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It’s early March and spring is in the air. The spring flowers are coming out into bloom – our garden is filled with snowdrops and daffodils. But then again last week we couldn’t see them because of snow! The start of spring though means not just the end of winter but also the end of one tax year and the start of another. This year, on the 6th April, though brings with it the start of a brand new tax – the dividend tax.
You may have seen lots of hype, but just what is it all about. For many of you David or I will already have had a chat, but we wanted to put a few thoughts down on paper for you!
Let’s have a brief look at what it’s all about.
What are the changes?
Change 1 –Grossing up of dividends is scrapped (believe it or not this little change is good news)
Currently all net dividends (this is same as the cash you receive) are grossed up by 100/90 before they are taxed. The 10% difference is a tax credit which is added to reflect the fact that the company paying the dividend has already paid corporation tax. Don’t worry if you don’t get this what it really means for most of us is that this ‘adjustment’ has the effect of reducing how much in terms of dividends taxpayers can really earn before they go into a higher tax band.
So for many company shareholder/directors the scrapping of this rule is good news as it
- Removes an area of tax which many tax payers find confusing as they grapple with gross and net dividends.
- It increases how much cash dividends they can take before they fall into a higher tax band.
Change 2 – Dividend Tax (This is the bad news for most Small & Micro business owner’s)
This new tax is applied to dividend income received in a year which is more than £5,000. The two groups of taxpayers who will be affected and therefore pay more tax in 2016/17 than they did in 2015/16 are:-
- Company directors who take a modest a salary and the rest of their income as dividends
- Taxpayers who have sizeable share portfolios which generate sizeable amounts of income
And when is an allowance not really an allowance?
Everyone will be entitled to a £5,000 tax free dividend allowance. This sounds very generous – after all its tax free. Well it’s not generous and that’s because it’s not really an allowance it’s a new 0% tax band has been created. The net result, is that it reduces a taxpayer’s basic rate tax band.
How much more tax could I pay?
Let’s have a look at the numbers (well I am an Accountant). This should make it easier to understand how the changes are likely to affect you!
The following table summarises the extra income tax which will be payable next year (2016/17) compared to this year (2015/16). Or put in simple terms for any Dividends you take from 6th April 2016 onwards!
|Cash Dividend||2015/16 Tax||2016/17 Tax||Increase|
The dividend tax is particularly punitive for the many family owned businesses where both the shares and income is split between both the husband and wife. In these cases the tax increases (as shown above) are doubled. So now coupled with increased operating costs in your business as a result of Auto Enrolment and the National Living Wage you can see why I am concerned that this is all too much for many small business owners. 2016 is the year of going backwards for many business owners’ in terms of PROFITABILITY unless they act now!
When will I be paying the extra tax for 2016/17?
Under the usual self-assessment rules then this extra tax would be payable in one lump sum payment by 31/1/2018. That gives taxpayers time to put some money aside each month and can budget accordingly.
It appears though that HMRC doesn’t want to wait that long for the extra tax. We understand that HMRC is in the process of amending tax codes for many company directors so that the lower ‘new’ code reflects the estimated amount of tax due on dividend income.
If you are a taxpayer where cashflow is challenging then this change will be bad news as you will be required an extra monthly tax payment to HMRC potentially as early as May this year. This doesn’t give much time to plan and budget.
How will it work?
Every taxpayer is notified of their tax code via a P2 (PAYE coding notice) and those affected the estimated amount of dividend tax will be shown within the notes.
Tip: If you get one of these tax coding notices it’s advisable to check the figures – an incorrect tax code could mean you unwittingly pay way too much or too little tax.
If you are unsure that the code is correct get in touch with your accountant.
What Can I do?
Everyone’s situation is different which I’m afraid mean the possible tax saving options that are available will also be different. That said here are a few ideas:-
Maximise the annual tax free dividend allowance
Everyone is entitled to the new £5,000 allowance. Married couples can spread their share portfolios in order to spread their dividend income and thereby use the whole of their allowance.
