A recent case concerned penalties that arose on a taxpayer due to a technicality. The taxpayer had run a business as a VAT registered sole trader. He brought his son in as a business partner, which was therefore technically a transfer to a partnership and a transfer of a going concern (TOGC) for VAT purposes.

The taxpayer did not realise this and did not notify HMRC until around 2 years later. However, he continued to submit his sole trader VAT returns and pay the tax due through this period. Two of the returns in the period were submitted late.

HMRC therefore sought penalties for late registration by the new partnership of more than 12 months and charged an 18% penalty. They did, however mitigate this by 70% as the VAT returns and tax were submitted through the sole trader registration and there was therefore no loss of tax.

The First-tier Tribunal felt that as the error was a technicality and that there had been no loss or administrative inconvenience to HMRC, the penalty should be reduced by 90% instead and lowered the 18% penalty to 12.5%. They also noted that the taxpayer had made a voluntary disclosure and that HMRC’s protracted case management had been inappropriate, causing “significant inconvenience and expense’” to the taxpayer

Overall the penalty was reduced from £582 to £100 and so the taxpayer’s appeal was allowed in part.

This case shows the continued firm approach that HMRC appear to be taking with penalties for minor mistakes. However, the Tribunals continue to provide a safety net to taxpayers and the comments of the Tribunal showed the importance of taking the first steps and making voluntary disclosure before HMRC find the error. If you would like assistance with making a disclosure or have any concerns about past transactions, please get in touch with us as we would be delighted to assist.

The Treasury has invited comments for the 2015 Budget.  I set out below some personal thoughts on a Budget for Small Business.  There are plenty of other ideas too – but please Chancellor make the rules clear and the policies consistent over time, so that business owners can plan for the future.  Tinker Not!

  1. Make the income tax rate on small traders/1890 Partnership Act partnerships limited to 20% on trading income.  [Do not include large 20+ member partnerships nor LLP’s.  Why should Mr Patel’s corner shop be subject to a 40% marginal rate charge on trading income above ~£40k when his rivals at Tesco, Asda, etc., only pay 20% maximum rate on £millions of profit?
  1. Abolish (or severely curtail) the connected parties rule for incentives such as EIS.  The current rules are complex and arbitrary and basically mean the only individuals able to claim the reliefs are those who know nothing about the business.  This encourages excess cost and mis-selling.  If a friend or family member were encouraged to invest via a tax incentive, I believe that would provide far more intelligent seed corn funds and encourage small business.
  1. Similarly, free up personal pension funds to invest in small business.  By all means encourage diversity, but do not think restricting investments to the ‘Trust me, I’m a Big City Institution’ circle is going to improve the UK economy swiftly.  At present people are prohibited from investing part of their pension fund in a growing, local small business that they believe in and trust, and instead have to hand it over to a faceless Fund Manager (where he generates neither emotion).  This cuts down on capital available to growing entrepreneurial businesses because all pension savings are focussed on large City Institutions.
  1. Split retail and investment banking, and in exchange for Government guarantees to the former, insist on x% of lending going to small business, decided at local level.
  1. Abolish rates and have a radical review of property taxes and local Government funding.  I do not know what the answer is, but the split state of the nation between London/South East and the rest, does not bode well for everyone.

I dare say preparing a National Budget is a complex affair, requiring detailed planning, financial modelling and intellectual thought.  I strongly approve of the idea of taking sounding from our profession who deal with the consequences of tax policy on a day to day basis.  However, it is a bit scary to think that anyone seriously expects radical policy ideas raised now are actually going to feature in a June 2015 Budget!  Perhaps next time?

The recent tribunal case of Mr Vaines v HMRC (TC02965) dealt with whether a deduction from trading profits was allowed under the ‘wholly and exclusively’ principles, for an out of court settlement of a bank claim relating to a previous trade.

If the claim was not settled the taxpayer could be made bankrupt thus preventing him from continuing in his current trade.

