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NEWTH TALKS TAX - JULY: Tax writer of the year John Newth solves your tax questions

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31st Jul 2006
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**For more of John Newth's exclusive contributions, visit the Newthwire archive***
https://www.accountingweb.co.uk/newthwire

Buy to let properties
Martin enquired, on 25 July 2006 (157594), whether tax relief on mortgage interest would be available if the purchase of a buy to let property was financed by remortgaging his home. Also, as he is a higher rate taxpayer, do profits have to be divided 50:50 between himself and his wife?

A number of respondents replied to this query. David Lochhead had stated, correctly, that it was the purposes of the borrowing that determined whether tax relief would be available on mortgage interest. Buy to let, rented, properties satisfies this test.

It is worth mentioning that the income from rented properties is now covered by ITTOIA 2005. The old Schedule A definition no longer exists. Income from rented properties becomes 'other income', but expenses such as mortgage interest, insurance, repairs and maintenance, agents' fees and accountancy charges are all allowable deductions.

It is possible for the income from the property to be divided for tax purposes other than 50:50, but this can only be achieved if the actual ownership differs from equality. Thus, Martin could ensure that the property was owned 80% by his wife and only 20% by him, and then file Form 17 to HMRC to reflect that change regarding the assessment of net income. What cannot be done is to own the property equally but then divide the income in a different proportion.

There are a number of other issues to consider with buy to let properties. As regards capital gains tax on eventual sale, it should be recognised that business asset taper relief will not be available, only non-business asset taper relief. Only furnished holiday lettings are treated as a business trade for these purposes. However, if the property is owned jointly by husband and wife, the joint annual CGT exemptions, now £8,800 each, could come in useful.

Another issue to consider is inheritance tax. Business Property Relief will not be available on a rented property, only on a furnished holiday letting (subject to conditions). Martin and his wife need to consider, with the help of their lawyer, whether the buy to let property should be held as a joint tenancy or as tenants-in-common.

Finally, if Martin and his wife intend building up a portfolio of rented properties, then they can of course mortgage the first rented property in order to finance the next purchase and so on. It should be noted, however, that in order to comply with the conditions for interest relief, compliance with HMRC Business Income Manual at BIM 45705-45710 regarding revaluation of properties is advisable.

* * *
Specialised professions
Paul NG, on 14 July 2006, posed a
question about the employment status of lecturers and examiners who worked for a higher education establishment. His new client, a higher education organisation, treats the majority of lecturers and examiners as self-employed, even though they appear to provide a continual service throughout the academic year.

Lecturers are paid on the basis of four weekly timesheets, coupled in some cases with their own invoices. Some pay NIC Class 1 on their earnings, but no PAYE, others have no deductions at all. At the end of the academic year they are paid 'holiday pay' as a percentage of their annual earnings.

Examiners are paid weekly on the basis of 'contracts'' which detail, inter alia, location, rate of pay and expenses.

Apparently there are no conclusive contracts of service or contracts for services between the college and the lecturers and examiners.

One's first reaction is that HMRC Employer Compliance Review Teams would be 'licking their lips' if they had any idea of the location of the college concerned, which is presumably within the private sector.

The college must have received poor advice from its previous professional advisers, or not heeded the advice given. There is plenty of specific advice regarding this situation, and helpful paragraphs or chapters appear in HMRC Employment Status Manual, Guide to the Tax Treatment of Specialist Occupations (now published by Tottel) and Tolley's National Insurance Manual.

Assuming that lecturers are engaged on a permanent basis, there is every indication that they should be treated as employees, both for direct tax and NIC purposes. This means that their four weekly pay should be subject to PAYE and class 1 NIC. This is evidenced by chapters or paragraphs in the two books mentioned, and in HMRC Employment Status Manual at ESM 4500 ' ESM 4503.

The position regarding examiners is slightly more complex. The Employment Status Manual at ESM 4150-ESM 4153 states that, generally speaking, examiners are employees, but by a strange quirk they are self'employed for NIC purposes, and could therefore be subject to class 2 NIC (unless small income deferment is claimed) and Class 4 NIC (if the fees were substantial). However, in his Guide to the Tax Treatment of Specialist Occupations Keith Gordon suggests that examiners may be covered by an administrative practice (not a concession) where a small amount of examination or invigilation fees are received. In such circumstances there is an unwritten agreement that they may be declared as trading income. Certainly ESM 4153 allows travelling expenses (even from home) to be claimed and presumably other relevant expenses could be claimed.

My remarks about examiners will be of little help to Paul, but this whole scenario highlights just what a minefield employment and self'employment status is. Certainly Paul has a problem regarding the lecturers. For how long has the practice of paying them gross been in existence? Does he make a voluntary statement to HMRC on behalf of his new client (who is unlikely to be too pleased about the situation)? And, even more importantly, he must observe the ethical rules of the professional institution to which he belongs. Specialist consultant advice may be needed here.