Use an ISA
ISA dividends are tax free and will be not be subject to the new dividend tax. You can transfer up to £15,240 worth of shares and investments into ISAs this year.
Maximise a spouse’s income tax allowance and tax band
Married couples should use the whole of their personal allowances and basic rate tax bands, where applicable, so that any dividends that paid to the spouse who pays the lowest rate of tax.
Invest in VCTs
VCT (Venture Capital Trust) are for taxpayers who are willing to take higher risks. Exactly like ISAs VCTs will give a taxpayer tax free dividends. Also like ISAs when the investment is sold the gain or profit is also tax free as it’s not subject to Capital Gains Tax.
Kim KMA Accountancy
This article is for general information only and no action should be taken, or refrained from, as a result of this information. Professional advice should be taken based on specific circumstances in each individual case. Whilst we endeavor to ensure that the information contained in this article is correct, no liability will be accepted by KMA Accountancy for damages of any kind arising from the contents of this communication, or for any action or decision taken as a result of using any such information.
Whilst consulting down in London for a client, I pop out quite frequently for lunch at a small local Cafe / ‘Wrap- bar’. The establishment is only about 8.5 square metres in size, and customers queue outside in long lines sometimes to get served. Obviously the wraps they serve up at lunch time are very good, but it the process that the proprietor has established, that has struck me as so novel.
FRS105 – The new Financial Reporting Standard for Small Entities (in draft) – (aka – FRED58 at present)
The Financial Reporting Council (FRC) has recently published FRED 58, being the Exposure Draft for FRS105, which in turn will become the new FRSSE (or replace the existing FRSSE, we believe).
Comments on the Exposure Draft was due by 30 April 2015, so if you missed it, we are afraid the the train has already left the station.
In a nutshell, we have some serious conceptual and philosophical concerns the FRED 58 does not address (and staff at the FRC at a recent event in London, prior to the General Election, could not provide assurances on).
Effectively FRS 105 (as it will be know), once it is ratified and adopted in parliament, will not be IFRS ‘Lite-lite‘, although it will have some of the overall principles of Fair Value Accounting contained within it.
At a fundamental level micro-entities (* as defined below) can choose to adopt either FRS 105 or FRS 102. However, be very careful in which one you choose, as the two standards have some fundamental differences contained within them, which, later down the line (as the proverbial can is kicked up the road), might cost you additional compliance fees and time and effort, if you need to convert from FRS 105 reporting to FRS 102 (New UK GAAP).
Our concern is this:
“The overall objective of all the initiatives (driven from Brussels) is HARMONISATION. The differences in approach between FRS 105 and FRS 102 do not underscore this fundamental principle!”
Hence, our health warning:
Think and consult carefully, before adopting either standard (FRS 102 or FRS 105) if you are a micro-entity caught in the compliance reporting net.
If you have any questions or concerns, please contact any Business Accountant in our network for more details.
*Definition of a micro-entity:
Micro-entities – HMRC guidance – May 2015 (as per the HMRC web site at the post’s publishing date)
Micro-entities are very small companies. Your company will be a micro-entity if it has any 2 of the following:
a turnover of £632,000 or less
£316,000 or less on its balance sheet
10 employees or less
If your company is a micro-entity, you can:
prepare simpler accounts that meet statutory minimum requirements
send only your balance sheet with less information to Companies House
benefit from the same exemptions available to small companies
You are the sole director in a company that undertakes some R&D. The annual profit is estimated at £140,000 for the year ended 31 March 2016 before taking into account the director’s remuneration.
You might think that the most tax-efficient remuneration package is £10,600 for 2015/16 to cover the personal allowance and then net dividends of £28,606 to take the director up to the basic rate band. You also need to consider whether the company can make an R&D relief claim and, if it can, how this might affect your decision.
