Tax Paper 2
State the conditions that must be satisfied to ensure that a change of accounting date is effective for Income Tax purposes for a sole trader who has been trading for many years.
• Accounts prepared for a period ≤ 18 months long. • Notify HMRC by 31 January following the tax year of change. • Either no accounting date change in previous five tax years or change must be made for bona fide commercial reasons. ITTOIA 2005, s.217
Define a production herd
"Production herd" means a collection of animals of the same species (irrespective of breed) kept by the farmer wholly or mainly for the products obtainable from the living animal which the animal produces for the farmer to sell.
Deidre is a self-employed hairdresser with a turnover of £87,000. She also has a parttime business as a dog groomer with a turnover of £10,000. Explain the term 'taxable person' for VAT purposes and how this will affect Deidre's dog grooming business.
A taxable person for VAT purposes is one who has made taxable supplies in the last 12 months exceeding the VAT registration limit. [½] This can be an individual, a partnership, a company or other legal entity. [½] A person may also become a taxable person by registering voluntarily if they make taxable supplies or intend to make taxable supplies. [½] Max 1 A taxable person must account for VAT on all taxable supplies made in the course of business carried on by them [½] so Deidre must account for VAT on the sales from her dog grooming business in addition to those from the hairdressing business. [½] She will offset against that liability any input tax on relevant purchases. [½]
Explain when a business may or must de-register for VAT and the date from which de-registration will take effect.
A taxable person may de-register voluntarily if their taxable supplies in the next 12 months [½] are expected to be £83,000 or less. [½] If HMRC are satisfied that registration is no longer required the registration will be cancelled. Cancellation will be effective from the date of notification [½] or a later date agreed with HMRC. [½] HMRC must be notified within 30 days [½] of ceasing to make taxable supplies. [½] Deregistration will take effect from the date of ceasing to trade. [½] Compulsory de-registration is also required when a business changes status. [½]
You are required to prepare a letter to Brian as his tax adviser covering the following issues: 1) What notification HMRC require of his self-employment.
An individual should notify HMRC that they are self-employed for income tax purposes within six months from the end of the tax year in which trade started. You started to trade in the tax year 2017/18, therefore you must notify HMRC by 5 October 2018. For NIC purposes HMRC must be notified of self-employment as soon as possible. Failure to notify HMRC of your self-employment by 31 January following the end of the tax year in which you start to trade, i.e. by 31 January 2019 in your case, can lead to penalties.
The basic tax point is overridden where?
An invoice is issued or payment is received before the basic tax point. The actual tax point is this earlier date. An invoice is issued within 14 days after the basic tax point - the invoice date is the actual tax point
Options for relieving the non-trading deficit (i.e. loss) from loan relationships
Claim to set any amount of the deficit against total profits of the loss making chargeable accounting period. 'Total profits' refers to all income and gains before qualifying charitable donations; • Claim to set the deficit against non-trading profits (LR) of the previous 12 months (this is an all or nothing claim); or • Carry forward against other non-trading income and gains. Initially this is to set off the maximum amount available to carry forward, but any amount can be disclaimed. Hastings Ltd can carry back the non-trading deficit without first having to use it in the loss making period.
Options for relieving the trading loss
Claim to set the loss against total profits of the loss making chargeable accounting period. 'Total profits' refers to all income and gains before qualifying charitable donations; • Claim to set the loss against: - total profits of the loss making chargeable accounting period, and then - make a claim to carry back the remaining loss against total profits of the previous 12 months, or • Carry forward any unrelieved trading loss and set against the first available trading profits from the same trade in future chargeable accounting periods. This is automatic for any unrelieved trading loss. The claims against total profits are 'all or nothing' claims. In other words, Hastings Ltd must use enough loss to bring its total profits down to nil provided it has enough loss to do so.
Edwina is an employee of Eggcellence Ltd. She has the use of a company car, resulting in an assessable car benefit of £5,500 and a fuel benefit of £4,662. Calculate the Class 1A National Insurance Contributions due in respect of Edwina's car for 2017/18 and state who is responsible for paying them and by what date they must be paid.
Class 1A NIC 13.8% of £10,162 (£5,500 + £4,662) £1,402 Class 1A NIC are payable by the employer (Eggcellence Ltd). For 2017/18 they must be paid by 22 July 2018 where payment is made electronically (19 July otherwise).
Briefly explain the rules for calculating and paying Employers' Class 1A National Insurance Contributions on benefits and expenses.
Class 1A NIC are payable in respect of the cash equivalent of taxable benefits provided to employees and directors. [1] The total amounts of relevant benefits and expenses are multiplied by 13.8% [½] and payment made to HMRC by 19 July, or 22 July if paid electronically. [½]
When are Class 2 & Class 4 National Insurance contributions payable?
Class 2 NIC is payable as part of the balancing payment for the tax year, on 31 January 2019. Class 4 NICs are payable in the same way as income tax under self-assessment - payments on account are due on 31 January 2018 and 31 July 2018 (each payment on account being 50% of the liability for 2016/17) and a balancing payment is due on 31 January 2019.
Explain the requirements for a limited company to keep records for Corporation Tax purposes, the period for which records must be retained and the penalty for failure to keep those records.
