The Result is in …..

We have opened the right envelope!

Congratulations and thank you for all who correctly entered our ‘Twelve Days of Christmas’ Quiz.  Eaves and Co are pleased to announce that the winner is Catherine Rogers of Ashford Rainham Ltd.  David Stebbings recently handed over her prize.

 

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For completeness here are the answers:-

 

The name Santa Claus evolved from Sinter Klass, a nickname for Saint Nicholas. What language is Sinter Klaas? Dutch

 

What fruit is traditionally used to make a ‘Christingle’?  Orange

 

Who ‘Rattle and Hum’ along to Angel of Harlem?  U2

 

Which carol is about a 19th Century Duke of Bohemia? Good King Wenceslas

 

“Christmas won’t be Christmas without any presents” is the first line from which literary classic by Louisa May Alcott? Little Women

 

Christmas Island, in the Indian Ocean, is a territory of which country? Australia

 

In the song ‘The Twelve Days Of Christmas’, how many swans were a-swimming? Seven

 

The North Pole, said to be Santa’s home, is located in which ocean? Arctic Ocean

 

The name of which of Santa’s reindeer means ‘Thunder’? Donner

 

Marzipan is made mainly from sugar and the flour or meal of which nut? Almond

 

Which traditional Christmas plant was once so revered by early Britons that it had to be cut with a golden sickle? Mistletoe

 

Who was Jacob Marley’s business partner?  Scrooge

 

The initial of each answer spells out DOUGLAS ADAMS.  The quote attributed to him on our website is ‘I’m spending a year dead for tax reasons’.

We are not, so look forward working with you again this year.  Remember the new tax year starts on 6 April.

Confirmation that Dividend Waivers should be treated with Caution

The recent First-Tier Tribunal (FTT) case of Donovan & McLaren v HMRC has confirmed that regular dividend waivers constitute a settlement for Income Tax purposes.

HMRC’s CASE

It was argued by HMRC that the effect of the dividend waivers and the intention of them was to allow higher dividends to be paid to the two directors’ wives than their respective shareholdings entitled and lower dividends to be received by the two directors.

HMRC stated that according to ITTOIA 2005 s.620 the directors’ dividend waivers and the consequent payment of dividends to their wives constituted an arrangement that can be defined as a ‘settlement’ whereby the directors were the settlors. HMRC inferred that the directors waived entitlement to dividends as part of a plan that dividend income otherwise due to the directors would be paid to their wives, therefore constituting an ‘arrangement’ under the settlements legislation. It was argued that this scheme was used for tax avoidance purposes so that the directors and their wives could reduce this aggregate liability income tax by using the wives’ unused basic rate band of tax.

HMRC rejected the alleged commercial rationale for executing the dividend waiver which was to maintain reserves and cash balances in order to accumulate sufficient of each to fund the purchase of the company’s own freehold property. They contended that this could have been more easily achieved by voting a lower rate of dividend.

The settlements legislation also requires an element of bounty to be part of the arrangement. Consequently, HMRC argued that the directors’ arrangement was not one that was entered into at arm’s length and the arrangement therefore contained an element of bounty.

APPELLANTS’ CASE

The two directors failed to provide any evidence to defend their position other than inferences from previous correspondence submitted by them and their accountant. Furthermore it had been admitted by the appellants and their agent in a letter to HMRC that ‘dividend waivers are by their very nature not on arm’s length or commercial’ which substantially weakened their appeal.

They had also argued that structuring the waivers as they did was tax efficient and made commercial sense.

FTT DECISION

The FTT found that the directors had waived their entitlement to dividends as part of a plan to ensure that the dividend income became payable to their wives so as to reduce their aggregate liability to Income Tax. The income which arises from the dividend waiver arrangement clearly arose during the lives of the director and the dividend income paid to their wives from their shares together with the dividend rights attached to them are benefits enjoyed by the directors’ wives. On the balance of probabilities the FTT accepted the submissions by HMRC; including the opinion that there was no commercial purpose for the waivers and that they did not have taken place at arm’s length.

The FTT also found that there was a lack of sufficient distributable reserves within the company were it not for the directors waiving the dividends.

