Getting more from the flat rate VAT scheme

The Taxman extols the virtues of the time and admin savings you can make by using his flat rate scheme (FRS), but he’s keen to play down some of the VAT savings it offers. What are these and when can you take advantage of them?

FRS secrets

We’re sure you’ve heard of the VAT flat rate scheme (FRS), but just to recap on the basics, it allows you to charge your customers VAT at the full rate, but pay a lesser amount to the Taxman. In exchange you have to give up your right to reclaim VAT on some of your purchases. The Taxman’s theory is that this is broadly cost neutral for businesses, but in practice there are several more obscure FRS rules you can use that might save you hundreds, or possibly thousands, of pounds.

Joining the schemesize matters

The FRS is aimed only at small businesses, but because larger ones often start their life as small fry, new companies shouldn’t dismiss using the FRS for a limited period. Where you have a reasonable expectation that your business turnover, excluding VAT, won’t exceed £150,000 for the next year, you can join the FRS. But the rules for leaving the scheme mean that you can stay in it longer than you might think.

Sapphire Tip. You don’t have to leave the FRS as long as your turnover for the previous year doesn’t exceed £230,000 including VAT.

Join early to avoid disappointment

There’s an incentive for joining the FRS as soon as you register for VAT because the rules allow you to keep a larger amount of the VAT you collect from your customers: 1% of your VAT-inclusive turnover to be precise. So, for example, if your first year’s VAT standard-rated turnover in the scheme is £70,000, you’ll save £840 ((£70,000 + 20%) x 1%).

Grouping purchases of capital goods

If you’re familiar with the FRS, you probably know there’s an exception to the basic rule which says you can’t reclaim VAT on purchases. Where you spend £2,000 or more on a capital asset, you can recover the VAT you’ve paid from the Taxman. For example, if you bought a coffee machine for £1,000 you wouldn’t be allowed to reclaim the VAT, but if it cost £2,000 you would. Sapphire Tip. You can group purchases made from the same supplier at the same time. So if you bought tables and chairs costing £1,200 (VAT inclusive) together with the coffee machine, you could reclaim VAT on the lot.

Sapphire Summary

If you use the FRS, you don’t have to leave the scheme unless your annual turnover exceeds £230,000. For most businesses, this will generate a saving (or a “gain”) of 3.5% of turnover. Where you join the FRS at the same time as you register, you’ll cut your VAT bill by 1% for a year.

HMRC loses a key employment status case

A tax tribunal recently considered whether a driver was an employee of the client he worked for. How was it viewed by the tribunal?

The case. EMS (Independent Accident Management Services) Ltd (EMS) was a firm involved in the recovery of damaged motor vehicles on behalf of insurance companies. Mr Makings (M) ran a sole trade business (DKM Services) and was contracted by EMS as a driver. HMRC said that M was an employee of EMS, which ought to deduct PAYE and NI from any payments to him. EMS claimed that M was an independent contractor so he was responsible for any tax and NI due on his income.

Tribunal decision. The tribunal decided that M was self-employed as EMS had no right to control how M carried out his job after having agreed what needed to be done – EMS left M to undertake the job as he saw fit. Financial risk was also considered to be a relevant factor – M had purchased his own van and trailer, had to arrange his own insurance and did not receive holiday pay, sick pay or other benefits such as a pension from EMS. M also had the very real risk that his invoices may not be paid as he invoiced in arrears.

Summary: This case demonstrates that HMRC is trying to argue that a worker is an employee when the facts clearly indicate the opposite. Given the introduction of the Onshore Intermediaries legislation, employment status has become a very important principle and it seems HMRC is trying to shift the definition of a self-employed worker.

Sapphire Tip. If faced with a similar challenge from HMRC, it might be worth reminding it of the outcome in this case. The tribunal ruled that the driver was self-employed as his client had no right to control how he carried out his job and he bore significant financial risk. You can use the facts of this case to back up any challenge to employment status.

VAT Fraud is on the increase – how can you prevent yorself (and HMRC) from being a victim?

