The Fizz! Blog

Is there a cap on holding investments through your company?

Company owners are fairly frequently under the impression that there’s some cap on the proportion of their company’s assets that can be held in investments, as opposed to cash.  This isn’t the case, although we know why the misapprehension exists.

It’s to do with Business Asset Disposal Relief (the relief previously known as Entrepreneurs’ Relief).  When originally introduced, Entrepreneurs’ Relief was fairly exciting.  It could reduce the tax you paid when you sold (or liquidated) your company from 40% to 10%!  At one point, that could apply to profits of up to £10m - in theory someone could save £3m tax if they qualified for the relief.

There were some conditions.  One was that the company had to be wholly or mainly a trading company; non-trading activities couldn’t be substantial.  One such activity is investment.  HMRC ended up issuing the guideline that they might consider 20% as a proxy for substantial.  But was that 20% of income?  20% of assets?  20% of management time being spent on investments?  They were non-committal.  There were various verdicts in tax tribunals over the years that clarified things a bit - generally suggesting that you were probably OK to have quite a lot of company funds invested as long as you weren’t very actively managing them - but if someone wanted complete certainty on the relief they’d generally tread pretty carefully if they were hoping for savings at the upper end of the scale.

Things are very different now.  The top rate of Capital Gains Tax on a company sale or liquidation isn’t 40%, it’s 20%.  And you can’t claim the relief on £10m of income, only £1m at most.  Back in the day you could theoretically save £3m.  Now the maximum benefit is £100,000.  The maximum benefit of the relief is only 3.33% of what it once was!  On top of that, the majority of company owners will probably not arrive at a point where the relief needs to be claimed anyway - and who knows if the relief will even exist at a future point when you come to sell or liquidate.

So, it’s true that for some company owners there was a strong incentive to err on the side of caution with investing funds, in case the effort to generate a bit more profit in the short term meant the loss of a massive tax benefit in the medium to long term.  But it seems to have morphed into a generally held belief that there’s an absolute cap on what a company *can* invest, which isn’t true at all.  Whether you *should* invest company funds is another matter!  But generally perceptions of some big tax disincentive are misplaced.

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My customer hasn’t paid their invoice - what can I do?

Understandably, many freelancers and other small business owners are reluctant to chase payment of invoices - they fear that it might cause problems in their relationship with the client.  In honesty, we think that fear is almost always misplaced - businesses that don’t pay invoices on time generally see that as part of the general cut-and-thrust of commercial life, and are likely to think that chasing them is a perfectly reasonable thing for you to be doing!

But if you’re still not comfortable doing it, there are a couple of other routes you could consider in order to depersonalise things.  You can fire reminders out of your accounts software (we’ll discuss statements of account shortly), rather than sending them personally (Xero even has the facility to send payment reminders automatically when an invoice becomes overdue - though if you do that, you need to make sure you keep everything up to date, lest Xero remind someone who has already paid!).  Or (/and) you could create a separate email address for your “accounts department” and have financial stuff go through another account entirely.

Broadly, businesses tend to pay invoices based on one of three triggers:

• The invoice (either paying it immediately or in some sort of scheduled pay run).  In an ideal world, you only have this type of customer!  Obviously the important thing with these customers is just to get an accurate invoice out on time to the right person.  If you’re dealing regularly with repeat customers, you might also consider getting something in place to just collect money from them automatically without their needing to lift a finger.  We use GoCardless for 95% of our invoices; it collects them automatically by direct debit on the due date and does the Xero reconciliation of the payments for us, saving time and effort all round.
• A statement of account.  This is a periodic (usually monthly) document summarising what a customer owes at a given point in time.  Big businesses are very used to issuing and receiving them.  They’re very easy to generate and send out via any mainstream accounting software.  If you have multiple customers owing you money at any point in time, you might want to just diarise sending out statements of account every month to anyone with an overdue invoice (we do), as this will quite often prompt payment of a forgotten invoice, or a request for a duplicate of one that’s gone astray.
• A legal threat!  It’s actually obviously highly unusual for that to be someone’s literal trigger, though we have been aware of a couple of local businesses over the years who routinely wouldn’t pay a bill until they got a threat of legal action.  Again, for them it just seemed to be part of the game of business.  Fortunately we were not amongst their suppliers!   We have seen clients have success getting payment of overdue invoices simply via a lawyer’s letter, either from a low-cost online provider like Thomas Higgins, or a firm they have a broader relationship with.  Of course, we’ve also seen clients who’ve had to go further down the legal process.

