Taxation of Owner-Managed Businesses

Transcription

1 The Chartered Tax Adviser Examination May 2014 Taxation of Owner-Managed Businesses Advisory Paper Suggested solutions

2 Answer 1 (1) Draft Corporation Tax computation for Widgets Ltd for the year ended 31 December 2013 Note Net profit on ordinary activities before taxation 100,000 Add: Legal and professional charges 1 2,000 Entertaining 2 2,500 Increase in general bad debt provision 3 2,000 Donations 4 2,000 Leased cars 5 1,500 Depreciation 6 20,000 30,000 Less: UK bank deposit interest 7 4,000 Dividend received from UK company 8 2,500 (6,500) Trading income 123,500 Loan relationship non-trading credit 7 4,000 Total profits 127,500 Less: Charitable donations relief 4 (1,000) Taxable total profits 126,500 Corporation Tax = 25,300 Notes: 1. Legal and professional charges Legal and professional charges will be deductible for Corporation Tax purposes provided that they are not incurred in relation to capital matters (CTA 2009, s 53) and that they are incurred wholly and exclusively for the purposes of the trade (CTA 2009, s 54). Fees incurred in relation to chasing bad debts ( 950) and drafting employment contracts ( 1,500) relate to trading matters and should both be allowable. Charges incurred in relation to leased premises for example, on acquiring, disposing or renewing a lease - are generally not allowable on the basis that they relate to a capital asset (CTA 2009, s 53). However, HM Revenue & Customs will allow legal fees incurred in relation to the renewal of a lease for less than 50 years (except in relation to any part of the legal and professional fees which relate to the payment of a lease renewal premium). Hence the business premises lease renewal charge ( 2,500) should be allowable as it relates to a 20-year renewal term. The alteration of the shareholding structure of a business will generally be a capital matter, and so the cost of providing taxation advice on a proposed company share capital restructure ( 1,250) should be disallowed (CTA 2009, s 53). Parking fines ( 750) will be a disallowable expense on the basis that they are not incurred wholly and exclusively for the purposes of the trade (CTA 2009, s 54) as the fines relate to cars leased by the company (rather than cars owned by the employees). Hence, the 2,000 disallowable legal and professional charges relate to the taxation advice on a proposed company share capital restructure ( 1,250) and parking fines ( 750). 2. Entertaining The cost of providing entertaining or gifts to business customers is specifically disallowed for tax purposes (CTA 2009, s 1298). Hence, the cost of providing customer entertaining ( 2,000) will be disallowed as it comprises the provision of food, drink, etc. Costs incurred in relation to the Christmas staff party ( 1,500) will be allowable on the basis that they are incurred wholly and exclusively for the purposes of the trade as staff entertaining, and will not be caught by CTA 2009, s 1298 as there are only staff and no business customers involved. 2