* * *
Rent a room relief
Jones Stephen disclosed that he had tried to sell his house last year, without success. He has now moved to a new house and retained the old house at present, which is being let out. He has also rented out a room in his new house.

He asked (query dated 10 July 2006), whether he could claim rent-a-room relief in respect of the letting of the room in the new house. He was conversant with the rules for declaring the rent on his old property.

Steve Coates replied in the affirmative, and stated that boxes 5.20 and 5.35 in the Land and Property pages of the self-assessment return should be completed. I would be a little more cautions, as there are some conditions to the claim for rent-a-room relief, which are worth considering.

The basic conditions are:

# The rent arises from the use of furnished accommodation in a residence. This may be inclusive of meals, cleaning and laundry etc.

# They accrue to the individual during the 'income period', normally the tax year.

# The residence in question is the individual's only or main residence for all or part of the income period. In the current case this is satisfied, as the former residence is let. The CGT exemption position should be watched, however, if the letting period exceeds three years.

# The receipts would otherwise be taxed as miscellaneous income for years 2005/2006 on, previously trading income or property income.

Full rent-a'room relief is claimable if the total receipts for the tax year, before deducting any expenses or capital allowances but after adding any relevant balancing charges amount to £4,250 or less. If half of the receipts accrue to another person, then the relief is halved to £2,125.

The effect of this is that neither the receipts themselves nor any related expenses, relevant allowances or relevant balancing charges are included in computing any trading profits, letting income or miscellaneous taxable income.

An alternative method of calculation can be made where the receipts described above exceed £4,250. The taxpayer may elect that the excess of the figure over £4,250 is taxed as taxable rent-a-room income. Such an election has effect for future tax years unless withdrawn. It should be noted that, once again, the figure on which the calculation is based is before the deduction of any expenses.

Taxpayers whose gross receipts exceed £4,250 will have to consider whether to claim on the alternative basis or compute a furnished lettings computation incorporating direct expenses such as meals, laundry, cleaning etc. and indirect expenses such as the various utilities. This is particularly relevant where, say, heavy repair expenditure is incurred in one year. Losses cannot be carried forward under the rent-a room method. In some case where one partner does not have employment the traditional method may be beneficial as the net income may be set against the annual personal allowance. The question of any restriction of the CGT principal private residence exemption should also always be addressed.

HMRC consider that rent-a-room relief is inapplicable to the letting of a residence (or part) as an office or for other trade or business purposes (see HMRC Tax Bulletin, August 1994, page 154). So the idea, in the case of an entrepreneur working at home of forming a company that rents a room in the home will not work for rent-a-room relief purposes.

Rent-a-room relief is not normally available to taxpayers who are living abroad or who are resident in job-related accommodation and who are letting their principal private residence while they are away.

* * *
Amending tax return
Completion of the self assessment tax return is difficult enough for individuals, trusts and companies. It is therefore fortunate that legislation makes it possible for returns to be amended, within a given period.

Colin, on 3 July 2006, asked for any help regarding this procedure, as he does not yet file his return online.

'Son of Grumpygit' answered this query and brought out a number of points. The basic legislation is in section 9ZA, Taxes Management Act 1970.

Paragraph (1) of section 9ZA states that a person may amend his or her return by notice to an officer of the Board. In practice, HMRC will accept:

# A letter.

# An amended return form.

# An additional supplementary page.

# An amended supplementary page.

It is also understood that a return amendment may be made by telephone, subject to authorisation and proof of identity.

Paragraph (2) of section 9ZA states that an amendment must be made not more than 12 months after the filing date. In normal circumstances this would mean that an amendment for a return for the year ended 5 April 2005 must be made by 31 January 2007, 12 months after the normal filing date. However, supposing that the return for that year had not been issued by HMRC until after 31 October 2005, then the taxpayer has three months in which to file the return. This would then automatically push the final date for amendment to 12 months after filing date beyond 31 January 2007.

'Son of Grumpygit' goes on to advise Colin to file the amendment as spoon as possible, as HMRC might attempt to impose a penalty on the grounds that 'the taxpayer acted negligently or fraudulently in the original submission of the return'. In practice, the department would be hard pressed to impose a penalty where a genuine error had been made originally, and the error was corrected in a timely manner before any tax was due or under challenge.

This is underlined by HMRC Enquiry Manual at EM1040. While the right of the taxpayer to amend the self assessment is suspended during an enquiry, early disclosure of any errors or amendments could affect the penalty loading, and in some cases lead to complete abatement of the penalty. The amendment to the return then takes place at the completion of the enquiry.

