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Tax agents’ toolkits – these toolkits provide guidance on areas of error that HMRC frequently see in returns and set out the steps that you can take to reduce those errors.
The beginning of the calendar year has seen a flurry of enquiry letters issued by the HMRC Repayment Credibility Team. Typically the taxpayers receiving the letters have multiple streams of PAYE and self employment income, with losses from the self employment set against the PAYE income, giving rise to a repayment of some or all of the tax paid at source.
The letters are all generic in style with an extract repeated below:
What you need to do know
Please send us a full breakdown of the ‘Total Losses’ claimed on your Self Assessment tax return for the tax year ended 5 April 2015. This should include a breakdown of the expenditure claimed that generated the loss. We also need evidence of the payments to verify the claim made. This could be receipts, invoices or bank statements.
Please also confirm that throughout the trading period, the business has operated on a commercial basis with a view to making a profit.
If, during our check, you want to amend your tax return, please send us the details rather than making the amendment online. This is because if you were to make an amendment online during our check, we may then open another check into this amendment. If you do send us amended details to your tax return, we will make any changes to your Self Assessment when we close our check.
There is nothing new about this type of enquiry, indeed they have been common over the last few years, but what is different is that a central team are now dealing with the cases. Will this lead to a more consistent approach with one team dealing with these enquiries, or will it lead to a more critical strategy with a higher benchmark set for determining what is a commercially driven business?
As a general rule of thumb, taxpayers who are able to produce robust business and marketing plans, cashflow forecasts and other supporting research, to demonstrate there is a reasonable expectation of a profit at some point, are more likely to successfully defend any such enquiry.
Internal HMRC guidance to inspectors can be found in the Business Income Manual at BIM85705 and there is bank of case law which can also play a part in building a winning argument to put before HMRC.
The Abbey Tax Investigations Team is available to provide consultancy help to taxpayers subjected to one of these enquiries, either working alongside the existing accountant or directly representing the taxpayer involved. The team’s e mail address is email@example.com or, alternatively, please ring 0345 223 2727 and ask to speak to me.
Q: I have been working remotely on two separate projects in two separate locations for the same end client. The locations are within the same defined geographical area, yet sufficiently far away to be served by different airports. The first engagement lasted a year; the second has just begun and is also likely to last for a year. It is possible that there may be further project work in the second location. How should my travelling expenses be considered in light of the 24-month rule – does the second project effectively ‘reset the clock’ for the 24-month rule?
A: The relevant legislation in ITEPA 2003 s339 definitively states that a workplace can only be temporary if the attendance at that workplace is for a limited duration or for a temporary purpose. A workplace is excluded from being temporary if attendance is in the course of a period of continuous work for a period of more than 24 months.
If, at the outset, it was known that an engagement would last more than 24 months, whether that is evidenced in writing or not, there would be no deduction for the travel and subsistence. The legislation also refers to the individual spending at least 40% of their time at that workplace; we assume that to be the case here.
It is just possible that HMRC might seek to argue the issue on the grounds that the duties are defined by reference to a geographical area. If your contract is to supply services within a defined geographical area, then the whole of that geographical area is likely to be treated by HMRC as a permanent workplace.
However, what we have to concern ourselves with is how HMRC might interpret the legislation – the examples given on HMRC’s website at EIM32000 onwards can only be treated as guidance, nothing more – each case must be considered on its merits. This does mean that you also have the right to interpret the guidance, and as long as you have taken reasonable measures to do so, and can evidence this, then even if HMRC win their argument, there should be no penalty levied on any tax that might become due.
Whilst our response must be treated as an opinion based on the facts provided, there is no guarantee that an Inspector will agree; indeed, in this current environment of HMRC clamping down on travel and subsistence you can expect HMRC to take a very narrow view!