Companies must keep all records used in making and delivering a correct tax return. The records must include records of: • all receipts and expenses in the course of the company's activities, and • all sales and purchases made in the course of trade. The records must be retained until the later of: • six years from the end of the accounting period, • the date after which enquiries may not be commenced, and • the date any enquiries are complete. A company which fails to keep and preserve records for the required time period is liable to a penalty not exceeding £3,000. FA 1998 Sch 18 paras 21 & 23
Susan, a UK based individual, commenced business on 1 September 2016. Her turnover was £4,000 a month for the first four months of trading. On 1 January 2017, her turnover increased to £15,000 a month and then fell to £9,000 a month from 1 April 2017 onwards. State the date by which HM Revenue & Customs should have been notified that Susan was liable to be registered for VAT and the date when she should have commenced charging VAT on her supplies.
Susan's turnover is as follows: £ September - December 2016 (4,000 x 4) 16,000 January - March 2017 (15,000 x 3) 45,000 61,000 April - June 2017 (9,000 x 3) 27,000 88,000 Susan exceeded the VAT threshold on 30 June 2017. [1] Susan is required to notify HMRC by 30 July 2017 that she is required to register for VAT [1] and will start to charge VAT as from 1 August 2017. [1]
Explain the differences between ordinary and preference shares.
Ordinary Shares • Ordinary shares normally carry voting rights, unlike preference shares. • Ordinary shares pay a variable rate of dividend that tends to go up and down with the level of profits. • Ordinary shareholders are repaid their capital last when a company is wound up. • Ordinary shareholders share in any surplus profits or losses when the company is wound up. Preference Shares • Preference shares typically have no, or limited, voting rights. • A preference share pays a fixed rate of dividend. This dividend is paid in priority to the ordinary dividend. • A preference share is normally repaid before the ordinary shares when a company is wound up. • Preference shareholders are not entitled to share in surplus profits on winding up.
A client is about to start trading and has asked you which records he should retain for VAT purposes. Give four examples of records he needs to retain for VAT purposes and state for how long he needs to retain them.
The records that need to be kept are as follows: • Invoices and credit notes (sales) • Invoices and debit notes (purchases) • Copy of VAT account • Accounting records, including P&L • Records of imports and exports [any 4 for ½ each] They should be kept for six years [½] (unless given permission by HMRC to retain for a shorter period). [½] VAT SI 1995/2518, Reg 31 & VATA 1994, Sch 11 Para 6(3)
Special NIC rule for trading losses used against net income
Trading losses relieved against non-trading income for income tax purposes are still available for relief for NIC purposes against future profits of the same trade.
You are required to write a letter to Mary explaining: 5) The availability of tax relief on pre-trading expenditure.
Some expenditure incurred before trading starts is treated as incurred on the day on which the trade commences and therefore is part of the calculation of the profit or loss for the first year of assessment. [1] To be allowable the expenditure must have been incurred within a period of seven years prior to the commencement of trading and must be of a kind that would have been allowable as a deduction if incurred after the trade commenced. [1] For example, advertising, rent and insurance incurred before trade commences will be allowed. Legal fees for a new lease for business premises will not be allowed as they are deemed to be capital in nature.
You have just started to prepare accounts for a client and have discovered that there was an error made by the client in last year's accounts which, when corrected, will increase the client's tax liability for that year by £10,000. The client is reluctant to inform HM Revenue & Customs. Explain the penalties for incorrect returns which can be charged by HM Revenue & Customs.
(FA 2007 Sch 24, paras 1, 3, 4, 5, 9, 10, 14) Penalties are based on Potential Lost Revenue (PLR) which is the additional tax due as a result of the inaccuracy. The inaccurate document must amount to or lead to an understatement of the tax liability and the inaccuracy must have been careless, deliberate, or deliberate and concealed. There is no penalty if the taxpayer makes a mistake despite taking reasonable care. If a document contains more than one inaccuracy, a penalty will be charged for each inaccuracy. Maximum penalties are: • 30% of PLR for 'careless' behaviour (failure to take reasonable care), • 70% of PLR for 'deliberate understatement' (knowingly making an incorrect return), • 100% of PLR for 'deliberate understatement with concealment' (knowingly making incorrect returns and then covering up the fact). Mitigation for disclosure is divided into 'prompted' and 'unprompted' disclosure. If a disclosure is 'prompted' by HMRC the above penalties can be reduced to 15%, 35% and 50% respectively. If a disclosure is 'unprompted' the above penalties can be reduced to 0%, 20% and 30% respectively. Penalties may be 'suspended', fully or in part, for up to two years if specific action agreed with HMRC is taken to correct matters (e.g. new bookkeeping system). This only applies to penalties for 'careless inaccuracies'. If, at the end of the period, the taxpayer has met all the suspension conditions, the penalty is cancelled.
Trade losses can be relieved by:
- Setting them against the net income of the loss making tax year and/or the previous tax year - After a net income claim has been made some of the remaining loss may be set against chargeable gains of the same tax year - A loss sustained in any of the first four tax years of a trade can be carried back against net income of the three preceding tax years, on a FIFO basis - Carrying them forward against the first available future trading income from the same trade There is a restriction on the total amount of certain reliefs an individual can take against net income. Total relief is limited to the greater of £50,000 or 25% of the individual's adjusted total income for the tax year
State when an accounting period of a company is deemed to begin for Corporation Tax purposes.
1) On acquisition of a source of income. 2) On starting to trade. 3) On becoming UK resident for CT purposes. 4) Immediately after the end of the preceding accounting period.
Explain the rules for registering for VAT for a UK-established person.