Section 28A, Taxes Management Act 1970 deals with the procedure where HMRC amends a taxpayer's self-assessment following a self-assessment enquiry. Where such an amendment is made the taxpayer has 30 days to amend his self-assessment to give effect to amendments already notified.

Schedule 3ZA to the Taxes Management Act 1970 refers to the date by which tax payment must be made following an amendment or correction of self-assessment. In the case of an amendment made by a taxpayer, and not within a self-assessment enquiry, and assuming that the amendment is made after the normal due date for tax payment, then the tax should be paid (or repaid) on or before the day following the end of the period of 30 days beginning with the day on which the notice of amendment was given.

The 30 day tax payment or repayment limit also applies in other instances. In the case of an enquiry, tax is payable 30 days after the closure notice, inclusive of cases where the taxpayer has already notified an amendment. The same time-limit applies where a return is corrected by HMRC, or where HMRC issues a notice of amendment to prevent loss of tax.

* * *
Class 2 NICs
Sarah Kedgely, on
29 June 2006 asked where she could find some literature regarding Class 2 National Insurance Contributions. She had a client who was employed, unemployed and employed and on maternity leave. Sarah needed to know when the client should be paying Class 2 NICs, and when not.

Two main sources of information regarding Class 2 NICs occur to me. The first is the National Insurance Manual, part of the HMRC Manual series. There is substantial coverage of Class 2 NICs between NIM 20000 and NIM 23003. In the private sector, Chapter 18 of Talley's National Insurance Manual, published by Lexis Nexis Butterworths, provides a useful narrative.

It is worth considering Class 2 NICs generally. They are payable by self-employed persons, who also pay Class 4 Contributions based on their taxable profits. Class 4 brings no benefits entitlements at all, and is in effect a levy on individual self-employed individuals. Payment of Class 2 Contributions, which only amount to £2.10, can preserve entitlement to certain State Benefits. It may be worth paying such contributions on a voluntary basis (which is permissible) in order to retain benefits entitlement.

An individual newly commencing self-employment must register with HMRC within three months of becoming self-employed. If this does not occur and the source of income is not otherwise known to HMRC, then a penalty of £100 may be imposed.

Self-employed individuals may apply for an exception certificate granting relief from payment of Class 2 NICs on the grounds that the income is less than a figure of £4,465 for 2006/2007. A formal application must be made to HMRC, and exception, when granted, will normally last for a period of three years. The individual may, nevertheless, elect to pay contributions voluntarily, even if they could have been excepted on small income grounds.

Other grounds for exception from payment (although voluntary contributions may be paid) include:

# Persons on incapacity benefit.

# Where the individual is incapable of work.

# Where a woman is in receipt of maternity allowance.

# Where the individual is in receipt of carer's allowance (formerly invalid care allowance) or unemployability supplement.

# The individual is a volunteer development worker.

Woman who would have been eligible to pay reduced rate primary Class 1 contributions are under no liability to pay Class 2 NIC.

Another scenario occurs when an individual is in receipt of earnings subject to Class 1 primary contributions, as well as having self-employment income for which Class 2 and Class 4 NIC may be due. It should be remembered that there is a maximum NIC liability for any one individual in a contribution year, and where Class 1 and Class 2 contributions would normally have been due, it is possible to apply for deferment of contributions.

Where Class 1, Class 2 and Class 4 NICs are all payable, a complicated calculation will reflect the maximum NICs payable, and the amount to be deferred or repaid. This aspect is dealt with in Tolley's NIC Manual, and where practitioners consider that such a situation may apply, they should apply to NIC Deferment Services. I dealt with such a scenario in a very early Newthwire on NIC matters.

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DougScott
By Dougscott
19th Jul 2006 07:28

Rent-a-room moral dilemna?
Here's a question. You rent a room in your house to your 10 year old daughter for £4250 a year who then sub-lets the room to Z Company for £5000 per year. Z Company just happens to be 100% owned by yourself. Your daughter has no other income. No tax. What's your view?

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By Sherlock
19th Jul 2006 15:09

Actual personal residence
I fear that sub-letting to the company disqualifies rent-a-room-relief, as the relief is for personal residential purposes, i.e. personal living, sleeping and eating.

If I am wrong, then I am sure that HMRC would find some way of attacking the scheme under 'unacceptable tax avoidance'.

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By Paula Sparrow
10th Jul 2006 13:49

Class 2 contributions?
Does Sarah really mean Class 2? Her query does not mention the client being self employed, so she would not be entitled to pay Class 2.

Class 3 contributions may be appropriate, but it would be necessary to look at a pension forecast first to ascertain whether they were worthwhile.

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