Our thoughts are as follows:
Scenario A – The engagement at Location 2 is known to last 24 months or longer
Assuming HMRC view Location 2 as another temporary work place, then, as noted above, if at the outset of the latest contract, it is known that the Location 2 engagement will last for more than 24 months, whether that is in writing or not, there would be no deduction for the travel and subsistence and you would only be able to claim for the first year at Location 1; i.e. the change in location is no longer relevant. Please note that it is at the point that you become aware that the engagement will last more than 24 months.
Scenario B – It was known that the engagement with the client would be for 24 months or longer irrespective of whether it was known that there would be a change of location.
If HMRC take the view that you knew at the outset that you were working for 24-months plus for the client, then the change in location is likely to be immaterial with HMRC arguing that the location was the geographical area. There is an argument to say that the travelling expenses between the two locations should be allowable with one of them being deemed the permanent location.
Scenario C – Assuming that HMRC are able to argue that the geographical area is the temporary workplace
If the geographical area is deemed to be the temporary workplace, then the clock will not reset and once the Location 2 is extended beyond 12 months or when you become aware that the second engagement will last long enough to mean that you have been working in the same geographical area for more than 24-months, there would be no further deduction for the travel and subsistence at that point.
Scenario D – The argument for ‘resetting the clock’
The basic principle is that a change in the location or the boundaries of a workplace will be recognised as a change of workplace provided that change makes a significant difference to the commuting journey.
The argument in your favour stems from HMRC’s guidance, which is that a journey to or from a temporary workplace has a substantial effect either on the journey that has to be made to get to work, and the cost of the journey. The question is whether the 30 mile difference between the two locations is enough for that to be significant when set against the overall journey from your home, which we assume is the location of your business. HMRC may try to argue that 30 miles is only a small portion of the overall journey.
An example of where the travel expenses can be claimed is found at EIM32300 on HMRC’s website and this cites the extra distance involved as being 10 miles or more each way:
An employee is a human resources manager who normally drives 9 miles to the office that is her permanent workplace. One day she has to visit a factory to discuss possible redundancies. The factory is 11 miles beyond her office. She drives the 20 miles to the factory along her ordinary commuting route and past her permanent workplace. The factory is a temporary workplace. The journey from home to the factory is along the same route as her ordinary commuting journey but is substantially longer. So it is not substantially ordinary commuting. She is entitled to mileage allowance relief.
However, as noted above, this is guidance and not written into the legislation.
Treat the clock as starting in 2013 and finishing when you knew the engagement at Location 2 will extend the engagement with this end client beyond 24 months.
‘Reset the clock’ if you believe that you can argue that a) you had no idea that further work would be offered to you in 2014; and b) that it is a completely different engagement.
HMRC’s objection might be that it is the same end client and because you are undertaking work within the framework of overall projects likely to last for a number of years, it was always likely that further work would be offered and that the engagements aren’t necessarily that different.
We are not saying that we agree with these arguments; just be prepared for them if you select Option 2. Our advice would be that if Option 2 is selected, you keep money aside in case you lose the argument.
As you can see from the above it is a very grey area and each case has to be looked at individually taking into account all the facts. Furthermore, no-one can guarantee that HMRC will not challenge the deductibility of the travel expenditure.
How will locum social workers operating through their own Personal Service Company (PSC) be affected by new intermediary reporting requirements under the amended agency legislation?
From August 2015, under Income Tax (Pay As You Earn) (Amendment No.2) Regulations 2015, the first reports from intermediaries (most commonly recruitment/employment agencies) will now fall due and must now advise HM Revenue & Customs (HMRC) of any workers who have been paid gross, which will usually be via their own PSC or an umbrella company (the individual is an employee of the umbrella company, but the agency is engaging with the umbrella not the individual).
If we focus on those individuals who have their own PSC, then agencies will be reporting details about the PSC and the individual because the agency will not have deducted PAYE. This applies to every sector – not just the social care sector – and no PSC engaged via an agency should escape these reporting requirements.
What this means is that HMRC will have a huge list of PSCs engaged in that typical chain of:
End client – Agency – PSC – Individual
Logic suggests that HMRC will have a list of PSCs where IR35 might apply to their engagement – and might is the key word.