A UK-established person is liable to be registered for VAT if at the end of any month their taxable supplies in the 12 months [½] ended on the last day of that month exceed £85,000 [½], unless they can satisfy HMRC that their taxable supplies in the next 12 months [½] will not exceed £83,000. [½] HMRC must be notified within 30 days of the end of the month in which the yearly limit is exceeded [½] and registration is compulsory from the beginning of the next month. [½] Liability to register also arises if at any time taxable supplies in the next 30 days alone [½] are expected to exceed £85,000 [½]. HMRC must be notified within 30 days after the day on which the liability arose [½]. Registration is effective from the start of the 30 day period. [½]
Briefly explain Emily's common law and statutory duties as a director regarding the proposed trading contract.
A director is in a fiduciary position (or position of trust) and has a common law duty to act honestly, in good faith (bona fide), in what they consider to be the best interests of the company and for the benefit of the company as a whole. A director also owes a number of statutory duties to the company. If you agree to a trading contract with your friend, you should not accept any personal benefit through the arrangement. The duty to avoid a conflict of interest does not apply in relation to the trading contract provided that you declare an interest in the proposed transaction to the other board members. You should not sign any contract without exercising reasonable care and skill. Any proposed contract should be for the benefit and success of the company and not your friend. (Chapter 12 of the Fourth Edition Law book - paras 12.4.1 - 12.4.5)
Explain the advantages and disadvantages of trading as a company compared to trading as a sole trader.
Advantages 1. If a company goes into liquidation the owners of the company (the shareholders) are only liable to pay any amounts that they have not yet paid for the shares they hold. A sole trader would be personally liable for any outstanding debts of the business. 2. The shareholders can share in the profits of the business without necessarily having to work for the business day to day. 3. Companies are in a better position when borrowing money, for example, they can issue debentures. 4. The company will continue to be in existence even if the shareholders die. If a sole trader dies the business will only continue if it is sold. Disadvantages 1. Most companies must have an audit of their accounts and therefore must pay audit fees. Special rules apply to companies with small turnover levels which exempt such companies from a formal audit and in some cases require a less demanding form of report. 2. A company must prepare its accounts in a format prescribed by legislation. 3. A company suffers a greater administrative burden than a sole trader. For example, it must file its accounts each year with the Registrar of Companies and may be required to hold an Annual General Meeting of its shareholders. The company must also maintain statutory books which must be available for inspection.
Stonegate Ltd makes baby monitors. On 1 February 2018 the company received an order. The monitors were delivered to the customer on 22 February 2018 and an invoice was issued on 4 March 2018. The customer settled the invoice on 25 April 2018. Show the tax point for the above supply.
Basic tax point = the date of despatch 22.2.18 Actual tax point = the invoice date of 4.3.18 as this is within 14 days after the basic tax point VATA 1994, s.6
Compare how relief will be given for the cost of the plant and machinery and the options for relieving a trade loss if Cath elects to use the cash basis of accounting versus relief if no such election is made.
Cash basis election: Tax relief will be given for the cost of the plant and machinery in the accounting period that it is paid for Trade losses can only be carried forward and set against future trading income from the same trade No cash basis election: Tax relief will be given in the form of capital allowances Trade losses can be relieved by: - Setting them against the net income of the loss making tax year and/or the previous tax year - After a net income claim has been made some of the remaining loss may be set against chargeable gains of the same tax year - A loss sustained in any of the first four tax years of a trade can be carried back against net income of the three preceding tax years, on a FIFO basis - Carrying them forward against the first available future trading income from the same trade There is a restriction on the total amount of certain reliefs an individual can take against net income. Total relief is limited to the greater of £50,000 or 25% of the individual's adjusted total income for the tax year.
Petula is a sole trader who runs a village store. The products sold by Petula include: • Chocolate • The local newspaper • Locally produced cakes • Postage stamps State the VAT liability of the above supplies.
Chocolate : Standard rated Local newspaper : Zero rated Locally produced cakes : Zero rated Postage stamps : Exempt
You are required to write a letter to Luke to: 1) Outline the key differences in the taxation of his business venture as a company and as a sole trader, including the basis of assessment for both.
Company or sole trader? The company will pay corporation tax at 19% on its taxable total profits for each chargeable accounting period (CAP). The first CAP will be the 12 month period to 30 June 2019. Corporation tax is payable by the company no later than nine months and one day from the end of the CAP, i.e. by 1 April 2020 in respect of the first period. Operating through a company, you can withdraw profits either via a salary or as dividends. If you take a salary, the company will have to pay Class 1 secondary NIC in addition to the Class 1 primary NIC that you will incur as a director. The company will however obtain tax relief for both the salary and any Class 1 secondary NIC paid. By taking dividends instead of salary, neither you nor the company will be liable for NICs, however no corporation tax relief is given for dividends paid. As a sole trader you will pay income tax on profits of the tax year, with those profits being reported on your self-assessment return. Any drawings you make from your business will not be tax deductible. For the first tax year (2018/19) you will pay tax on the profits of the period from 1 July 2018 to 5 April 2019. This will require the results of your first accounting period up to 30 June 2019 to be apportioned. In 2019/20 you will be taxed on profits of the first 12 months of trade (1 July 2018 to 30 June 2019). This means some profits will be taxed twice. These are called 'overlap profits'. You will receive relief for these either if you move your accounts date nearer to 5 April, or on the cessation of your trade. Given your estimated profits you will pay some income tax at 20% and some at 40%. As a sole trader you will pay Class 2 and Class 4 National Insurance rather than Class 1 NIC as a director of a company. You must notify HMRC of your liability to NIC as soon as you start to trade.