Salary vs Dividends
If the director takes a typical remuneration package, then the net tax and NI savings over taking a salary of £39,206 would be £5,265, assuming the £2,000 employment allowance is available. This saving is made because dividends received within the basic rate band attract no further income tax plus no NI for the director or the company. This more than outweighs the additional corporation tax suffered on profits retained for dividends.
Taking R&D relief into account
From 1 April 2015 the R&D tax credit for SMEs increased from 225% to 230%. There is no R&D uplift on dividends received – only on salary. This means that paying a £39,206 salary would actually result in a saving over taking a small salary and dividends of £1,208.
What about a larger salary? In fact, if the client wanted to take out more than the basic rate band, then the salary may become even more tax efficient. A £70,000 salary would result in net tax/NI due of £1,366 after the R&D relief (assuming there was sufficient profit to offset the CT relief), whereas a salary of £10,600 and net dividends of £59,400 would result in net tax/NI of £5,883 – so the saving by taking a salary over dividends is £4,517.
HMRC will generally not accept 100% of a director’s salary costs within the R&D claim unless it can be clearly demonstrated that the director was exclusively involved in R&D activity.
While dividends don’t qualify as eligible staff costs for R&D claims, company pension contributions do. New pension freedoms make pension contributions a much more attractive option, so you might want to consider this as part of your remuneration package.
If a company makes pension contributions of £40,000 for the director and they spend 60% of their time on R&D, the R&D relief on this will be £55,200 (£40,000 x 60% x 230%). This means that the overall CT saving on the pension contribution will be £14,240 (((£40,000 x 40%) + £55,200) x 20%). As there’s no NI due on pension contributions, this is an even more efficient option than taking additional salary.
Get the best deal for yourself
For advice on the best split between salary and dividends or help with setting up a limited company and registering for VAT, please contact Alterledger.
Losses and profits
You might think that HMRC is being unfair in refusing loss relief, but if your activity is a hobby you won’t have to pay tax on profits either. This rule can be tricky as revealed in the case of P, when HMRC dismissed his claim for loss relief.
Trade or personal loss?
HMRC challenged P’s claim at a tribunal because in its view it related to non-business transactions and so was a personal financial loss and not one arising from a trade. Non-trading losses can’t be set against taxable income and it’s not just HMRC being difficult.
HMRC and tax specialists refer to the so-called “badges of trade” to decide if a trade exists. These tests were set out in a court judgment decades ago, but remain valid today. One of the tests to establish if a trade exists is that there must be an intention to make profit from a business. In P’s case the tribunal extended this test a little further.
Incapable of making a profit
P started two “businesses”, neither of which made a profit because, in the tribunal’s view, he was inexperienced and couldn’t devote enough time to them. Neither venture was capable of making a profit without P reducing the hours he spent in his main job. In essence P didn’t have the business acumen or time to devote to making his business profitable.
Putting the boot on the other foot
The ruling in P’s case is useful, not just for guidance on when losses are deductible, but for countering HMRC if it claims money you make from a hobby is taxable. Its view has always been that if you advertise your hobby in a newspaper or online you’re probably trading. But the tribunal’s judgment, supported by HMRC, dispelled that idea. If you don’t have the time or intention to carry on a trade, profit you make from isolated sales isn’t liable to income tax.
Turn your hobby into a business
For advice on converting your hobby to a profitable business, including help with setting up a limited company or registering for VAT, please contact Alterledger.
How to maximise your VAT reclaim
Plan ahead and reclaim everything
If you are setting up a business and can ahead, you can register for VAT from the date your business will start. For most traders there is not any restriction on the date the business can start, but for some professional services eg barristers and advocates, no trade exists until they qualify. To maximise the VAT to be reclaimed, the sole trader can register for VAT in advance of date of commencement, effective the date they are due to qualify. This means that the VAT registration will be in place from the 1st day of trading and all sales invoices can be issued as VAT invoices.