HMRC’s state of the art analytical Connect system will, no doubt, be able to cross reference and narrow down the list into something more definable e.g. trades/sectors, turnover, dividend to salary ratios etc.
So, the premise that all PSCs are at greater risk is correct, but the issue for social workers, I believe, is whether many of them are operating outside of IR35.
The engager must have a significant right of control, in particular over the manner in which the work is done.
The judgement did determine that other components present must be consistent with a contract of service. Elements such as ownership of significant assets, financial risk and the opportunity to profit are not consistent with a contract of service and should also be taken into account where the three key factors do not provide a conclusive result.
The key questions which follow the key factors are:
Can the individual social worker send a substitute? I suspect that in most cases the answer is ‘No’ i.e. the social worker’s personal service is a requirement of the role.
Does the social worker have to accept work offered by the Department engaging them? The answer could be ‘No’, which would be a positive, but evidence of rejected work would probably be required to appease HMRC. Even if the social worker can decline work, there is still the issue of ‘mutuality within the engagement’ i.e. is there an obligation to complete any assignment once accepted? Please see the reference below to the Court of Appeal case of Prater v Cornwall County Council 2006.
Is the social worker being controlled? Unfortunately, with the introduction of the reporting requirements, control is now considered more widely as direction, supervision or control. Based on the wider application of the control test, it is possible that HMRC may conclude the social worker is controlled.
These comments are made without seeing any specific contracts or knowing the individual working practices of any particular social worker. However, if they resonate with you or any of your social worker clients, a contract review may be prudent because of IR35 as opposed to the new agency reporting requirements.
Prater v Cornwall County Council 2006
From the conclusion:
‘To sum up, the legal position between the Council and Mrs Prater was as follows.
(1) During that period 1988 to 1998 Mrs Prater had a number of work contracts with the Council. The issue was whether or not they were contracts of service. If they were, she enjoyed continuity of employment, notwithstanding the breaks between the contracts.
(2) Under the contracts Mrs Prater was engaged and was paid to teach individual pupils unable to attend school.
(3) There can be no doubt that, if she was engaged to teach the pupils in a class, collectively or individually, at school under a single continuous contract to teach, Mrs Prater would have been employed under a contract of service.
(4) It makes no difference to the legal position, in my view, that she was engaged to teach the pupils out of school on an individual basis under a number of separate contracts running concurrently or successively.
(5) Nor does it make any difference to the legal position that, after the end of each engagement, the Council was under no obligation to offer her another teaching engagement or that she was under no obligation to accept one. The important point is that, once a contract was entered into and while that contract continued, she was under an obligation to teach the pupil and the Council was under an obligation to pay her for teaching the pupil made available to her by the Council under that contract. That was all that was legally necessary to support the finding that each individual teaching engagement was a contract of service. Section 212 took care of the gaps between the individual contracts and secured continuity of employment for the purposes of the 1996 Act.’
If you would like to discuss any of the points raised in this article, then please ring 0845 223 2727 and ask to speak to Paul Mason.
Self Assessment (SA) tax returns are issued by HM Revenue & Customs (HMRC) to people who are self employed, either on their own or in a partnership, to directors of companies and to those people who have more complicated tax affairs. This latter group can include high net worth individuals, people with a large number of income sources from the UK and overseas, as well as pensioners who may have substantial savings and investments.
Certainly HMRC would expect to receive a tax return from you, if in the last year, you:
Were self employed
Were a company director, unless that role was for a non-profit organisation
Had an income in excess of £100,000
Had an income in excess of £50,000 and either you or your partner received Child Benefit
Had savings or investment income in excess of £10,000 before tax
Had untaxed income in excess of £2,500, perhaps from rent or other investments
Had taxable income from abroad
Lived abroad and had an income from the UK
Made a profit selling property, shares or other assets which were liable to Capital Gains Tax
Had work expenses in excess of £2,500.