Something else to consider - if an invoice is paid late, you’re entitled to charge interest.  This is another thing that businesses are understandably reluctant to do - but which in reality we’ve never seen cause a problem.  Another part of the game for late payers.

The Small Business Commissioner has some more useful suggestions about how you might go about making sure invoices to your customer are received, processed and paid properly.  Try to get past any reluctance to assert yourself, especially once invoices are actually late - from that point, most customers will genuinely recognise you’re just doing your job!

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Why you should raise sales invoices on your accounting software

It’s very surprising how many businesses don’t create their sales invoices on their accounting software. It’s far from uncommon to take on a client and find they create sales invoices elsewhere, send them out, and track whether or not they’ve been paid using either a spreadsheet - or even via some more informal system. This is a shame, for a few reasons:

• It doesn’t save any work at all - it probably creates more work, as a VAT registered business is going to have to recreate the invoice in its accounting software anyway.
  It could mean confusion. They might send out an invoice, amend the invoice, and give the old invoice to their accountant for accounts or VAT prep, meaning there’s work to be done to figure out why the amounts coming into the bank don’t match what’s being paid.
  As a worst case scenario, it could mean they lose out financially. For example, they might send out an invoice, forget to track it, never be paid, and never notice.

If the invoice is created in accounting software in the first place, and emailed out from there, there’s one unambiguous source of truth about how much the invoice is for (if you amend it, you’ll amend it in the software), and one unambiguous source of truth about whether it’s been paid or not - amounts coming into the business bank account must be logged against the invoices they’re settling, so if everything’s up to date you can generate a list of outstanding invoices at the click of a button.

The most common objection to generating invoices using accounting software - particularly amongst businesses in creative industries - is that they won’t look precisely as the business would like them to look. That’s true - but they really do look fine, and are quite customisable, and you’ll also know for sure that they include everything that’s legally mandated to appear on an invoice. Businesses are very used to receiving invoices generated from all the major accounting platforms and are unlikely to judge the appearance of a Xero or FreeAgent invoice with your logo on harshly. Ultimately, the important thing about an invoice is that it gets paid!

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What accounting records are for

Usually when keeping records, sole traders are focussed purely on capturing things that will be tax deductible. This is a perfectly understandable perspective. However, although accounting records are necessary if you’re to eventually complete a robust tax return, that’s really a by-product - really their main purpose is to give you some useful information as you go along.

For example - you might capture the costs of all your tax-deductible travel and meals through the year. You’ll then include them in the costs you record on your tax return, to reduce your tax bill. Great. But maybe you might also look at the amounts and think - “How much?? I’m going to start cycling/taking a packed lunch in/whatever”.

That’s what accounting records are for. It’s nice to save tax on costs if you’ve incurred them and they’re tax deductible. There might be as much or more benefit, though, in reviewing and contemplating the records. As well as saving a few hundred pounds in tax for last year, you might save thousands of pounds of actual expenditure in future years.

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HMRC pushing back on early furlough claims

In Spring 2020, a company called Carlick Contract Furniture Ltd furloughed much of their workforce, and began claiming funds from HMRC under the Job Retention Scheme to cover the cost. As part of that process, they did something that a lot of other employers will have done. They included a couple of new employees, who had been taken on in February 2020, but hadn’t been paid that month - as is often the case with people who start late in the month, it was agreed that they’d just be paid for their February hours on their March payslip.

However, the JRS rules were actually unambiguous on this point. Although people were quite understandably wanting to stretch those rules in the interest of fairness, it was made quite clear that to come under the scheme, an employee had to have formed part of a formal payroll report to HMRC prior to 19 March 2020. For most monthly-paying employers, that meant the person had to have been paid at the end of February. It wasn’t enough to have been an employee, you had to have had salary actually reported to HMRC. This isn’t something that emerged later on - it was widely discussed on accounting and payroll forums and everyone advising on claims and making them knew or should have known about it.

