Presented by
Robert W Maas, FCA, FIIT, FTII
of Blackstone Franks

The Basis of Tax Planning

1. The company rarely has a purpose independent of its shareholders. Its purpose is to increase the wealth of the shareholders

- saving tax at company level does not achieve much (other than a cash flow benefit) unless the saving can flow through to the shareholders.

2. What Does the Client Really Want?

a) To save tax.

b) To increase after-tax income.

c) To increase wealth.

d) To leave a business for his heirs.

e) To build up a business to sell

- is it likely to be saleable?
- it is not necessary what he says he wants
- has he identified the problem or merely a possible solution?

3. Minutes and other documents

a) it is not sufficient for your plan to work; you must be able to prove that it works

b) which means you need to be able to evidence what happened

- minutes
- contracts
- letters

c) what will the Revenue see if they gain access to your letters?

- balance protecting yourself and helping your client

d) "back-dating" documents

- it is fraud to put a false date on a document
- but if a document merely records an agreement entered into earlier it can bear the earlier date
- a document entered into now can recite in its premises what you forgot to record previously.

4. The more complicated something is the more likely that it will be considered by someone with technical knowledge.

5. If your scheme is attacked have the courage of your convictions

- especially with Special Compliance Office.

6. Compromise can be nearly as good as winning.

7. Ramsey v CIR and Furniss v Dawson

- Craven v White
- CIR v McGuickian.

8. Tax planning needs to be looked at globally, ie Income tax/ IHT/CGT/Corporation Tax

- and should be approached in the context of personal financial planning.

Structuring the Family Business

1. Should you have a company?

a) do you need limited liability?

b) only retained profits are taxed at a low rate

- distributed profits are often better earned as a sole trader, a partnership or an LLP
- and the tax is paid earlier on both distributed and undistributed profits
- but dividends can be attractive in arithmetical terms

c) it is easier to pass shares to children than an interest in an unincorporated business - but an LLP is an incorporated business.

2. Who should hold the shares in a family company?

a) what is likely to happen?

- a sale?
- a flotation?
- company will become a family heirloom?
- all the profits will be extracted as salary?
- the company may pay dividends?
- it will pass to employees?

b) entrepreneur 40%
family trust 30%
children's trust 30%

c) get the shareholdings right to start with; there can be problems in transferring later

- IHT: will the 100% relief apply?
- CGT business asset taper relief

trading company: all shareholdings
investment company: only shares held by officers or employees without a material interest

3. Consider keeping assets outside the company

- qualifies for business asset taper relief
- but only attract 50% IHT business property relief
- are you likely to sell the asset during the lifetime of the business?
- Consider particularly goodwill, copyrights etc as the new regime means that the full gain will be taxable income with no indexation and no taper relief
- but gives cash flow benefit of depreciation.

4. Is it better to withdraw funds as salary or dividend?

a) who will receive the income?

b) who is taxable on it?

c) What is payment?

5. The section 660A challenge

a) s660G(1): settlement includes a disposition trust, covenant, agreement, arrangement or transfer of assets"

- but must be an element of bounty (CIR v Plummer).

b) s 660A: income arising under a settlement where settlor retains an interest.

- a settlor retains an interest if the property or any derived property will or may become payable to the settlor or his spouse(s 660A(2))
- but a settlement does not include an outright gift by one spouse to the other of property from which income arises unless either:

- the gift does not carry the right to the whole of that income, or
- the property given is wholly or substantially a right to income (s 660A(6)).

c). If an arrangement consists of husband giving shares to wife, giving his skills to the company at an undervalue, and the company paying a dividend to the wife, is the gift of shares "wholly or substantially a right to income"?

- it depends on the facts.

d) s 660B: payments to unmarried minor child of settlor

- no equivalent of s 660A(6)
- but that probably makes no difference.

e) Tax Bulletin Article April 2003:

Some of the factors that the Revenue is looking for might include:
· Main earner drawing a low salary leading to enhanced profits from which dividends can be paid to shareholders who are friends or family members.
· Disproportionately large returns on capital investments.
· Differing classes of shares enabling dividends to be paid only to shareholders paying lower rates of tax.
· Dividends being waived so that higher dividends can be paid to shareholders paying lower rates of tax.
· Income being transferred from the person making most of the profits of a business to a friend or family member who pays tax at a lower rate.
There are a wide range of arrangements that can potentially be caught by the settlements legislation which do not involve a trust. Each case will depend on the facts but some of the most common situations are:
· Shares subscribed at par that carry only restricted rights.
· Shares given away that carry only restricted rights.
· Shares subscribed at par in a company by someone else where the income of the company derives mainly from a single employee.
· A share in a partnership gifted or transferred below value.
· Dividend waivers.
· Situations where dividends are paid only on certain classes of shares.
· Dividends paid to the settlor's minor children.

