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Sole trader vs limited company?

Archive for the ‘Tax planning’ Category

Sole trader vs limited company?

Thursday, December 5th, 2019

When people are setting up a business, one of the first questions they have to grapple with is what legal structure they are going to trade under – sole trader, limited company or partnership.

If you’re one of our clients, you will already have made this decision but we thought it would be useful to give a quick outline of the differences.  

Sole trader

Being a sole trader is the most popular legal structure. Approximately 3.4 million sole proprietorships were created in 2017 and they accounted for 60% of small businesses in the UK. 

On the plus side, there are no set up costs and it’s very simple to get up and running. The only requirement is to inform HMRC by 5th Oct of your business’ second tax year. There is very little paperwork and you don’t have to have any dealings with Companies House. None of your information is held on the public record.    

As a sole trader, however, you are completely responsible for your business and its finances. You need to be aware that if your business goes bust or you have any business debts, your personal finances and assets could be in danger. Legally, your liability is unlimited.

It’s advisable, therefore, to take out small business insurance policies. This way you can avoid getting sued personally should there be any legal disputes. Remember, the buck stops with you! 

You and your business are treated as a single entity, which is also significant for tax purposes. You will have to pay tax on the profits that are above your personal tax allowance (£12,500 for the 2019/20 tax year). This is calculated through the self-assessment system and you will also pay Class 2 and Class 4 NICs.

Being a sole trader is thought to be less tax efficient than being a limited company as there is less opportunity for tax planning via the self-assessment system. 

Limited company

The second most popular legal structure is a limited company of which there were 1.9 million in 2017. There is a certain amount of paperwork required and you need to deal with Companies House but it is relatively straightforward. Note that your company details will be on public record.   

The main advantage of having a limited company is that you have limited personal liability should something go wrong. The business is treated as a separate entity from its owners so your own assets are protected.    

Despite the higher dividend taxes that were introduced in 2016, a limited company is still  considered to be more tax efficient. The company will pay corporation tax and dividend tax and employer’s Class 1 NICs on salaries, while staff pay employees’ Class 1 NICs on salaries. Under the limited company structure, there are more possibilities for tax planning by delaying dividends, for example, until a future tax year to minimise the tax liability. 

One of the disadvantages, though, is that you are obliged to prepare annual accounts which need to be filed with Companies House. You also need to file a full set of corporate tax accounts for HMRC. As a limited company, it’s advisable to use an accountant to make sure the accounts are done thoroughly.

In our article next month, ‘Do you need an accountant?’, we’ll be looking at this in more detail.  In the meantime, if you know anyone who has any questions about the right company structure for them, we’re always happy to have a chat.    

Is inheritance tax for the chop?

Wednesday, November 13th, 2019

Inheritance tax is deeply unpopular, there’s no denying it. According to a 2015 YouGov poll, 59 per cent of the population think it’s unfair. 

So whichever party is in power after the Election, it’s likely they will include it as one of the taxes to be reviewed.    

Indeed, at the Tory party conference in September, the Chancellor, Sajid Javid, went so far as to hint he was considering scrapping inheritance tax altogether. He is thought to be uneasy that revenue from the tax reached an unprecedented £5.4 billion in 2018-19; a figure made even more noteworthy when only 4-5 per cent of UK estates are liable for inheritance tax.    

Politicians have protested against the tax for many years – and not just in the UK. Way back in 2007, George Osborne proposed that the threshold should be raised to £1 million. In the US, the Republicans under George W Bush gradually reduced inheritance tax until it was abolished altogether for a temporary period in 2010. As for the current day, Donald Trump has doubled the threshold from $5.5m to $11.2m. Other countries that have eliminated the tax altogether include Sweden and Norway, India, Canada and Austria.     

Inheritance tax is thought to be unjust, sometimes even referred to as the ‘death tax’, because it is deemed to be a form of double taxation. As Sajid Javid put it, “I do think when people have paid taxes already through work or through investments — capital gains and other taxes — there is a real issue with then asking them to, on that income, pay taxes all over again.” 

But it’s not the only instance of double taxation in everyday life. For example, we all pay VAT on goods with income that has already been taxed. What’s more, it is the bequeathed estate that is taxed, not the person. The tax (at a rate of 40 per cent) only kicks in on estates above £325,0000 or £650,00 for a couple, with the relatively new nil rate band allowance enabling property up to £1million to be transferred.   

Those who defend a progressive inheritance tax system do so in the interests of equality of opportunity. They believe it prevents privilege simply being transferred from one generation to the next.  