3 Promotional events for customers which publicise the company s products will not, prima facie, be disallowed as business entertaining, but the food and drink costs incurred as part of any event will be disallowed under CTA 2009, s Hence, whilst the promotional event venue hire costs ( 500) should be allowable, the food and drink costs ( 500) will be disallowed. The cost of business gifts of diaries and mouse mats ( 1,250) will be allowed as the gifts cost less than 50 per person, incorporate the business logo, and do not comprise food, drink, tobacco or gift vouchers (CTA 2009, s 1300(3)). Free product samples ( 500) will be allowable as they are given to the public and so do not comprise business entertaining (CTA 2009, s 1300(2)). Hence, the 2,500 entertaining disallowance comprises customer entertaining ( 2,000) and promotional event food and drink costs ( 500). 3. Bad debts Tax relief is given by way of a deduction from trading profits for impairment or release of trade debts under the loan relationship provisions (CTA 2009, ss 55, 303, 479). This means that Widgets Ltd s specific bad debts are allowable, but its general bad debt provision (or any yearly increase in its general bad debt provision) is not allowable where it is made without consideration of the recoverability of the debts or the circumstances of the particular debtors. Hence, tax relief will be given in accordance with the profit and loss charge arising from the bad debt account, except in relation to the increase in the general bad debt provision carried forward as at 31 December 2013 ( 2,000) which is disallowed. Alternatively, as the accounts have been prepared in accordance with UK GAAP, it could have reasonably been assumed that the general bad debt provision was made on the basis of knowledge as to the debts of this specific organisation (otherwise it wouldn t have been allowed under UK GAAP). On this basis, they could have been taken as impairment losses under UK GAAP, which had been correctly accounted, without any disallowance being required. 4. Donations Donations are not normally allowable trading deductions as they are unlikely to meet the wholly and exclusively requirement under CTA 2009, s 54. However, a company can deduct a charitable donation from its total profits provided that it is a qualifying donation including a gift of money made to a charity (paid gross) and for which any benefit received by the donor or connected persons falls within prescribed limits (CTA 2010, s 189). Hence, neither the donation to Oxfam ( 1,000) nor the donation to a promising young sportsman ( 1,000) appear to have been incurred wholly and exclusively for the purposes of the trade and so should be disallowed in calculating the trading income of the company. (In the case of the young sportsman, there might have been an argument for an allowable sponsorship expense incurred for trade purposes if it was incurred on a commercial basis as part of the marketing activity of the company, however this appears to be unlikely as the individual is a relative of Sid who it is assumed will not be undertaking any marketing or promotional activity for the company.) The donation to Oxfam ( 1,000) should meet the criteria for a qualifying donation, as Oxfam is a registered charity, and so will deductible from total profits for Corporation Tax purposes. 5. Leased cars The lease rental restriction for Car 1, being subject to a lease entered into after 1 April 2009 but before 1 April 2013, is 15% of the rentals because the car s carbon dioxide emissions are greater that 160 g/km (CTA 2009, ss 56, 57 and CAA 2001, s 104AA) ie 6,000 15% = 900. The lease rental restriction for Car 2, being subject to a lease entered into after April 2013, is 15% of the rentals because the car s carbon dioxide emissions are greater that 130 g/km (CTA 2009, ss 56, 57 and CAA 2001, s 104AA) ie 4,000 15% = 600. Hence, the total leased cars restriction is = 1, Depreciation The depreciation charge ( 20,000) is not an allowable expense for tax purposes because it is incurred in relation to capital assets (CTA 2009, s 53). 3

4 7. Interest receivable UK bank deposit interest received ( 4,000) is non-trading income for Widgets Ltd and so must be excluded from the company s trading profits calculation. It is then brought back into the main Corporation Tax computation as a loan relationship non-trading credit (CTA 2009, ss 295, 299). UK bank interest is received gross by UK companies (ITA 2007, Pt 15). 8. Dividend received Dividends received from UK companies are chargeable to Corporation Tax under CTA 2009, s 931A unless the distribution is exempt ; the dividend received by Widgets Ltd ( 2,500) will be exempt, hence it can be excluded from the Corporation Tax computation (CTA 2009, ss 931B, 931D). Answer 1 (2) Profit extraction opportunities The most commonly used tax-efficient method of profit extraction from owner-managed companies is through a combination of salary/bonus, dividends and pension contributions. Salary / Dividends A salary/bonus/nics: would be corporation tax deductible for Widgets Ltd; the salary should be determined subject to the following: 7,696 would not be subject to employer s and employee s NICs (falling within the respective thresholds for 2013/14 of 7,696 (employer s) and 7,755 (employee s)); so as not to be subject to income tax (falling within Sid s personal allowance for 2013/14 of 9,440); and to protect Sid s social security/state pension entitlement (even if neither Sid not Widgets Ltd actually pays any NICs on it). A dividend: would not be corporation tax deductible for Widgets Ltd; would not be subject to employer s/employee s NICs; of 30,378 (which grosses up to 33,754) would not give rise to an income tax liability as it falls within Sid s remaining personal allowance and income tax basic rate band (being 7, ,754 = 41,450 = 9, ,010); and would effectively be subject to 25% higher rate tax to the extent that it exceeds Sid s basic rate band. Employer pension contributions An employer pension contribution by Widgets Ltd (to Sid s UK-registered scheme) would be: tax deductible for corporation tax purposes; not chargeable to Sid s 50,000 annual allowance for 2013/14; not subject to income tax/benefit in kind provisions; not subject to NICs; and may be preferable to pay from the company as not limited by Sid s salary, etc. and not subject to NIC. 4