HMRC has an online checker for people to find out whether they are required to complete a tax return. The checker can be accessed via this link http://abytx.co/doineedto
If a tax return is not issued, there is still an annual obligation to notify HMRC within 6 months of the end of the tax year in which the chargeability to tax arose i.e. by 5 October.
Chargeability usually arises when there has been a change in circumstances, which could include the commencement of a new business, sale proceeds from the disposal of a capital asset giving rise to Capital Gains Tax, the acquisition of a buy to let property or even if an individual simply becomes liable at a higher rate of tax and has savings.
It is important to remember to let HMRC know of any such changes because there are financial penalties for a failure to notify HMRC. The HMRC guidance on failure to notify penalties can be accessed via this link http://abytx.co/failuretonotify
If you receive a tax return from HMRC as part of the bulk issue in April and intend to send it back in a paper format, then it must reach HMRC by midnight on 31 October.
If you receive a tax return from HMRC as part of the bulk issue in April and intend to file it online, then it must reach HMRC by midnight on 31 January.
If HMRC write and ask you to complete a tax return after 31 July, the deadline moves to three months from the date of issue of the tax return.
There is also the lesser known filing deadline of 30 December, if you want HMRC to collect any tax owed through your tax code. Currently you can ask for this if you owe less than £3,000 and have sufficient PAYE income to code out and collect the debt.
The First-tier (Tax Chamber) Tribunal (‘FTT’) has decided in RKW Limited v HMRC  UKFTT 151 (TC) http://abytx.co/1ib3CJ2 that consideration payable by an individual in future instalments for subscribing for shares in an unconnected close company, as defined in section 414 Income and Corporation Taxes Act 1988 (‘ICTA’), is not a loan or debt within the meaning of section 419 ICTA (‘section 419’).
RKW Limited (‘RKW’), a close company, carried on a UK business described in the decision as ‘the provision of authentic table dancing and cafes’. RKW identified John Gray, a US citizen, as a potential new investor in RKW. He had extensive knowledge and experience of this business, but was not at that time connected to RKW or its shareholders. RKW and Mr Gray executed a shareholder agreement by which it was agreed that he would subscribe for shares in RKW for a consideration of over £2m payable in four annual instalments (the first payment being £500,000). None of these instalments was paid. HMRC assessed RKW to tax under section 419 on the basis that Mr Gray was a participator in RKW and had advanced over £2m to him. RKW appealed to the FTT. An alternative section 419 assessment was later made on RKW in relation to the £500,000 first instalment.
The ICTA close company provisions applied to the facts of this case. The relevant equivalent provisions are now contained in Corporation Tax Act 2010 (‘CTA’). Section 414(1) ICTA (see sections 439 and 442 CTA) defined a close company broadly as a UK resident company that was privately owned and controlled by five or fewer persons. Section 419(1) (see section 455(1), (2) and section 456(1) CTA) provided that, if a close company made a loan or advance to a participator, or a participator’s associate, otherwise than in the course of a lending business, the company was liable to a 25% corporation tax charge on the sum in question, refundable when the loan was repaid. Section 419(2) (See section 455(4) CTA) extended the meaning of loan to include where a person incurred a debt to the close company.
The parties’ contentions before the FTT
RKW contended that the extended meanings of ‘loan’ and ‘debt’ in section 419(2)(a) did not apply as Mr Gray had not incurred a debt to RKW. In the context of section 419 the word ‘debt’ does not extend to a liability to pay for shares by instalments on future dates and so no section 419 liability arose. Investing in a company is far removed from the purpose of section 419 and the mischief at which it is aimed (namely, a participator’s untaxed extraction of money from a close company).
HMRC contended that the words ‘loan’ and ‘debt’ in the context of section 419, have a wide meaning as the purpose of the section was to reduce the scope of tax avoidance involving close companies. Mr Gray became a debtor of RKW on entering into the shareholder agreement, the whole subscription price being a debt that was due and payable (albeit in the future on fixed instalments). They argued that an extraction can cover both an act and an omission, including forbearing to recover a debt and in any case there is nothing absurd in the notion of a person being both investor and debtor.