f) Can you show that the result of the overall arrangement is not the transfer wholly or substantially of a right to income? If so fight!

g) Can the Revenue make a discovery in respect of the past? It is questionable. They had the company's accounts. They were therefore aware that a dividend had been paid and who the shareholders were. But the Inspector dealing with the individual's affairs would not have had access to the accounts.

h) Can anything be done for the future?

a) Accumulate and invest some of the profits so that the shares will acquire a value.
b) Don't pay dividends; liquidate the company every couple of years and start a new one. This is undoubtedly within s 703, ICTA 1988 but so what? Do you mind the disposal proceeds being recategorised as dividends?
c) Amalgamate the two holdings of shares in the joint names of both spouses? Section 282A, ICTA 1988 deems the income to be 50/50. But may not work as s 282A(5) says that s 282A does not apply to the extent that it is treated by virtue of any other provision of the Income Tax Acts as the income of the other of them.

6. Should you have a company car?

a) are you prepared to maintain detailed records?

b) do you have significant private use?

c) how different is the car's value to its original list price?

d) The round sum petrol benefit only applies if the use benefit does.

e) the car use benefit is now a percentage of cost based on the car's carbon dioxide emission rating for cars first registered after 30 September 1999 (31 December 1998 if it has an emission certificate)

- ranges from 15% - 35%
- for older cars the charge is still based on engine capacity

f) a car can be a pool car only if

- it is actually used by more than one employee
- it is not ordinarily used by one to the exclusion of the others
- any private use (including home to office) is merely incidental to the business use
- the car is not normally kept overnight in (or in the vicinity of) any residential premises where any of the employees was residing.

g) mileage allowance payments for 2003/04 onwards where employee uses his own car.

first 10,000 miles 40p per mile
excess 25p
Plus 5p per mile passenger payment (per passenger)

7. Beware "self-employed" workers

a) what does the person actually do?

- line management?
- consultancy?

b) you cannot rely on a letter from his tax inspector

c) do not overlook the "agency" rules

d) or the tax deduction scheme for sub-contractors in the building industry.

8. "One man" companies

- is the person's home his base?
- or does he not have a fixed base, ie it is where he is working at a particular time?
- Miners v Atkinson.

9. IR 35

a) Applies only to engagements where -

i) a worker provides services under a contract between a client and an intermediary, and
ii) but for the presence of the intermediary the income would have been employment income of the worker.

b) It is looked at on an engagement by engagement basis

- subject to Hall v Lorimer (1994 STC 23).

c) Prior to 10 April 2003 it did not apply if the client was not carrying on a business.

d) The normal employment v self-employment tests apply

- but remember you are looking at a hypothetical contract not the actual contract between the worker and the intermediary
- mutuality of obligations is an important test
- so is whether the person is in business on his own account
- if it goes to the Commissioners they will expect the client to be called to give evidence.

e) Why take on individuals on a self-employed basis?

- engaging them via a service company shifts the risk from the client to the worker.

f) The notional salary will be:

- gross income and benefits from relevant engagements (net of VAT where applicable) - including any payment or benefits received from a third party
Less:
- 5% of the relevant gross income
- expenses and capital allowances allowable under Sch E rules
- employer pension contributions to an approved scheme or personal pension contributions
- employer's NIC including on the deemed salary
- gross salary already paid.

g) Travel expenses from home to the client's premises are allowable provided contractor does not expect to spend more than 40% of his working time or more than 24 months at any one site.

h) Professional indemnity insurance

- allowable under ICTA 1988, s 201AA.

i) If the receipts suffer deduction of tax under the construction industry scheme the notional salary is based on the gross income.

j) Any necessary apportionments are made on a just and reasonable
basis.

k) The normal PAYE penalties will apply.

l) If the intermediary is a company and in the same or a later year makes a distribution, the worker can claim relief against double taxation by reducing the distribution.

m) If there are several relevant intermediaries they are jointly and severally liable for the tax.

m) You cannot avoid the rules by using an overseas company

- the intermediary is treated as having a place of business in the UK
- regulation 42
- section 203C.

n) The intermediary can claim a deduction for the notional salary and National Insurance

- but only in the period of account in which the notional salary is paid
- if the intermediary is a partnership the deduction cannot reduce the partnership profits to less than nil
- and no deduction can be claimed for expenses in relation to relevant engagements which are not allowable in calculating the partnership profit.