5 1. Benefits in kind Tax-efficient benefits in kind include: The provision of CO 2 -efficient company cars and fuel for private motoring may be tax-efficient potentially for both the company and Sid depending on the cost and CO 2 -efficiency of the car involved, Sid s business and private mileage, etc. A beneficial (i.e. interest-free) employer loan up to 5,000 for 2013/14 without incurring any income tax or NIC liability. Workplace childcare facilities are not subject to income tax or NIC for the employee if certain conditions are satisfied. The provision of a mobile phone (including a smartphone) is exempt from an employment income tax charge. The provision of car parking facilities at or near the place of work is exempt from income tax. The same applies to motorcycles or bicycles. Other tax-efficient benefits include the cycle to work scheme, free eye tests, free annual health screening, employer contributions to use of home for working ( 4 p/w for 2013/14) and payment of a mileage allowance (45p/25p for 2013/14). 2. NIC-efficient arrangements Loans to the company Sid could charge the company a commercial rate of interest on any loans he makes the interest payable would be tax deductible for Widgets Ltd, and the interest receipt would be taxable for Sid, but it would not be subject to NIC. Rent If Sid owns any business assets outside the company, he could charge the company a commercial rent for their use, and thereby achieve NIC savings compared with a salary or bonus. 5

6 Marking scheme Marks Part 1 Legal and professional charges Adjustment 1 Legal and professional charges Explanation Entertaining Adjustment 1 Entertaining Explanation Increase in general bad debt provision Adjustment Increase in general bad debt provision Explanation Donations Adjustment 1 Donations Explanation Leased cars Adjustment 1 Leased cars Explanation UK bank deposit interest Adjustment 1 UK bank deposit interest Explanation Dividend received from UK company Adjustment Dividend received from UK company Explanation 10 Part 2 Salary Corporation tax deduction 7,696 for NI efficiency Below personal allowance of 9,440 Protect social security/pension status Dividends: No corporation tax deduction No NICs No further tax to pay within basic rate band 30,378/ 33,754 most tax-efficient Effective 25% higher rate Employer pension contributions: Corporation tax deduction 50,000 annual allowance No employee IT/BIK No NICs Better for company to pay than Sid 1/2 marks awarded for reference to CO 2 -efficient company cars/beneficial loans/childcare facilities or vouchers/mobile phone/car parking facilities/cycle to work/eye tests/health screening/mileage allowance/use of home allowance/interest on loans to the company/renting property to the company

7 Answer 2 High Cross Motor Services 1. Partnership computation year ended 31 March 2014 Bank charges - Negotiation of new long-term loan The new bank facility is required as a result of a change in the members of the partnership and might be viewed as linked to a change in the capital structure of the partnership. However, statutory relief for the incidental costs of obtaining loan finance may be claimed (s. 58 ITTOIA 2005), subject to meeting the following conditions: the costs are incurred on fees, commissions, advertising, printing and other incidental matters; the expense is wholly and exclusively for the purpose of obtaining the finance, providing security for it or repaying it; and interest on the loan is deductible as a trading expense. On the information provided the above conditions may be satisfied but if the funds are intended to be used as funding for a letting activity; (i.e. following the closure of the convenience store and petrol station), it might be arguable that the new finance was not wholly and exclusively for obtaining finance for the trade. 1 Allocation of loss 2013/14 Loss per accounts (272,000) Add: depreciation 12,000 Trading loss (260,000) 1 Marks 6 months to 30 6 months to 31 Total September 2013 March 2014 losses Alex 50% (65,000) 40% (52,000) (117,000) Nick 50% (65,000) 40% (52,000) (117,000) David 0% 0 20% (26,000) (26,000) 2 2. Relief available for trade losses Alex 2012/ /14 Trade loss Marks Trade profits 60,000 0 (117,000) Other adjusted net income 0 15,000 Carry back of trade loss s.64(2)(b) ITA 2007 (60,000) 60,000 Current year trade loss s.64(2)(a) ITA 2007 (15,000) 15,000 Adjusted net income 0 0 Trade losses carried forward s. 83 ITA 2007 (42,000) 1 Alex can make a claim under s.64 ITA 2007 for trading losses in 2013/14 to be offset against general income in that tax year and the previous tax year, 2012/13. With effect from 2013/14 there is a general cap on relief for certain losses, including trade losses. Relief against income is restricted to the greater of 50,000 or 25% of adjusted net income - s.24a ITA The cap does not apply to offset against profits from the same trade

