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A retrospective for SMEs: 2020 and tax

/ 8 December 2020

David Whiscombe

Writing for Tax Journal, BKL consultant David Whiscombe reviews the effect of tax changes in 2020 on small and medium-sized enterprises (SMEs).

Speed read

Ameliorating the effects of the ‘loan charge’ and deferring the expansion of the ‘off-payroll working’ rules were welcome; and changes made by the March Budget were generally benevolent. Nor did anything especially depressing for SMEs or their advisers come out of the year’s crop of tax cases. But with the Budget having reduced the business asset disposal relief lifetime limit to £1m and the OTS proposing both to (effectively) replace the relief with a form of retirement relief and to tax ‘money-boxing’ more heavily, the landscape for CGT looks very different from the way it did in December 2019.

Loan charges and off-payroll working rules

Compared with coronavirus, the effect on SMEs of tax changes in 2020 has in many cases been barely noticeable. But changes there have been; and further changes there certainly will be in future.

The year started well. In December 2019, the government had announced its package of changes to the controversial ‘loan charge’ following the Morse review. Key revisions included the removal of the charge in relation to loans made before 9 December 2010 and to loans made before 6 April 2016 where HMRC had not launched a timeous enquiry despite ‘reasonable disclosure’ having been made. The position continues to develop: as recently as 19 November HMRC confirmed that it would until the end of the year accept late elections to spread the charge over the three tax years from 2018/19.

The review of the ‘changes to the off-payroll working rules’ (extending the public sector rules to the private sector) was published in February, with some modest but welcome amendments to the rules. Subsequently (but far too late for many businesses that had already put into place the necessary changes) implementation was deferred until April 2021 as part of the package of responses to the pandemic.

Policy changes

By the time of the Budget, the coronavirus was, though already somewhat larger than a ‘cloud the size of a man’s hand’, not yet the raging storm it was to become. The cutting back of the entrepreneurs’ relief lifetime limit to £1m was expected: the anti-forestalling provisions less so. And it was just odd to rename the relief as ‘business asset disposal relief’ (BADR) when it doesn’t apply to disposals of business assets in isolation but to disposals of businesses. Looking ahead, the recent report of the Office of Tax Simplification now recommends replacement of BADR with something more akin to the old retirement relief, which was of course itself replaced by taper relief 20 years ago.

Other changes made in Budget 2020 seem, perhaps, less important now than they did then, especially when compared with the effects of coronavirus and with the scale (and cost) of past and continuing government support following the pandemic.

They included increasing the annual rate of structures and buildings allowance (which gives tax relief for the cost of constructing, renovating or converting non-residential buildings and structures) from 2% to 3%; and raising the rate of research and development expenditure credit claimable (usually) by large companies from 12% to 13%. The maximum employment allowance (effectively a rebate of employers’ NICs) increased from £3,000 to £4,000 but ceased to be available to employers with annual employers’ NIC liability in excess of £100,000.

The Budget also made changes to the pension rules. The income thresholds beyond which the pension annual allowance starts to be reduced were increased by £90,000 with ‘threshold income’ (broadly, net income before tax) becoming £200,000 and ‘adjusted income’ (broadly, net income plus pension accrual) £240,000. This was done largely to ease the tax problems of high-earning employees on final salary schemes (especially NHS consultants). However, the minimum pension annual allowance for the highest earners (with income over £300,000) fell to just £4,000.

The dog that didn’t bark on pensions was the widely-rumoured restriction of tax relief on contributions to the basic rate of tax. But, looking forward at the chancellor’s options in a very different post-coronavirus world, it now seems a racing certainty that that change will be brought in sooner rather than later – perhaps even from 6 April 2021.

Some important cases

After a short hiatus while they came to terms with remote hearings, the tribunals and courts have handed down some interesting and important decisions; some that have caught the writer’s eye are noted below.

Two covered share buy-backs in private companies. Khan [2020] UKUT 168 (TCC) concerned a taxpayer who, apparently to help out a client, agreed to buy shares in a cash-rich company using short-term finance that would immediately be repaid out of the proceeds of a share buy-back. His overlooking the fact that the buy-back would create a very large charge to income tax was an expensive object lesson in the need to examine all aspects of a transaction.

Boulting [2020] EWHC 2207 was a judicial review case of potentially wider application: essentially HMRC had declined to be bound by an advance clearance given under CTA 2010 s 1044 on the grounds that they purported to have discovered that the shares had been bought back for a price that was greatly more than their market value (despite the fact that questions of valuation form no part of the clearance application). Judicial review was refused: the matter will have to be litigated, if at all, via the First-tier Tribunal.

Partnership lessons

There was also rich crop of cases involving partnerships. Four in particular spring to mind.

As is well-known and accepted by HMRC, in computing partnership profits a deduction may be made for an expense incurred by a partner (as distinct from by the partnership) where that expense meets the other criteria for deductibility including being wholly for business purposes. Shiner and another [2020] UKFTT 295 (TC) helpfully reconfirmed the principle but posed the question whether that same rule also applies to interest paid by a partner on a loan applied in defraying partnership expenses. Perhaps surprisingly, the answer according to the FTT is no.