RKW contended in the alternative that the meaning of ‘debt’ is informed by relevant company law. Accordingly, when shares are issued for a subscription price payable in instalments, no debt arises until an instalment becomes due. The only liability under section 419 related to the first instalment of £500,000, which became payable one year after the shareholder agreement was executed.
HMRC contended that a subscriber ‘incurs a debt’ to an issuing company within the meaning of section 419(2)(a) where the shares are allotted fully paid and called up, and the subscription price is not paid immediately on allotment.
RKW contended that even if there was a debt for the purposes of section 419, Mr Gray was not a participator in RKW when that debt was incurred. It was in fact incurred in consequence of his share subscription.
HMRC contended that, where the subscription price becomes due and owing on entering into an agreement to subscribe for shares but the consideration is payable by instalments, the subscriber is a participator and incurs a debt within section 419(2). On signature of the agreement, Mr Gray simultaneously acquired in relation to RKW the status of participator and loan debtor.
Analysed objectively and in the context of the relevant mischief, there was no section 419 debt as Mr Gray was effectively an investor who owed RKW nothing. He had no liability to repay monies borrowed or owed. His liability was to honour an investment promise (a share subscription), not a share purchase. The subscription agreement referred to “fully issued”. Nothing in the terms relating to Mr Gray’s investment referred to “fully paid and called up”. In any event, the FTT thought that it probably would not realistically have been possible to extract assets or profits from the ‘impecunious’ RKW.
If HMRC were correct in saying there was a section 419 ‘debt’ or ‘loan’, tax would be payable on a truly arbitrary figure (the subscription price). If tax was payable under section 419, more or less tax would be payable depending on the amount invested by way of subscription. Tax would be payable on a figure which had no relevance in terms of extraction of funds from the company. The greater the subscription or investment the greater the tax, irrespective of whether the company had any assets or generated any profit. The FTT concluded that this would be illogical and could not be correct.
Mr Gray had secured control of RKW and perhaps could at some future date extract untaxed profits or value from RKW, but if that situation arose section 419 should then apply. Securing control of a close company is not within the contextual or purposive meaning of incurring a ‘debt’ under section 419.
As RKW succeeded under argument A, it was not necessary for the FTT to consider argument B. However, the FTT rejected HMRC’s contention, deciding that RKW could not sue on any such debt until the instalment became due and payable.
The use of the present tense in section 419 (‘is a participator’) means it does not include a prospective participator. Mr Gray was not a shareholder of RKW when he subscribed for the shares. He was therefore not then a participator (‘a person having a share or interest in the capital or income of the company’) within the meaning of section 417 ICTA.
HMRC is strongly of the view that section 419 applies on an issue of shares by a close company where a previously unconnected person subscribes for those shares in consideration of a subscription price payable in future instalments. This issue has been the subject of considerable debate among tax practitioners. While the better view appears to be that there is no debt/loan at that stage, a reasonable argument can be made to the contrary based on the extended meaning of loan/debt. However, it seems unarguable that the person subscribing for the shares could not have been a participator at the time of the share subscription.
Although this decision is not a binding precedent, it represents a welcome clarification of the relevant law. Interestingly, the FTT preferred a purposive/mischief approach to construction, distinguishing the ‘ordinary meaning’ approach adopted in Aspect Capital Limited v HMRC  UKFTT 430 (TC). It is likely that HMRC will appeal this decision to the Upper Tribunal.
The Transparent Benchmarking Team within HM Revenue & Customs (HMRC) has selected a number of trade sectors to test the use of ‘benchmarks’. The benchmarks provide businesses, within the chosen trade sector, with a guide to see whether the net profit rate they are achieving is comparable to their competitors and within the ‘parameters’ expected by HMRC.
