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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Claiming Capital Losses

If you sell assets like rental properties, shares or cryptocurrency at a profit, you have to consider whether you have Capital Gains Tax (CGT) to pay for the tax year.  But you might also have sold some other assets at a loss in the year - if so, you can deduct those losses from your profits to get to a net profit or loss for the year.

If you wind up with net gains, but they’re less than the Annual Exemption - this year, £12,300 - then there’s no CGT to pay and you move on.

If you wind up with net losses, then you get to hang on to them.  If, in a future year, you have net gains over the Annual Exemption, then you can set those old losses against them, using just enough to get down to the Annual Exemption and eliminate any tax that would otherwise be due, and carrying anything left forward still further.  It might be that you never have sufficient gains in a future year to ever use them, in full or at all, but they’re there if you do.

Capital losses are about to become more valuable, because the Annual Exemption is being cut sharply.  Next year, it’ll be only £6,000, the year after, £3,000.  That means that more taxpayers will be dragged into the CGT net.

There’s an easy trap to fall into.  In order to establish entitlement to most losses, you generally have to claim them within four years of the tax year they occur in (there’s a shorter deadline for some niche cases).  That could be on your Self Assessment Tax Return, if you have to submit one for the year, or you could just do it by letter or some other way.  But you have to somehow tell HMRC before that deadline.  We recently saw a case where someone had losses in 2013-14, and gains over the Annual Exemption in 2021-22.  Unfortunately, HMRC hadn’t been told about the losses, so it was too late for the taxpayer to take advantage of them.  Fortunately, the losses weren’t enormous.

A final consideration - you might need to make a judgement about how much effort you’re prepared to put into quantifying losses that you’re not certain will be useful.  If someone is pretty sure that they’ve got losses this year, but they’ll have to put research time into establishing the history of the share transactions, or pay an adviser to work out the actual loss, should they do it when they don’t anticipate having an opportunity to use the loss in future? To begin with they can kick the can down the road, by making a note for three years’ time to look at it again.  The point will come, though, where they have to make a judgement on whether to do the work before the deadline passes.

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Should I sell my rental property now to avoid a bigger tax bill later?

If you’ve got a rental property that you’ll eventually sell for more than you paid for it, then there’s a good chance you’ll have some Capital Gains Tax (CGT) to pay when you come to sell it. Sometimes people worry that the longer they keep the property for, the more profit they’ll make when they sell it (because of rising house prices), and therefore the more tax they’ll pay. It’s worth remembering, though, that the highest rate of tax on capital gains is currently 28%, so if waiting for a year meant making an extra £10,000 of profit, your tax bill would increase by £2,800, but you’d still be £7,200 better off!

Things can seem a bit more complicated if you’ve lived in the property for part of the time you’ve owned it. When you sell your own home for a profit, the gain is generally exempt from tax. When you sell a property that was your home for part of the time you owned it, but has been let out for the rest of the time, then the gain is split into two. The portion of the gain that relates to the time you lived there is exempt from tax, and the portion that relates to the time you were renting it out is taxable.

It’s quite common in these circumstances for people to worry that they’re holding onto a property for “too long”, and creating an unwanted tax bill. In the majority of cases, though, it’s very unlikely that keeping the property for longer will leave you worse off. For example:

If you bought a property for £200k in 2018, lived there for three years, rented it out for one year and then sold it for £240k, you’d make a gain of £40k. You lived in the property for three out of four years in total, so ¾ of the gain (£30k) would be tax-free*. So only one year’s worth of gain (£40k x ¼, i.e. £10k) would potentially be taxable. Worst case scenario, you’d pay tax on that at 28%, so a little under £3k, leaving you with £37k profit after tax.

