The Fizz! Blog

Selling your business?

In the current economic climate, it's unlikely that too many people are selling their businesses - at least not for a good price - but here's something to think about anyway.

A new system has been introduced recently for calculating the penalties due when an individual or business underpays its tax.  Among other factors, the penalty will be reduced if the taxpayer co-operates with the authorities.

This raises an interesting problem when a company is sold to a new owner.  The sale contract will almost always include a clause requiring the old owners to suffer the cost if it subsequently turns out that the company has underpaid its tax under their stewardship.  However, the exact amount that's due will depend upon how helpful the new owners are to the taxman when the problem is uncovered.  And, since the new owners aren't going to have pay the tax, there's absolutely no reason at all for them to be helpful in the slightest!

Vendors would be well advised to have the sale contract require the new owners to do all they can to mitigate any tax penalties.

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As I wrote last year, filing penalties for accounts filed late at Companies House are increasing.

At present, a private limited company filing accounts up to three months late faces a penalty of £100, which rises to £250 for up to six months late. From 1 February 2009 the harsher penalties of the new Act will apply - there will be a £150 penalty for accounts filed up to one month late, rising to £375 for up to three months late and £750 for up to six months late.

Well, those new penalties come in at the end of this month.

On top of that, there's another increase in penalties as well as the basic changes above.  For accounts covering periods starting 6 April 2008 or later (in most cases, this means accounts for years ending 31 March 2009 and later), if it's the second year you've been late with your accounts, the penalty is doubled.

So, if you file your March 2008 accounts in March 2009 (i.e. two months late), under the old regime that would have been a £100 penalty, but now it's £375.  If you then file your March 2009 accounts in March 2010, what would have been another £100 under the old rules is now a £750 fine - it's your second year filing late, so the already increased fine is doubled.  What was a total cost of £200 is now a total cost of £1,125.

I still think this is a good change overall.  If a company's directors cannot prepare and file its accounts within ten months (nine before long) of the year-end, there's a problem somewhere, and it isn't at Companies House.  But if you've got a March 2008 year-end and haven't yet done your accounts - get your skates on!

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IR35 - yet another consideration

If you have no interest in the increasingly convoluted detail of IR35, look away now!

A further issue that has come out of the Dragonfly case concerns the concept of "upper" and "lower" contracts.

In that earlier post I explained that:

IR35 is a rule that says that if an individual is working for another entity doing what is, to all intents and purposes, a job, then, even if the individual forms a limited company which sits between him and that other entity, then tax and National Insurance must be paid as if the individual were are an employee of the entity.  In other words, the individual loses the tax benefits of having their own limited company, and suffers the higher tax burden of an employee.

The central point in the Dragonfly was a "substitution clause" in a contract - a commonly used device that states that the individual can send someone else to do the work if they want.  This is a good pointer that the relationship is not a job - if you're an employee, you can't just send someone else in to work to do your job for you, generally.  However, in the case of Dragonfly, the end customer essentially told the court "Well, yes, the contract says that, but in reality he has to come in and do the work himself, and he knows that".  So the clause was set aside as it didn't actually reflect the real relationship.

So, the end user of the contractor's services can tell the Revenue that the substitution clause is, as far as they are concerned, a non-starter, causing the contractor problems.

But there's a further problem.

In many such engagements there are actually two contracts.  The first one (the lower contract) is between the contractor and an agency that places contractors.  The second (the upper contract) is between the agency and the end user.  It's that latter, upper contract that the Revenue will look at to try and establish the nature of the contractor's engagement with the end user - that's reasonable, because it's what the contractor is required to do for the end user that determines their IR35 status.

The problem is that, in all likelihood, the contractor will never see that contract.  Not only that, but, because of commercial confidentiality, it's unlikely that they'll be allowed to.  So you can find yourself in a situation where the end user's contract with the agency leads to your paying extra tax, without you ever being able to find what it is that's in the contract.  Maybe there's a substitution clause, maybe there isn't.  Who knows what's in there.  An absolutely impossible situation for a contractor.

The one ray of sunshine in all this is, given that they are laying off staff at a rate of knots, it's unlikely that the Revenue will be able to review the status of more than a handful of contractors.

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Starting them young

Happy New Year everyone!

An interesting tax case from the summer.

The main taxpayer in the case of 'Peter Eley Partnership v HMRC' had, for many years, been a sole trader.  He had submitted tax returns and paid tax on that basis.  One year, however, he claimed that he had three new business partners.  Therefore he intended to pay tax on only a quarter of the profits of the business.  The other partners would pay tax on their respective 25% shares.

Who were the partners?  They were his grandchildren, aged ten, nine and two.  Unsurprisingly, they had no other income - pocket money is not taxable - and their share of the profits came within their 0% personal allowance.  So their tax bills would be nil.

Equally unsurprisingly, the taxman wasn't too happy with this.  He didn't really believe that the toddler was actively contributing to the business.  He had a suspicion that the whole thing had been set up to save tax.  The Revenue pursued the case and it ended up before the Special Commissioners - the final step before a tax case actually goes to court.

Obviously, the guy would lose, right?  Well, yes, he did lose.  However, the reason he lost wasn't the obvious reason - i.e. that the whole setup was ludicrous and designed purely to avoid tax.  The Special Commissioners decided the scheme was invalid because there wasn't actually any evidence that a partnership existed.  The stationery only showed the sole trader's details.  The bank thought the business was still that of a sole trader, and so did all the suppliers.

So the taxpayer lost.  However, the nature of the verdict has left the possibility open that if he'd set things up properly then he might just have got away with it.  If you fancy going into business with your grandchildren (it won't work with your own children, for other reasons we needn't concern ourselves with here), you might want to think about setting up such a scheme.  The downside is that you will almost certainly be the subject of tax enquiry lasting many years, causing uncertainty and stress which will probably far outweigh the benefits.  But if you've plenty of spare time on your hands, and feel lucky, then go for it!  Someone will, I guarantee.

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