As one of the selected trades, painters and decorators have started to receive letters telling them that HMRC has compared the tax returns submitted by all painters and decorators over the last three years. The turnover declared and expenses claimed on all of the returns have been used by HMRC to determine a ‘net profit ratio’. The net profit ratio benchmark range for painters and decorators has been calculated at between 59-79%, to reflect the fact that every business, even comparable businesses within the same sector, are run differently and have their own unique characteristics.
The letters go on to state that if the painter or decorators net profit ratio does not fall within the benchmark range, this could be down to two common reasons:
Numbers – have the right numbers been put in the right boxes?
Expenses – have any expenses been claimed by mistake or not claimed for?
However, the key question really is, what will HMRC do if a painter or decorator files a tax return which is outside the benchmark range, in other words achieving less than 59%? Is a full blown investigation the inevitable outcome?
Titled ‘Helping you complete your 2013-14 tax return’, the HMRC letters read word for word as follows:
Dear Mr Xxxxxx
Do you want to save time by avoiding unnecessary contact with us?
Do you want to know how your business compares to others in your trade?
Then we can help by using something called a benchmark, which is a guide you can use to help compare your business to others in your trade sector.
Why are we writing to you?
We are testing the use of benchmarks because we think it could help business owners to make sure that their Self Assessment returns are correct. If anything is wrong with your Self Assessment return, it may mean that you have to spend valuable time putting things right – instead of being able to get on with running your business.
Research in other countries has shown that telling businesses in the same trade how similar businesses are performing, can help them get their return right. We want to see if this works in the UK. To test it, we are looking at a small number of trade sectors. One of the trades we’ve chosen is painter and decorators and our records show that you are a painter and decorator.
What is the benchmark and how has it been created?
We’ve used information from returns from all painter and decorators for the past three years. We’ve taken the numbers for business income (turnover) and expenses and worked out a ratio from them. (We call this the ‘net profit ratio’).
Net profit is often called the ‘bottom line’ for business.
People in the same trade run their businesses differently, so we do not expect everyone to have the same net profit rate. Instead we are giving a range:
The net profit benchmark range for painters and decorators is 59 – 79 per cent.
How do we work out yours?
You can easily work out the net profit ratio for your business:
Step 1: Work out how much money your business has made for the financial year 2013-14 – this is your business income (turnover).
Step 2: Work out all the expenses you can properly claim and subtract this amount from the turnover. This will give you your net profit.
Step 3: You then take your net profit and divide it (/) by your turnover and then multiply it by 100 – This is your net profit ratio.
What should you do now?
When you are completing your Self Assessment return, use the steps above to work out the net profit ratio for your business and then see if it falls within the range of businesses like yours.
If you have a tax agent (e.g. accountant) please let them have a copy of this letter as soon as possible.
What if you are outside the benchmark range?
Don’t worry as there can be good reasons why your business might fall outside the range, for example if you are using the simplified expenses scheme.
However, if the net profit for your business doesn’t look right, it could be a sign that some of the figures on your Self Assessment return aren’t correct. There are two common reasons for this and we’ve listed these below:
1. Numbers – For example, have you put all the right numbers in the right boxes?
2. Expenses – For example, have you claimed all the expenses you are entitled to? Have you included any expenses by mistake? (such as private use, capital spend, your own wages.)
If you have checked and you are happy your figures are correct then you should submit your return as normal by the deadline.
Help and advice
You can find further information and definitions to help you complete your Self Assessment return on our website:
We have also set out examples of business expenditure and what can and cannot be claimed as expenses.
Transparent Benchmarking team
Some people may remember Eric Morecambe, during a classic comedy sketch with Andre Previn on the Morecambe and Wise show, saying ‘I’m playing all the right notes, but not necessarily in the right order.’
This could be argued as being very similar, with HMRC saying ‘ You’ve got all the right numbers, but not necessarily in the right boxes.’
Author: Guy Smith, Senior Tax Consultant on the ReSource Tax and VAT Consultancy Team.