The Fizz! Blog

On fiscal drag

Fiscal drag is the process by which a government can stealthily increase the tax they collect by leaving the thresholds and bands unchanged (or insufficiently changed) as incomes rise with inflation. If that happens for one or two low-inflation years, you’ll hardly notice it. But if it happens over a long period, or in a year of high inflation, you will notice. Unfortunately, both of those things are now the case! The important tax thresholds have been frozen for five years, and inflation is no longer trivial.

Five years ago, someone with a sufficiently profitable limited company might have looked with their accountant at the tax landscape, and their domestic income requirements, and decided to draw £50,000 a year from their company. They’d have known that they’d get a tax bill themselves of around £3,000, leaving them with effective net pay of £47,000 (or a little under £4,000 a month). That might have been fine to meet their requirements both for current spending and personal saving, and they’d stop there, given the sharp increase in tax rates if they paid themselves more.

Similarly, someone else might have figured out they’d draw £100,000, knowing they’d wind up paying tax of £20,000, leaving them with a net for the year of £80,000. Again, if that was enough to meet their aspirations they’d probably stick there - above that level of income you begin to lose your tax-free personal allowance, leading to some brutal tax rates between there and about £125,000.

If the bands don’t move for a year or so, it’s no big deal. If inflation is 2%, the things that used to cost you £47,000 now cost you £48,000. You might not even notice, and if you did notice you could manage it by just cutting down on treats, or rebalancing between saving and spending, allocating a bit more of your income to now, and a bit less to the future.

But if there are two years of 2% inflation, a couple of years of 4%, and then a year of 10%, you’ve got a problem. The things that used to cost £47,000 now cost £58,000! Maybe you can still cope by saving less, or saving nothing, or digging into savings. But even when all the treats are long gone most people will find that the maths doesn’t work and that they’re going to have to change something, and most likely pay themselves more and move into a higher tax bracket.

There’s more to it than tax, though.

Our £50,000 person has a couple of kids. If they can cap their income at £50,000 (and they don’t have a partner earning more), then the household gets to keep all its Child Benefit. But if their income goes above that level, they’ll have to start giving it back. Taking that and the increased dividend tax rate into account, the effective tax rate on the next £10,000 is nearly 55%! £5,500 for the government, £4,500 for the household (if they've got a Student Loan, then the effective rate will be even higher - 64%).

Leaving the bands unchanged for so long has really made a punishing difference, as more and more people are dragged into higher bands. If that Child Benefit threshold had risen with inflation over the years, the kind of employees who were originally deemed to not be earning quite enough to repay any of it would, obviously, still not be earning quite enough to repay any of it. Because the threshold has not changed at all, but their salary has, they’re having to repay all of it! The higher rate tax threshold has been frozen for five years - that Child Benefit threshold has been unchanged for 10.

Our £100,000 case could have even bigger problems. They gave up their right to Child Benefit long ago, but at least that “only” meant losing £2,000 in total in respect of their two kids. There are another two child-related issues though:

1. If someone in a household has income over £100,000, then the right to 30 hours a week free childcare for 3 and 4 year-olds is lost! That’s worth much more than £2,000.
2. And you also lose the right to a Tax-Free Childcare account, which could be worth up to £2,000 a year *per child*.

If one takes into account the value of the childcare hours, this person is actually going to find themselves with an effective tax rate way, way in excess of 100% on the first chunk of income over £100,000. This is not an obscure edge case; every year we’ll spot a couple of cases where people have to be careful not to jeopardise free and Tax-Free childcare by creeping over the £100k mark (you can sometimes recover the situation after the event with carried-back charitable donations, if you’re alive to it).

The issue doesn’t just affect people with their own company, making choices about personal income, of course. It applies to anybody managing a balance between consumption and saving, and trying their best to avoid cliff edges where entitlements are lost. Someone with a job could have been managing those issues by making pension contributions to keep their effective income below £50,000 or £100,000 - but the point will come where they no longer have enough money for the present day if they do that.