Jemm Ltd has prepared accounts for the 18 month period ended 31 December 2017. The company is not required to pay its Corporation Tax by instalments. 1) State the due dates for the payment of any Corporation Tax due in respect of these accounts. 2) State the due date for the filing of the Corporation Tax Return(s) in respect of these accounts.
Corporation Tax payments will be due: • on 1 April 2018 for the year ended 30 June 2017 [½], and • on 1 October 2018 for the period ended 31 December 2017. [½] Returns for both periods must be filed online by 31 December 2018. [1]
Plasticpipe Ltd's accounts for the year to 31 March 2018 need to be finalised, but the following two transactions have yet to be reflected in the accounts: 1) The company supplied pipes to a house builder in June 2017. These pipes have suffered extensive cracking and, after some negotiations, in January 2018 were agreed to be faulty. The probable cost of replacement is estimated at £20,000. 2) The company dismissed one of its employees in February 2018 on the grounds of poor performance. The employee has sought legal advice and has decided to test the case at an Employment Tribunal. He is trying to claim damages of £14,000. State the relevant entries to be made in the company's accounts for each transaction, together with a brief note of your reasoning.
Dr Provision for replacement (P&L expense) £20,000 Cr Provision for replacement (BS liability) £20,000 Being provision for replacement pipework [1] A provision is necessary because the liability relates to an event that took place before the balance sheet date [½] and the cost is known. [½] No provision is necessary for the employment issue [½], although a contingent liability note may be placed in the accounts if the sum claimed is material. [½] The provision is not necessary because, although the event took place before the balance sheet date, there is no certainty that a liability will actually arise. [1]
You have just started to prepare accounts for a client and have discovered that there was an error made by the client in last year's accounts which, when corrected, will increase the client's tax liability for that year by £10,000. The client is reluctant to inform HM Revenue & Customs. Explain the course of action you should take with regards to advising the client and informing HM Revenue & Customs of the error.
Explain to client HMRC has wide-ranging powers to obtain information from taxpayers, their agents and third parties. Explain the consequences of non-disclosure and the benefits of voluntary disclosure (i.e. reduced penalties). Explain: • you will be required to put your advice that disclosure is required in writing • you will be obliged to cease to act if disclosure is not made • you will comply with your professional obligations relating to the appointment of a new adviser If client remains unwilling to disclose, write to client confirming that full disclosure should be made and the consequences of non-disclosure. If permission is given - write to HMRC accordingly. If permission is not given - cease to act in relation to client's tax affairs and inform the client in writing accordingly. Write to HMRC advising that you no longer act for the client, but do not disclose why in order to maintain client confidentiality. Consider whether you need to make a report under the money laundering regulations.
Explain how the cost, any replacements and the sale of mature animals are treated if an election for the herd basis is made.
Farmers can make an irrevocable election for the herd basis where animals are treated as a fixed asset instead of trading stock. The initial cost of the herd is not an allowable deduction, nor is the cost of any subsequent increase in herd size. The selling price of the old animal is included as income and the cost of the replacement animal is deductible as an expense.
Self-employed - how long should tax records be kept for and potential penalty?
Five years from the 31 January following the tax year to which the records relate. Maximum £3,000 (can be mitigated by HMRC)
The balance sheet of a company includes both fixed assets and current assets. Explain clearly the difference between these two categories of assets.
Fixed assets are bought for the longer term [½]; they are capital expenditure [½], so there is no immediate charge to the Profit & Loss account. [½] They are used to help the business trade. [½] They include items such as premises and motor vehicles. [½] Current assets, at least in theory, can be easily converted into cash [½]; balances arise as a direct result of trading activities. [½] They include stock, debtors and cash. [½]
Gladrags Ltd is a trading company that has been very profitable over the last few years and has invested some of its profits into property. In the year to 31 August 2017 one of its tenants went into liquidation, resulting in a property business loss for that year of £7,000. Explain how this property business loss may be used by Gladrags Ltd.
Gladrags Ltd will automatically set the loss against its total profits for the year to 31 August 2017. Any remaining loss is carried forward and set against its first available total profits in a subsequent year.
Gladrags Ltd is a trading company that has been very profitable over the last few years and has invested some of its profits into property. In the year to 31 August 2017 one of its tenants went into liquidation, resulting in a property business loss for that year of £7,000. Explain how this property business loss may be used by Gladrags Ltd.
Gladrags Ltd will automatically set the loss against its total profits for the year to 31 August 2017. [1] Any remaining loss is carried forward and set against its first available total profits in a subsequent year.
Describe what goodwill is and explain how it should be treated in company accounts.
Goodwill is the difference between the value of a business as a whole and the value of the business's individual assets less liabilities. The treatment of goodwill in company accounts is set out in FRS 102. FRS 102 states that if goodwill is internally generated it must not be included as an asset in a company's accounts because it is nearly impossible to value. However if goodwill has been purchased when another business was acquired it can be treated as a separate intangible fixed asset and included on the Balance Sheet. FRS 102 states that all assets have a finite useful life, and if the useful life cannot be reliably estimated, it shall not exceed ten years. The goodwill intangible fixed asset is therefore amortised on a systematic basis over its useful life which cannot exceed ten years. Tutorial Note: FRS 102 Section 27 also requires that all assets should be reviewed annually for impairments, and written down if required. An impairment is where the recoverable amount (the fair value less the costs to sell) of an asset has dropped to below the value at which it is carried in the balance sheet. This is particularly relevant for goodwill which, due to its nature, is subject to many external and internal influences, e.g. bad publicity.