The Scam

Not all businesses or suppliers are required to be VAT registered. Any trader whose turnover exceeds £77,000 must register for VAT. Those with lower turnovers do not have to. But it’s been reported that a number of businesses and suppliers, such as tradesman, are charging VAT on their invoices even though they are not VAT registered. In these circumstances most customers will take it at face value that their builder, for example, is genuinely VAT registered and pay the bill in full. The customer ends up paying an additional 20% on their bill which the supplier simply pockets. It’s what the builder would call (adopt a cockney accent) “a nice little earner”.

How to avoid being a victim

Now most businesses operate within the law and it is a minority that are committing this type of fraud. But there is a quick and simple way to avoid becoming a victim of this type of fraud. If a business claims to be charging VAT for the goods or services they provide then:

  • Ask for a VAT receipt or invoice – they have to legally provide you with this if they are charging you VAT. If they can’t then they are breaking the law.
  • Make a note of the VAT number – The invoice should contain details of it.
  • Check that the VAT number is genuine by checking it online – It will take just a few second and will show if the VAT number is genuine and registered to the supplier in question.

http://ec.europa.eu/taxation_customs/vies/vatResponse.html

 

What should you do if you suspect VAT fraud?

If you suspect that a firm is avoiding paying VAT, or charging VAT when they aren’t VAT registered, you should report them to the Customs Hotline, telephone 0800 595 000. Don’t worry; you won’t have to provide any personal details so you can remain anonymous.

Using a dividend waiver

If you’re already a higher rate taxpayer the problem with taking an extra dividend is that you pay higher rate tax on it (25% of the dividend you take!), yet fellow shareholders may have no tax to pay. How can you use this to your advantage?

Scenario

When a company pays a dividend, all the shareholders receive a dividend in proportion to their shareholding. It’s a case of all or nothing. Plus, under present rules, anyone liable to the higher rate of tax suffers an additional income tax on dividends, the so-called “Schedule F upper rate”.

 

Example: John and his wife Mel each own one share in Fantasy Ltd (the company only ever issued two shares). Currently, Fantasy Ltd can afford to pay a dividend of £20,000. John already takes a salary from another company which is sufficient to put him in higher rates of income tax but Mel is between jobs. (Although she does have profits from rental income of about £5,200pa.) John will pay an extra £2,500 in income tax on his share of the dividend while Mel will pay none.

 

The Solution: If the dividend of £20,000 is voted and paid but John waives his right to his share, it all (£20,000) goes by default to the other shareholder, Mel. She still has no extra tax to pay on this £20,000 dividend as her total income is within the lower rate tax band of £34,600. Overall, Fantasy Ltd is in the same position and the family is £2,500 better off – the tax that John would have paid without the waiver. Tax saved £2,500. Is it really that simple?

The Admin Required (Sapphire’s Specialism!)

Tip 1. Put the waiver in place before the right to the dividend arises or it won’t work. A final dividend becomes payable once it is approved in an Annual General Meeting, however the deed has to be in place well before then. Any interim dividends must be waived before they are paid.

Tip 2. Use a formal deed to effect the waiver. It’s not a complicated document (Sapphire can help you with this) and it should be formally witnessed.

Tip 3. Have genuine commercial reasons for waiving dividends. This is to avoid the Taxman treating it as some sort of ‘bounty’ or gift out of income and so taxable on the shareholder waiving the dividend.

For example, a board minute saying that “A car is required in order for one shareholder director (Mel) to provide new/better service for existing clients. In fact her current lack of mobility is seen as holding back the company’s growth. However, following a brief discussion it was decided that this car should be bought outside the company so as to save on the employers’ NI associated with a company car of the director’s particular preference. At this point in the meeting (John) the other shareholder director volunteered to waive his dividend in order to allow sufficient funds to be extracted (by Mel) to purchase said vehicle privately. This was on the sole condition that growth in new business could be seen to be achieved”.

Tip 4. Don’t be greedy. Don’t waive every year as it’s too obvious to the Taxman what you are doing. Use this tax avoidance tactic selectively.

 

Sapphire Summary

Waiving your right to a dividend can save you higher rate tax. But the waiver must be a legal document and in place before the dividend is paid. Use this tactic sparingly to avoid unwanted attention from the Taxman.

HMRC to start issuing Advance Payment Notices (APNs) in respect of tax investigations

If you’re in dispute with HMRC it can now demand an up-front payment of the extra tax it thinks is due.