There are specific rules allowing pre-registration VAT to be reclaimed, but any claims to recover pre-registration VAT must relate to the same trade and made by the same person. A sole trader who incorporates the business is not the same legal person as the new company. Any VAT suffered by the (unregistered) sole trader can’t be claimed as pre-registration VAT by the new company.
Get help with registering
Your accountant will be able to register you for VAT and recommend the best scheme for you. It can take a few weeks for HMRC to process applications, but accountants who are registered as agents with HMRC are likely to have a quicker turnaround time. For advice on registering for VAT and setting up your invoices, please visit the Alterledger website.
Anyone who works with businesses is fully aware of how important accounting is for the success of a company. Yet many business owners have a negative attitude towards accounting. A high percentage of entrepreneurs see accounting as a necessary evil and often a hindrance to starting a new company.
How is that possible? Wasn’t accounting invented to help companies manage their business?
The IT industry has brought us computers and the ability to create software to automate bookkeeping. While there is no doubt that accounting software has been a great help, when we look at the usage of it, something is wrong. More than half of the businesses in the UK keep track of their finances by using a combination of spreadsheets and word processors rather than using accounting software. In an age where computing power is ubiquitous and virtually never too far from our pocket, we should be able to do better than this.
In 2013, international accounting software provider e-conomic was considering what its next generation accounting software should look like. And decided to take a different approach. What would happen if we created a piece of accounting software for people who had no knowledge of accounting? And what if we made the basic functions free for people to use? We hoped that it would make accounting approachable by virtually anybody.
That’s how the Debitoor invoicing and accounting software was born.
Introducing simple accounting to the world
Today, more than 33,000 people in the UK and almost 300,000 people worldwide have signed up for Debitoor and have given us the privilege of approaching accounting in a different way. Debitoor is used in more than 30 countries, from the UK to South Africa, from Colombia to Australia and New Zealand.
Debitoor is an accounting package for very small businesses. It allows them to manage their customers, create quotes and invoices. It allows them to register their purchases, deal with bank and payments and helps them report their VAT directly to HMRC at the click of a button. Debitoor helps those small companies manage their assets and keep track of what’s on their balance sheet in a very simple manner. Finally, Debitoor helps business owners collaborate with their accountants by allowing them to share their data with them.
Debitoor’s mission is to make accounting cool to work with. Two years after we started, the typical reaction we get from accountants is: “Wow, convincing my clients to use this is going to be super easy!”. We have captured the essence of Debitoor in this video.
Letting users shape accounting software
But what have we done to make this possible? The most important ingredient has been a clear focus. Our mission has always been to make accounting easy for small business owners who know very little about accounting.
Here are some of the key principles we followed to build the Debitoor invoicing and accounting software:
– Approachable: We have removed any obstacles to getting started. There is no setup needed, we do not ask questions, users can start on the free package, the program is ready to go.
– Natural: We have eliminated all technical lingo. You will not find the words “debit” and “credit” in Debitoor. The workflows in the program follow the natural flows of a user with no accounting knowledge and the program uses the typical words he’d use.
– Forgiving: People make mistakes; and accounting systems typically make it quite complicated to correct mistakes. In Debitoor, actions can be undone and mistakes can easily be corrected.
– Instructive: We assume people do not know much about accounting, so we have structured the entire program to let users learn along the way. This is not just functionality but it encompasses the entire packaging of the product.
– User-driven: In an open forum, users can give their feedback and suggest new features, vote for their own or others’ suggestions and influence the further development of the software. This transparency is super important for us to develop a truly user-driven program.
– Collaborative: Most of our users share their data with their accountants in order to get help with taxes, reporting and ensuring quality.
We also had the privilege of building the product with the technology which was available in 2013. This has huge benefits for our users because it allows us to provide them with a service which is reliable, improving at a fast pace and very secure. Having a modern architecture also ensures that Debitoor is very easy to connect to other popular cloud services.