Mrs Florence is a self employed florist. Her tax return for the year to 5 April 2017 was filed on 13 December 2017. She now thinks that she may have omitted to include some business expenses when she sent in her tax return. State, with brief reasons: 1) The latest date by which HM Revenue & Customs may enquire into Mrs Florence's 2016/17 tax return. 2) The latest date when Mrs Florence may amend the return. 3) The effect that an amendment has on the enquiry period.
HMRC may enquire into the return at any time up to 13 December 2018 [½] (i.e. 12 months after date of lodging 'on time'). [½] Mrs Florence may amend the return up to and including 31 January 2019 [½] (i.e. 12 months from normal filing date.) [½] If the return is amended after 31 January 2018, then the enquiry window is extended until the quarter date (31 January, 30 April, 31 July or 31 October) following one year after the amendment, but only in respect of matters covered in the amendment to the return. [1]
Paybill Ltd wants to pay the home telephone bill of its managing director. The telephone will be used for both business and private purposes. Explain which class of National Insurance Contributions is payable if the company contracts directly with the telephone company or alternatively if the managing director contracts directly with the telephone company.
If Paybill Ltd contracts directly with the telephone company, then the payment will be a benefit in kind [½] and will be subject to Class 1A National Insurance [½] contributions by the employer. Alternatively if the director contracts directly with the telephone company and the bill is settled by Paybill Ltd, then Paybill Ltd is settling a pecuniary liability [½] of the director and that payment should be placed through payroll [½] where it will be liable to Class 1 employers' (and employees') NI contributions. [½] Tutorial Note: If it can be demonstrated that a particular amount is paid in relation to business calls, then that amount is not subject to Class 1 NIC.
VAT becomes due on a supply of goods or services at the time of supply. State the tax point for: A supply of goods
If goods removed = time of removal If goods not removed = time when made available
Cromer Ltd has traded for many years and every year purchased several items of equipment. Unfortunately it had been suffering poor trading conditions and, due to the loss of a major customer, ceased trading on 31 December 2017. Explain the basis for the calculation of capital allowances, balancing charges and balancing allowances in the final period up to the cessation of trade.
If new expenditure is incurred, it is added to the appropriate pool. [½] No AIA, FYA [½] or WDA [½] are available in the final period. Disposal proceeds or deemed disposal proceeds [½] are deducted from the pools [½] subject to the amount not exceeding the asset's original cost. [½] A balancing allowance is given if a balance remains on the pool. [½] However, a balancing charge applies if the disposal proceeds exceed the pool's value. [½]
Explain how a dividend would be treated in the accounts.
If the dividend is declared before the accounting year end it will be shown as an expense in the profit and loss account of the year to which it relates. The amount will also need to be shown as a liability (i.e. a dividend creditor) in the balance sheet if it will not be paid until the following year. If the dividend is declared after the accounting year-end, it will not be shown as an expense in the profit and loss account of the year it relates to, instead it is shown as an expense in the profit and loss account of the year in which it is paid.
Finance lease - Legal, accounting, tax rules
Legal - No legal ownership but bears all risks and rewards of ownership Accounting - Fixed asset on the balance sheet - Depreciate through P&L - Finance lease charge through P&L Tax - No capital allowances - Allow depreciation and finance lease charge in P&L but restrict where: Car > 130g/km (disallow 15%) - Private use by sole trader/partner
Hire purchase - legal, accounting, tax rules
Legal - legal ownership capable of being acquired Accounting - Fixed asset on balance sheet - Depreciate through P&L - Interest expense through P&L Tax - Capital allowances on cash price Cars: < 75g 100% FYA, 76-130 18%, >130 8% - Restrict for private use by sole trader/partner - Allow interest expense in P&L
Operating Lease - Legal, accounting, tax rules
Legal - no legal ownership, short term rental agreement only Accounting - Not on balance sheet - Rental expense through P&L Tax - No capital allowances - Allow rental expense in P&L but restrict where: Car > 130g/km (disallow 15%) - private use by sole trader/partner
Special rules apply to a company's 'loan relationships' for Corporation Tax purposes. 1) Explain the term 'loan relationship'. 2) Give two examples of loan relationships. 3) Briefly explain how the amount to be included in the Corporation Tax computation is calculated. (
Loan relationships cover all loans made both by and to the company. [1] Examples include: Bank overdrafts and loans, mortgages, employee loans, interest on underpaid and overpaid corporation tax, corporate bonds, interest on savings, etc. [½ for each - max 1] All non-trading debits (i.e. expenses) and credits (i.e. income), calculated in line with generally accepted accounting principles, are aggregated and the overall debit (expense) or credit (income) included in the Corporation Tax computation. [1] If the loan was for trade purposes, the associated income or expenses would be included in the calculation of trade profits.
Explain whether the partnership is bound by the new contract signed by Bill.