In what situations can it use these new powers?

What are APNs? Advance payment notices (APNs) are a new weapon in HMRC’s armoury to tackle unfair tax avoidance. APNs allow it to demand payment where it believes a scheme has been used to avoid tax. An APN can apply to most types of tax, including corporation, income and capital gains tax.

Avoidance schemes. The types of scheme HMRC will target range from marketed investment products, such as film partnerships, to any arrangement where it believes the main purpose of which is to reduce a tax bill. This is likely to be the main tool in attacking off shore arrangements going forward.

Conditions. Certain conditions must exist before HMRC is allowed to issue an APN:

1) it must have started an enquiry into the tax return of the person or company using a scheme

2) there must be a tax advantage arising from the scheme; and

3) HMRC has notified you that it believes the arrangement you’ve used involves tax avoidance.

What next? Even if HMRC is yet to prove that an arrangement involves unfair tax avoidance it can issue an APN and demand extra tax which must be paid within 90 days.

Can you appeal? You can make a written objection to an APN within the 90-day period, but only if you believe HMRC hasn’t met one of the three conditions (see above) or that the tax demanded is inaccurate.

Retrospective effect. HMRC can issue an APN for avoidance arrangements used in the past and, of course, those you use from now on. HMRC’s intention is clear; it doesn’t want anyone using avoidance arrangements even where they are within the terms of the legislation.

Sapphire Tips The tips that can be drawn from this are:

Tip 1: To demand extra tax HMRC must have started an enquiry into your tax return and indicated that it believes you’ve used a scheme to reduce your tax bill. If the conditions aren’t met, ask for the demand to be withdrawn

Tip 2: If you think a scheme or arrangement is genuinely effective don’t be put off using it, but be prepared to stump up extra tax initially knowing that it could take months or even years to get it back.

Tip 3: Where payment of the disputed tax will cause hardship, you can ask HMRC if it will accept money by instalments.

Allowable Expenses – Travel & Subsistence

Temporary workers who intend to complete two or more assignments during their employment are able to claim the cost of their travel to and from work and a scale rate subsistence as tax deductible expenses, but what are the limitations of this?

24 Month Rule

There is often confusion over HMRC’s rules regarding a ‘temporary’ workplace. The statutory definition of a temporary workplace indicates that ‘limited duration’ is 24 months, any contract that is extended over this amount of time on the same work site is then considered ordinary commuting and thus the expenses become subject to full PAYE and NICs.

Various Worksites

Some temporary workers may find themselves moving between a succession of sites each week so how does the ’24 month rule’ affect them? If the different sites are visited following a regular pattern, for example they were at the same site each Monday, the same site each Tuesday and so on, HMRC states that when the contract extends beyond 24 months the same rules apply and it will be considered ordinary commuting.

Work defined by a Geographical Area

Some temporary workers do not have a single site as a regular workplace but they have a job where their duties are defined by reference to a particular geographical area. For these workers, the 24 month rule will apply if they continue to work within the same geographical area.

Summary

If you continue to travel to the same worksite/s or geographical area for more than 24 months then you will no longer be entitled to claim travel and subsistence as tax deductible expenses. However if your regular site changes during your temporary employment, then the 24 month rule is reset!

A look into the future….

The Office of Tax Simplification (OTS) issued their second report in January 2014, which details a comprehensive review of employee expenses and benefits. Chapter 6 of the report sets out some specific concerns and suggested changes surrounding travel and subsistence expenses. A consultation was published on 18th June by HMRC to explore the findings of the reports further and this is due to end on 9th September.

Sapphire’s comment

We continue to review legislative developments in our industry to ensure we are always thinking and planning ahead. The OTS report and recent HMRC consultations as a result are an example of where further changes are inevitable. There may well be an update in the autumn statement in December 2014 – we will obviously keep you updated with any changes that may affect temporary workers and their entitlements.

Allowable Expenses – Travel & Subsistence

Temporary workers who intend to complete two or more assignments during their employment are able to claim the cost of their travel to and from work and a scale rate subsistence as tax deductible expenses, but what are the limitations of this?

