Tax tips for Family Businesses
Find out how family businesses can reduce their tax burden with some practical forward thinking.
Owners and managers of family-owned businesses rightfully spend the vast majority of their time ensuring that the business runs well and generates profits. In the midst of such a demanding task, it can be easy to overlook some tax considerations that can potentially be significant.
The topic of tax in the context of family-owned businesses is a large one – however, there are a few key considerations to bear in mind:
- How is your business set up?
- How are you extracting funds?
- What’s New?
- How are you incentivising your staff?
- Are you thinking of an exit?
- Planning with pensions
- What about the next generation?
How is your business set up?
Most family-owned businesses are set up as companies, but some do run as partnerships. These two structures differ in terms of tax, and it is worthwhile for business owners to consider which structure could be most beneficial for their business.
Companies may pay lower rates of tax initially, but further tax (including National Insurance Contributions in the case of salary/bonuses) is often due when higher profits are extracted. Partnerships however are tax transparent, so profits are taxed as they arise, even if they are not extracted (but are taxed only once). It is generally easier to convert a partnership into a company than the other way around.
How are you extracting funds?
The business has a choice, broadly speaking, of paying dividends or paying salary/ bonuses. However, recent legislation has attempted to narrow the tax difference between companies and sole trader/partnerships.
The Finance Bill 2016, published on 24 March 2016, contains the new rules for dividends.
- From 6 April 2016, the notional 10% tax credit on dividends will be abolished
- A £5,000 tax free dividend allowance will be introduced
- Dividends above this level will be taxed at 7.5% (basic rate), 32.5% (higher rate), and 38.1% (additional rate)
- Dividends received by pensions and ISAs will be unaffected
- Dividend income will be treated as the top band of income
- Individuals who are basic rate payers who receive dividends of more than £5,001 will need to complete self assessment returns from 6 April 2016
- The change is expected to have little impact upon non-UK residents
The proposed changes raise revenue despite the so-called “triple lock” on income tax. Perhaps aimed to tax small companies who pay a small salary designed to preserve entitlement to the State Pension, followed by a much larger dividend payment in order to reduce National Insurance costs. It appears that the government is anti-small companies, preferring workers to be self-employed.
These changes will affect anyone in receipt of dividends: most taxpayers will be paying tax at an extra 7.5% p.a. Although the first £5,000 of any dividend is tax free, in 2016/17:
- Upper rate taxpayers will pay tax at 38.1% instead of an effective rate of 30.55% in 2015/16
- Higher rate taxpayers will pay tax at 32.5% instead of an effective rate of 25% in 2015/16
- Basic rate taxpayers will pay tax at 7.5% instead of 0% in 2015/16
This measure will have a very harsh effect on those who work with spouses in very small family companies. For example, a couple splitting income of £100,000 p.a. could be over £5,000 p.a. worse off.
Businesses should therefore consider these tax issues when using either of these methods to extract funds.
There can be benefits in various family members being involved in the business, particularly if they, for example, perform smaller roles and are not paying taxes at the higher rates. Care is always required here to ensure that any salaries are commensurate with the job performed.
There can also be complexities in giving away shares to spouses to enable them to capture dividends at the lower rates.
How are you incentivising your staff?
Clearly, the retention of key staff is of critical consideration for businesses of any size. With cash flows being restricted in these difficult times, consideration can usually be given to granting share options to employees. Certain tax-approved options schemes (such as Enterprise Management Incentives) are potentially very tax-efficient and a good incentive for key workers.
Are you thinking of an exit?
It is never too early to contemplate what would happen if the business were sold. The headline rate of capital gains tax is not good as it once was but there are potentially reliefs available which may minimise the tax burden on exit. With the right structuring, valuable relief can potentially be opened up to various family members through tax planning.
Tax Planning with pensions
Pensions are all the rage now, given the recent changes.
In certain instances, an appropriate pension plan for a family-owned business can lead to substantial tax efficiencies. Also the use of SIPPs and SASSs can be used a valuable tax planning tool to extract funds from otherwise taxable business profits.
What about the next generation?
Succession planning is a key strategic matter for any family-owned business. Where the business is a trading concern, it is often possible (depending on the particular circumstances) to give away shares without adverse tax consequences.
But care is required here to avoid certain pitfalls that can exist if even a few investment assets are located somewhere within the business.
It may also be the case that a trading business qualifies for inheritance tax relief (under the business property relief regime); therefore, founders may not be worried about inheritance tax now. If the business is sold however, this relief will be lost, potentially generating a significant inheritance tax bill in the future. Fortunately, planning options do exist here, such as transferring the business into a trust before an exit.