A government can really only employ fiscal drag as a tactic for a limited duration before things just don’t add up any more. For many people, things are not adding up any more.

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Can Artificial Intelligence provide tax advice? An experiment

The business current account provider Anna recently launched an experimental “tax advice bot”, Terrapin.  In fairness to them, they’re not holding it out as the finished article, or as a substitute for real-life advisers!  But it’s a good illustration of something we often say - the skill in our work often doesn’t lie in just answering the question we’ve been asked, but in identifying what the correct question to ask actually is.

Obviously, what one wants to do is to pick a question where there’s a good chance of getting the wrong advice.  And actually the first one we picked to ask worked perfectly. 

We asked: “Can I save tax on a bike I've purchased to travel to my studio?”

Terrapin replied: “Yes, you can save tax on a bike you've purchased for commuting to your studio through the Cycle to Work scheme. This scheme allows your employer to loan you a bike and safety equipment as a tax-free benefit. The cost of the bike and equipment is deducted from your salary before tax and National Insurance contributions are calculated, resulting in a tax saving. The amount you can save depends on your tax band, with basic rate taxpayers saving 32% and higher rate taxpayers saving 42%. For example, if you purchase a bike and safety equipment worth £600, as a basic rate taxpayer you could save £192 in tax.”

But how does Terrapin know that the questioner is an employee?  There’s nothing in the question to imply that’s the case (in fact, “I”, “I’ve” and “my” all suggest it’s not, though to be fair it’s entirely possible someone working via a limited company could thoughtlessly phrase the question that way).

So, we followed up with a clarification: “Those are the rules for employees - I'm self-employed.”

Terrapin replied: “As a self-employed individual, you can claim tax relief on the cost of buying a bike if it's used solely for your business purposes. The cost of the bike can be claimed as a capital allowance, which allows you to deduct the value of the bike from your profits before calculating your tax liability. For example, if you purchase a bike for £500 and use it exclusively for your business, you could claim the entire amount as a capital allowance. This could potentially reduce your tax bill by £100 if you're a basic rate taxpayer.”

Useful links:

1: https://gov.uk/hmrc-internal-manuals/tax-credits-manual/tcm0126220
2: https://gov.uk/hmrc-internal-manuals/tax-credits-manual/tcm0118180
3: https://gov.uk/working-for-yourself/print

There’s a new problem here, though!  Terrapin has now understood what set of rules it should be looking at.  But, a non-accountant is clearly going to quite reasonably imagine that getting to their workplace is a “business purpose” in this context.  It’s not, though.  So we nudged Terrapin towards the right answer once more:

“I think you're overlooking that I use it to commute to my place of work. I understand that's not a qualifying business trip.”

Terrapin replied: “You're correct in your understanding. For self-employed individuals, travel between your home and a regular, permanent place of work is generally not considered a business journey, and therefore the costs associated with this travel cannot be claimed as a business expense. This is often referred to as 'ordinary commuting' and is the same rule that applies to employees. The cost of a bike used for such commuting purposes would not be allowable as a capital allowance. The rules are different for travel to temporary work locations or for journeys that are all at once part of the performance of the work duties. As a self-employed individual, you cannot claim the cost of commuting to your regular place of work as a business expense, including the cost of a bike used for this purpose. This is considered 'ordinary commuting' and the costs associated with it are not allowable as a capital allowance.”

Useful links:

1: https://gov.uk/hmrc-internal-manuals/business-income-manual/bim37600

This is a pretty good answer - but it was only reached by repeated questions from someone who knew the right answer to begin with.  It’s effectively doing the job of an unskilled accountant, who can only get to the right answer with the guidance of a very sophisticated client!.  To repeat, this is not a knock on this particular tool, which is an explicitly experimental one.  But tax and accounting advice very often involves figuring out what the real issue is, rather than simply addressing the initial question.  Of course, it might be that AI quickly catches up with the experience, thoughtfulness and pattern recognition of good advisers.  It’s some way off it at present though.

