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TolleyGuidance SA action pack for sole traders

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23rd Jan 2013
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To prepare for the final leg of the self assessment assault course, TolleyGuidance surveyed AccountingWEB members in December to find out which issues were causing them the most trouble. This article summarises the findings, and points readers at free resources to help overcome any last minute technical hurdles.

Various tax options available for sole traders and owner-managed businesses cropped up repeatedly in the responses, which were carried through to the Tolley Self Assessment Support centre on AccountingWEB. Read on for a summary of the main issues covered, or click the links below for detailed guidance on the following topics:

Dividends

For many director shareholders, the most effective remuneration strategy is a low salary combined with high dividends, but many businesses fail to properly document dividend payments. There are essentially two types of dividend: final and interim, depending on how they are paid. A final dividend is approved at the company's annual general meeting, while interims can be awarded by establishing the reserves available and determining the amount to be distributed at an ordinary board meeting.

But the underlying principle is the same: dividends must be authorised by the directors after suitable consideration of the company's distributable profit. This is done when the final accounts are signed off so there is an “automatic” consideration of the company's distributable profits.

A company must not pay a dividend unless it has distributable reserves, which can come from current year profits, or those retained in previous years. A dividend declared without sufficient distributable reserves may be considered illegal, so directors must demonstrate they acted responsibly in declaring the dividend.

If there is any ambiguity over the arrangements, the door is open for a challenge by HMRC.

Particular areas of risk for owner-managed businesses include alphabet shares and dividend waivers. These are already subject to scrutiny by HMRC, but further concerns have arisen from the PA Holdings case. The Court of Appeal’s decision caused concern about dividends essentially being reclassified as earnings, but is being contested in the Supreme Court.

The following dividend guides have also been made available by TolleyGuidance:

Pension contributions for sole traders

Sole traders have very few options besides pension contributions to extract profits to bring them into a lower tax band - and everyone is entitled to pay up to £2,880 a year into a pension scheme regardless of their earnings.

But do not give advice on investing in pensions unless you are suitably qualified and authorised to do so. Restrict the advice you give to your client as to the tax consequences of making contributions. A good rule to observe is: advise on the timing of payments, not the amount. This will help you draw a line between advising on the most efficient way to make pension contributions and advising a client to invest in their pension.

The maximum contribution to a pension fund for which tax relief can be claimed in any one tax year is the lower of: 100% of relevant earnings for that year, or the annual allowance (£50,000 in 2011/12, reducing to £40,000 in 2012/13).

For the self-employed, in addition to the profits of their main trade, income from professions, vocations and furnished holiday lettings are relevant income for pension purposes.

Where pension contributions exceed the amount of annual allowance available, an annual allowance charge arises under FA 2004, s 227. Advice and worked examples are available from the TolleyGuidance material on how to work out timings and make these calculations.

Accounting period end planning

Prior to the end of the year, you may be able to consider the timing of significant items of income or expenditure and certain elements within the final accounts.

Bringing capital expenditure forward into a tax year is a popular technique to reduce taxable profits as it ensures tax relief is received at the earliest opportunity, and possibly at a higher rate. But there are other expenditures that can be considered, including: employee bonuses and pension contributions; small capital items relieved under the renewals basis; professional fees; stock and work in progress; bad debt write-offs; and other provisions.

Be careful not advise a client to incur expenditure that they would not otherwise be subject to. Instead look at the timing of expenditure that would be incurred anyway.

Sole trader clients will be used to you checking personal use of business expenses, but it can be easy to overlook situations where personal expenses have a business purpose.

With sole traders, check whether deductions of expenses against taxable profits have mixed business and personal use. Costs they may not have considered previously could be included in the final accounts under deductible headings including: use of home office;  telephone/internet; finance; subsistence; private vehicle; charitable donations that might qualify as advertising; accountancy fees; training and subscriptions.

Strategies for delaying income to 2013/14

The 2012 Budget brought in a 5% reduction in the additional rate of income tax from 50% to 45% on 6 April 2013. The dividend additional rate will also be reduced from 42.5% to 37.5%, so it benefit affected individuals to delay the receipt of income until after this date, effectively saving 5% on any income successfully deferred.

Individuals who run their own companies will be able to reduce their own salaries (if they have not not already do so), and ensure profits are withdrawn from the company by way of dividends by delaying the vote and payment of dividends until after 5 April 2013.

They may need to cover any cash flow difficulties via a short-term loan from the company, and then repay the loan using the delayed dividends. If the company is a close company there will be a corporation tax charge of 25% on the amount of the loan, unless it is repaid within nine months of the company year end. A benefit in kind (taxed as additional income) will arise if the loan is interest-free or the interest rate is lower than the HMRC official rate of interest (4% for 2012/13), and should should be factored into any calculations. As long as the date of the dividend payment is within nine months of the year end (and after 6 April 2013), the corporation tax charge on the loan should be avoided.

Remember, it is only tax efficient to delay the receipt of income in excess of £150,000 as this is the point at which the additional rates apply. There is no reason to consider delaying income under this threshold, unless you are trying to reduce income in order to preserve an individual's personal allowance.

Sole trader losses - established trades

When a sole trader makes a loss, the trading income assessment (taxable profit for the year) is nil. Loss relief is available to the taxpayer in this situation only if the business is being run on a commercial basis with a view to realising a profit.

The trader may choose how the loss should be relieved by making appropriate loss relief claims against the following, each of which is covered in the detailed Tolley guide:

  • net income of the year of loss or the preceding year
  • current year or preceding year capital gains
  • trading income for the preceding three years, and
  • future profits arising from the same trade.

Careful planning is required to achieve the optimum balance between relieving losses early and relieving losses at the highest possible tax rates.

Claims are not mandatory and the taxpayer can choose not to do so, but no partial claims are permitted. A taxpayer must either use all of the available loss or relieve all of the available income. Where a claim has been made and it is sufficiently large, it could reduce net income to nil, which will waste some personal allowances.

People claiming relief for trade losses against net income who are not able to make full use of the losses may use the balance as an allowable loss for capital gains tax purposes. This may be done in the year that the losses arise, or the preceding year. However, a claim under ITA 2007, s 64 must be made in whichever year first.

Where taxpayer makes a claim to carry forward an unrelieved trading loss for relief against future profits from the same trade, the losses are carried forward without time limit. Losses must be offset against the first available profits and will continue to be relieved until the losses are exhausted.

The main factors which should be taken into account in loss relief planning are as follows:

  • marginal rate of tax - for maximum savings, losses should be offset in priority against income taxed at higher marginal rates of tax
  • personal allowances and annual exempt amount - where possible relieve losses in such a way as to preserve personal allowances
  • timing - consider whether it is more important to the taxpayer to have relief earlier, which may generate a cash repayment, or to obtain relief at the highest marginal rate.

Also available for free from the TolleyGuidance Self Assessment centre

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