The Fizz! Blog

Why you should set up a direct debit for your VAT payments

If you’re a normal VAT-registered business, you have eight opportunities a year to screw up and fall foul of HMRC’s VAT penalty regime.  You’ve four returns to submit, and four payments to make.  Being late with any of those eight tasks risks a penalty, or accumulating points that eventually lead to a penalty.

If you sign up to make payments by direct debit, you only have four opportunities to screw up, because you then only have to submit the returns - the VAT is automatically collected by HMRC.  The system has always been rock solid.  It’s also better in other ways too - the VAT is automatically taken at the very last minute and you don’t have to worry about getting the right account number and reference from the multiple options that you’ve probably got available in your online banking.

It’s a really easy win and only takes a couple of minutes to set up.  Do it now!

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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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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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Going on maternity leave? Think twice about opting out of your employer’s pension scheme

When someone's about to go on maternity leave, they'll quite often look at trying to temporarily cut all unnecessary overheads.  You might think that one sensible step would be to opt out of their employer's pension scheme for a while.  Cutting this particular overhead is probably a very bad idea though.

If your employer operates their Automatic Enrolment pension scheme on the most common basis, you’ll be making a contribution each month, and so will they.  Those contributions vary according to your income, and get capped if you’re earning more than £50,000 per annum.

If you go on maternity, your income drops, and so do your contributions.  In fact, after the first six weeks of leave, from which point your salary will probably just consist of basic Statutory Maternity Pay, they’re likely to drop to zero.

But, crucially, your employer’s contributions do NOT reduce at all.  They’re obliged to carry on paying into your pension pot at the level mandated by your normal salary!  Other non-salary benefits work on the same basis, too; they can’t take away your company car or withdraw your medical insurance, for example.

So, by opting out at the start of maternity, an employee could lose nine months of employer pension contributions, whilst saving herself virtually nothing.  A very easy trap to fall into!

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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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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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Can I make pension contributions for family members through my limited company?

The rules on how much money can go into someone’s personal pension in a tax year aren’t intrinsically complicated - there are just lots of them. Broadly:

• Almost anyone (even an infant) can have up to £3,600 go into a pension scheme or schemes in a tax year.
• The cap each tax year (the Annual Allowance) on what can go in is £40,000.
• However, unused Annual Allowance from the prior three years can be used too (if you had a pension pot of some sort in place at the time).
• Personal contributions in any year are capped at earned income.
• Employer contributions aren’t capped in that way (so a director with a small salary isn’t limited to contributions equivalent to that salary - their company can contribute more).
• Annual Allowance may be reduced for those with income over £200,000.
• The Lifetime Allowance may prohibit or penalise contributions for those with very big pension pots.

All simple individually, but the synthesis of them can be complex!

There’s another consideration involved where contributions are being made via one’s own limited company. For the company to get tax relief on the contributions, the same standard must be met as for any other overhead - is the cost incurred wholly and exclusively for the purpose of the company’s trade? In practice, that means - does the bundle of PAYE salary, pension contributions and other benefits that the director is receiving represent a reasonable bargain for the work being done, or is it excessive?

For a typical fee-earner, generating the company’s income, it’s almost certainly going to be fine. If your company is making enough money to sustain £12,000 of salary plus £40,000 of pension contributions a year, a £52,000 “package” is unlikely to be excessive and there should be no trouble with the company getting tax relief.

A fairly common question from people already doing that is - can I do the same for my spouse or partner too? That’s much more problematic. If they’re doing no work for the company, then a package of £1 would be excessive, let alone any greater amount! If they’re doing some work, you’ll have to take a position on whether the proposed contribution would meet that “wholly and exclusively” test, when considered alongside any PAYE salary also being paid.

In practice, this tends to mean that for fee-earners, big contributions are fine, whereas for a spouse doing some admin support, say, material contributions aren’t really defensible (and there would instead be an argument for their being taxable as income on the director instead!). It’s easy to get confused about the mechanical “how much can go into the pot” rules, and overlook that aspect.

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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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