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The OnlyFans creator tax case actually shows that part of our tax system *is* fit for the 21st century

We were listening recently to a podcast discussing, amongst other things, the tax relief claimed by an OnlyFans creator on costs of cosmetic surgery.  The assertion was made that it’s an example of our tax system not being fit for the 21st century - those who drafted the legislation couldn't possibly have even imagined some of our modern-day sources of income, and it’s in need of overhaul.

Actually, the system of figuring out if costs are tax-deductible is beautifully designed for new and innovative businesses, because it’s principles-based rather than rules-based.  The central principle has always been - “is the cost incurred wholly and exclusively for the purpose of the trade?”.  That trade could be anything - it could be the trade of a blacksmith, but it could be the trade of a fitness influencer.  From time to time there are grey areas, in which case it may go to a tax tribunal (a “tax court”, basically), and there’ll be a verdict that will either be binding or persuasive in similar situations in the future.  Or, in a grey area, a taxpayer and their advisers might just take a view, understanding that HMRC might have a different one if they looked at it (“would you be able to look a tax inspector in the eye and defend your treatment?” is often a good benchmark).  From time to time a government may actually impose rules if they want to encourage or discourage particular behaviours, but in general deductibility is driven by that first principle, which can be applied to absolutely any business.

There are definitely areas where the modern tax system has not kept up!  20th century legislation and international tax treaties were created for a world where global mobility was generally imagined to be fairly rare - nowadays migration and digital nomads are perfectly normal.  Arguably the treatment of cryptocurrencies (in the UK at least) is based on long-used principles, but does seem counterintuitive to many minds.  And our National Insurance system was designed for an era where most people were in salaried work, with both them and their employer paying into the system.  The subsequent proliferation of freelancers and personal service companies has broken that model.  But the framework for figuring out whether a cost is tax-deductible or not is elegant and foolproof!

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NFTs and Tax

One of the hottest financial topics at the moment is NFTs - Non Fungible Tokens.  Leaving aside questions of the degree to which they could be considered a bubble or environmentally wasteful, we’re starting to get questions about how trade in them might be taxed.

The good news is, there’s not really anything special about them in that regard.  If you’re in business making and selling NFTs, then that’s a trade and you’re going to pay tax on the profits.  You’ll have identical considerations around structure and tax planning to any other business (one interesting one might be - if your main business is VAT registered, might you want to keep this sideline out of the VAT net by keeping it separate?).

One thing that might be a bit different is that you’re probably much more likely than most businesses to get paid in cryptocurrency.  That’s fine - as with any other business, that’s just taxed the same as if you’d been paid in real money.  If you get paid one ETH (say) today, that’s about £1,200.  That’s your income, whatever you're going to do with the ETH subsequently - you can't defer the tax by keeping the revenue in crypto. 

If you convert the ETH into real money at that point, we’re done.  If you don’t, and hang on to it, then you need to retain an awareness of the potential Capital Gains Tax consequences of buying and selling crypto.  That’s taxed in more or less the same way as buying and selling shares.  We wrote more about the traps people might not realise they’re falling into here.

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Excel problems that aren't Excel problems

As an accountant, you do most accounting jobs using accounting software, and a few using Excel.  It's usually the smaller ones where you'd use Excel; maybe a sole trader who doesn't need to track debtors and creditors and doesn't have a dedicated business bank account, say.

Sometimes a reluctant business owner might be resistant to using accounting software, and the classic objection is "why do I have to pay for a glorified spreadsheet?".  It's not a glorified spreadsheet, that's why.  It's a database, and a database has built-in checks on the integrity of the data (in the case of accounting software, thanks to the beauty of double entry bookkeeping).