Debitoor’s user base is very diverse as its appeal is quite broad. Many of our users are freelancers, artists, consultants, designers or other creative people, but we have also small artisans and shop keepers or owners of clinics and small distributors. They all have missions and purposes in their lives and we try to help them with their accounting.
Changing how an industry works
As with any change in technology, this brings great opportunities to the industry it affects. The introduction of new technology, however, takes a bit of time to mature. When television started to gain mass adoption in the 1950s, broadcasters used it as it was radio. The first shows had older men with glasses reading papers in front of a microphone. This was how it used to be with radio programs.
The availability of cloud software has created a set of providers who simply made traditional accounting software available on the internet. This, we believe, will change and we will see more and more software which is transformational in nature. That is what we are trying to do with Debitoor.
We are only at the beginning of this journey. The roadmap for Debitoor will focus on three main aspects:
1. Continue to add simple flows to support what today are very difficult accounting scenarios
2. Introduce more and more automation and intelligence to enable our users to do more with less knowledge
3. Strengthen the collaboration between users and their accountants by facilitating the sharing of data between them.
What will this mean for accountants and the accounting industry? This is what our users are telling us: They love doing their invoices and keeping track of their costs in Debitoor. It gives the nice feeling of being in control, it keeps them organized and allows them to focus on their business going forward.
At the same time, they also tell us that they need help from their accountants. They need help with taxes, they need help with reporting to authorities and a lot of them need a quality check from the experts. In addition, most of them need legal and financial advice on ad hoc issues they encounter in their life as entrepreneurs.
The biggest change for accountants is to be prepared to embrace the possibilities that technology gives us. Things like cloud storage and online applications will substitute manual processes, paper and data disks. Everything is now available via a web browser on your computer or on your phone.
In order to be successful, accountants will have focus on services that draw on their knowledge and experience and they will need to be prepared to serve their customers as they move towards those new technologies.
Increased access will not be limited to technology but also to services. This will also mean increased competition. The best thing an accountant can do is embrace change and be ahead of the curve, start small but start early. The customers are already going there.
Limited Liability Partnerships came under closer scrutiny in the Budget 2013. The aim is to target LLPs which use the structure to hide the employment relationship of the partners and those with Corporate partners who divert business profits to the corporate partners in order to avoid tax.
Although the following measures come in to play from 6th April this year, the anti-avoidance measures make it effective from 5th December 2013. This is to prevent partnerships changing their arrangements in order to avoid the new rules.
The two main areas of focus are salaried or fixed profit share partners which is referred to as disguised employment, and profit and loss sharing arrangements within mixed partnerships.
LLP partners with fixed profit share
HMRC believe that many members of an LLP should be taxed as employees, because they don’t see them is true partners.
A new test has been brought in which has three conditions. Where the member tested meets all three conditions then he or she must be treated as an employed salaried member and be brought within the PAYE system with tax and class I NIC applied to any earnings, which had previously been Taxed as profit share.
This also means that if a vehicle is provided for the members use by the partnership this will be taxed as a benefit in kind. As such the member will have to pay tax and NIC and the LLP will have to pay Class 1a NIC on the benefit.
HMRC does actually accept that employment tax rules are imposed on the individual but that in fact the individual has no employment rights. This is because he is not actually an employee for employment law purposes.
The test is as follows. The provision is triggered when all conditions A to C are met:
Condition A: The Member is performing services for the LLP in his capacity as a member of the partnership and it’s reasonable to expect as a result of these arrangements that any amounts paid to him in respect of his services will be wholly or substantially wholly a disguised salary. In other words if his reward package is comparable to that received by an employee, either a fixed salary or a variable bonus based on performance rather than profit share.
Condition B: The Member doesn’t have significant influence over the affairs of the partnership.