Of course, the longer you own the property for and continue to rent it out, the bigger the portion of the gain that attaches to the period it was rented, leaving a higher proportion of the gain exposed to tax. So if, for example, you held onto the property until 2028, you would have lived in the house for three years out of ten years in total, so only 3/10 of the gain would be tax-free, instead of ¾ of the gain in the first scenario. But having owned the house for an additional six years might mean that you sell it for quite a bit more – let’s say £300k, meaning a gain of £100k. If that were the case, then the tax-free portion of the gain would be £30k, and the taxable portion would be £70k. Worst case scenario, you’d pay tax on that at 28%, so around £20k. But you’re still left with £80k of profit after tax. So despite the fact that you’ve got a much bigger tax bill, you’ve still got £43k more in your pocket.

One situation that could result in you being worse off is if you kept the property for 10 years, but the value didn’t increase in that time. If you sold it in 2028 and still only got £240k for it, then 3/10 of the £40k gain (£12k) would be tax-free, and 7/10 of the gain (£28k) would be taxable. Tax on that could be up to £8k, leaving you with £32k in your pocket, i.e. £5k less than if you’d sold it in 2018 for the same amount.

But the key point is that the potential size of the tax bill alone is a red herring. Whether or not you keep or sell the property should really be an investment decision, and not be driven by concerns about tax. If renting the property for a few more years means you’ll be able to sell it for a higher price in the future, then although you’ll have a bigger tax bill, you’ll still be left with more in your pocket in the end. The only time the tax can make you worse off is if you hold onto the property for longer and the price stays around the same or falls. But if you thought that was going to happen, you probably wouldn’t hold onto it anyway! So in the vast majority of cases, it’s fine to make your decision based on when you think it’s a good time to sell the property in terms of your expectations about the housing market and whether you feel the property is a good investment for you, rather than being driven by worries about CGT.

There are a couple of situations where tax *might* be a consideration, though:

• If the government announced a change to the rate of CGT, that could be a legitimate reason to consider the timing of selling a property. If you knew that the rate was going to increase significantly next year for example, you might prefer to sell now.

• The first £12,300 of capital gains you make in any tax-year are exempt from tax, so if you’ve already sold other assets that are subject to CGT in the current year, you might want to wait until the next tax year to sell the property, so that you can make use of the following year’s exemption.

But those things aside, the overall message is that you’re always likely to be better off by selling your rental property when you can get a good price for it and it’s the right decision for you from an investment point of view. Selling at the time that makes you the most profit will likely mean a higher tax bill, but you’ll still have more in your pocket in the end.

* This is a slight oversimplification, because the final nine months of ownership are also tax-free (this is always the case for a property that was your only or main home at some point), but we’ll set that to one side for now as including it would make the examples more complicated, and it rarely changes the overall picture.

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Should I put my Buy To Let property into a company?

Owners of rental properties pay tax on the profits, and often the biggest cost associated with the property is mortgage interest. Over the last few years, the tax relief on that interest has gradually been tapered down for those with higher income, and people who might once have saved tax at 40% (or more) on that interest now save tax at a maximum of 20%.

As a result, the idea of putting a Buy To Let property into a limited company is often floated as a possibility. Is it a good idea? For most people, on balance it’s unlikely to be. Here are a few significant factors:

• If it’s a property that you already own, then transferring it to a limited company will be taxed as if you’d sold it at market value. If it’s gone up materially in value since you bought it, you’ll probably pay some Capital Gains Tax.
• There’ll also be Stamp Duty to pay on such a transfer; Stamp Duty on the transfer of a property from an individual to a company is calculated on the basis of market value, not the amount paid.
• Although the tax-efficiency of the rental income in the company might be a bit better, it’s quite likely that the tax position when you come to sell the property might be worse. An individual has a tax-free allowance for capital gains and only has to pay tax on profits above that Annual Exemption. A company pays tax on every penny. And then, as the owner, you’re likely to want to get the profits out of the company - and you’re likely to pay tax then as well. That kind of double taxation is always an issue when appreciating assets are held within a company.
• The professional fees you’ll incur in having a company’s accounts and taxes properly looked after are greater than those for an individual, so a bit of the year-on-year tax efficiency is absorbed by that anyway.
• It’s often the case that it’s more expensive for limited companies to borrow than it is for individuals.
• Fundamentally, it’s a big punt on the tax regime remaining stable for a long time, and such punts are pretty risky. It’s easy to imagine the rules changing to eat away at tax efficiency for the company ownership route - and you’ll still have paid the switching costs if you used to own the property personally, and you’ll still be stuck with double taxation on exit!