Needless to say, the above gives only a taste of some of the relevant tax considerations where family-owned businesses are concerned. The important point is to remember the significant impact that tax can make, and to take advice early and regularly.
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As lockdown slowly eases across the UK, we look at some of the practical issues faced by individuals already impacted by COVID-19. One issue we are being asked about is the impact of buy-to-let landlords who have decided to take a mortgage payment holiday. We outline the impact of this and how this can affect your tax payment for the year.
In March, the Government announced that homeowners struggling to pay their mortgages due to Coronavirus would be able to take a three-month mortgage payment holiday. They confirmed that this option would also be available to buy-to-let landlords, who may suffer cashflow difficulties if, as a result of the virus, their tenants were unable to meet their rent in full when it is due. In May, the Government announced that those struggling to pay their mortgages because of the impact of Coronavirus would be able to extent their mortgage payment holiday by up to three months.
Where a landlord opts to take a mortgage payment holiday, what impact does this have on tax relief for interest payments and, in turn, their tax payments?
Interest continues to accrue
The first point to note is that interest continues to accrue during the period of the mortgage holiday, although the landlord will not be required to make any payments during this time. This is important and will impact on the timing of the associated interest relief, which will depend on whether accounts are prepared on a cash basis or on the accruals basis.
At the end of the holiday, the missed payments and interest may be recovered by extending the term of the mortgage or by making higher payments once payments restart.
Relief as a basic rate tax reduction
From 2020/21 onwards, tax relief for finance costs (such as mortgage interest) on residential properties is given only as a tax reduction at the basic rate. This means that 20% of the allowable finance costs are deducted from the tax that is due.
Impact of a mortgage holiday – Cash basis
Most landlords whose rental receipts are £150,000 a year or less will prepare the accounts for their property rental business under the cash basis. As expenditure under the cash basis is recognised when paid, if the landlord does not make a payment, there will be no relief for that expense until the payment is made.
Where the landlord takes a mortgage, no interest will be paid during the period of that holiday. As a result, a landlord may pay less in interest in 2020/21 than in 2019/20. The interest rate reduction is calculated by reference to the interest paid in the year.
Ali has a buy-to-let property on which he has buy-to-let mortgage, the interest on is £500 per month. As a result of the Covid-19 pandemic, his tenant struggles to pay his rent on time. Ali takes a three-month mortgage payment holiday. The mortgage term is effectively extended as a result.
In 2020/21, Ali only makes nine mortgage payments instead of the usual 12, paying interest of £4,500 rather than £6,000. The tax reduction for 2020/21 is £900 (£4,500 @ 20%) rather than £1,200 (£6,000 @ 20%).
Tax reduction – accruals basis
Under the accruals basis relief is given for the period in which the expense arises rather than when payment is made. As interest continues to accrue throughout a mortgage holiday, the landlord will be able to claim the full tax reduction on the interest accruing in the 2020/21 tax year, even if the interest was not paid in full in the year because the landlord took advantage of a mortgage payment holiday.
So if, in the above example, Ali prepared his accounts for 2020/21 on an accruals basis, he would be able to claim a tax reduction of £1,200, whereas under the cash basis his deduction will only £900, the higher deduction will of course reduce any rental profits (or increase a loss) subject to tax and thereby reduce any tax payable in the year.
If you need advice regarding your rental properties please call us on 0114 272 4984 or email firstname.lastname@example.org.
Under the dreadful cloud of COVID-19 some major tax changes are seemingly going under the radar. One such change is lettings relief, a previously valuable tax break available to those selling their home which was rented out at some stage. This tax mitigation opportunity has now been abolished and has been replaced with a much less attractive tax break which severely restricts the circumstances in which relief is available. We explain the changes here.
Lettings relief provided additional relief for tax where a property that has been occupied as a main residence is let out. For disposals prior to 6 April 2020, a substantial tax relief was available where a property was let as long as that property had at some time been the owner’s only or main residence.
However, availability of the relief is now seriously curtailed in relation to disposals on or after 6 April 2020. Under the new rules, lettings relief will only be available where the homeowner and their tenant are in occupation of the property at the same time – shared occupation. So from 6 April 2020, relief is only available where the owner shares the property with the tenant, a move which seriously narrows any claim that could have been made under the previous rules.
The new-style (narrow) relief
For disposals on or after 6 April 2020, the new lettings relief is available where:
- part of the property is the individual’s only or main residence and
- another part of that property is let out by the individual, otherwise than in the course of a trade or a business.