HMRC picked up the point, and demanded Carlick repay the money. The First Tier Tribunal has ruled (whilst expressing some regret) that they’re within their rights to do so, despite the claim having been in the spirit of the rules. This is obviously very unfortunate for the employer, who hasn’t benefited from the money and was really being kind to the employees, who otherwise they’d have simply cut loose. But it was always clear that the claim was not permitted by the letter of the law, so if you made a similar claim you should expect there to be a good chance that HMRC will come and ask for the money back at some point, and that if they do then you’ll have to pay.

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Should my company buy stuff before 31 March 2023, or after?

At present, companies buying plant and machinery (computers, machinery, furniture, vans, that kind of thing - not cars, though) can claim the Super-deduction.  This means that for every £1 they spend, they save tax as if they’ve spent £1.30.  Since corporation tax is currently 19%, this means they effectively save tax at 24.7% on those purchases this year.

This was put in place because corporation tax is going up in April 2023, and if nothing was done then companies would have deferred those purchases until then.  The Super-deduction was designed to put companies in a broadly similar position whenever they bought stuff, so as not to discourage investment.

So, with corporation tax going up in April, and the Super-deduction being withdrawn, does that mean it’s not worth thinking about when you buy new assets?  Not necessarily!  There are actually going to be three corporation tax rates in place:

• Companies with profits under £50,000 will still pay tax at 19%.  If you know your company will have profits of less than £50,000 each year, you should invest before the end of March.  You’re effectively saving 24.7% this year, not 19% next year, a big saving.
• Companies with profits over £250,000 will pay tax at 25%. If you know your company will have profits of more than £250,000 each year, it doesn’t really matter when you invest.  A 24.7% tax deduction this year and a 25% tax deduction a year later are more or less the same.
• Profits in between £50,000 and £250,000 will effectively be taxed at 26.5% - a “catch up” rate to go from 19% to 25%.  If you know a purchase will reduce your profits from less than £250,000 to more than £50,000, arguably you might want to wait until next year to invest, as saving 26.5% is better than saving 24.7%.  But it’s only a bit better, so you might as well just buy whatever it is as soon as it’ll be useful to you!

(Things are a bit more nuanced for companies that don't have a 31 March year-end, who won't get the full 130% deduction - but they'll still get more than 100%).

Of course, you should never buy anything solely to save tax!  You buy things to ultimately pay MORE tax, not less.  But if you’re going to buy something, the good news is that you’re not going to go far wrong by just getting it as soon as your company needs it.

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Trivial benefits revisited

Some years ago now, HMRC surprised everyone by quantifying the level at which they considered a non-cash benefit given to an employee to be trivial and disregarded for tax purposes.  £50 was much higher than everyone had imagined up to that point.

It doesn't represent carte blanche to give people an onslaught of things worth £50 in lieu of taxable pay!  If the provision of benefits becomes regular enough that it's effectively become just part of the deal with the employee and therefore contractual, it'd just be taxable as normal.  So a £50 John Lewis voucher every Friday or every month isn't going to work.  But sporadic £50 vouchers are fine.

The rules are tighter for directors - there's also a tax year cap of £300.  But that's still six £50 vouchers!  Or, if you're particularly prone to getting the wrong card out of your wallet and accidentally using the company one from time to time, the trivial benefits allowance can be used as a backstop so that you don't have to repay the company when that happens.

A small win perhaps, but small wins at the expense of HMRC can be disproportionately satisfying!

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If you’re considering whether to work as a sole trader or form a limited company, accountancy fees are a red herring

A frequent question when you’ve recommended to someone that a limited company is the route you’d advocate for them is “can I just check how much those fees would be if I worked as a sole trader instead?”.

That’s a totally understandable question, but actually should not rationally be part of the decision-making process. A conscientious adviser will already have taken that into account when giving the advice! They wouldn’t simply ignore a significant cost.

A literal answer to that question might be something like “If you were a sole trader, those fees would be £1,000 a year lower”. But that’s totally unhelpful as an answer, because the tax liabilities of a typical sole trader are going to be greater than those of a company and its owner, by at least as much, so someone with annual revenue of, say, £50,000 is going to end up in pretty much the same position either way when you take taxes AND fees into account.