Condition C: The Member’s capital contribution to the LLP is less than 25% of the total amount of his disguised salary which would be expected to be paid in the relevant tax year by the LLP in respect of the members performance of services as a member. Normally the relevant time would be the beginning of the new tax year.
These tests must be reviewed each tax year.
Corporate LLP Members
This applies to partnerships who have members which are not subject to UK income tax for example this might be a limited company. The problem here is that HMRC believes these structures are used to avoid tax on a very large scale. Where for example an individual member introduces his Ltd company as a corporate member, and which then receives a profit share that would otherwise have been paid to the individual member. If the Member then has the power to enjoy the fund which had been paid to his company then:
- The individual member will be treated as a salaried member.
- The amount paid to the company will be treated as employment income paid to the individual member.
There are anti-avoidance rules are in place to catch anyone trying to put measures in place to counteract these new rules.
Economy in recovery
It now looks like the UK economy is in recovery. Even if this isn’t the case, when people think that times will get better they start to spend money again. With interest rates at historic low rates there is little incentive to stockpile cash in the bank for consumers and for entrepreneurs debt is relatively cheap to finance a new venture.
What’s your plan?
If you are starting a new business, it is important to work out what you will be selling, but to survive the early days of a start-up you will need good projections of your cash flow. As you grow you may need investment from banks or other third parties. Without good quality management accounts is it more difficult to persuade a potential investor to part with their cash.
Ask for help!
You can’t do everything on your own. Work out what your core activities are and how much time you need to do them. If you have time left over for ancillary activities then you are better completing these yourself too. The cost of hiring specialist help, whether it be an accountant, web designer or lawyer can seem to be too much for a nascent company to bear. However if you are spending so much time working out your accounts that you don’t have time for your customers you will cost yourself more in the long-term.
Business booming in Scotland
According to this article from the BBC more Scots are starting up their own business. Records from Companies House show that more than 340,000 companies were formed in Scotland last year. Glasgow and Edinburgh are at the forefront of the economic recovery in Scotland. If you have a good business idea, now could be the time to let that idea take form, especially if you have a service that supports other new businesses.
Give yourself a break
To give your business the best start, make sure you understand your finances. Don’t forget that if you registered a company you are obliged to file accounts with Companies House as well as HMRC. For more information on company formation see my blog here.
For support and advice on the finances of your business contact Alterledger or visit the website alterledger.com.
Starting a new business is always a challenge but there are some common financial mistakes that all start ups should avoid.
- Lack of Planning – Businesses normally start with a great idea but you need to have business model that works and to at least have a basic business plan and cash flow.
- Over Trading – this happens when a business expands too quickly for its working capital, when you start a new business its tempting to accept every order without considering whether you can have the resources and the cash to deliver.
- Wasted Marketing and Advertising – new businesses are an easy target for marketing companies but its important to stick to the essentials to start with, having a website, e mail and business cards are essential, magazine advertising and other things can be done as the business grows, in the early stages you are experimenting and finding your market so if you spend too much too soon you might promote the wrong things at the wrong price.
- Wrong Business Structure – Before you start your business get some advice from your accountant, its important to choose the right structure not just for tax reasons but also for investment and ownership.
- Wrong Staff – Choosing the right team is critical for business success, choose staff that have the right skills, the right attitude and are dedicated to the success of the business.
- Over Ambitious – All too often businesses plans are over ambitious with sales growing rapidly, often they prove to be unrealistic, when preparing a sales forecast start with your order book and be cautious in your assumptions.
- Overheads – Many businesses over spend on overheads for example renting premises too early, work from home, if you can, to minimise costs.
- Stock Problems – Buying the wrong stock, under or over stocking are also issues for start ups, try to adopt a ‘just in time’ stock policy.
- Getting Paid – A sale is only a sale if you get paid, any one can give things away, make sure you manage your clients and get paid on time.
- Competition – Keep an eye on your competitors, they will be watching you and responding to maintain their market share.