If you're not careful, then those little Excel jobs that seem the most straightforward can actually be the riskiest ones, where you can make expensive or embarrassing blunders.  When we do accounts in Excel, we always build in some kind of proof that all the transactions feeding into the accounts have been captured once, and only once, and that any adjustments are complete and transparent.  If you don't do that, all you've got is some numbers that may or may not be right.  Generally, when staff join us from another firm, they've not come across this kind of check before.  But  the extra minute or two spent proving that the output is consistent with the inputs are vital if you want the output to be reliable and credible.

Whenever we read about a big error involving the numbers in the accounts of some listed company - say an enormous error in a stock valuation - we always speculate that it will be a problem that's arisen in Excel, outside of the core accounting software.  A SUM formula that hasn't been stretched to pick up some extra rows, for example.  We're *always* right.  And often the company will try to explain it away as a problem with Excel.  It's not, of course.  It's a problem with Excel being used for an inappropriate purpose, or Excel being used for an appropriate purpose but without some kind of integrity check in place.

So, when you're using Excel for accounting, it's important to think "we need to have some sort of proof in place that the data is complete".  You also need that if you're using it to track a deadly infectious disease.

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Do you have teenage kids with forgotten Child Trust Funds?

Back in his Chancellor of the Exchequer days, Gordon Brown announced that all children born from 1 September 2002 onwards would qualify for a “Child Trust Fund”.  HMRC sent vouchers for £250 to parents (or £500 for lower income households) for them to deposit into a Child Trust Fund, either to be saved as cash or invested in shares.  If that wasn’t done within a year, then HMRC automatically set up an account for the child themselves.  The scheme continued for all children born until 1 January 2011.  Until August 2010, children received an additional £250 (or £500) on their 7th birthday.  Families were also able to top up the accounts themselves if they wanted to.  Once the child turns 18, they have full access to their savings.

So, from this month, the first batch of CTFs are maturing, for those children born in September 2002.  It’s quite likely that parents will have forgotten all about their kids’ CTFs – 18 years is a long time, and you might not have given it a thought since then!  The CTF provider should be writing to your child to set out their options now that the account has matured, but if you’ve moved house since, they might not know where to find you.  Usefully, the government have provided an online tool that children and parents can use to track down their CTFs:

https://www.gov.uk/child-trust-funds/find-a-child-trust-fund

There could be a useful little nest egg there to help your kids kick-start their savings, pay for driving lessons, or whatever else they might need!

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Applications for the second and final Self Employed Income Support Scheme grant open next week - here's what you need to know

Sole traders and partners in partnerships who were eligible to apply for the last SEISS grant in May are going to be eligible to apply for another, with applications open from Monday 17 August.  If you didn't meet the basic income eligibility criteria for the first grant, you won't meet them for the second one either.  They're exactly the same.  This second grant isn't going to help anyone whose income meant that they were not eligible for the first one.

 

This time the payment will be at a slightly lower level; the first one was at 80% of three months of average profits (quantified on a basis that we won’t go over yet again), capped at £7,500.  The second one is at 70% of the exact same average profits figure, meaning that the grant will be 7/8ths of the previous one, and the cap is £6,570.

 

You can only apply if you've been affected by Coronavirus, and they're clear what that means for this second grant.  You can claim this grant if "your business has been adversely affected on or after 14 July 2020".  Although HMRC have produced some guidance around how you might judge whether that applies, that's guidance not law.  The legislation is clear - your business simply has to have been adversely affected in some way since then.

 

That means it'd be quite possible for it to be appropriate to claim one grant and not the other.  For those who meet the basic income condition, there are four possible permutations:

1. Claiming both grants.  Most claimants will probably have been legitimately adversely affected over both periods so will claim both payments.
2. Claiming neither grant.  Some industries have done well over this period, and for many people there's no claim to legitimately make.
3. Claiming the first grant but not the second.  You may have suffered over the first few months of the crisis, but as of July you'd got back to normal and are expecting similar income in these summer months as you’d usually have, in which case it’ll be appropriate to have claimed the first grant but not the second.
4. Claiming the second grant but not the first.  If your income was unaffected over the early months of Coronavirus then you won’t have claimed the first grant, but perhaps now the jobs you were working on are finishing up and not being fully replaced because of the crisis, in which case it’ll be appropriate to claim the second grant.

