Author Archives: Graeme Blair - Partner

About Graeme Blair - Partner

T +44 (0)20 7874 8835

Graeme helps guide businesses through the corporate tax world. He is particularly expert at issues that property companies and professional practices have to navigate and therefore often manages large and complex assignments, many of which have an international element.

As a client of Graeme's wrote "I am increasingly impressed that when I pick up the phone to Graeme I receive robust and appropriate advice."

Catriona:     Welcome to another Goodman Jones conversation. Today Graeme Blair of Goodman Jones and Declan Merry, of Merry Mullen in Dublin will be looking at the issues for British and Irish companies exploring the new business opportunities across the water.

Graeme:      Hi Declan, it’s great to hear from you. Of course, it’s a shame with the lockdowns of both our countries that we can’t meet face to face at one of the regular events we jointly attend such as the British Irish Chamber of Commerce sessions, and then obviously have a pint afterwards.

Declan:        Yes, it’s good to talk. It’s been awhile and we would have had a number of different events to join up and meet and network and go through some of the opportunities in the different countries and some of the challenges. So let’s see if we can talk through a couple of the permutations and some of the issues that we’ve had.

What are the issues for British companies looking to Ireland now?

Graeme:      We obviously have mutual clients and regularly rely on each other’s expertise for our own clients, expanding into the other’s countries. As we can’t meet, and as we can’t travel its worth catching up and just exploring what the typical situations that get asked, for expanding to the other’s country. One of my clients said to me, I’m still looking to Ireland as a new market. What advice would you give British businesses right now when taking those first steps into the Republic?

Declan:        The country is in pretty good stage at the moment in terms of exiting the lockdown. We’ve reacted reasonably quickly and we hope that we’ll be in a good position. The clients that we have at least outside the hospitality sector have generally experienced the ability to work remotely. And as we exit, there seems to be an expectation that the booming economy that was before lockdown is going to surge forward with everything that was happening beforehand.

So we’re hoping that we’ll exit relatively quickly, and we can rely on some of the established technology, financial services and pharma sectors, which are thriving through the boom. So hopefully they will give a bit of leverage. The government has done quite well in terms of the supports. There’s good supports there in terms of the ability for companies to progress forward. And that’s going to hopefully continue the economy going forward. With regards to your clients, a number of supports that we can put in place, especially through Enterprise Ireland and the I.D.A.

And we can put them in touch with some of the contacts we have there, would be willing to get in touch with them and see whether there’s any assistance or grants that they can give to your clients.

With reference to construction, the Irish economy is growing strongly and was predicted to grow strongly further through 2020. There was significant projects in train, numbers of cranes in the skyline. So all of those projects are recommencing. And the view of economists is there has been shortage. It’s still going to be there. And with the pre-let offices being developed, there will still be under supply for some time yet. So hopefully the construction industry is going to bounce forward, and there’s going to be a couple of years of activity there in train, or to continue.

Graeme:      What mistakes have you seen businesses make when they expand into Ireland? And what examples of best practice can you give?

Declan:        The main mistake that we have Graeme is people coming here and not being fully committed. A company needs to be managed and controlled in Ireland to be tax resident. And it needs a physical presence with employees here also. Once the company is committed to establishing a presence in Ireland that will then suffice. There’s the usual concerns that exist, which can be determined generally with good advice, whether or not you have a branch or a subsidiary or a standalone company or a subsidiary structure they can be developed with some simple advice as to what’s best.

Somebody might want the Entrepreneurs’ Relief in the UK and a standalone structure might be preferable, but the overall sense within any businesses, is what’s intended for the accumulated profits of the company? How are they going to be repatriated to the UK or elsewhere? We meet with advisers such as yourself to work out what is the overall strategy for the investment and we can do that working with yourself or others. One point I would raise is coming from the UK, Irish companies require an EU tax resident director. And from January, 2021, the company’s board cannot solely be UK tax residents. That’s something we just got to look forward and plan.

Graeme:      Declan, that’s a really good point about the EU resident directors. At the moment, if a business is in two minds, whether it should physically move to Ireland to set up or stay in the UK and expand directly from the UK. What issues do you see for both alternatives? Effectively we’re asking, what’s the benefit of a branch versus a subsidiary?