8 Nick 2012/ / /14 Income Income Gain Trade loss Marks Trade profits 60,000 (117,000) Other adjusted net income/ gain 0 55, ,000 Carry back of trade loss s.64(2)(b) ITA 2007 (60,000) 60,000 Current year trade loss s.64(2)(a) ITA 2007 (see below)* (50,000) 50,000 Set off against capital gains s.261b TCGA 1992 (7,000) 7,000 Taxable income/capital gain 0 5,000 93,000 0 Nick may also make a claim to carry back trade losses against 2012/13 trading income and this is unrestricted. The sideways loss claim for offset against general income in 2013/14 is restricted to the higher of 50,000 or 25% of net income ( 55,000 25% = 13,750); i.e. in this case 50,000(see above*) 2 The general cap on trade losses does not apply to the offset against capital gains. The claim to offset the remainder of the 2013/14 trade losses against the gain must be made after all available reliefs for using the loss against general income - s.261b TCGA Nick s taxable income will be reduced to nil by the personal allowance and the capital gain will be reduced further by the annual exempt amount. 6 David 2013/14 Marks Income Trade loss Trade Loss 0 (26,000) Other adjusted net income 40,000 Current year offset of trade loss (restricted) (20,000) 20,000 Taxable income/losses carried forward 20,000 (6,000) 1 The sideways relief for David s trading losses is restricted by the lower of the following amounts; The contribution to the partnership in early tax years (applying in the tax year of commencement and next 3 tax years) s.110 ITA 2007; and 1 An overall cap for non-active partners of 25,000 for any tax year s.103c ITA David is a non-active partner for the period from 1 October March 2014 and this will limit the use of his trade losses against other income to 25,000. However, his contribution to the partnership capital of 20,000 is lower and this will cap relief for losses in 2013/14. The remainder of the trading loss can be carried forward and used against profits of the same trade. 1 Note: David cannot claim for sideways loss relief against net income in 2012/13 (s.64(2)(b) ITA 2007) or under relief for early years trade losses of the previous three tax years (s. 72 ITA 2007) due to insufficient taxable income and gains. Marking scheme High Cross Motor Services Marks Part 1 Partnership computation 1 Statutory relief for finance costs - s. 58 ITTOIA 2005 conditions 1 1/2 Allocation of losses between partners 2 1/2 5 Part 2 - Use of losses Alex - carry back/general cap/ losses forward 4 Nick - Restriction against general income/ offset against gain 6 David - Restrictions re contribution/non-active status 5 15 Total

9 Answer 3 Disincorporating Jonjo Glass Ltd Disincorporation would involve the transfer of the glazing business as a going concern from Jonjo Glass Ltd to Jonjo. He could then continue to run it as a sole trader. The main Corporation Tax consequences for a company transferring its business to its shareholder arise from the disposal of its assets. Any gains made on the disposal of goodwill, property, plant and machinery, and stock, in particular, may be liable to Corporation Tax. However, the Government has recently introduced a temporary disincorporation relief to potentially enable companies such as Jonjo Glass Ltd to disincorporate without any significant Corporation Tax disadvantages arising. Disincorporation relief In general terms, the qualifying criteria which must be met for Jonjo and Jonjo Glass Ltd to make a disincorporation relief claim are as follows: 1. A company and its shareholders can make a claim for disincorporation relief if: (a) the company transfers its business to some or all of its shareholders, (b) the transfer is a 'qualifying transfer', and (c) the transfer occurs between 1 April 2013 and 31 March A 'qualifying transfer' meets all the following conditions: (a) the business is transferred as a going concern, (b) the business is transferred together with all the assets of the business or together with all the assets of the business apart from cash, (c) the total market value of the qualifying assets at the time of the transfer does not exceed 100,000, (d) the transferee shareholders must be individuals (and not members of a limited liability partnership) who must continue to run the business after the transfer, and (e) the shareholders must have held their shares in the company for 12 months before the transfer. 3. Qualifying assets are interests in land (other than land held as trading stock) and goodwill. 4. The disincorporation relief claim must be made jointly by the company and all of the shareholders to whom the business is transferred in the company tax return within the period of 2 years from the business transfer date. From the information given, the proposed disincorporation of the business from Jonjo Glass Ltd should meet all of these criteria and they should jointly be able to make a claim for relief. Corporation tax implications of disincorporation Freehold property and goodwill Jonjo Glass Ltd would incur a Corporation Tax charge as a result of the gains realised on the transfer of the freehold property and goodwill to Jonjo on the disincorporation of the business without a disincorporation relief claim. Jonjo Glass Ltd s tax position, based on the values as at 31 March 2014, would be as follows: Chargeable gain: Freehold property Disposal consideration (deemed) 45,000 Less: Cost (30,000) 15,000 Credit on realisation: Goodwill Proceeds on realisation (deemed) 30,000 Less: Written down value for tax purposes (0) 30,000 45,000 Corporation Tax = 9,000 9