A limited company is more likely to be indicated where there are multiple properties and where there’s a really long term vision for the business. If it’s intended that a rental business will have multiple properties and it might be contemplated that it might even last generations, a limited company could well be indicated. But in 90% of situations, our view is that personal ownership is still more appropriate.

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Investing in cryptocurrency? Here’s how the tax side works

Cryptocurrency and tax has fast gone from being a largely theoretical subject to a quite practical one. Buying and selling them has become both more popular and more easy, and far more people are having to address the consequences of the activity now.

So, how are profits on selling cryptocurrencies taxed on an individual?

For 99.99% of people it’s a Capital Gains Tax (CGT) matter. CGT is fundamentally a tax on disposals (i.e. sales) of assets. The principles and calculations are the same ones you’d follow when figuring out CGT on profits from selling shares. Most people seem to assume that the fluctuating value of their cryptocurrency during the year has some impact, but it doesn’t. Similarly, often people think that the value of what they hold at the end of the tax year makes a difference, but it doesn’t. If you don’t sell any cryptocurrency, there’s nothing to declare and no gain to tax. It doesn’t matter if you bought it for £10,000 and it’s now worth £200,000. It’s not until you actually sell something that tax becomes a consideration.

A useful thing to bear in mind is that we can all make some capital gains free of tax each tax year. For 2021-22, your first £12,300 of capital gains are tax-free and it’s only the surplus above that amount that’s taxable. If your gains are below £12,300 and the total proceeds are less than four times that amount - £49,200 - then you don’t even need to tell HMRC about the transactions at all.

So, what are those principles?

Let’s say you sell some Ethereum for £15,000. You need to figure out how much it cost you. This might be quite simple. If that’s all the Ethereum you have, and you bought it all in one go for £7,000, you’ve a profit of £8,000 to be taxed. Easy!

What if you didn’t buy it all in one go? If you’ve bought Ethereum on two or more occasions, you have to keep track of all the times you bought Ethereum, and keep a running record of the average cost of each unit - a record of your “pool” of units and their average cost. Then, when you sell X units, you need to take the relevant number of units at the average cost out of the pool, and figure out the profit you made on selling them. Fairly easy!

There’s a further complexity, though. Sometimes you have to look at the units you bought afterwards as well. This is because of rules designed to stop people realising tax-free profits at the end of one tax year and then buying the same things back a day or two later at the start of the next. In our example, if you buy some Ethereum in the 30 days after you sell some, then you need to match that purchase against the disposal instead of the older units, and for tax purposes you’ll still be deemed to hold those older ones at their original cost. Not easy!

These rules are thorny enough for share trades, but there are a few factors that make them trickier still for cryptocurrencies:

1. Cryptocurrency transactions are often far more frequent. When you sell some shares, it’s usually fairly easy to identify when you bought them and how much for, and to therefore work out the profit you’ve made. With cryptocurrency there are often far more transactions to assess (though in fairness this may become more common in share trading too, as apps and push notifications encourage people to trade more frequently).
2. Most people do their share trading via a single broker account, but many people have multiple accounts/wallets for cryptocurrency. You might need to match a sale of cryptocurrency from one wallet against a purchase made via one or more other wallets.
3. A big trap is that you might not even dispose of cryptocurrency for actual money. If, say, you exchange some Ethereum for some Bitcoin, that represents a disposal of Ethereum to declare and pay tax on, even if you’ve no GBP to show for it. Someone may never have cashed out any cryptocurrency at all, but still have multiple taxable disposals. We’ve written about this before.
4. Similarly, you may use some cryptocurrency to pay for something - that represents a disposal of the cryptocurrency at its market value and a potential tax bill.
5. Finally, even if you gift the cryptocurrency to someone, that’s also a disposal at whatever its market value is at that point (unless you're gifting it to your spouse or civil partner, anyway), with tax to pay if you’ve made a gain - that’s the same with shares and any other assets too.