10 Employee shareholdings

a) the options are

- give/sell the shares to the employee
- CSOP options
- SAYE options (all employee)
- EMI options
- "funny shares"

b) what is the value of a tiny minority shareholding?

c) do you need to start the taper period running?

d) - there is no tax on the grant of an option

- the charge arises on exercise
- or on removal of restrictions etc.

Taper Relief

1. A two-year holding period for trading companies makes taper relief very attractive.

2. Forget share option schemes for employees. Gift or sell them the shares ASAP and accept tax on the current value to start the taper period running?

3. Beware cessation of trade

plan ahead
get ESC C16 clearance before trade ceases
distribute the assets immediately trade ceases, subject to the shareholders taking over the liabilities.

4. If a company is poised to take off and the shares did not qualify as business property between 6 April 1998 and 5 April 2000 consider a disposal and reacquisition, e.g. to a settlement for the client's own benefit, to crystallise the non-business asset liability while it is low.

5. Trading company = a company carrying on trading activities whose activities do not include to a substantial extent activities other than trading activities (para 22A, Sch A1, TCGA 1992).

6. A holding company is a holding company of a trading group (51% subsidiaries) if one or more members of the group carry on trading activities and the activities of all the group members do not include to a substantial extent activities other than trading activities (para 22B, Sch A1, TCGA 1992).

7. The Revenue interpret "substantial" as not exceeding 20%. They apply this test to "some or all" of income, the asset base of the company, expenses incurred in undertaking the different activities and time incurred in undertaking them (Tax Bulletin 62, December 2002).

8. Some points to consider -

a) it may be inadvisable to put new non-trading activities into an existing trading company

b) if one of several associated companies does not qualify as a trading company because of the 20% test it might be worth considering grouping the companies to spread the non-qualifying activities over a larger turnover/area

c) remember para 10 (period of limited exposure to fluctuations in value not to count) - but this could be a good thing as it is arguable that it will cover a period subsequent to the cessation of trading.

9. Should you hold assets through trading companies?

- generally not from a tax point of view!

New Ventures

- should you use the same company
- or a parallel company
- or create a group?

Substantial Shareholdings

a) No CGT on a disposal after 1 April 2002 by a trading company (or a member of a trading group) of a holding of 10% or more in another trading company (para 2, Sch 7AC, TCGA 1992). The Revenue refer to the relief as SSE (Substantial Shareholding Exemption).

b) The disponor must have held qualifying shares for at least 12 months in the 24 months prior to disposal (para 7).

c) Both the investor and investee company must have been a trading company or member of a trading group from the start of that 12-month period to the time of the disposal (paras 18 & 19).

d) The exemption does not apply if, in pursuance of arrangements from which the sole or main expected benefit is to obtain the exemption, an untaxed gain accrues to a company and before it accrued either -

a) the vendor acquired control of the investee company, or the same person acquired control of both companies, or
b) there was a significant change of trading activities affecting the investee company at a time when it was controlled by the vendor (or a person who controlled both companies).

A gain is untaxed for this purpose if all of it (or all but a part that is not substantial) represents profits that have not been brought into account (in the UK or elsewhere) for the purposes of tax on profits for a period ending on or before the date of disposal (para 5). The Revenue have said that they expect cases in which this anti-avoidance provision applies to be "unusual and infrequent" (SP 5/02).

c) The Revenue say that, although not identical, the definitions of trading company and trading group "are essentially common" to SSE and taper relief. The main difference is that in the SSE legislation the definition of a holding company includes a subholding company (Tax Bulletin 62, Dec 2002).

d) If immediately before the disposal the investee company holds an asset that was gifted to it in the two year qualifying period and hold-over relief claimed, the hold-over gain crystallises as a chargeable gain on the disposal (para 37).

Basic Inheritance Tax Planning

1. Basic Principles of IHT Planning

a) Gift early

b) There is no longer much point in equalising estates

c) Both husband and wife should endeavour to leave £25,000 to their children; the rest can be left to one another

d) What most people really want is:

i) to be sure his spouse is comfortable after his death
ii) to enjoy the rest of his life without being dependent on his children
iii) to be able to leave something for his children
iv) not to pay too much IHT.

2. Making Inter Vivos Gifts

a) PETs or chargeable transfers?

b) Does the order matter?

c) Consider the CGT effect - it may be worse than the IHT (especially if IHT business relief applies)

- shares in private companies
- gifts to discretionary trusts

d) Insurance cover is needed for the remaining estate more than for the gift.

e) Gift "family heirlooms" and non-income producing assets.

f) If income producing assets are to be gifted you may need to replace the income.

g) Gifts with reservation of benefit - shares
- houses

h) Gift needs to be effective, e.g loan waiver by deed.

3. The Family Company

a) Can you qualify for the 100% business property relief?