10 However, Jonjo Glass Ltd would have no Corporation Tax charge on the transfer of the freehold property and goodwill to Jonjo if a disincorporation relief claim were made. Jonjo Glass Ltd s tax position in that case would be as follows: Chargeable gain: Freehold property Disposal consideration (deemed) 30,000 Less: Cost (30,000) Nil Credit on realisation: Goodwill Proceeds on realisation (deemed) Nil Less: Written down value for tax purposes (Nil) Nil Nil Corporation Tax charge Nil Hence, a disincorporation relief claim would save Jonjo Glass Ltd from incurring a Corporation Tax liability of 9,000 on disincorporation. Stock On disincorporation, Jonjo Glass Ltd would cease to carry on a trade and its stock would have to be valued and the company s trading profits adjusted accordingly. As its controlling shareholder, Jonjo would be a connected person with Jonjo Glass Ltd and the value of its stock for these purposes would be deemed to be its market value. So, on disincorporation, the stock would be valued at 15,000 for the purposes of calculating the company s trading profits. However, Jonjo and the company could jointly elect for the stock to transfer at book value of 12,000 instead, thereby preventing the company s taxable profits from increasing by 3,000. Plant and machinery The cessation of Jonjo Glass Ltd s trade on disincorporation would also cause a deemed disposal of its plant and machinery, giving rise to a balancing charge or allowance which is calculated as the difference between the disposal value and the tax written down value of the assets. Again, because Jonjo and Jonjo Glass Ltd are connected for these purposes, the disposal proceeds on disincorporation would be deemed to equate to the market value of the assets. So, on disincorporation Jonjo Glass Ltd would be deemed to dispose of its plant and machinery for its market value of 15,000, which exceeds the tax written down value of 10,000, and would give a balancing charge of 5,000. Again, however, Jonjo and Jonjo Glass Ltd could make a joint election for the assets to be transferred at their tax written down value of 10,000 instead, thereby preventing the company s taxable profits from increasing by 5,000. Tax benefits of operating as a sole trader Some of the tax advantages which could arise through Jonjo operating as a sole trader include: 1. Sole traders have more flexible personal offset opportunities for trading losses. 2. The marginal rates of NICs on Jonjo s sole trade profits would be lower. 3. The company car taxable benefit rules don t apply to a business car used by a sole trader any tax charge in this case arises from the disallowance of his private use element of the car expense - which may result in a lower effective tax charge for him. 4. He could avoid a potential double layer of taxation by operating as a sole trader (as the company first pays Corporation Tax on its profits and gains, and the shareholders then pay personal tax on extraction of the post-corporation Tax profits. 5. Sole traders don t have to have their accounts made available to the public. 6. He would not need to operate payroll administration / PAYE procedures in relation to his extraction of profits from the business. 10

11 7. The rules for self-employed individuals recovering expenses incurred in relation to the business are less restrictive than for employees. 8. He could also claim certain business expense deductions at a fixed rate from 2013/14 including vehicle expenditure and use of the home for business purposes which could simplify his recordkeeping requirements. 9. He would still have to submit an annual self-assessment tax return but he would no longer have to submit Corporation Tax returns, which should save on his professional fees. 10. Sole traders can use the cash basis of accounting. Marking scheme Marks Disincorporating Jonjo Glass Ltd Explanation / Introduction 1 Disincorporation relief Transfer must occur between 1 April 2013 and 31 March 2018 Business must be transferred as a going concern Business must be transferred together with all the assets of the business or together with all the assets of the business apart from cash Total market value of the qualifying assets must not exceed 100,000 Transferee shareholders must be individuals who continue the business Shareholders must have held their shares for 12 months before the transfer Qualifying assets are interests in land and goodwill Disincorporation relief claim must be made jointly by the company and the shareholders within 2 years from the business transfer date Freehold property and goodwill Chargeable gain calculation no disincorporation relief freehold property 1 Chargeable gain calculation no disincorporation relief goodwill 1 Chargeable gain calculation disincorporation relief freehold property 1 Chargeable gain calculation disincorporation relief goodwill 1 Stock Stock deemed transfer value 1 Stock deemed transfer value election Plant and machinery Plant and machinery deemed transfer value 1 Plant and machinery deemed transfer value election Tax benefits of operating as a sole trader mark each for referring to flexible use of losses/nic savings/business car savings/no double taxation of profits/accounts not to be made public/no need for PAYE scheme/less restrictive recovery of business expenses/fixed rate deductions/no corporation tax return / lower professional fees/cash basis of accounting etc