As before, you 'll have to certify that your income has been affected, and it’s always possible HMRC will one day check up on that – a self-employed-person who winds up with similar income as usual in 2020-21 AND a grant may have some questions to answer.  There's nothing in that basic scenario that indicates there's definitely a problem - your income this year may be bigger than last year, but if it would have been bigger still were it not for Coronavirus then you've been adversely affected nonetheless, and you absolutely qualify.  But the question could be eventually asked.  And you have to certify that you are still operating your self-employed business – which won’t be the case if, for example, you moved your business into a limited company since 5 April 2019, or you’ve left the UK and don’t meet the criteria for reporting self-employed income here on an eventual 2020-21 tax return.

 

And don't forget - it's taxable.  It'll go on your eventual 2020-21 Self Assessment Tax Return and be taxed as part of your income.  If you're in the sensible habit of putting aside some of your income for the eventual tax on it, don't leave this payment out!

 

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Made any big donations since 6 April?

We've written before about the Gift Aid box when you make a donation, what it means, and - amongst other things - why anyone with income that takes them into higher rates of tax should include the donation on their tax return.

Ordinarily, you'd just include donations made in the year in question on your tax return. In fact, there's an alternative option, which is to "carry them back" and include them on your tax return for the previous year, if you've not yet submitted it. Generally, it's not worth the hassle - if you're donating on a regular basis and your income doesn't vary wildly year-by-year, who cares if a £10 a month donation saves you tax this year or next year? It's not worth the hassle of keeping track of what's been carried back and making sure that you don't claim it again next time, and waiting to file your return at the last minute so as to carry back as many donations as possible.

However, this year there are likely to be a lot of people who made unusually large donations in the early part of the tax year, for obvious reasons. If you donated a one-off £1,000 in mid-April, say, as a higher-rate taxpayer you're going to get £250 knocked off your tax bill. So the amounts involved start to become a bit more interesting, and you might well consider carrying the donation back and sticking it on your 2019-20 return to save the tax early.

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How do I get my hands on my Business Rates grant?

As part of the government's package of business support, a lot of businesses that are the ratepayer for commercial premises but pay little or no Business Rates are getting cash grants.

Initially the government said that the payment of grants to businesses that claim Small Business Rates Relief (who should get £10,000) and retail, hospitality and leisure businesses (who should get more if their property has a rateable value between £15,000 and £51,000) would be dished out automatically by local authorities, and that businesses should sit tight and wait to be contacted.  But in practice, that's not what all councils are doing.

We've already seen some councils contacting relevant businesses and paying the grants out right away where they hold bank details for the ratepayer.  That's how the system was expected to work.

However, it turns out that other local authorities are making business apply.  That's what our local council, South Oxfordshire District Council, for example, are doing:

http://www.southoxon.gov.uk/business/business-rates

Moral of the story, if you're waiting to be contacted, it'd be worth looking at the website of your council.  And don't forget that you should be eligible for the £10,000 grant, even if you pay no Business Rates at all because your premises qualify for Small Business Rates Relief.  But if you don't occupy commercial premises, or you do but you're not the ratepayer yourself, there's no grant available.

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A round-up of help available to sole traders and partners in partnerships

Now that new announcements have dried up (for a little at least), we’ve put together a round-up of the help available for sole traders and partners in partnerships (you can see our equivalent for limited company owners – the same in many respects – here). 