Background

The taxpayer, Mr Vaines, was a member of Harrmann Hemmelrath LLP, a German law firm with offices in London, until 31 December 2005.

The taxpayer subsequently became a partner in Squire Sanders & Dempsey.

On 27 October 2009 the taxpayer made an amendment to his tax return for 2007/08, claiming a deduction of £215,455 against his professional income from Squire Sanders & Dempsey.

The deduction claimed was for a payment made to a German bank, under an agreement made by a number of individuals who were connected with his previous law firm, Haarmann Hemmelrath.  The firm had ceased to trade and owed approx. €17m to a number of German Banks.

The taxpayer believed that the risk of challenging the banks through the German courts was unacceptably high; as if he lost he would be made bankrupt.

If made bankrupt he would lose his current position as partner at Squire Sanders & Dempsey.

Following negotiations with the bank, he agreed to pay them €300,000 (£215,455) in full and final settlement of all claims.  This was paid in January 2008 (tax year 2007/08).

An amendment was made to his 2007/08 tax return and a deduction from his professional income from Squire Sanders & Dempsey claimed.

HMRC denied a deduction primarily on the basis that the payment was not wholly and exclusively for the purposes of his trade.

HMRC’s Arguments

HMRC argued that the deduction should not be allowed for three reasons:

  1. Mr Vaines did not carry on a profession or a trade as an individual,
  2. If he did carry on a trade individually the payment was not wholly and exclusively for the purposes of the trade as it also enabled him to avoid bankruptcy and preserve his reputation, and
  3. If it was wholly and exclusively, it was capital and not revenue expenditure and therefore no deduction was allowed

Tribunals Conclusions

1. Trading as an Individual

 HMRC had tried to rely on a case that predated self-assessment. However this case was found to be superseded by ITTOIA s.862, which states that members of an LLP are treated as carrying out the trade and not the partnership itself.

The tribunal therefore dismissed HMRC’s argument that Mr Vaines did not carry on a trade in his own right.

2. Wholly & Exclusively

The tribunal held that as a matter of fact the purpose of Mr Vaines making the payment was to preserve and protect his professional career or trade.

With this in mind the case of Morgan (Inspector of Taxes) v Tate & Lyle Ltd (1955) states that ‘money spent for the purposes of preserving the trade from destruction can properly be treated as wholly and exclusively expended for the purposes of the trade’.

As a result they found that the payment to the Bank was wholly and exclusively for the purposes of his trade.

3. Revenue or Capital?

The final consideration was whether the payment was revenue or capital.  HMRC contended it was capital and therefore no deduction was allowed.

Mr Vaines argued that no asset or enduring advantage was brought into existence by the payment made to the Bank and as a result it was a revenue expense.

He relied on Lawrence J in Southern (HM Inspector of Taxes) v Borax Consolidated Ltd (1940) where he stated;

‘..if no alteration is made in the fixed capital asset by the payment, then it is properly attributable to revenue’ and ‘it appears to me that the legal expenses which were incurred…did not create any new asset at all but were expenses which were incurred in the ordinary course of maintaining the assets of the Company, and the fact that it was maintaining the title…does not, in my opinion make it any different’

The tribunal found that as the payment was to preserve and protect his professional career or trade it must follow that it is a revenue and not capital payment in line with the case above.

Decision

As a result the appeal was allowed and the payment found to be wholly and exclusively for the purposes of his trade.

In this article on Partnership Tax, we will take a look at some of the latest developments in practical tax matters relating to Partnerships. 

Incorporation of a Business within an LLP

The increased usage of LLPs as business vehicles has raised thoughts over how a business owned by an LLP could be transferred to a company.

Routes for incorporation must be carefully considered and options include transferring the business of the LLP to the company or transfer of the members’ interests to the company.   Generally commentators opinion is that HMRC are indifferent to the structure utilised but the incorporation relief rules regarding CGT must be reviewed thoroughly in the planning phase.

Also solicitors should be consulted to make sure implementation is carried out properly.