Declan:        The branch activity Graeme is far simpler to set up. As you know, we simply have to register the branch in Ireland. There may be VAT implications, and we’ll register for VAT in Ireland or PAYE in Ireland. The difficulty obviously is that it doesn’t have a limited liability structure in Ireland. And therefore there isn’t a ring fencing of the losses. Sometimes there can be a tax angle, as you know, in terms of the benefits of one or the other, but setting up a company in Ireland has got a different level of documentation and bureaucracy, which has to comply with in terms of money laundering, legislation, bank accounts, verification and as I said, just their requirements under companies law to have EU tax resident directors.

Graeme:      For those businesses that are expanding outside the UK into the Republic. It’s not unusual to bring some key staff over at the early stages. What strategies are there to motivate key staff and to remunerate them, especially if they’re moving their families to a new country?

Declan:        So I think that the main thing is to bring them over Graeme, buy them a pint of Guinness, and they’ll see the benefits straight away. Ireland is an attractive place to live and work. It’s got a good quality of life. It’s got the fastest growing economy in Europe, youngest population in Europe and a good education system. So overall it’s a good place to live. Dublin is the biggest city, but it’s a small city and it can be established in other cities around the country.

There is a special assignee relief program in Ireland, which allows key personnel to come to Ireland under assignment by their employer, where their salary is in excess of 75,000 Euros. 30% of the amount in excess of 75,000 Euros can get disregarded for tax purposes. This can be a key incentive in order to attract your personnel to relocate in Ireland, that together with our non-domiciled system, whereby we have a remittance basis of tax, it would only be their Irish source income, which will be taxed in Ireland. These two combined can give a really attractive package coming to Ireland.

Graeme:      Great. I wish we had something similar.

Declan:        Yes, it’s up to a million euros.

Graeme:      Wow.

Declan:        So if you’re earning 675,000 effectively 200,000 just gets disregarded for tax.

Graeme:      That’s a really attractive relief. Is it aim that specific sector such as professional practices or people businesses, or is it used across the board?

Declan:        No, it’s across the board. It’s probably aimed and designed for US Multinationals coming to Ireland more than Ireland to the UK. The relief can be quite attractive and there can be quite an amount of the remuneration package that can fall out of the tax net. There is also a keep share option scheme Graeme, which is very similar to your EMI scheme, where a company can provide options to the employees and the employees can exercise the options straight away and effectively where as the deferred tax on that option until such time as the company’s sold. So that’s something that we see happening more often in some of the mid-sized companies that we have, which can offer an attractive way to incentivize the employees.

Graeme:      Good stuff, very useful.

Irish Companies Looking to the UK

Declan:        When I’ve got a client looking to establish a presence in the UK. If I want to develop the British markets, do you think a physical presence is now necessary, or can I take advantage of the fact that offices and businesses are now working more remotely?

Graeme:      That’s a really interesting question, especially as we come out of the Covid crisis. What we’re finding is that some of our recruitment agents in the UK are already advertising work at home type assignments. And therefore the suggestion is that we are actually going to move into a more remote working environment as a nation. What that really talks about to me is branch versus subsidiary, because traditionally there’s been a perception in the UK that to recruit good quality staff, you need a subsidiary here. If people are working from home, then why can’t they work for the Irish employer as a branch operation in the UK?

I think the world will change slightly in that regard, I think more and more Irish businesses coming to the UK will look at that possibility. Really, there’s no one size fits all answer. You need to consider the commercial needs of the business and you need commercial protection as well. And obviously if you have a UK subsidiary, you tend to ring fence the UK operations into the subsidiary, and that protects the Irish parent from the activities of the UK subsidiary.

Declan:        And what do you think will happen to the availability of offices and property as we all address our new office needs post Covid?

Graeme:      I really think that I’m going back to my school days of basic economics and supply and demand. I think as I’ve said, the world is changing the way businesses expand into the UK may change. And I actually think there’s going to be an availability of commercial premises going forward. That’s both factories and more traditional office blocks. Rents in the UK are pretty expensive compared to certainly Dublin and many of the European capitals. And therefore, if a business can save on rent, it can actually save a considerable amount of its overhead.

And I really believe that businesses, those expanding into UK in particular will start looking at home workers more than maybe having people in offices. However, from the people perspective, really, you need to make sure your employees integrate and your teams work efficiently. And that leads to the question of maybe we won’t have exclusive homeworkers maybe we will have office hubs where people can come together for short periods of time, maybe in central London and interact with other team members.

We’ve got one client who’s already looking to downsize their central London offices and take out serviced office space so that teams can meet infrequently and actually do the bonding that we all do in the office without really realizing it.

Declan:        That’s really interesting. So will London become less popular given the requirement to use public transport?