Partners are bound by the terms of their partnership agreement, but where there is no formal agreement, the provisions of the Partnership Act 1890 apply. This Act defines the authority of a partner to make contracts as follows: Every partner is an agent of the firm and his other partners for the purpose of the business of the partnership. • All partners may, therefore, be bound by a contract which one partner makes. • A partner may act so as to bind the firm and his partners, unless he has no authority to act for the firm in that particular matter, and the person with whom he is dealing either knows that he has no authority, or does not know or believe him to be a partner. • Where a partner pledges the credit of the firm for a purpose apparently not connected with the firm's ordinary course of business, the firm is not bound, unless he is specially authorised by the other partners. • If it has been agreed between the partners that any restriction shall be placed on the power of any one or more of them to bind the firm, no act done in contravention of the agreement is binding on the firm with respect to persons having notice of the agreement. The above provisions mean that, other than when the partner has actual authority, authority depends on the perception of the third party. If the third party genuinely believes that the other partner has authority, the partner is likely to bind the firm.
You are required to write a letter to Mary explaining: The dates on which Income Tax and National Insurance are payable.
Payments on account (if due) of Income Tax and Class 4 NIC are payable on or before 31 January in the tax year and 31 July following the end of the tax year, with the balance due on or before 31 January following the tax year. Class 2 NIC is collected with the balancing payment of Income Tax and Class 4 NIC on or before 31 January following the tax year.
Outline the income tax rules for post-cessation payments
Post-cessation payments made in the seven years after permanently ceasing to trade are given relief by claiming a deduction against net income for the year in which the payment is made. (ITA 2007, s.96) This relief can be extended to treat any unused part as an allowable loss for capital gains tax purposes for the year in which the payment is made, and so offset against capital gains in the same tax year (ITA 2007, s.101). If the expenses exceed the income and gains for that particular tax year, the excess can be carried forward against future post-cessation receipts. Unutilised expenses will be wasted and may not receive any relief. (ITTOIA 2005, s.254) Relief is only given for qualifying payments as follows (ITA 2007, s.97): • Remedying defective work • Damages • Legal fees in relation to claims about defective work • Insuring against liabilities arising out of claims regarding defects, or legal fees in connection with claims about defects • Debt collection A claim for relief must be made on or before the first anniversary of the normal filing date for the tax year the relief is to be claimed, i.e. by 31 January 2020 for relief in 2017/18.
Pradeep is setting up a business in the UK selling electrical goods and services. His supplies will be made to other businesses and consumers, both in the UK and overseas. Outline the place of supply rules for Pradeep's supplies.
Provided the goods are in the UK then the place of supply of Pradeep's electrical goods is in the UK. [1] Business to business - supplies of services take place where the customer is established. [1] Business to consumer - supplies of services take place where the supplier is established. [1] VATA 1994, ss.7 & 7A
Explain when the business will be required to register for VAT and the effects of being VAT registered.
Registration for VAT is compulsory if your turnover (i.e. sales) of taxable supplies in the previous 12 months (or from the date of commencement if shorter) exceed the VAT registration threshold which is currently £85,000. Based on your business plan, you will breach the threshold on 31 December 2018, so you should notify HMRC of your requirement to register for VAT by 30 January 2019 and should charge VAT on sales from 1 February 2019. The main effect of being VAT registered is that you must charge VAT at the standard rate on all your sales. You will however be able to recover any VAT you incur on your purchases. You will also have to file quarterly VAT returns. The quarterly VAT returns are due to be submitted online within seven days and one month of the end of the return period. Any VAT you owe is also payable at this point. If you set up a direct debit to pay the VAT owed, payment is normally taken three days after the normal payment date.
For companies, rental income and loss rules
Rental income earned less expenses incurred wholly and exclusively for the purpose of the rental business is treated as profits of a property business. [½] Capital allowances are deducted as an expense in arriving at the profit or loss. [½] Income and expenses are calculated on the accruals basis for the company's accounting period. [½] Max 1 Interest on loans relating to the let property is not deducted as an expense [½] but is taken into account in arriving at the overall surplus or deficit on non-trading loans (ie the loan relationship rules). [½] Total 1 If a property loss arises then, provided that the property business is conducted on a commercial basis, the loss may be set against total profits [½] of the same accounting period. [½] Any unrelieved losses are carried forward [½] against future total profits of the company (assuming the property business is still carried on). [½]
Explain how the research expenditure should be treated in the accounts of LV plc.
Research expenditure should always be written off or expensed as incurred, apart from expenditure on fixed assets acquired to provide research facilities (which can be capitalised as normal).
A company wishes to raise finance with a rights issue of shares. Explain the rules for determining the number of shares a shareholder might acquire, any conditions relating to the price of the shares and the shareholders' options for dealing with a rights issue.
Right issues are offered to existing shareholders in proportion to their shareholding. [½] Often the shares are issued at a favourable cost (i.e. less than market value) [½], but they cannot be issued for less than nominal value. [½] Shareholders have three options: 1. Take up their rights and pay for the shares, [½] 2. Sell their rights to a third party, [½] or 3. Do nothing. [½] If the shareholder does nothing, the rights lapse [½] and the company will sell the rights for them and send them the proceeds. [½]
You are required to write a letter to Mary explaining: 4) The legal issues to be considered when starting an unincorporated business.
Setting up in business as a sole trader is the simplest and most straightforward way from a legal point of view as there are few formalities involved. [1] As an unincorporated business you are required to keep accounting records for tax and VAT purposes, but there is no requirement to file accounts as a public record. [1] The business of a sole trader has no legal identity separate from that of the individual so, although you are entitled to the full amount of profits, you are also fully responsible for any debts and losses of the business and you have unlimited liability. [1] You do not have to use your own name as the business name, but you must follow the rules contained in the Companies Act 2006 to ensure that there is no confusion between your business and another business with a similar name and to ensure that the business name chosen is permissible. [1] As an employer there are various legal obligations imposed on you regarding employees' rights in respect of pay, conditions of employment, dismissal, and health and safety at work. [1] You must have employer's liability insurance to provide cover in the event of an employee being injured at work or causing injury or damage to someone else. [1] You should check the terms of the shop lease carefully so that you are sure of any restrictions placed upon you and the overall liability for rent and service charges that you may be taking on.