24 Month Rule

There is often confusion over HMRC’s rules regarding a ‘temporary’ workplace. The statutory definition of a temporary workplace indicates that ‘limited duration’ is 24 months, any contract that is extended over this amount of time on the same work site is then considered ordinary commuting and thus the expenses become subject to full PAYE and NICs.

Various Worksites

Some temporary workers may find themselves moving between a succession of sites each week so how does the ’24 month rule’ affect them? If the different sites are visited following a regular pattern, for example they were at the same site each Monday, the same site each Tuesday and so on, HMRC states that when the contract extends beyond 24 months the same rules apply and it will be considered ordinary commuting.

Work defined by a Geographical Area

Some temporary workers do not have a single site as a regular workplace but they have a job where their duties are defined by reference to a particular geographical area. For these workers, the 24 month rule will apply if they continue to work within the same geographical area.

Summary

If you continue to travel to the same worksite/s or geographical area for more than 24 months then you will no longer be entitled to claim travel and subsistence as tax deductible expenses. However if your regular site changes during your temporary employment, then the 24 month rule is reset!

A look into the future….

The Office of Tax Simplification (OTS) issued their second report in January 2014, which details a comprehensive review of employee expenses and benefits. Chapter 6 of the report sets out some specific concerns and suggested changes surrounding travel and subsistence expenses. A consultation was published on 18th June by HMRC to explore the findings of the reports further and this is due to end on 9th September.

Sapphire’s comment

We continue to review legislative developments in our industry to ensure we are always thinking and planning ahead. The OTS report and recent HMRC consultations as a result are an example of where further changes are inevitable. There may well be an update in the autumn statement in December 2014 – we will obviously keep you updated with any changes that may affect temporary workers and their entitlements.

National Insurance is showing its age

The government plans to remove Employers National Insurance Contributions for under 21’s

What are the current rates?

National Insurance “Free Pay” Allowances

 

Rate above allowance

2014/15

2015/16*

Primary Employee’s NI Free Pay

12%

£7,956

*£8,060

Upper Primary Employee’s NI Earnings Limited

2%

£41,860

£42,276

Secondary Employer’s NI Free Pay

13.8%

£7,956

*£8,060

Upper Secondary Threshold

13.8%

 

£42,276

 *Estimated values

What is changing? From 6th April 2015, employers will not be required to pay National Insurance Contributions (NICs) on earnings up to a new ‘Upper Secondary Threshold’ (UST), for employees who are under the age of 21. NICs will however continue to be payable on all earnings above the UST. The introduction of this policy will reduce the rate of employer secondary contributions to 0% for this younger group of employees but it will not alter the basic structure of National Insurance or how Employee’s NICs are assessed.

Why make the change? The government announced their intention to abolish Employer NICs for under 21’s in their 2013 Autumn Statement. The change is part of a wider package of measures announced by the government to help boost the employment opportunities for young people who leave school or college. For example, it will be over £500 cheaper to employ an under 21 year old earning £12,000 a year and over £1,000 cheaper to employ an under 21 year old earning £16,000 a year.

How will it work in practice? The change will be delivered by introducing a new earnings threshold called the Upper Second Threshold (UST). The government has said that for tax year 2015/16 the value of the UST and the Upper Earnings Limit (UEL) will be the same. The UEL for 2015/16 is expected to be £813 per week. The UST will not be reportable to HMRC on RTI returns.

Sapphire Summary: This is a welcome easement of overhead costs for all businesses from 2015/16, in addition to the £2,000 Employment Allowance introduced from this tax year. It is however another calculation added into an already complex tax system. It will be very interesting to see how the simplification and merger of PAYE and NICs, which has been earmarked for a few years now, will consider all of these arrangements. Watch this space…..!!

Rules on company loans to directors

New rules apply to most directors who borrow money from their company. Until now if they repaid this within nine months of the end of its accounting period, no tax charge would arise. What’s changed?

Bed and breakfast not allowed… In the 2013 Budget new rules were announced to penalise those who, in HMRC’s view, abuse the rules on company loans. This is directors who borrow money from their company, repay it to avoid the corresponding tax charge and then re-borrow the money a short while later. HMRC calls this “bed and breakfasting” and new rules aim to penalise this.