Graeme:      The interesting thing about London is it has a disproportionate percentage of the UK GDP and a disproportionate percentage of our national population. And a question I’m sometimes ask is why the business simply not relocate to cheaper parts of the country and save on the salary and property costs. For example, the BBC has traditionally been located in West London and in recent years has relocated many functions to the North of England.

I think the reality is that London and the Southeast is a natural destination for the wealthy and internationally mobile. It’s also a natural staging post for exports to continental Europe, including obviously those original 18 in the Republic. The government has long understood the difficulties associated with disproportion of wealth and population in the Southeast, and has introduced measures to try and spread that more evenly throughout the country.

For example, in recent years there have been announcements about funding the Northern powerhouses to spread the wealth more evenly and HS2 the train project has been specifically designed to make working outside London more practical.

The same principle applies to the upgrade of the Manchester Leeds rail link. However, we can’t turn away from the fact that the UK’s two largest airports are in London. Heathrow I understand is the third busiest in the world, and it’s another reason why internationally focused businesses might naturally gravitate towards London despite the higher employment in rental costs.

Declan:        So what other hubs do you see developing that I could take advantage of?

Graeme:      I would think the obvious ones would be Birmingham and Manchester. Birmingham, the second biggest city in the United Kingdom and only an hour and a half from London. Manchester has really reinvented itself over the last decade. Its industrial activities as they’ve close to being replaced by more technological and media friendly businesses. And that I think is going to help it in the long-term.

Declan:        Okay. Interesting. What if I wanted to buy into the British markets through acquisition? What issues would you flag that are different to the process you would understand in Ireland?

Graeme:      I think there’s great similarity between the processes that we would adopt in the UK and the processes that you’re firm are well versed in Declan. Obviously you need your due diligence and to instruct local advisers to ensure that the tailored advice or structuring legal agreements and other matters that always come out of a transaction are tailored specifically for the UK. However, because of the geographical proximity of our countries, the shared histories, the cultural similarities and I also would argue our combined isolation from mainland Europe tends to mean our regulatory processes are similar.

Our outlooks are similar, our tax systems are similar, and we really understand how each other operate. For example, Entrepreneurs’ Relief, it’s a million euros for you. It’s a million pounds for us. And the fundamentals of Entrepreneurs’ Relief is similar across both our nations.

Declan:        And they’re both 10%.

Graeme:      And they’re both 10% absolutely.

Declan:        Graeme, my clients won’t always have cash to put into staff benefits. What can I do to attract and incentivise the talent I’m after in the UK?

Graeme:      That’s a great question. And I’m going to start with a salutory tale I think. You’ve asked for benefits and highlighted the desire to preserve cash. Just one point that sometimes gets overlooked when coming into the UK and that is that we do have statutory pension obligations. These are on top of employment costs and with an increasingly aging population and therefore the number of workers whose taxes finance the retired, I should imagine the statutory pension obligations will increase to protect against future generations, having an ever increasing problem.

The statutory pension obligations are auto enrollment and Declan I believe you’ve got something similar in the Republic. Turning to your specific question, the matter that bridges cash and non-cash salary is of course share options. And we have a number of government approved share option schemes. Approved in this context means special tax breaks for both the employer and the employee. And that’s deliberate to make them attractive as part of a management package. The logic of course, is that if management were incentivized with equity ownership through an option, then in theory, they work harder, they grow the business and they participate in the future sale of that business.

The share option schemes, I’m thinking of are specifically tailored for unquoted companies and they’re regularly used when foreign businesses come to the UK for the first time to attract the key people who will manage the UK operations on a daily level. And therefore the key people who are instrumental in the business’s success.

One other part of the package that regularly is debated in the UK and it can be quite an emotive subject when recruiting staff is providing a car, it’s a historical anomaly in the UK, a car would of course be a cash cost to the business and we’re finding many businesses are leasing cars to spread that cost over the period of ownership. And there are some tax breaks for low or no emission vehicles such as electric cars, and these are deliberate. And when you combine them with some of the leasing opportunities can actually make a pretty efficient package at relatively modest cost.

We can’t do one of these discussions without the B word, Brexit.  Obviously it’s the big unknown, but actually I believe that our mutual trade, our combined in shared history and our fundamental similarities will remain with us and Brexit won’t impact on that too greatly.

Declan:        Agreed, I think business will always find a way when there’s investment opportunities and business opportunities, despite any changes that will come from Brexit,

Graeme:      Given what I’ve said, we can’t just assume that what your clients are used to would necessarily immediately translate into the UK.