Finally, they rejected the claim by the directors that the discovery assessments raised by HMRC were invalid. All appeals asserted by the two directors were dismissed.

CONCLUSION

This case serves as a reminder that companies need to be cautious when considering the use of dividend waivers. The definition of a ‘settlement’ is wide-ranging and to avoid being caught in an arrangement which may constitute a settlement arrangement it is best to seek professional advice.

There are options that remain effective for efficient tax planning through family companies that can be used without the need for dividend waivers. Seeking professional advice in advance is preferable to finding out the planning did not work in the Courts.

Private Residence Relief Denied – Dream House but not the same Dwelling House

Background

In this recent case, the taxpayer Paul Gibson purchased a property called Moles House for £715,000. Mr Gibson decided to demolish the original house (referred to by HMRC as Moles House One) so as to build his dream family house in its place for him and his partner (referred to as Moles House Two.) Demolition and complete reconstruction of the house was deemed as more cost effective than renovating and extending the existing structure.

Following financial difficulties due to the expense of the project and relationship problems, it was decided that the ‘new house’ would be sold upon completion. When the house was sold in February 2006 for approximately £1.5million, the capital gain on the sale of the property was not reported in Mr Gibson’s 2006/07 tax return assuming Private Residence Relief was due under TCGA s.222. HMRC opened an enquiry into that return and issued a closure notice that brought the capital gain on the house into charge as well as subsequent penalties. Mr Gibson appealed against the rejection of PPR and the 50% penalty imposed.

First-tier Tribunal Decisions

The main points considered for whether Private Residence Relief was due in this case were:

1.)     Did Moles House Two constitute the same ‘dwelling house’ as Moles House One according to its ordinary meaning under TCGA s.222(1)?

  • The FTT noted that if an existing dwelling house was fundamentally remodelled and renovated it would still be classified as the same dwelling house.  They considered whether a house that was demolished and reconstructed in order to achieve the same end as remodelling the existing house by a more cost effective means should also be regarded as the same dwelling house.
  • However, the Tribunal Judge ruled that the words of ‘dwelling house’ need to be given their ordinary meaning. ‘Dwelling house’ refers to the building itself rather than to the land. If one house is completely demolished and a new house is built in its place, then the new house is not the same ‘dwelling house.’
  • Mr Gibson’s case was weakened by the fact that the two houses were built out of different materials and it was not built on the same foundations; it wasn’t considered as the same house physically.  Perhaps the outcome would have been different if the materials from Moles House One were recycled and used to build Moles House Two in the same plan as before?  His case was also weakened by his own reference to Moles House Two as the ‘new house’ in his testimony.

On the grounds of the meaning of ‘dwelling house’, Moles House Two was found to be a different dwelling and Mr Gibson would not to be entitled to Private Residence Relief unless he had resided in the new dwelling. 

2.)     Was Moles House One and subsequently Moles House Two the individual’s only or main residence throughout the period of ownership?

  • HMRC argued that a dwelling house must be physically occupied by the individual during their period of ownership for it to be their only or main residence and for relief to apply. The intention to occupy a dwelling house but having to sell it for unforeseen reasons does not qualify the individual for relief.
  • It was accepted by all parties that Moles House One had been Mr Gibson’s main and permanent residence.
  • It was only revealed during the course of the court proceedings that he had ‘lived’ in Moles House Two following its completion. However, Mr Gibson had only ‘camped’ at Moles House Two during the process of the sale and had not occupied the reconstructed property at any other time prior to his decision to sell it. He had also testified that permanent residence in the property was not possible before the construction of Moles House Two was complete.
  • Occupation of a property does not equate to residence unless it becomes a person’s home.

As the newly constructed house was not considered as the principal residence of Mr Gibson, the claim for PPR was rejected on this point too.

Despite Mr Gibson’s appeal being rejected in its entirety, if a couple of circumstances had differed slightly in this case then the outcome may have been different.  The intricate facts of each case are vitally important and taking advice before undertaking transactions can allow the position to be considered and, perhaps corrected, in advance.