What’s changed? A close company (broadly one that’s controlled by five or fewer individuals) is liable to a tax charge where a director/shareholder borrows money from it. The charge for a company’s accounting period is 25% of what the director owes at the end of the financial year (if the amount exceeds £10,000), but this is repayable if the money is paid back within the next nine months. But by using bed and breakfasting a director can reduce or wipe out the tax bill.

 

Example. Bob is a director/shareholder of AnyCo Ltd. He often uses the company’s credit card to pay for personal items. At the end of its 2012/13 accounting year (January 31 2013) Bob owes AnyCo £16,000, but soon after repays £14,000 using cash raised from a personal overdraft. A few days later he re-borrows £13,000 from AnyCo. Despite this it will only face a tax bill of £500 (£2,000 x 25%), because £14,000 of the £16,000 owing at January 31 was repaid within nine months.

New anti-avoidance rules

There are two new rules which can catch Bob and AnyCo out in future years:

  • the 30-day rule
  • the intentions and arrangements rule.

1)     The 30-day rule  Where a director repays more than £10,000 of the money they’ve borrowed from the company and within 30 days of this re-borrows more than £10,000, the reduction that’s normally allowed in the 25% tax charge will be restricted by the lesser of the amount repaid and the amount re-borrowed (see The next step).

2)     The Intentions and arrangements rule Where the amount owed by a director is £15,000 or more, a full or part repayment of this is made and at the time the director had arranged to re-borrow the money from the company or had the intention to do so, the reduction in the 25% tax charge is restricted in a similar way as it is for the 30-day rule. Taking our example this would mean AnyCo would be taxed on £15,000 instead of just £2,000

Sapphire Summary:

Tip 1. Reduce what you owe your company to £10,000 or less no later than nine months after the end of the accounting period. But do this by taking extra salary, a bonus, etc. or dividend which is credited against the debt rather than being paid out to you. In these circumstances if you re-borrow the money HMRC accepts that this won’t trigger the new anti-avoidance rules.

Tip 2. If the amount you owe your company at the end of an accounting period is greater than £10,000, repay this within nine months to reduce the 25% tax charge, but leave it more than 30 days before you borrow more from your company.

If you repay a loan of £10,000 or more to your company and re-borrow within 30 days, the tax charge, equal to 25% of the borrowing, will apply. But where you reduce the debt by crediting a dividend or a bonus against it within nine months of your company’s accounting period, the re-borrowing won’t result in a tax charge.

Horse Racing – advertising or entertainment?

You advertise to promote your business and expect to recover any Input VAT you suffer in the process. But there are a number of VAT cases that say otherwise. How are you going to make a racing certainty of your position?

Straightforward advertising of products or services should be allowable (i.e. you get to claim back any VAT charged to you). But what about promoting your business’ name through an involvement in horse racing?  It doesn’t have to be grand or expensive – perhaps a keen yearling or promising point- to-pointer.

But a VAT Inspector may seek to reverse any Input VAT you have claimed back on the basis that it is amusement or entertainment. So how do you convince the VAT-man?

It’s all in the mind

The key here is to demonstrate that the horse racing expenditure can be seen as a true attempt to benefit the business rather than indulge the personal interests of the proprietor.   Let’s start by looking at a landmark case in the taxpayer’s favour.

Flockton Developments Limited (1987), a company which manufactured plastic storage tanks, reclaimed Input VAT on the training and upkeep of a racehorse. The VAT-man issued an assessment to recover the tax and the company appealed, contending that it had purchased the horse for promotional purposes.  Indeed the main director gave evidence that this was the sole motivation, which he had in his mind when he decided to buy the horse.  The Court allowed the company’s appeal. Customs did not take the case any further and the decision has been quoted in a number of subsequent cases.

http://www.hmrc.gov.uk/manuals/vitmanual/VIT10400.htm

Sapphire Tips

The tips that can be drawn from this and the cases that followed are:

Tip 1. Have the horse or syndicate named after your company or its product. Even better if you can connect the name with your type of business in the programme.

Tip 2. Enter races near to your trading premises or within the catchment area of most of your customers.  Make a note of any business that comes about as a direct result of competing.  It helps if there is a reasonable chance of being successful in this objective of attracting customers.

Tip 3. Entire ownership of the horse is more appropriate than a share in one.