Claudia Harz has been running children's parties as a sole trader for several years. As her turnover increased, she established Harz Ltd, a company that also runs children's parties and that is wholly owned by Claudia. Both businesses are now turning over approximately £70,000 per annum. She is now considering establishing a partnership with her husband, Stefan, that will also run children's parties. Explain what impact the limited company and proposed partnership have on Claudia's obligation to register for VAT.
The VAT registration limit is £85,000 and Claudia's sole trader business is currently below this. [1] It is the person who is registered for VAT and, if they operate two or more trades, the taxable supplies of those trades must be combined to determine whether the threshold has been breached. [1] The limited company and partnership are separate from Claudia; however, where a business is disaggregated, HMRC may direct that the businesses should be aggregated for VAT purposes. [1] Such directions are not retrospective (i.e. they apply to future supplies only) [1]. There is a risk that the existing company and sole tradership already fall within these provisions and the new partnership may fall foul too. [1]
Explain what is meant by the accruals basis of accounting.
The accruals basis of accounting is a concept which underlies the preparation of all accounts which aim to give a 'true and fair' view or 'fair presentation' of the position and performance of the business. [1] The accruals basis requires that all income and the related expenses incurred in generating that income must be included in the accounts of the same accounting period. [1] There will normally be some items of income and expenditure which are earned /incurred in one accounting period which are received/paid in another. [1] The profit and loss account should show the income earned or expenditure incurred in the accounting period rather than the income received or expenditure paid in cash. [1] Adjustments may be needed for expenses incurred but not yet paid for at the balance sheet date (accrued expenses) or expenses paid for in advance for a period extending beyond the accounting period (prepaid expenses). [1] Similarly adjustments may be needed for income received in advance or income accrued which has been earned but not yet received.
VAT becomes due on a supply of goods or services at the time of supply. State the tax point for: A supply of services
The basic tax point for a supply of services is the time when the services are performed, i.e. completed
Catchfish Ltd makes supplies of machinery to its customers on credit. Briefly explain the time of supply rules for VAT purposes.
The basic tax point is the time that the goods are made available to the customer. [1] If an invoice is issued or payment is received in advance, the time of supply is the date that the invoice is issued or the payment is received. [1] If an invoice is issued within 14 days of the basic tax point (and no earlier tax point applies) then the tax point is the invoice date. [1] VATA 1994, s.6
The time of supply rules are used to determine on which VAT return tax is accounted for. Explain the rules for determining the time of supply for VAT purposes.
The basic time of supply (tax point) is the date the goods are made available [½] or the services are performed. [½] This is replaced by the: • date of invoice [½] or • date of payment [½] if earlier. [½] However, if goods or services are invoiced within 14 days of the basic tax point [½] the invoice date replaces the basic tax point [½] unless the date of payment has already established a tax point. [½] VATA 1994 s.6
Yeo Ltd started trading on 1 June 2017. Turnover is £12,000 per month for the first five months. On 9 November 2017 the company won a new contract. Turnover will be £90,000 per month from November 2017 to April 2018, and £94,000 per month thereafter. Outline from which date the company is liable to be registered for VAT.
The company must be registered from the beginning of the period when taxable supplies are expected to exceed £85,000 in the next 30 days alone. Thus on 9 November 2017 there are reasonable grounds for believing that the £85,000 limit will be breached in the next 30 days alone. The company must be registered from 9 November 2017
Tom, a higher rate taxpayer, had run a widget manufacturing business for many years and decided to sell it in November 2017. He wishes to claim entrepreneurs' relief in respect of the gains made. State: • the maximum amount of gain that will qualify for relief, • the way in which relief will be given, and • the time limit for making the claim.
The maximum amount of lifetime gains qualifying for entrepreneur's relief is £10 million. Any chargeable gains up to the lifetime limit will be charged to tax at a rate of 10% if a claim for entrepreneurs' relief is made (rather than at 20% for a higher rate taxpayer). The claim for relief must be made by the first anniversary of 31 January following the tax year of disposal (i.e. for disposals in 2017/18 by 31 January 2020).
Explain the ways in which a company can obtain relief for a trading loss.
The options available to relieve a trading loss are as follows: The trading loss can be set against total profits of the same chargeable accounting period before the deduction of qualifying charitable donations. [1] After setting a trading loss against the total profits of the current accounting period [½], any balance can be carried back and set against the total profits in the previous 12 months, before any qualifying charitable donations. [½] If the previous chargeable accounting period is less than 12 months, the trading loss can be carried back to the period before that one by applying time apportionment to the total profits of the previous period. [½] The carry back period is extended to three years on the cessation of the trade. [½] Any remaining trading loss can be carried forward for set off against future trading profits of the same trade.
Explain three differences between accounts prepared for a sole trader and those for a partnership.