12 Answer 4 Merryweather Ltd Mr Gupta Merryweather Ltd Birmingham B10 XXY My ref: ABC/0514 XX May 2014 Dear Mr Gupta Employee tax issues on the proposed disposal of Merryweather Ltd I am writing to follow up on two areas discussed at our meeting on XX April 2014: The impact of the proposed sale of Merryweather Ltd on employees who hold approved share options; and The treatment of travel expenses following Mr Jones s relocation to Penzance. 1 (presentation) 1. Enterprise Management Incentive ( EMI ) and Company Share Option Plan ( CSOP ) share options As you are aware from your previous involvement in setting up the employee share schemes the objective of the scheme is to incentivise and retain employees by offering a tax efficient means of participating in the growth of the business. Specifically the use of an approved EMI share option scheme or CSOP allows employees to acquire shares with no Income Tax or National Insurance liabilities arising on the difference between: the excess of the actual market value of the shares at the date of exercise; and the price agreed under terms of the option (where the right to buy shares is the unrestricted market value at the date of grant - which is the case here). For employees who choose to exercise their EMI and CSOP options, the difference between the grant price of 1.20 and the current market value of 1.60 will not be taxed as earnings where exercise is made before the company is sold. 2 The purchase of Merryweather Ltd will be treated as a disqualifying event under the EMI rules as the company will no longer be independent (ie it will be under the control of another company) and options in issue will no longer be eligible. Similarly the CSOP scheme will no longer be regarded as qualifying as the company will be under the control of the purchaser. The options were granted on 1 July The CSOP scheme requires that the options are exercised during a period between 3 and 10 years following the date of grant. Recent changes to CSOP legislation allow the 3 year anniversary to be ignored where there is a takeover - provided that the employee receives cash for the shares acquired under option. This condition is satisfied under the terms of the proposed transaction. You should note that the approved status of the CSOP options will only be retained if the take-over was not contemplated when the options were granted and the main purpose was not the avoidance of tax or National Insurance. The approach was first made by the purchaser in January 2014 (i.e. after setting up the schemes) however you should review all of the circumstances here to confirm that the anti-avoidance provisions are not breached. 1 You should explore whether employees might be invited to join an approved or unapproved share scheme operated by the purchaser. An EMI scheme would not be available if the purchaser has gross assets in excess of 30m which I understand this would be the case here as the company is listed on the FTSE 100. Corporation tax deduction Merryweather Ltd will be able to claim a statutory deduction for the difference between the market value of the shares awarded to the employees and the option price paid. Relief is available in the accounting period in which the shares are acquired. 1 12

13 Capital gains tax implications - sale of shares The employees should take independent advice on the computation of the Capital Gains Tax liability arising on the sale of their Merryweather Ltd shares. Where an individual is eligible to acquire shares under an approved scheme the base cost for purposes of computing the capital gain on the disposal of the shares will be the amount paid for the shares (i.e. the option price as the capital gains tax market value rule is dis-applied), plus the payment for the option (if relevant). 1 For EMI option holders the gain on the disposal of the shares may qualify for entrepreneurs relief ( ER ) meaning that the gains will be taxable at 10%. The personal company tests for claiming ER have recently been relaxed. The qualifying holding period now starts from the date the option was granted and a requirement to hold a minimum 5% of the nominal voting ordinary shares has been removed (this applies for disposals after 5 April 2013). In order for EMI option holders to qualify for ER an unconditional contract for the disposal of Merryweather Ltd must not be entered into before 1 July 2014; i.e. 12 months after the options were granted. 1 The changes to ER do not apply to shares acquired under the CSOP and gains for these employees will potentially be subject to Capital Gains Tax at 18% or 28%. I recommend that employees of both share option schemes should exercise their options prior to sale of Merryweather Ltd. This will enable them to participate in the growth of the value of the business to date whilst preserving the Income Tax and National Insurance benefits of buying shares at less than the current market value. 2. Travel expenses The travel costs from Penzance to Birmingham will be regarded as ordinary commuting as this is a journey to a permanent place of work. The decision to move to Penzance was for personal reasons consequently the journey is dictated by where he has chosen to live rather than the requirements of his employment. 1 The reimbursement payments to Mr Jones should, therefore, be processed as general earnings with deductions for PAYE and Class 1 National Insurance, together with Class 1 secondary contributions for the employer. This will be reported when payment is made under Real Time Information ( RTI ) in the same way as salary payments. 1 The reimbursement and the secondary contributions will be deductible for Corporation Tax for the company. With regard to the attendance at a monthly meeting in Bristol, a deduction for business expenses is allowed where: An employee is obliged to incur the expense in his capacity as part of his employment; and The amount is wholly, exclusively and necessarily incurred in performance of duties of the employment. 1 Travel for attendance at a monthly meeting in Bristol would normally be treated as business travel where this location is a temporary workplace. However, the element of rail fare reimbursed to cover the journey from his home to Bristol will not meet the test for necessary attendance as this relates to part of his ordinary commuting en route to Birmingham. Mr Jones may be able to claim the local travel costs for transport from Bristol station to the Bristol depot - if these are not reimbursed by the company. 1 Please do not hesitate to contact me if you require further assistance. Yours sincerely A N Tax Advisor AAB LLP 13