All this means that, for someone with complex cryptocurrency activities, some software that can pull everything together is likely to be necessary!

For the time being, the £12,300 annual exempt amount is likely to keep most people from having to report anything to HMRC (though if you make losses you might want to report them, so you can offset them against future gains). Even so, make sure you keep proper records - if you’ll be selling cryptocurrency in future it’s important to have your precise trading history on record so that you can figure out the profit on each disposal when the time comes.

www.fizzhq.com

 

A big change from April when you sell a Buy To Let

If you sell a Buy to Let property (or any other property that's not clearly your own home, for that matter) at a profit, it's pretty likely you'll have to pay Capital Gains Tax.  At present that's paid via a Self Assessment Tax Return for the year in question.  So if someone realises such a profit today, it's going to go on their tax return for the year ending 5 April 2020, and that means that the tax is payable in January 2021.

By the time the payment deadline comes around, it's not uncommon for there to be a problem.  The seller hasn't got the money any more.  It's reasonably common for people to labour under the misapprehension that if they use the money to buy another property, then the profit somehow isn't taxable.  Or for them to believe that there's some interaction with mortgages and repayments that makes a difference.  But those things aren't relevant in the slightest.  Or they might simply think that there's no tax on selling a house.  There is, unless it's unambiguously and genuinely your own home.

From 6 April 2020, therefore, the rules are changing.  If you sell that BTL and make a profit, you've got to tell HMRC and pay the tax within 30 days.  It'll be impossible for many people to be 100% sure of what that tax bill will be - the tax rate on capital gains in someone's basic rate tax band is currently 18%, and on gains above that 28%, and you might not know how much of your basic rate band is going to end up being used up by other things.  But that's fine - you just pay your best estimate, and then the difference can be sorted out later on.

Of course, the people in the best position to warn sellers about this are the conveyancing solicitors.  But a similar regime came in for overseas sellers of UK properties already, and we can tell you that there's no evidence at all that solicitors are advising sellers about it, and we've had to belatedly help more than one seller declare and pay the tax to HMRC.

Even if you're not planning on selling any time soon, one practical thing to do now might be to make sure you've got all the details of how much a property cost, easily and clearly available.  That way, you won't be frantically looking for them in years to come when faced with an unexpectedly tight deadline for paying the tax.

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If I were Chancellor

I have to concede that I'm unlikely to hold the position in the near future, but if I were Chancellor, I'd be increasing Capital Gains Tax (CGT) in today's budget.  Taxable capital gains always used to just be added on to your income and taxed accordingly - so if you were a higher rate taxpayer, they'd be taxed at 40%.  Then, a couple of years ago, in a confused fudge typical of many tax changes over the last few years, CGT was reduced to a flat 18% for everyone.  Given that, generally speaking, capital gains are the preserve of the relatively well-off, this largely represented a significant reduction in tax for the wealthier members of society.  Why should income tax go up for the better off as they earned more, but not capital gains tax?  What was the logical reason for the change?

It made no real sense then, and it doesn't make any more sense now that the coffers are empty and tax needs to be raised somewhere.  So the obvious thing to a non-politician would be to put CGT back the way it was, so that next year people will pay it at 0%, 20%, 40%, 60% or 50% depending in their income.  Whether the Chancellor will risk the headlines that might follow from effectively doubling a tax for some people remains to be seen, though.  We'll find out this afternoon.

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MP sacked for normal, mainstream tax planning

I have as much contempt for MPs as anyone else, and firmly believe that they should be first against the wall come the revolution.