It seems likely, however, that political parties on each side of the spectrum will propose an alternative to the current rules. Whatever is introduced, a simplified system would be welcome. The Institute for Public Policy Research (IPPR) has put forward a solution which would abolish the tax and replace it with a lifetime donee-based gift tax. This new tax would be due on any gifts received by an individual over a lifetime allowance of £125,000, at the same rate as income tax, but gifts between partners would be exempt. 

The Resolution Foundation estimate this would raise £15 bn in 2020/21, £9.2 bn more than the existing system, making it an effective way to replace the current £5.4 bn.   

Watch this space to see how this this particularly contentious hot potato is handled by whoever is in power next.

Help to Buy ISA deadline is looming

Wednesday, October 2nd, 2019

After 30th November 2019, potential first-time buyers will no longer be able to apply for a new Help to Buy ISA.   

Savers who already have an account will be able to keep saving into it until 30th November 2029, regardless of when the ISA was opened, but accounts will close to additional contributions after that date. 

What is the Help to Buy ISA?   

The Help to Buy ISA was introduced to help first-time buyers over the age of 16. Individuals receive a bonus of 25% of their savings when it comes to purchasing a property, up to a value of £3,000. They can put £1,200 into the ISA in the first month, while subsequent payments are limited to £200 a month. The final criteria is that the property purchase cannot exceed £250,000 (£450,000 for London) if the buyer wants to receive the 25% boost. 

How does the Lifetime ISA differ?

The Help to Buy ISA is not the only option available. The Lifetime ISA is designed to help people aged between 18 and 40 to save towards their first home or for later life. The Government will again give a bonus worth 25% of what is paid in, up to a maximum of £4,000 per year. Savers can then receive a maximum of £1,000 per year as a government bonus. This can be used to buy a home worth up to £450,000 anywhere in the country. 

Both ISAs can be helpful when it comes to saving for a first-time property purchase, although there are some marked differences between the two. 

The Lifetime ISA rules mean that savers have to wait at least a year before they can use it to buy a home. With the Help to Buy ISA, individuals have to have saved £1,600 before they can claim the minimum government bonus of £400 but this can be done over a period of three months: £1,200 in the first month followed by two subsequent deposits of £200 in the next two months. 

It is possible to spread deposits across multiple ISAs. However, the maximum that can currently be saved in ISAs is £20,000 for the 2019-2020 tax year. 

Helping your children get their first house 

Given the struggles the younger generation face to get on the property ladder today, you may be wondering the best way to give financial support. If you’re considering giving your child enough money for a deposit, there are no immediate tax implications. You can give as much money as you like to your children tax free, but if you were to pass away within seven years of the gift, they could be faced with an inheritance tax bill if your estate was worth more than £325,000. You can gift up to £3,000 a year without paying inheritance tax.            

If your children or grandchildren are interested in taking out a Help to Buy ISA, encourage them to do so as soon as possible before time runs out. If you would like to know more about the options around gifting money to your children to help with a deposit on a house, don’t hesitate to get in touch.  

Own a second property? Look out for Capital Gains Tax changes.

Wednesday, September 25th, 2019

There have been several changes relating to Capital Gains Tax (CGT) over the past few years. The coming years are set to bring more. Here’s our summary of some of the more important changes coming that might be coming into effect from April 2020. 

If you are thinking about selling a residential property in the next year or two, you need to know about proposed changes to the capital gains tax rules for disposals from April 6th 2020. 

If you only own one property and have always lived there, you should not be affected. However, if you own more than one property or you moved out of your only property for a period of time, you might face a capital gains tax bill. 

The two main changes you should be aware of are: 

Final period exemption 

The last period of ownership counting towards private residence relief will be reduced from 18 months to just nine. Currently, the final period exemption allows individuals a period of grace to sell their home after they have moved out. However, the government feels that individuals with multiple residences have been taking advantage, hence the reduction.   

Lettings relief

Lettings relief is set to be removed, unless you live in the property with the tenant. For UK property, HMRC must be notified and tax paid 30 days after completion rather than the January following the end of the tax year in which the disposal took place. Failure to pay on time will result in HMRC imposing interest and potential penalties. 

With no transitional measures in place, this means that higher-rate taxpayers previously expecting to benefit from the maximum potential relief of £40,000 could be lumped with £11,200 extra tax overnight. 

Here’s an example of how the new taxes could influence a sale:

Steve, a higher rate taxpayer, bought a flat in April 2009 for £100,000. He lived there for 6 years until April 2015 before moving out to live with his partner. He let the flat until 2020 when he sold it for £300,000. The sale was completed on 4th June 2020. 