Applies on a gift (or other chargeable or potentially exempt, transfer) of,

a) a business, or an interest in a business,

b) unquoted shares,

c) unquoted securities in a company which (alone or together with other shares held by the transferor) give the transferor voting control of the company.

There are a number of caveats:

i) the business (or the company's business as the case may be) must not consist wholly or mainly of dealing in securities, stocks or shares or land or buildings (s 105(3)(4)),

ii) the business must not consist wholly or mainly or making or holding investments unless, in the case of a company, the company is a holding company of one or more trading companies, ie companies not within (ii) or

(iii) (s 105(3)(4)),

iii) at the time of the transfer the company must not normally be in liquidation (s 105(5)),

iv) the business or shares must be owned for at least two years prior to the transfer (s 106),

v) if the shares are in a company which is a member of a group the relief does not apply to the extent that this value reflects the value of group companies not carrying on a qualifying trade (other than a property investment company holding the group's trading premises) (s 111),

vi) the relief is not given if a contract for sale of the business or shares has been entered into at the time of the transfer (s 113),

vii) the relief is restricted to the extent that the company holds assets which are not used wholly and exclusively for the purpose of the business (s 112).

b) For how long do you think it will last?

c) It is important to gift the assets before the relief disappears.

d) But if it lasts until death you avoid both IHT and CGT.

4. Relationship of IHT planning to personal financial planning

a) pension planning

- to provide income at retirement
- to provide capital at retirement
- to provide a fund on death outside the estate
- life assurance cover

b) Income requirements

- can income be split from capital?
- can capital be consumed and replaced by a fund growing outside the estate?

c) Control over assets

- gifts do not necessarily need to involve a loss of effective control

d) Spendthrift children

- is it sensible to give assets to teenage children?
- or to lock capital away from adult children for too long?

5. Wills and deeds of arrangement

- discretionary will
- revocable life interest will
- problems with deeds of arrangement
- take care with nil rate band discretionary trusts; the children could end up with all of the assets.

6. Using trusts

a) What sort of trust should you use; the tax treatment is different?

- interest in possession trust
- discretionary trust
- accumulation and maintenance trust
- overseas trust

b) Trusts can give enormous flexibility

c) Uses of Accumulation and Maintenance trusts

d) Uses of discretionary trusts

e) Uses of interest in possession trusts.

7. Miscellaneous

a) A widow may need free funds pending probate

- joint bank account
- insurance policy proceeds

b) Personal portfolio bonds

c) Non-UK domiciled individuals

- only taxable on UK assets
- will the person be affected by the new domicile proposals?
- if so consider a trust now
- do not forget IHT deemed domicile

Pension Provision

Top Up Pensions

1. The attributes of approved pension schemes are

a) no tax on qualifying contributions

b) tax free build-up of the fund

c) no tax on lump sum on retirement (which with a company scheme could exhaust the entire fund)

d) tax on the pension

e) you need earnings (other than for a £3,600pa stakeholder pension).

2. The attributes of an ISA are

a) qualifying contributions are made out of taxed income (or capital)

b) tax free build-up of the fund

c) no tax on lump sum on retirement

d) no tax on any "pension" drawn from the fund.

3. The attributes of a FURBS are

a) qualifying contributions by the company are taxed on the employees as a benefit in kind

b) both income and capital gains within the fund are taxed - but usually at 25% only

c) no tax on lump sum on retirement (which could, and should, exhaust the entire fund)

d) tax on any pension drawn from the fund.

4. The attributes of an unfunded pension scheme are

a) there are no contributions

b) there is nothing to build up

c) tax on lump sum on retirement

d) tax on the pension.

Appendix

Extracting Profits from a company 2003/2004

Conclusions

1. If profits bear corporation tax at 19% it is cheaper to extract funds by way of dividend than as remuneration.

2. Even if profits bear corporation tax at 30% it is still cheaper to extract funds as remuneration.

3. If profits are under £10,000 the effective tax rate is 25% if the taxpayer is a higher rate taxpayer and nil if he is a basic rate one (as the tax credit franks the personal tax and there is no corporation tax).

4. If the taxpayer has no other earnings he will have to pay NI on the first £30,420 of earnings, which at 10% is £3,042. That will make a dividend even more attractive.

5. For a basic rate taxpayer a dividend is always more attractive as it is effectively taxed at the corporation tax rate only. If the taxpayer has no other source of income he will come into higher rates on the dividend once the dividend and tax credit exceeds £34,515 (£29,900 reduced rate plus £4,615 personal allowance). This is equivalent to a dividend of £31,377 (plus a tax credit of £3,138).

back to top

© Blackstone Franks
Barbican House
26-34 Old Street
London EC1V 9QR
October 2003