Incorporation Relief

Key tests for the relief from capital gains tax include whether a business is being operated and whether the whole business is transferred.

The Tribunal Case of Elizabeth Ramsey looked at whether a property portfolio could be a business.  The Tribunal Judges held that in her case, it wasn’t a business, but there is some doubt as to whether this decision was appropriate.  It isn’t binding given that it was a Tribunal case.

SDLT on Incorporation

It is thought that there could be an interpretation of the current rules where SDLT is avoided on the transfer of a property as part of a business from a partnership to a limited company.  Such an interpretation may be in contravention to HMRC’s view and specific written advice should be obtained.

Certainly conversation to a partnership business from a sole trader and then incorporation could be caught by anti-avoidance rules.

Corporate Partner

Consideration of the introduction of a company into a  partnership of natural persons is still a consideration in terms of allowing a structure that works commercially for a business.

If commercial reasons dictate that a company would be a useful partner then tax savings might be achieved, especially as we are still to have a highest rate of income tax of 45% + 2% NI.

It is important to note that the introduction of a company needs bespoke consideration and could cause difficulties  in terms of partnership succession, unless a careful plan is set out.  There are a number of different options under which a company could interact with a partnership.

D J Cooper and Partners was formed as a partnership to provide services to one customer.  The customer was a limited company which traded as a builders merchants.  The partners were also shareholders / directors of the limited company.
HMRC challenged the tax treatment of cars which were owned by the partnership and used by the partners (who were also directors of the limited company).  HMRC said that the directors of the limited company should have declared a benefit in kind for usage of the cars which they said were provided because of their office.
The tribunal case hinged on the commerciality of the arrangements and the court held that the partnership was wholly dependent on the company.  This structure would not have existed without the connection and the partnership was seen as an attempt to avoid paying tax on what was primarily a personal benefit.

partnership agreement
(Photo credit: o5com)

The case of Mrs Pauline Valantine v HMRC (TC 01644) demonstrates that in certain cases it may be useful to engage in discussions/meetings with HM Revenue and Customs as this could prevent cases being taken to Tribunal unnecessarily.
The key issue in the case concerned whether Mrs Valantine was in partnership with her husband.  If Mr & Mrs Valantine were in partnership then Mrs Valantine would become liable for unpaid income tax/NICs on her share of the partnership profits and unpaid VAT for which she would be joint and severally liable.
The question of liability was particularly relevant because Mr Valantine was expected to declare bankruptcy, therefore if a partnership did not exist then Mrs Valantine would not be liable for the unpaid tax and HM Revenue and Customs could not expect to receive payment.
Based on the evidence before them the Tribunal found in favour of the taxpayer on the basis that the relationship between the taxpayers made it unthinkable that they would have entered a business partnership.
Interestingly however, the Tribunal concluded that HM Revenue and Customs should not be criticised for their handling of the case or for bringing the case to Tribunal.  They went on to say that had the taxpayers been willing to meet HM Revenue and Customs to discuss the case then the case may never had been brought to appeal.
Taxpayers involved with investigations/enquiries from HM Revenue and Customs may find professional advice useful to ensure that matters are concluded both quickly and robustly.
For information regarding our tax investigation/enquiry services please contact Paul Davison on 0113 244 3502 or visit our website www.eavesandco.co.uk

The taxpayers appealed a fixed penalty of £200 for the late filing of their 2009/10 partnership income tax return.
They appealed on the grounds that the HM Revenue & Customs online submission software was unavailable, and that the return had been submitted before 31 January 2011. They also argued that they had been successful in an appeal under similar circumstances for 2007/08.
HM Revenue & Customs explained that they had accepted their 2007/08 appeal for a late return, as it was the first year that paper returns had required to be submitted by 31 October.  However, their 2010/11 paper return was received on 24 January 2011, nearly three months after the deadline.
The key in this case was that the tribunal stated that as there is no obligation to file online, the lack of software to do so is not a reasonable excuse to why the return was late, as it is clearly stated on the return that external software is required, therefore the penalties were upheld.