If the contracts were to be exchanged before the April 2020 changes, a CGT of £6,618 would be due. However, after the deadline a CGT of £21,636 would be due, payable seven months earlier – this is due to there being a lower period of private residence relief and a lack of lettings relief. 

The next steps

The two above changes are set to be enacted as part of the 2020 Finance Act and at the moment are not definite. The consultation to these steps closed on 5th September 2019. Assuming that draft provisions reach the Finance Bill 2019-20, we will have to see if any changes are made to either after it is debated in Parliament. 

IR35 reforms: what you need to know

Wednesday, August 21st, 2019

Changes to  IR35 legislation are coming into effect in April 2020. IR35 legislation is designed to target “disguised employment” between firms and freelancers. This is where a company hires freelancers and contractors to undertake work, yet they are effectively employees of the company. It also affects freelancers who operate as sole traders or limited companies. The change in 2020 shifts the onus onto employers in relation to proving the contractor’s self-employed status. 

Who will be hit the most by the IR35 changes?

Many industries rely heavily on freelance workers. The trade off is simple – the more freelancers operating in a sector, the heavier the effect. In a document published in 2018, HMRC predicted that 90% of freelancers who fall within IR35 are not complying with the existing IR35 rules. It’s clear that from April 2020, private sector businesses will need to do more to comply with the legislation.

What are the critics saying?

The general view is that the reforms will increase burdens and costs on businesses during a time of uncertainty and change, whilst also having to comply with many other acts of legislation that are evolving in all areas. 

The fact that HMRC have lost a number of tax tribunal cases surrounding IR35 also illustrates the point that there is a possibility for different conclusions to be reached on the same facts and for tribunals to even take opposing views against HMRC. 

So, as we can see, the influences of IR35 are not quite as definitive as HMRC would like. 

How can a firm protect themselves? 

HMRC has a tool named CEST that determines whether an individual should be classed as employed or self-employed for tax purposes although concerns have been raised around the tool due to its rate of accuracy. HMRC says that the tool arrives to a conclusion 85% of the time, leaving 15% of cases pending further investigation. 

There has even been debate between HMRC and professionals around the validity of those percentages. This is further highlighted by a number of high profile cases involving television hosts and broadcastersthat have gone against HMRC. 

Here are a few extra tips to make sure your firm is compliant:

  • Develop a robust process for recording the use of freelancers centrally. 
  • Determine how those contracts are being carried out. 
  • Use CEST as a starting point. CEST can be very black and white, however, so it’s best to also develop a back-up process. 
  • Identify who IR35 will apply to and make sure they’re trained to comply. 
  • Monitor each freelancer’s status and re-run status determinations periodically (every 6 months is a good rule of thumb). 
  • Ensure that there is an appropriately drafted contract for each engagement which reflects the working arrangements and status determination. This will give the business the right to deduct PAYE and employer NICs from the fees if required. 
  • Decide which freelancers are critical to the business and for whom the business is prepared to pay extra due to IR35. 
  • Consider looking into business processes to determine if any changes are required. 

With over 1.4 million British freelancers working across all sectors, IR35 is set to affect many working relationships all over the country. Making sure your firm is compliant with the changing legislation is critical to avoiding any HMRC investigations.

For more expertise on changing legislation in the world of tax, don’t hesitate to get in contact. We’re here to help.

Making Tax Digital: are you onboard?

Wednesday, July 17th, 2019

A survey of small to medium-sized businesses, conducted by the Independent, has found that 11% of UK companies are unaware of new ‘making tax digital’ requirements.

As of 1st April, more than one million firms with annual taxable income over £85,000 are now required by law to submit VAT returns online. The same rules will then apply to trusts, local authorities, not-for-profits and public corporations from October. This is all part of HMRC’s new Making Tax Digital (MTD) initiative.

Of all the businesses leaders who responded to the survey, 46% of those who believed they were compliant with the new rules were found not to be, whilst 25% of compliant companies believed they were underprepared. 

HMRC have been quoted to be taking a “light touch” approach towards penalties during the first year of the law’s implementation. However, this is only where they believe businesses are doing their best to comply. 

Only 13% of respondents said that moving to MTD was more time consuming than they thought it would be. Showing that the government’s plans to slow the pace of mandation might be working. MTD will not be mandated for taxes other than VAT until at least April 2020. Further to this, the government announced in March that any new taxes or businesses will not have to worry about the legislation until 2020. 