14 Marking scheme Merryweather Ltd Marks Part 1 EMI and CSOP Presentation 1 Summary of tax incentives for EMI and CSOP schemes 2 Disqualifying event 1/2 CSOP rule on early exercise 1 Purchaser's share schemes/conversion of CSOP 1/2 CT Deduction 1 1/2 Basis for capital gains tax computation 1 Entrepreneurs relief 1 1/2 CSOP - no ER 1/2 Recommendation/summary 1/2 10 Part 2 Director's travel costs Ordinary commuting 1 Reimbursement of expenses as earnings subject to PAYE 1 Deductible for corporation tax 1/2 Statutory rule for travel as business expense 1 Attendance at temporary workplace on route to work 1 1/2 5 14

15 Answer 5 The Grange Hotel Ltd Capital Allowances Accounting period 1 May 2013 to 30 April 2014 AIA FYA Main Special rate Total expenditure expenditure pool pool Car F' Allowances TWDV b/f 1 May , ,000 45,000 Additions Lift 100, ,000 Central heating 50,000 50,000 Electrical wiring etc 65,000 65,000 Cold water system 35,000 55, ,000 AIA -250, , ,000 Car 'A' 18,000 FYA -18,000 18,000 Car 'B' 22,000 Car 'C' 25,000 Gazebo 15,000 Paintings and murals 22,000 Furniture 30,000 Demolition costs 20, , ,000 Disposals Car 'D' -2,000 Car 'E' -10, , ,000 45,000 WDA (18%/8%) -40,860-14,000-3,000 57, , ,000 42,000 Transfer of balance re single asset pool to main pool 42,000-42,000 TWDV c/f 30 April , ,000 0 Total allowances 325,860 15

16 MEMORANDUM To: Tax Partner From: Tax Manager Client: The Grange Hotel Limited Subject: HMRC letter re discovery The Inspector is out of time for enquiring into the 2012 return as the deadline for enquiry passed on 31 January If the Inspector now wishes to withdraw relief for the payment he must now proceed by making a discovery under FA 1998, Sch 18, para 41, subject to paras 43 and 44. In Langham v Veltema CA 2004, 76 TC 259 a discovery assessment was made in respect of a house transferred by a company to one of its directors, who submitted a valuation of 100,000 with his tax return. A valuation of 145,000 was agreed for the purposes of the company s tax return and it was held that, within the terms of para 44, the individual s Inspector could not have reasonably been expected to infer that the taxpayer s selfassessment was insufficient as a result of the valuation being inadequate and the discovery assessment was therefore upheld. However, SP1/06 gives three examples where the taxpayer can rely on the information in the tax return providing protection against discovery, the third of which is where the taxpayer adopts a different view of the law from the H M Revenue & Customs published view. In such circumstances if comments indicating that a different view has been adopted or that no adjustment for the item in question has been made, this would protect against later discovery. Given that the company s disclosure is clearly within the terms of SP1/06, and therefore the Inspector could have reasonably been expected to have been aware of that information, it does not appear open to the Inspector to now raise a discovery assessment having missed the deadline for opening an enquiry into the company s 2012 return. Marking Guide Poss Bonus Marks Part 1 Allocation of lift, CH, electrical & plumbing to special rate pool 2.0 Allocation of AIA against integral features in priority 1.0 FYA re car A 0.5 Car B allocation to main pool 0.5 Car C allocation to special rate pool 0.5 Demolition costs added to main pool 0.5 Claims for gazebo, furniture, paintings & murals 1.5 Transfer of balance of balance on single asset pool re car F to main pool per FA 2009, Sch 11, para Allocation of disposal of car D to main pool 0.5 Allocation of disposal of car E to special rate pool 0.5 Overall computation 1.5 Total Part 2 Enquiry now out of time 0.5 Para 41 applicable subject to paras 43 & Inspector reasonably expected to have been aware 1.0 Discussion of Langham v Veltema 1.0 Discussion of terms of SP1/ Conclusion that terms met and discovery not competent 1.0 Total