At the same time, the witch hunt over expenses is becoming, in some aspects, ridiculous.  Kitty Ussher MP has been sacked as a minister for changing the home she nominated as her "principal private residence" for tax purposes for a month in order to escape paying Capital Gains Tax on its sale.  That's just standard tax planning.  You learn about it when you're studying for your tax exams when you're training as a chartered accountant.  People do it all the time.  If you look at any online tax forum (OK, it's maybe just me who looks at those) then you'll find tons of queries on the mechanics of how to do it, and how long you need to change the nomination for.

On top of that, it's somehow being held as further evidence against her that she sought and received the advice of an accountant on doing it.  Surely seeking and paying for professional advice on the subject legitimises her actions?  If she'd taken no advice and just hadn't told the taxman about the sale and hoped to get away with it (as other MPs have probably done) then I could see that as dishonest.  But getting written professional advice in advance?

It's one thing to be angry when MPs exploit the rules in ways that we civilians can't or won't.  But sacking them for doing things that "normal" taxpayers do all the time, on the basis of written professional advice, is frankly bizarre.

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Entrepreneurs' Relief

As expected, the Chancellor climbed down in large part over his proposed changes to the Capital Gains Tax system.

What was proposed was a) withdrawal of taper relief, b) withdrawal of indexation relief and c) a change in the rate of CGT to 18%.  The aim was to placate trade unions by increasing the rate of tax paid by private equity investors from 10% to 18%.  However, the collateral damage was a similar increase in tax paid by all those selling their own businesses.  In effect, it was an 80% increase in tax for entrepreneurs.

So, the change we now have is an extra relief known as Entrepreneurs' Relief.  Changes a), b) and c) above still stand - reversing the proposed changes would be too damaging politically and would never happen; you always get more rules, never fewer.  The effect of Entreprenuers' Relief will be that the first £1 million of gains made on the disposal of businesses by someone in their lifetime will effectively be taxed at 10%.

The legislation actually isn't as simple as this; the gain is tapered by 4/9ths before being taxed at 18%.  But the effect is to tax it at 10%.  In effect, for the disposal of many - probably most - small businesses, the tax bill is now pretty much the same as it would have been under the old rules - because of the interaction with the annual exemption, the bill will be a little higher, but not cripplingly so.

There was some fear that the sudden withdrawal of taper relief would lead to some business owners scrambling to dispose of their businesses before 5 April to ensure a low tax bill.  These changes do mitigate the hike in tax on the horizon, so a speedy sale of a business is unlikely to be so important now.  However, the new system still involves the abolition of indexation allowance, so it may be that those who have owned a business for a very long time will still want to take some action before 5 April to "bank" that indexation, perhaps by a transfer of their interest in the business to a spouse.

Overall, it's hard to describe the process by which we've arrived at this point as anything other than a shambles.  Radical rule changes, designed to curry favour before a possible election, announced with absolutely no consultation, then radically altered when almost everyone complained, and all coming into effect with only a couple of months' notice.  I think Vince Cable summed it up best: “The Chancellor’s climbdown on Capital Gains Tax reform was inevitable and is a stark demonstration of the pitfalls of making up tax policy over a weekend.  The truth is that Capital Gains Tax does need reform, but it must be done through full and open consultation with business, not written on the back of a fag packet in a bid to pull together a snap election manifesto."

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Are you a sole trader or a partnership?

Or do you know anyone who trades as a sole trader or partnership?

If so, transferring an unincorporated business to a limited company can provide fantastic tax savings.  Not only are you likely to pay less tax on an annual basis in future, but, depending on the particular business, there's often an amazing one-off opportunity to save tax on the transfer of the business into the company.  I've personally used this system a number of times, saving one client over £200,000 in tax in the process.

But, from 6 April, thanks to the changes to CGT proposed by the government, although the option will still be there, the tax savings are going to slashed.  So, if you - or anyone you know - might be able to benefit from moving to a limited company, tell them to talk to Fizz straight away!

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