Businesses also need to keep digital records from the start of their accounting period using MTD-compatible software. It’s best to do some research into which software may be best for you, as many providers offer extra benefits that might be of help. The government has even provided a handy search tool to help businesses find the right MTD-compatible software to suit their needs.

Rules for MTD VAT rules can be found here

For more information on the government’s MTD initiative and how to best prepare yourselves for the new era of digital taxation,  get in touch. 

“UK Tax system is unfair,” say small businesses

Wednesday, May 15th, 2019

The British Chamber of Commerce (BCC) conducted a tax survey throughout January and February of 2019 that produced some interesting findings. The survey covered more than 1,000 businesses across the UK, 96 per cent of which were SMEs with fewer than 250 employees; 68 per cent of the businesses were in the service sector and 32 per cent in manufacturing.

Undertaken to discover how fair respondents believed the UK tax system to be in a number of different situations, the results show that faith in the integrity of the system aren’t exactly high. 58 per cent of respondents felt that businesses like theirs were not treated fairly by the tax regime. 6 per cent of respondents did not believe that tax rules are applied fairly across all sizes of business by HMRC. Smaller businesses are more likely to hold that view, at 70 per cent, but it’s still the view held by the majority of medium and large businesses, at 59 per cent.

When asked whether they agree that HMRC applies tax rules fairly regardless of where a business is based geographically, 64 per cent of respondents did not agree. The trend of smaller businesses being more likely to feel this way continues, with 67 per cent of small businesses believing this, as opposed to 59 per cent of medium and large.

It isn’t just how fairly the rules were applied that come under fire in the results of this survey, however. The quality of service that the HMRC provides, and the support they offer to ensure that businesses remain compliant, is considered insufficient by 51 per cent of small businesses. This figure still sits at 42 per cent for medium and larger companies, with an overall average of 49 per cent of respondents finding it unsatisfactory.

As the tax system becomes ever more complex, firms are suggesting that sufficient support needs to be provided to ensure that they can keep up with regulations and remain compliant. The BCC are taking this call one step further, and pushing for the HMRC to take action by providing the same level of investment into support and tax advice for businesses as it puts into tax avoidance work.

Head of Economics at the BCC, Suren Thiru, sees it like this; “HMRC must step up efforts to provide better support to smaller businesses to get their tax right, rather than simply pursuing and enforcing penalties. This should include matching investment in frontline HMRC help towards SMEs, with their work on non-compliance and tax evasion. More also needs to be done to address the escalating burden of upfront costs and taxes to provide firms with much-needed headroom to get on and invest, train their staff, and compete on the global stage.”

6 bad habits to avoid during retirement

Wednesday, May 8th, 2019

Planning for retirement can be complicated, as anyone approaching the end of their working life will tell you. However, navigating the myriad of choices, both financially and socially, doesn’t have to be such an enigma. Here are a few tips to help you avoid common bad habits that retirees often fall into:

1. Spending your pension fund money

Yes, that’s right. If you delay spending your pension and spend other available cash and investments first, you could keep your money safe from the taxman. Not spending your pension fund money until you have to may also help the beneficiaries of your estate avoid a large inheritance tax bill.

2. Taking the full brunt of inheritance tax

Inheritance tax can cost your loved ones vast sums if you were to pass away. There are plenty of ways to protect them from losing a large portion of your estate. Strategies such as making gifts or leaving assets to your spouse are an effective way to avoid the tax, among other valuable strategies.

3. Failing to have a plan

Many retirees have multiple avenues of income to provide for them during retirement. Making the most out of those streams of revenue is key to a stress free retirement, as unwise investment or poor planning can lead to unnecessary worries. We recommend contacting a financial adviser in order to set out a plan that’ll let you focus less on worrying about income and more on enjoying your well-earned retirement.

4. Not taking advantage of the discounts

There is an absolute boatload of price slashes available to retirees over a certain age. This ranges from discounts on train fares to reduced prices of cinema tickets. We recommend that all pensioners takes full advantage of these discounts as every penny saved provides more financial security for yourself and your loved ones.

5. Thinking property is the only asset worth having

Property can be a valuable source of retirement revenue, but it’s not the only way to create more income. Property can often incur maintenance expenses for landlords and take up time to resolve that could be spent making the most out of your retirement (though there are many pros and cons to the pension vs property discussion).

6. Buying into scams

When you retire, it seems that all kinds of people come crawling out of the woodwork to give you a “great” investment opportunity or insurance policy. Tactics can include contact out of the blue with promises of high / guaranteed returns and pressure to act quickly. The pensions regulator has a comprehensive pensions scam guide that’s definitely worth a read.