Self-Employment Income Support Scheme

We’ve emailed clients about this scheme in detail already, but in short anyone who was a sole trader or partner in a partnership in 2018-19, got most of their income that way, and had profits of less than £50,000 will be eligible for a grant.  That’s as long as they’re still a sole trader or partner, and as long as their business has been affected by coronavirus.  The grant will be based on 80% of average profits, capped at £2,500 a month, initially paid for three months.  It'll be taxable, just as the profit would have been.

Even if you do qualify, HMRC's aim is to start to get money to people at the end of June, and the process will involve *them* contacting *you* on the basis of the information they hold about your income, not the other way round.  So there's a cashflow gap to bridge, and there's nothing you can do to speed the process along.

VAT and Tax deferrals

The vast majority of our clients are great at saving for VAT and personal tax as they go, and the tax payment deferral measures should mean that you can safely dip into your tax savings for a while if you need to.  If you want to do that, then:

• VAT payments for the quarters ending in February, March or April can be delayed until early 2021 (though if you’ve a direct debit in place with HMRC for your VAT it’s important that you cancel it – they’ll take the VAT on time otherwise).
• You can delay your July 2020 personal self-assessment payment until January 2021.

Deferring PAYE payments if you have employees

The VAT and self-assessment deferments above are automatic and you don’t have to apply for them.  There aren’t any formal general agreements that PAYE can be delayed.  But HMRC have set up a special helpline for businesses that need to discuss deferring other payments.

It might take a long time to get through, although a client called them one day last week at 8.15am and she was through within five minutes, so aiming for the start or end of the day is probably sensible.  It sounds as if generally HMRC are very open to agreeing more generous payment terms.

Grants

• Rates-related grants - If you formally rent premises subject to Business Rates, you should be eligible for a grant if either (a) you currently benefit from Small Business Rate Relief (remembering that you will qualify even if SBRR means you pay no business rates all), or (b) you’re in the retail, hospitality, nursery or leisure sectors.
• Job Retention Scheme - If you employ staff but don’t currently have work for them, you can use the JRS to claim a grant to cover 80% of their wages.
• Statutory Sick Pay – some years ago HMRC stopped reimbursing employers for SSP they paid to staff – but they will now reimburse it if it’s coronavirus-related. Not right away, though, there’s no mechanism for doing so right now, so you’ll need to fund the (modest) cashflow to begin with.
• A self-employed person can’t get SSP, but if you’re unable to work because of coronavirus, or you’re having to self-isolate and cannot work from home, you may be able to claim ESA, albeit it’s not a lot of money and has similar conditions as Universal Credit.

Other things to consider

• Check your business insurance policy, in case you have Business Interruption cover.
• Speak to your landlord (for both your home if you rent, and your business premises) to see if you can delay payments, get a discount, or a rent-free period. Some landlords are open to this.
• Consider talking to your lender to arrange a mortgage payment holiday.
• Talk to your bank to see if you can arrange a business or personal overdraft facility.
• If a loan would be more appropriate, consider asking your bank about the government-backed Business Interruption Loan Scheme.
• If you want to take another job during this period, that’s absolutely fine – there’s nothing to stop you from having a job as well as being self-employed.
• Universal Credit may be available to you – you’ll need to check online to see whether you meet the criteria, but it’s potentially worth a look.
• Some clients are finding opportunities to use their skills to provide different services, or to deliver their services in new ways, or to find new customers to target. It could be worth asking yourself whether you can adapt your business model to find opportunities in the current circumstances – we’re seeing a number of clients doing this successfully.
• Remember also that it’s fine to dip into your savings. While it’s natural to want to preserve them, one of the great benefits of having savings is to help you survive an unexpected loss of income.  With interest rates on cash savings being low, it’s unlikely to cost much in terms of lost interest, and you can look to rebuild savings once things return to normal.  You’ll need to check the rules for withdrawals from your particular account, but even some ISAs now allow you to withdraw cash and replace it later in the same tax year.

Hopefully there are some helpful pointers here, and we’ll of course let you know as and when any new measures are announced.

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