The second partnership case was Tyrwhitt [2020] UKFTT 272 (TC). Former employees had become members of the LLP. After the employment had ceased, they received amounts of deferred bonus calculated by reference to their time as employees. Did NICs fall to be calculated on the basis that the amounts were earnings from the employment or as profit share? The judgment is notable less for the fairly predictable decision that class 1 applied than for the observation of the tribunal judge that it would have been straightforward (and presumably, given its provenance, acceptable) to have avoided NICs (of close to £1m) by contractually surrendering the right to the bonus in return for the award of an equivalent amount of LLP profit share: a rare case of a court suggesting a route to tax avoidance.

Third, the year saw the first tribunal case on the ‘mixed member’ rules introduced by FA 2014. Walewski [2020] TC 07554 contained a helpfully careful and comprehensive analysis of the legislation and concluded by agreeing with HMRC’s interpretation on every point.

Finally, the saga of Investec found its way to the Court of Appeal in [2020] EWCA Civ 579. Buried deep in the procedural issues and the complexities of international financial dealings, the main question of interest to SMEs is whether and in what circumstances the disposal of an interest in a partnership can itself give rise to a trading profit; and how any double taxation (on both the partnership profit and the profit on disposal of the partnership interest) is to be dealt with.

It depends on the facts…

There was the usual crop of cases demonstrating that some things are entirely fact-dependent, including whether there has been a ‘discovery’ (and if so, whether it has become ‘stale’); whether a holiday lettings business is an ‘investment business’ for the purposes of IHT business property relief; and whether particular arrangements fall within IR35. But along with these there were other decisions of more general interest beyond their particular facts.

Among these may be counted Looney v HMRC [2020] UKUT 119 (TCC), on the treatment (as a revenue receipt) of a payment received on early termination of a trading contract, which, as one commentator succinctly put it ‘reminds taxpayers of the importance of supported and justified witness evidence, of the critical weight to be given to contractual agreements including terms and conditions and that a subjective interpretation of the circumstances does not amount to a fact’.

In cases where repair costs are in dispute, the question of whether there has been a replacement of an ‘entirety’ or the repair of a subservient part is a regular bone of contention. Steadfast Manufacturing and Storage [2020] UKFTT 0286 (TC) was a case in which HMRC failed in an attempt to deny relief for the costs of repairing a factory yard, unsuccessfully contending that the size and importance of the yard in the context of the site as a whole rendered the expenditure capital in nature.

When a business is transferred on incorporation, standard advice is that care should be taken that the company does not overpay, lest the excess be treated as remuneration or distribution. Such was the problem in Pickles v HMRC [2020] UKFTT 00195 (TC): the excess of the price paid for goodwill over HMRC’s assessment of market value (accepted by the tribunal in the absence of expert evidence to contradict it) was held to be a distribution. An interesting point of the case was, however, the fact that only some two-thirds of the price was actually paid over before the company went into liquidation: was the taxable distribution to be calculated by reference to the contractual price or what was actually received? On a split decision, the FTT chairman’s casting vote was for the latter: distributions are distributions only to the extent that they are, well, distributed.

A look ahead

So much for the past. Looking ahead, the elephant in the room is the need to find the wherewithal to start to reduce the eye-watering amount of debt that government has had to take on over the past several months.

On any analysis, the measures recommended in the recent report of the Office for Tax Simplification go well beyond mere ‘simplification’. Indeed, the OTS is unabashed in saying that some of them would complicate the taxation of capital gains.

None of the measures imply any reduction in tax liabilities; most would significantly increase the effective rate of CGT, either by increasing the headline rate or by removing or restricting reliefs and exemptions.

The government made much of its manifesto commitment not to increase income tax, VAT or NICs. If that commitment is not to be broken, its options for dealing with a historically unprecedented debt mountain are somewhat limited. It will surely leap to adopt any justification to increase the yield from CGT, though whether the measures proposed by the OTS would in fact do so, once behavioural changes are taken into account, may be open to question.

Apart from the suggested abolition of BADR referred to above, two of the areas of proposed reform have especial relevance to SMEs. One is around the interaction between CGT and IHT and in particular the rebasing to market value on death for CGT purposes. At present, best advice to an SME proprietor thinking of passing the business to the next generation is often to do nothing; if the assets are still held on death, any chargeable gain will be wiped out and business property relief will take care of IHT. The OTS perceives that as anomalous. Removing rebasing, as OTS suggest, would require a major re-think of succession planning.

The other area of CGT reform particularly pertinent to private companies is ‘money-boxing’: accumulating undistributed value within a company to be extracted or realised as capital gain (at worst) on sale or liquidation. The suggestion that some way should be found to tax accumulated retained earnings in smaller companies at income tax rates would re-write the rules of SME tax planning – and not in a good way. Just as the proposed BADR changes bring to mind the old retirement relief, so the proposals to discourage money-boxing conjure up (unwelcome) memories of the even older rules on ‘apportionment’ of close company income that were abolished in the 1980s.

As with so much in tax, plus ça change…

This article was first published in Tax Journal Issue 1513 and is available on the Tax Journal website.

David Whiscombe

Consultant

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