17 Answer 6 MEMORANDUM To: Tax Partner From: Tax Senior Client: Marcel Duval Subject: Capital Gains Tax on property and share disposals / Entrepreneurs Relief The disposal of one of the properties used in the business is a disposal of part of the business. The question of what constitutes part of a business has been considered in a number of tax cases, mainly concerning disposals of land by farmers, the leading case being McGregor v Adcock, Ch D 1977, 51 TC 692. However, the test applied in M Gilbert v HMRC [2011] UKFTT 705 (TC) was whether the part sold (which was sold as a going concern for VAT purposes) was capable of operating as a separate business which it clearly was in that case. The question is however whether the vendor has disposed of part of a business, not whether the purchaser has acquired a business (Jarmin v Rawlings, Ch D 1994, 67 TC 130). Therefore the fact that the purchaser did not wish to continue the business is not relevant. The disposal of part of a business is a material disposal of business assets within s.69i(2)(a) TCGA The gain on sale of 200,000 therefore qualifies for CGT Entrepreneurs Relief ( ER ). Although the property was sold prior to cessation of the business, that disposal is treated as part of the disposal of that part of the business which ceased on 30 June 2013 The disposal of the second property on 31 March 2014 following the cessation of the business is also a material disposal of business assets falling within s.169i(2)(b) i.e. the disposal of an asset used in the business at the time the business ceased. The conditions at s.169i(4) are met i.e. the business was owned by the individual and the asset was disposed of within 3 years of cessation. The fact that the third floor of the building was let is not relevant since all that s.169i(2)(b) requires is that the asset was in use for the purposes of the business at the time the business ceased to be carried on. There is no requirement that the whole of the asset must be so used and there is no provision for restriction of relief. The whole gain of 250,000 therefore qualifies for ER. The sale of Marcel s shares in RIBL would be a material disposal of business assets within s.169i(2)(c). The conditions at s.169i(6) are met during the period of 1 year ending with the disposal, i.e. that the company is a trading company, is Marcel s personal company within s.169s(3) of which he is an officer or employee. The disposal of the office premises would also qualify for ER as an associated disposal within s.169k(2)(b). However, it is a requirement at s.169k(3) that the associated disposal must be made as part of the individual s withdrawal from the business. Under H M Revenue & Customs guidance the individual is not required to cease work or even reduce their working hours and therefore Marcel continuing to work for the company will not prejudice his claim for ER. The H M Revenue & Customs guidance also states that the material disposal and the associated disposal must be part and parcel of one single withdrawal from participation in the business, and there should normally be no significant interval between the two disposals, although HMRC will allow between one and three years for the associated disposal to take place depending upon the circumstances. However, ER is restricted in relation to associated disposals where any of the conditions at s.169p(4)(a)- (d) are met. As the property was let commercially for four years from April 2002 to April 2006 condition (a) applies and under s.169p(5)(a) ER is restricted for that period. Out of 12 years ownership therefore 4 years i.e. 1/3 rd does not qualify for ER. The gain on the sale of the property is 300,000 of which 200,000 will qualify for ER. 17

18 Marking guide Marks Disposal of 1st shop a disposal of part of a business within s.169i(2)(a) 1.0 Consideration of tax cases re part of a business 2.0* Disposal of 2nd shop a disposal within s.169(2)(b) 1.0 Conditions at s.169i(4) 1.0 No restriction of ER re letting of flat 1.0 Sale of shares a material disposal within s.169i(2)(c) 1.0 Personal company tests 1.0 Sale of offices an associated disposal under s.169k 1.0 Material disposal and associated disposal part of withdrawal from business 1.0 Reduction in working hours not required 1.0 No significant interval between disposals/discussion of time limits per HMRC guidance 1.0 Discussion of restrictions under s.169p 1.0 Restriction required for period of letting 1.0 Discussion / calculation of gain qualifying for ER 1.0 Total 15.0 *Alternative marks awarded in some cases where it was considered whether the Brighton shop was a separate business and therefore whether the sale of the property might qualify under s.169i(2)(b) on the basis of the cessation of that business. This would not appear to be correct but is, perhaps, a grey area and possibly unreasonable to penalise candidates for taking that view. 18