Inheritance Tax Series – Overseas Issues

A series of articles highlighting key areas that affect taxpayers and practitioners involved with inheritance tax and estates and identifying opportunities to mitigate inheritance tax.

Inheritance Tax – Overseas Issues

General Rules

Where a person is UK domiciled their estate will be subject to inheritance tax on their worldwide assets.

Therefore overseas assets such as foreign bank accounts, holiday homes etc. will be subject to inheritance tax in the UK.

Relief is given for foreign liabilities (for example an overseas mortgage) by deducting the amount of the liability from the value of non UK property.  Any excess can then be set off against UK property.

 Foreign Property – Deduction for Expenses

Where the estate includes overseas property, the personal representatives may incur additional expenses in connection with the disposal.

It is possible to claim a deduction for expenses of administering or selling overseas property up to a maximum of 5% of the value of all foreign property in the estate.

Thus, where the estate of a UK domiciled person includes a house in Spain worth £250,000, the personal representatives may claim a deduction for expenses of up to £12,500 (£250,000 x 5%), potentially saving inheritance tax of £5,000 (£12,500 x 40%).

Double Tax Relief

Where an estate is subject to inheritance tax in both the UK and another country on the same assets the estate may be subject to double tax.

The UK has double tax treaties for inheritance tax purposes with the Republic of Ireland, USA, South Africa, France, Netherlands, Sweden, Switzerland, Italy, India and Pakistan.

These double tax treaties set out the taxes that qualify for relief under the agreement, the taxing rights of each country in respect of different types of assets as well as the mechanism for double tax relief where inheritance tax is payable in both countries.

It is important that care is taken to review the appropriate double tax treaty carefully because the personal representatives will need to understand whether relief should be claimed in the UK or abroad.

Where inheritance tax is payable in the UK and a similar tax is payable in a country that does not have a double tax treaty with the UK, double tax credit relief should be available in relation to assets situated in the other country under the unilateral relief provisions.

For these purposes the location of the asset is determined in reference to UK law.

The amount of double tax relief under the unilateral provisions is limited to the lower of (i) the UK inheritance tax, or (ii) the foreign inheritance tax.

In cases where tax is payable in both the UK and another country in relation to an asset that is situated in a third country, or treated as situated in the UK under UK law and the other country under that country’s law, a proportion of the tax may be relieved in the UK.

Termination Payment Tribunal Case – PILON Was Contractual (Kayne Harrison v HMRC)

Termination payments, specifically a payment in lieu of notice, were considered in the recent First-tier tribunal case of Kayne Harrison v HM Revenue & Customs.

Mr Harrison had been dismissed on 16 February 2006 without written notice and had successfully won a small amount of compensation from an Employment tribunal.

Three days after he was dismissed, his employers made a termination payment, consisting of a payment in lieu of notice.  This termination payment was made in line with the terms of his employment contract.  Mr Harrison argued that as his position was terminated without written notice, the payment was not contractual as it had been made in circumstances outside of his contract.  He believed that the findings of the Employment tribunal backed up this belief.

The tribunal found that Mr Harrison’s interpretation of the Employment Tribunal was incorrect in that they found the payment in lieu of notice had been made in accordance with the contract.  Despite the issues raised at the Employment Tribunal, Mr Harrison’s employment had ended on 16 February 2006 and the payment had been made in accordance with his contract.

HMRC were therefore correct to argue that the payment was taxable and the tribunal dismissed Mr Harrison’s appeal.

Private residence relief – Daniel Regan v HMRC (TC02247) (PRR/PPR)

A private residence relief (PRR/PPR) case was recently heard by the first-tier tax tribunal.  The appellant, Mr Regan bought a house at the back of a club which was owned by a family company which he managed. The entertainment manager of the club also lived at the house.

In Christmas 1996, Mr Regan moved out of the property temporarily so that the entertainment manager’s wife’s family could stay.

At this time, Mr Regan and his new girlfriend (who later became his wife) spent most of their time at her flat.  Despite this, most of his belongings had remained at the house behind the club, which he also continued to use as his main postal address.

In 1998, Mr Regan and his girlfriend purchased a new house together and his parents purchased the house behind the club from him in 2000.