The profit and loss account for a sole trader and a partnership are the same except that a partnership has an appropriation statement at the bottom. [1 for discussion of the P&L account] The net profits of a sole trader belong to them but a partnership net profit has to be divided between the partners. [½] A partner may be allocated a 'salary' with the remainder of the profits being divided according to an agreed formula. [½] The salary of a partner is not an expense of the business as it relates to the owners. [½] There may also be interest provided on capital. This is also not a business expense but a way of remunerating the partners for the capital they have invested in the business. [½] [Max 1 for discussing division of profits] The bottom half of a balance sheet for a sole trader will show capital, profit and drawings. [½] For a partnership, the bottom half shows the partners' capital and current accounts. [½] The capital account represents the amount that the partner cannot withdraw until they leave the partnership. [½] The current account shows each partner's share of the profits from the appropriation statement less any drawings. [½] [Max 1 for balance sheet issues] Tutorial Note: The examiner confirmed that answers to written questions of this nature are marked flexibly and that full marks could have been achieved by stating the following: • There is an appropriation statement to share the net profit between the partners. • The capital account in the balance sheet represents the amount that the partners cannot withdraw from the partnership until they leave the partnership unless the other partners agree to the withdrawal of capital. • The current account in the balance sheet represents each partner's share of net profits to date less any drawings they have taken out to date.
Bob commenced trading on 1 January 2017 but did not register for VAT. For each month until 30 June 2017 his turnover was £6,000 per month on goods which would be standard rated if he was VAT registered. From 1 July 2017 his turnover increased to £8,000 per month of which £7,500 would be standard rated and £500 zero rated. The turnover has continued at this level since that date. Calculate the month in which Bob became liable to register for VAT, state the date by which HM Revenue & Customs must be notified and the date from which the registration would take effect.
Turnover: £ 6 months to 30 June 2017 6 x £6,000 36,000 [½] 6 months to 31 December 2017 6 x £8,000 48,000 [½] 84,000 Less: January 2017 (6,000) [½] Add: January 2018 8,000 [½] 86,000 Liable at end of January 2018 as limit (£85,000) exceeded [½] Notify HMRC by 2 March 2018 [1] Registered from 1 March 2018
10. Depreciation may be charged on either a straight line or reducing balance basis. Briefly explain the difference between the two methods and the effect that each method has on an asset's net book value.
When depreciation is charged on a straight line basis, it means that the same amount of depreciation is charged for each period of the asset's useful life [1]. This means that the asset's value decreases by the same amount each period. [½] When depreciation is charged on a reducing balance basis it means that a set proportion of the net book value of the asset is charged in each period [1]. This means that the asset's value falls more quickly when it is new and the depreciation charge will decrease each period. [½]
You are required to write a letter to Mary explaining: The requirement to register for VAT and the circumstances in which voluntary registration may be beneficial.
You are required to register for VAT if, at the end of any calendar month, your cumulative turnover of taxable supplies in the previous 12 month period (or since the commencement of trade if shorter) exceeds £85,000. [½] You have 30 days following the month in which the threshold is reached to notify HMRC. You must charge VAT on supplies from the first day of the following month - ie if the threshold is breached on 31 March you must start charging VAT on 1 May. [½] You must also register if your turnover of taxable supplies within the next 30 days alone is expected to exceed £85,000. In this case, HMRC must be notified by the end of that 30 day period and VAT must be charged immediately on any supplies. [1] You can choose to register voluntarily before you reach the limit which will avoid problems with missing the compulsory registration threshold. It will also allow you to reclaim input tax and give the impression of a sizeable business. [1] However, voluntary registration may not be an advantage to you if you are selling direct to the public as your customers will not be VAT registered so you will either have to increase your prices or absorb the cost of the VAT.
You are required to write a letter to Mary explaining: 1) The requirement to notify HMRC of her self-employment.
You must register with HM Revenue and Customs as self employed for Income Tax and National Insurance purposes. This should ideally be done as soon as possible, however, the deadline for notification is by 5 October following the end of the tax year of commencement.
Emily Tuesday is a director of a family trading company, Tuesday Trading Ltd. She works full time for the company and owns 25% of the share capital. Emily is concerned that any trading relationship may eventually be detrimental to Tuesday Trading Ltd and she is being encouraged by her father to consider the sale of the shares. Emily has owned the shares for four years and is likely to make a gain of £150,000 if she were to sell. Explain the Capital Gains Tax implications of the sale of the shares and, in particular, the availability of Entrepreneurs' Relief on any disposal by Emily and her father. No calculations are required.
You were also concerned that if you were to sell your shares, you may have a substantial liability to capital gains tax. When you sell any shares in the company, a gain will be calculated based on sale proceeds less cost of acquisition. A claim for Entrepreneurs' Relief will result in the gain (after deduction of any available losses and the available annual exemption) being taxed at the rate of 10%, regardless of your level of income. To qualify for Entrepreneurs' Relief you have to meet the relevant qualifying conditions throughout a period of one year. This period ends with the date on which you dispose of a qualifying asset. Shares will qualify for relief if you hold at least 5% of the ordinary share capital and that holding gives you at least 5% of the voting rights in the company. In addition, the company must be a 'trading company', and you must be either an officer or employee of that company. It would appear that you meet these criteria. However, as your father does not work for the company, it would appear that his gain would not qualify for entrepreneurs' relief.
Jenny is a baker making zero rated supplies of bread. John runs a betting shop making exempt supplies. Explain the difference between zero rated and exempt supplies and the impact on the input VAT which can be reclaimed by each business.
Zero rated supplies are where VAT is charged but at 0% rate. [½] No VAT is charged on exempt supplies. [½] Jenny can reclaim all input VAT incurred as she is making taxable supplies. [½] John cannot reclaim any input VAT as he is not making any taxable supplies. [½]