You can only sensibly compare that total bundle of “all taxes plus professional fees’ down each route, not just a single component. Otherwise it’d be like deciding to work as a sole trader to avoid having to pay corporation tax, without considering that you’ll have to pay income tax and National Insurance! All of the costs and benefits need to be considered - and as tax rates stand at the moment, the relative professional fees for those two routes aren’t relevant to the decision for anyone who understands how the pieces fit together.

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Your company doesn’t have to die just because you’ve stopped working

Often limited company owners - especially those that essentially sell their own services through the company - assume that, when they stop working, that will necessarily be the end of the life of their limited company too.  It’s easy to see why people default to believing that their personal company is tied to their own working life in that way, but it needn’t be.  It will often be appropriate to close down a company when its owners stop working, but not always.

Although owners will often use their company to channel year-on-year income to themselves, and they might consider the dividends they get this year to be “this year’s” profit, there’s no actual link between a £1 of revenue coming in and £1 of dividends going out.  Money is a fungible asset (a few years ago, it was mostly just accountants who knew what that meant, but now the concept is rather more widely known!).

It can be helpful to think of the profits in a company as being like a reservoir, where profits go in, and dividends get drawn out.  If a company is making significantly more profit than its owner is taking out in dividends, the reservoir will fill up.  Just because the owner stops working, and therefore stops filling up that reservoir, it doesn’t have to be drained immediately.  There’s no special link between the work done to create the profits and the dividends that are paid out (if you own some shares in Vodafone, you’ll get a dividend from time to time, but you’d not expect to be told it was the profit from Dave selling an iPhone last Thursday).

Sometimes it can be efficient to empty the reservoir right away!  There can be tax planning opportunities from winding up a company like that.  Equally, though, it might be appropriate to keep taking dividends for the time being - gradually emptying out that reservoir.  It could be a way of getting money out even more tax-efficiently than a liquidation, and some people might prefer the gradual, planned drawing-down of the money to one big hit of cash.

It can be hard to separate your company from yourself (especially if you’ve been working through it for a long time and it’s called Your Name Limited!).  But if you can get to the point of seeing it as a separate entity (or reservoir!) that can be very helpful.

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The problem is often domestic consumption, not business profits

“Annual income twenty pounds, annual expenditure nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery” - Wilkins Micawber

A frequent frustration for accountants (at least, accountants like us who try to help people form a holistic view of their finances, rather than just preparing legally-mandated accounts and returns for signature) is that you generally only really get to assess and consult on 50% of a client’s position. You see the income coming into their business, you see the costs going out, and you see the profits. You’ll have conversations about how the income might be increased, or the costs decreased - or the costs increased so that the income might be increased even more, or the costs increased so that the owner’s life might become happier or more satisfying (or the income decreased so that the owner’s life might become happier or more satisfying!). You’ll see the year-end snapshot of the position of the business (i.e. its balance sheet), and talk about the liquidity of the business, its resilience to short and medium term adversity and the “runway” it has to continue stably paying its owners and workers without persistent worry about short-term cashflow. This is all really useful and important.

However, there’s a similar picture in everyone’s personal life, and you often get little or no insight into that. If an individual or household kept and assessed similar records, they could consider all those same issues, which are just as important in a domestic context - and, for a business owner, considering the interaction of the finances and their own could bring an extra layer of insight. It doesn’t matter so much if there’s little runway in a business if there's masses of it in the owner’s own life, and it doesn’t matter so much if the owner has minimal personal savings if there’s a big reservoir of profits to draw on in her business.

When there’s an incompatibility between income and outgoings, it’s actually often not between the income of a business and the outgoings of the business - it’s just as likely to be between the income of a business and the domestic outgoings of its owner! Often the owner might be fixated on relatively trivial costs in the business and trying to drive them down a bit. But a bigger question than “can I reduce the £50 a month business mobile phone contract?”, and one that would probably unlock greater revelations and behaviour changes, might be - “what’s happening with the £100,000 that’s being drawn out of the business by its owner each year?”.

Unfortunately, we don’t have much of a culture in this country of that kind of personal financial record-keeping, and there’s no outside mandate forcing anyone to do it. On top of that, people often seem to have a more fatalistic attitude about personal and household finances than business ones, and may feel that they simply can’t be materially changed. If you’re a business owner, though, it pays to think about business finances and personal finances as two sides of one coin, not two entirely separate systems.

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