The Fizz! Blog

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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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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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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Should I make pension contributions personally or via my limited company?

Generally, via your limited company.  An exaggerated example explains why.

Imagine it’s the evening of the last day of your company year, and you’re so keen to get your year-end accounts done that they’ve been drafted already.  You can see you’ve got £10,000 of profits.  You’d like to get that into your pension pot.  There are two ways you could achieve that.

The first is for your company to make an employer contribution directly to your pension fund of £10,000.  That reduces the company profits and tax bill to zero (if you do it before midnight, anyway!), and gets £10,000 into your pension pot at a cost of £10,000.

The second is to take a dividend and make the pension contribution yourself.  If you decide to do that, you know that the company will have £1,900 of corporation tax to pay on its £10,000 of profits, so you take the maximum legally permitted dividend of £8,100, once more leaving the cupboard bare.  You contribute that £8,100 to your pension personally.  There’s basic rate tax relief on it, which means that the government gives the pension company another £2,025.  You’ve got £10,125 in your pension fund - that’s better, right?  It is until you do your tax return and have to pay tax on the dividend.  Assuming it sits in your basic rate tax band you’ll pay £700 of tax on it, so actually it’s cost about £10,700 to get that £10,125 into your pension pot (and there’s a similar marginal cost if the dividend is taxed at higher rates too, as higher dividend tax and greater tax relief cancel each other out).

One small caveat.  If you’re thinking of applying for a mortgage or a remortgage, you might choose to take higher dividends and make personal contributions, even though you’ll wind up a bit poorer that way.  That’s because it will maximise your personal taxable income, and that’s what a lender looks at when deciding how much to lend to you. But if you’re looking for the biggest pension pot at the lowest cost, company contributions are the way to go.

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MTD for Landlords - what do you need to know?

UPDATE, DECEMBER 2022:  Nothing!  This initiative has now been postponed until (at least) 2026, and only landlords with revenue (initially) of £50,000 a year will now be affected.  But, here's what we said back in October anyway...

The government has a long-standing drive to make us report income to them a) digitally and b) more frequently - “Making Tax Digital”.  The initial phases of this forced all VAT registered businesses to submit their quarterly VAT returns online, with an unbroken link between the return and the source records.  This has basically worked well.  For businesses used to keeping paper or spreadsheet records, the jump they probably made to accounting software will have involved a bit of work, but most businesses were using software anyway, and many of those that weren’t have found life better with it.

The next phase will be a bit less smooth.  Making Tax Digital for Income Tax is going to force all sole traders and landlords with revenue of over £10,000 a year to make quarterly reports of their income and costs to HMRC, from April 2024 (partnerships won’t be brought in until 2025).  This won’t (for the time being, anyway) affect the calculation of annual profits, or the timetable for payment of tax, it’s just to give HMRC more timely in-year information to analyse.  Many or most of the sole traders will be using software already, so more regular reporting shouldn’t be too much of a burden for them.  Virtually none of the landlords will.

For smaller landlords - those with gross rents below £85,000 - the minimum required report will be rather simple; total revenue and total costs.  Not really enough for HMRC to do much analysis of.  Larger landlords will be required to file costs in more detailed categories.  99% (at least) of individual landlords are going to fall into the former category though; there aren’t many with rents of over £85,000 a year.

If you have gross rents under £10,000 a year, you don’t have to do anything in the first instance.  But if your revenue goes over that level, quarterly digital reporting becomes compulsory - and you can’t come out of the system unless you cease to have any such income, or it’s below £10,000 for three straight years.  Effectively, sole traders will be in until they retire, landlords will be in until they sell their properties.

It’s important to note that the £10,000 is revenue or gross rents, not profit.  So a sole trader with £12,000 of revenue and £9,000 of costs, making £3,000 of profit a year, must sign up, and so must a landlord with £13,000 of gross rents and £5,000 of costs.  And if you’ve both sole trader income *and* rental income, it’s the total that’s important.  So someone with £8,000 of sole trader revenue and a flat rented out for £500 a month must sign up - that’s £14,000 of income in total.

On the more generous side, if a couple own a rental property, then the £10,000 threshold is per owner - so if gross rents are £18,000, split 50/50, there’s no need to sign up to MTD (although, less generously, if the gross rents are £21,000, they will *both* have to make reports - a report is for a single individual).  And if you’ve income that doesn’t have to be reported on a tax return at all (like rent a room income below £7,500) then that’s disregarded entirely when deciding if you have to sign up or not (although, if you’re in for some other reason, the rent a room income *does* have to be disclosed in the MTD reports!).

One thing that on the face of it seems problematic is that owners of Furnished Holiday Lettings (FHLs) will have to make a different report in more detail - but you don’t always know if your property qualifies as an FHL until after the end of the tax year!  Presumably the suggestion will be to report as if it were an FHL.  At least owners of those properties are pretty likely to already be in the habit of keeping decent contemporary accounting records.

There will be some practical problems.  There’s supposed to be a digital link between the report you make and the underlying records.  But what if the underlying records are necessarily kept in different places?  Perhaps you own one property outright and 25% of an unconnected one with a group of other owners.  You’re going to have to aggregate those figures somehow and then report them to HMRC.  There’s a fudge called “bridging software” that can report from Excel records, not from accounting software, and it may come into play.

So, what should you do in terms of changing your record keeping?  At the moment, probably nothing.  Previous phases of MTD were repeatedly delayed; the general feeling is that this phase of MTD is 99% likely to happen, but maybe only 50% likely to happen in 2024 as planned.  When it does happen, we’ll be helping clients set up a system that will work for them.  FreeAgent have introduced a special version of their excellent bookkeeping software just for landlords, and for portfolio landlords who could actually benefit from more advanced tracking of multiple properties there are products like Hammock.  And for very simple cases, it might be that Excel and bridging software is fine.  For now, the important thing is just to know that it’s (almost certainly) going to happen!

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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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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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It's not your *January* tax return!

The last tax year finished a couple of months ago, which means that those of us who have to do a Self Assessment Tax Return can do it any time from now on.  The ultimate deadline is 31 January, but that doesn't mean you have to do it in January!  We've ploughed through a good number of client tax returns already.  There are loads of benefits to doing your tax return as early as you can:

• You don't have to have it in the back of your mind, hanging over you.
• You don't have to go around searching for year-end documents nine and a half months after you received them.
• You don't have to desperately try and remember what happened the best part of two years ago.
• If you've got, tax, NI or student loan repayments to make, you know how much they'll be well in advance.
• If you're due a refund you get it sooner.
• If you're applying for a mortgage, you can get evidence of income quickly if you need it.
• Your accountant will love you and shower you with praise!

So don't think of it as a January return that you might do early.  It's an April return that you're going to get on to RIGHT NOW!

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The last tax year finished a couple of months ago, which means that those of us who have to do a Self Assessment Tax Return can do it any time from now on.  The ultimate deadline is 31 January, but that doesn't mean you have to do it in January!  We've ploughed through a good number of client tax returns already.  There are loads of benefits to doing your tax return as early as you can:

• You don't have to have it in the back of your mind, hanging over you.
• You don't have to go around searching for year-end documents nine and a half months after you received them.
• You don't have to desperately try and remember what happened the best part of two years ago.
• If you've got, tax, NI or student loan repayments to make, you know how much they'll be well in advance.
• If you're due a refund you get it sooner.
• If you're applying for a mortgage, you can get evidence of income quickly if you need it.
• Your accountant will love you and shower you with praise!

So don't think of it as a January return that you might do early.  It's an April return that you're going to get on to RIGHT NOW!

www.fizzhq.com