Alleviating your inheritance tax bill

Wednesday, April 10th, 2019

Inheritance tax (IHT) can be an incredibly punitive tax on your estate. However, by making the right choices, you can vastly reduce the amount of your estate liable for IHT.

While other tax free allowances, such as the ISA allowance, have risen in recent years, the IHT threshold has remained stagnant. Since April 2009, the individual allowance has remained at £325,000. Anything above this is taxed at 40%. Research from Hargreaves Lansdown suggests that had the threshold kept pace with inflation since 2009, it would now stand at £436,566. Here are some ways you can mitigate the amount of your estate the taxman takes when you die.

Spend

This is the simplest way to reduce the size of your estate. If you spend money on yourself, it’s not considered part of your estate for IHT purposes when you die. However, things you gift to members of your family or friends can become liable for IHT.

Gifts

As we previously mentioned, in some cases gifts can be liable to IHT. Gifts made to an individual become exempt from IHT only if they are made seven years before you die.

If you die within seven years of making the gift, the value of any gift that lies outside of your £325,000 tax free allowance is taxed according to a sliding scale. Gifts made less than three years before you die are taxed at 40%. This reduces to 8% within six to seven years after your death.

The annual gifting allowance is £3,000, while you can also make small gifts of £250 per person. Gifts between spouses and civil partners are always exempt from inheritance tax, providing that they were born in the UK. If they weren’t, there may be limits.

Trusts are sometimes used to control how the gift is spent by the recipient. This means you can choose what the money goes towards, as well as when they can access it. Other common ways of gifting are contributing towards a Junior ISA, helping with education fees or contributing towards a deposit on a property.

Investing

Investing in certain types of stocks can be a good way of reducing your liability.

AIM stocks – invested in smaller companies – count as part of your estate, but are taxed at only 0% after a period of time. These assets become exempt from IHT after they have been held for two years rather than seven. If you’re interested in investing in AIM stocks it’s worth doing your research to make sure they’re the right financial decision for you.

If you’d like to know how you can begin to reduce your IHT liability, it’s worth seeking independent financial advice. This will enable you to tailor an estate plan right for you.

The perks of saving into a Junior ISA

Wednesday, March 20th, 2019

There are so many factors for a parent to consider in doing their best to make sure their children are prepared for the world when they reach adulthood. A lot of those things will be out of your control, but one thing you can consider that could make a real difference is investing into a Junior ISA. If you start early you could accumulate a pot of over £40,000; that’s a birthday present that no 18 year old would be disappointed with.

Entering adulthood with that level of finances comes with life changing opportunities and great freedom of choice. Depending on their priorities, your child could put down a deposit on a property, start a business, pay for training or tuition fees, or even travel the world to their heart’s content.

On April 6th 2019, the amount that can be saved annually into a Junior ISA or Child Trust Fund account will increase from £4,260 to £4,368. Just like an adult ISA, your contributions are free from both income and capital gains tax and often come with relatively high interest rates. For example, Coventry Building Society offer an adult ISA with an interest rate of 2.3% per annum, whereas their equivalent Junior Cash ISA comes with a 3.6% per annum interest rate. Junior ISAs are easy to set up and easy to manage: as long as the child lives in the UK and is under the age of 18, their parent or legal guardian can open the ISA on their behalf. On their 18th birthday, the account will become an adult ISA and the child will gain access to the funds.

Both Junior Cash ISAs and Junior Stocks and Shares ISAs are available, and you can even opt for both, but your annual limit will remain the same across both ISAs. When making that decision there are a few considerations to make; cash investments over a long period of time are unlikely to overtake the cost of inflation but come at a lower risk than their stocks and shares equivalent. With a Junior ISA, however, you can benefit from a long term investment horizon. Although the stock market comes with a level of volatility, you can ride out some of the dips and peaks over a long period. Combined with good diversification, it’s possible to mitigate a fair amount of risk.

Taking a look at potential gains, had you invested £100 a month into the stock market for the last 18 years, figures from investment platform Charles Stanley suggests that a basic UK tracker fund would have built you a pot worth £39,313. In comparison, had you saved the same amount into cash accounts, you’d be closer to £24,000, a considerable difference of nearly £16,000.

With this latest hike in the saving allowance, it’s time to make the most of Junior ISAs and prepare to swap bedtime reading from Peter Rabbit and Hungry Caterpillar to stories of how a stocks and shares portfolio can secure your child’s future.