HMRC argued that private residence relief (PRR) was not available as Mr Regan had not been able to demonstrate sufficient permanence in his occupation of the property.  The tribunal found in favour of Mr Regan, stating that his occupation of his girlfriend’s flat did not have the required “settled quality” to detract from his occupation of the house. As he had moved out within 36 months of the sale of the property to his parents, relief was available.

Bank Employee is Taxed on Beneficial Mortgage – J Flanagan v HMRC (TC02161)

The First-Tier Tribunal has recently heard the case J Flanagan v HMRC (TC02161).

An employee of RBS plc took out a mortgage with his employer.  The terms of the mortgage were better than those available to normal RBS customers.

HMRC assessed Mr Flanagan with tax on a benefit in kind through the provision of a “Cheap Loan” by his employer (ITEPA s175), because the rate of interest was lower than the official rate determined by HMRC.

Mr Flanagan appealed on the basis that there were mortgages available in the open market with a lower interest rate than the official rate.

In upholding HMRC’s assessment the Judge had sympathy for the appellant but stated that under the rules tax was technically and correctly due.

Bank employees beware!

Changes Proposed to ESC A19

Under the current concession taxpayers that have outstanding tax are able to apply to use ESC A19. This concession writes off the amount owed if the taxpayer can show that HM Revenue & Customs failed to use information at their disposal in a timely manner.

Under the proposed changes taxpayers would be deemed to have a basic level of knowledge and understanding of their own tax affairs. Also, if the taxpayer believes there is an error relating to their tax affairs they would be expected to contact HM Revenue & Customs without delay.

This also brings into question whether there should be a time limit on using the concession as taxpayers have to take ‘personal responsibility’ in making sure their tax affairs are correct.

The proposals are currently under consultation and Eaves & Co are to provide a response as we have successfully assisted clients in claiming under ESC A19 on a number of occasions.

In practice these proposed changes would appear to make it more difficult for taxpayers to make a claim under concession ESC A19 as there is more onus on the taxpayer to make sure their affairs are correct.

Olympic Torches & Tax

Those who take part in the Olympic Torch relay can buy their Olympic Torch as a commemorative keepsake for £215 .

A number of Olympic Torches have been put up for sale on online auction websites, however torchbearers should be careful because where the sale proceeds are above £6,000 the sale will be a chargeable disposal for capital gains tax (CGT).

The amount of CGT will depend on whether the seller has already used their annual exemption (£10,600 for 2012/13) and the amount of their other income (18% rate of CGT for basic rate taxpayers and 28% for higher rate taxpayers).

Those planning to donate the proceeds to charity should be careful because the gain will still be chargeable to CGT although income tax relief may be available for the amount of the gift.

Research & Development (R&D) Project – The R&D Claim Process

A recent Eaves and Co project involved helping a client prepare a claim for their Research and Development (R&D) Expenditure. Small and medium companies are able to benefit from a deduction of 200% (2011/12) and 225% (2012/13) of the qualifying expenditure.

The initial stage in the process was determining whether the research and development undertaken qualifies for a claim for a deduction from their taxable profits. In order for the expenditure to qualify, the research and development undertaken must aim to solve a scientific or technological uncertainty and not just find evidence to support previous conclusions. We interviewed the individual who is responsible for R&D and formed a ‘product matrix’ of all the products worked on and why the work qualified as R&D.

Once it had been decided that the client’s research and development qualified for the deduction, Eaves and Co gathered the information required, for example expenditure on gas, water and electricity as well as staff costs and materials specifically relating to the research and development undertaken.

The next step involved determining whether the client would be classed as a large or small/medium company and calculating the tax reduction/saving that they would benefit from. This entailed applying the company in question to the legislation on R&D in areas such as the criteria for small and medium companies and the criteria surrounding the number of employees, and the annual turnover and balance sheet figures.

The final part of the project involved the preparation of the R&D calculations and the supporting paperwork to the claim. This also involved liaising with the company’s accounts department and auditors to ensure that the claim was reported in the correct manner.

On this occasion, Eaves & Co were able to help the client save nearly £60,000 in their R&D claim.