The gain relating to the let part is only chargeable to capital gains tax to the extent that it exceeds the lesser of:
- the amount of private residence relief; and
Spouses and civil partners can take advantage of the no gain/no loss rules to transfer the property or a share in it to each other without a loss of lettings relief. Where lettings relief would be available to a transferring spouse or civil partner for the period prior to the transfer, it remains available to the recipient.
Let’s look at how this works in a real life scenario.
Idris brought a three-bedroom house in 2015. He lived in the property for five years until it was sold in May 2020, realising a gain of £90,000. Throughout the time that he lived in the property, he let out two rooms. The let rooms comprised one-third of the property by floor area.
Two-third of the property was occupied as Henry’s main residence, and thus two-thirds of the gain qualifies for private residence relief. This equates to £60,000 (2/3 x £90,000). The remaining gain of £30,000 is attributable to “letting”.
As Idris occupied the property with the tenants, he can claim lettings relief. Previously, Idris would have been able to claim the relief irrespective of whether he lived with the tenants at the same time.
Thus, in Idris’ example, the gain attributable to the letting is only chargeable to capital gains tax if, and to the extent, that it is greater than the lower of:
- 60,000 (the amount of the private residence relief); and
As the gain attributable to the letting is less than £40,000, lettings relief is available to shelter the full amount of the gain. As such no capital gains tax arises.
Although in this example the entire gain is free from tax, the circumstances in which the relief can be claimed is much narrower than before and will definitely bring more people into the tax net.
In addition, the requirement for shared occupation will apply not only to future lettings but also any let periods before 6 April 2020.
This means that people who have let properties after they moved out will lose the relief that they would have been entitled to for those letting periods. In effect, the change is retroactive and, as such, will have a massive impact on unwary homeowners.
This change to how selling your home is taxed is harsh, both because of the retroactive impact and because of the sudden impact of the change. There are no transitional measures are in place and, considering letting relief has been around for 40 years, this has been criticised by tax advisory sector.
If you need tax advice in selling your home please call us on 0114 272 4984 or email email@example.com.
Most businesses have suffered due to the COVID-19 pandemic, but should you take the option to defer your tax payment on account to 31 January 2021? We weigh up the option below.
To help those suffering cashflow difficulties as a result of the Covid-19 pandemic, the Government have announced that self-assessment taxpayers can delay making their second payment on account for 2019/20. The payment would normally due by 31 July 2020.
Under self-assessment, a taxpayer is required to make payments on account of their tax and Class 4 National Insurance liability where their bill for the previous tax year is £1,000 or more, unless at least 80% of their tax liability for the year is deducted at source, such as under PAYE. Each payment on account is 50% of the previous year’s tax and Class 4 National Insurance liability. The payments are made on 31 January in the tax year and 31 July after the end of the tax year. If any further tax is due, this must be paid by 31 January after the end of the tax year. In the event that the payments on account are more than the final liability for the year, the excess is set against the tax due for the next tax year or refunded.
The normal payment dates for payments on account for the 2019/20 tax year are 31 January 2020 and 31 July 2020, with any balance due by 31 January 2021.
Delay not cancellation
The thing to note is that the option on offer is a deferral option not a cancellation. Where this is taken up, the payment on account must be paid by 31 January 2021. As long as payment is made by this date, no interest or penalties will be charged.
Should I pay if I can?
The deferral option is clearly advantageous to those who have taken a financial hit during the Covid-19 pandemic, particularly those operating in sectors where working is not possible during the lockdown, such as hairdressers and beauticians and those operating in the hospitality, leisure and retail sectors.
For those who have not taken a financial hit or who are otherwise able to pay, from a cashflow perspective it may be attractive to defer the payment. However, this may simply be a case of delaying the pain; not only will the delayed payment on account be due on 31 January 2021 together with any Class 2 National Insurance liability, but also the first payment on account for 2020/21. This may amount to a sizeable bill and as such it may be better to spread the payments rather than be faced a lump sum on 31 January 2021.
The decision as to whether to pay or defer is a personal one; but the option to choose is a welcome one. We recommend you aim to work out your 2019/20 tax liability early and have a discussion with your accountant as to the best course of action. At the same time, looking further forward and doing an estimated calculation of your potential tax liability for 2020/21 (COVID-19 tax year) will help identify any planning opportunities.
If you would like help deciding whether to defer or not please call us on 0114 272 4984 or email at firstname.lastname@example.org.