupation of the house should constitute not only sleeping, but also periods of ‘living’, being cooking, eating a meal sitting down, and generally spending some periods of leisure there.

It is important that clients appreciate the quality of occupation as well as the quantity when seeking to claim private residence relief.

Tribunal decision Hezi Yechiel TC06829

Pension Tax Trap

Individuals may have made pension contributions in the year but they may also have accessed some of their pension savings in the year or in an earlier tax year.

The MPAA does not apply if the benefits are taken as:

Where an Individual has flexibly accessed their pension benefits from a defined contribution pension scheme or SASS, their pension contributions should be restricted from that date onwards (the trigger date). This restriction is imposed by the money purchase annual allowance (MPAA), which was initially set at £10,000, but reduced to £4,000 on 6 April 2017.

The MPAA does not apply if the benefits are taken as:

  • a small pots lump sum;
  • a pension commencement lump sum and no income is taken; or
  • the income comes from a capped draw-down arrangement.

Where the MPAA does apply, any contributions paid into a money purchase (defined contribution) scheme after the trigger date are measured against the MPAA. Where those contributions exceed the MPAA, a tax charge will be due.

As 2017/18 is the first year for which the lower MPAA of £4000 applies, more Individuals are likely to be caught by this tax charge. HMRC has recently set up an online tool to help clarify whether the MPAA tax charge applies, but the accompanying explanation is not easy to follow.

So specialist advice may be required to clarify whether an individual has to pay a pensions tax charge in respect of contributions paid in 2017/18 or earlier.

Guidance for IFAs on the MPAA

HMRC guidance on the MPAA

Venture capital schemes

New compliance statements for EIS, SEIS and SITR

If you use, or are considering using, one of the venture capital schemes to raise money for your small company or social enterprise (schemes: SEIS, EIS or SITR) you need to be aware that the compliance statement, formerly known as form SEIS1 or EIS1, has changed.

The new compliance statement must be completed online and every question must be answered except those marked optional. However, the form can’t be saved while you complete it, and you can’t view all questions until you come to them. Once the compliance statement is completed it must be printed and posted, or emailed to HMRC.

We have included a link below to the 2014 PDF version of the EIS1 form to give you an idea of the questions which are asked, but this is only for reference. You should not use this PDF EIS1 form as HMRC has a new procedure for approving company applications under the VC schemes. Each successful application is given a unique reference number, which must be included on the compliance certificates the company gives to its investors.

Links to the new compliance statements are included within the HMRC guidance for the particular scheme.

PDF of 2014 version of EIS1

Guidance for EIS applications

Guidance for SEIS applications 

Guidance for SITR applications

Entrepreneurs Relief – Personal Company definition

The government has now tabled an amendment to Paragraph 2 of Schedule 15 of the Finance Bill, which contains the changes to the definition of ‘personal company’ for ER purposes. See the proposed amendment here: 

The amendment will add an alternative test based on the shareholder’s entitlement to proceeds in the event of a sale of the whole company, which can be used instead of the tests based on profits available for distribution and assets on a winding up.

The original tests have been left in to provide certainty to those with straightforward company structures, but the new test will help those who are not able to meet the original test for commercial reasons, and does not rely on the definitions in the Corporation Tax Act 2010.

Let properties – Interest Relief Restriction

The proportion of finance and interest charges which can be deducted from residential property income is gradually being reduced to nil as follows:

Tax Year in which interest is paidProportion of finance charges
deductible
2017/201875%
2018/201950%
2019/202025%
2020/21 and laterNil

The landlord will have a tax credit (20% x blocked interest) that reduces his income tax bill. This 20% rate applies irrespective the landlord’s actual marginal tax rate.

Some landlords will get a nasty shock when they see their tax bill for 2017/18 is much higher than what they paid on a similar level of profit for 2016/17.  Their tax bill for 2018/19 may be even higher.

There are four ways out of this bind, but they all require careful thought around the knock-on tax implications;

  • Sell some residential property and reduce the level of debt for the remaining property business.
  • Let the property in such a fashion so it qualifies as furnished holiday lets for tax purposes.
  • Sell all residential property and reinvest in commercial property.
  • Transfer the let properties to a company controlled by the landlord.

Some landlords have no debt in their property businesses, and they are not affected by the interest and finance restrictions.

However, individual landlords (of all types of property), should draw up their accounts for 2017/18 using the cash basis for landlords (different to the cash basis for trading businesses).

Where the total receipts of the property business exceed £150,000 for the tax year, the cash basis should not be used, and GAAP accounting can be used instead. Any individual landlord can elect to use GAAP accounting rather than the cash basis, by ticking a box on the 2017/18 tax return.

We can help you advise your clients on restructuring, but time is running out for residential property businesses which are supported by large mortgages.

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
SEIS and EIS

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