Declan:        What mistakes have you seen companies make when coming to the UK and any examples of best practice?

Graeme:      I’ve already hinted that tailored advice should be sought. And it’s almost stating the obvious that if you don’t seek UK advice about UK structuring, then there’s possibility of a problem there. In terms of what mistakes I’ve seen, the one that springs to my mind is pensions. I can remember a situation where an overseas business was expanding into the UK by acquisition, and they did the commercial due diligence, they did the tax due diligence, and it was pretty late in the day that they engaged the pension lawyers to look at the pension due diligence. And actually they didn’t do the transaction. There was a defined benefit scheme in place that was pretty underfunded and the costs of sorting that out, made the transaction unattractive. So in summary, the opportunities for Irish businesses expanding into the UK are considerable. Our method of working may change to more of a remote homeworking environment, and we still retain our incentivization, particularly through EMI share options to attract the best talent into the UK.

Declan:        Absolutely. I think the similarities are greater than the differences Graeme. The EMI scheme is very similar to our KEEP scheme and we can always take advantage of these different opportunities. I think now in this environment where we’re working remotely, working with somebody locally in your city, or working with somebody across the water, I think is going to be very similar and I think there’s going to be more opportunities for people to work together and more business being conducted remotely. And that’s going to give great opportunities for all our clients in order to progress and take advantages of whatever opportunities exist.

Catriona:     Thank you both. And thank you for listening. If you’ve got any questions or would like to get in touch with Graeme or Declan, you can find us goodmanjones.com or merrymullen.ie.

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Catriona: Hello everyone, as we’re working through the implications and repercussions of the current crisis, we have begun to get quite a few questions about whether and how businesses should be thinking about restructuring. Some, I think are from a defensive perspective obviously, but others are looking more to the future. So today Graeme Blair, our head of business tax is here to talk through some of the issues. So Graeme, can you give us a flavour of the sorts of questions people are asking?

Graeme: Hi, there are three general areas that people are looking at, at the moment. The first is gifting shares throughout the family generations. The second is incentivising employees through share schemes and the third is restructuring for trade and asset protection or financing purposes.

Is now the right time to gift shares in my family business?

Catriona: Okay. So there’s quite a lot of different things going on there. You mentioned gifting shares. Why would people be thinking about that now?

Graeme: It’s always been possible to gift shares in family trading businesses. However, there’s more than one tax to consider when gifting shares. The interaction of tax reliefs makes gifting of shares between the generations tax efficient for trading businesses. However, there are many companies which look like they’re trading but aren’t able to rely on these reliefs. Typically these are successful trading companies which use surplus monies to reinvest often in property.

What the shareholders may not have appreciated is the investments they’ve made the company non-trading in the eyes of the tax law. They might be trading commercially, but in the eyes of the tax law, they are non-trading. The investments don’t have to be large for this to become a problem. And the impact is that there can be a tax charge when shares are gifted.

Catriona: And presumably low interest rates are making alternative investments even more attractive at the moment, for those that are lucky enough to have assets to invest.

Graeme: With low interest rates, people are starting to consider cash balances and thinking about other areas to use their spare cash. And this can only perpetuate any problems about having non-trading assets on the balance sheet.

There’s also the thought that tax rates may rise in the future and so people are considering the possibility of gifting under known current reliefs rather than running the risk of doing nothing now and considering gifting in the future on uncertain tax regimes.

Catriona: Okay. So can you expand a bit more on what taxes you’re talking about?

Graeme: When there are gifts, there are two taxes that need to be considered. The first is capital gains tax, which is payable by the donor and the second is inheritance tax. The capital gains tax costs are difficult to overcome and this has led to an increased interest in gifting at this time while share prices are depressed, effectively it’s an opportunity to minimise a tax charge, which is determined with reference to a company’s open market value.

As companies struggle in the current economic climate their values are depressed and the tax costs associated with gifting are reduced. I’ve already highlighted that these tax costs arise when you have a non-trading company.

There are techniques such as demergers which we’ll come to in due course which may be able to protect against the tax consequences for non-trading businesses. They do this by converting a business into a trading business and allow them to access the tax free gifting rules.

How can I incentivise staff when cashflow is a problem?

Catriona: You mentioned that we’re getting a lot of calls from employers who are understandably concerned and upset about the fact that they’re having to make cost cutting and indeed reduction of wages and the impact that that’s having on their staff. What could they be doing that could incentivise staff or go some way to helping those people that wouldn’t be an in upfront salary costs?

Graeme: Cash is king here. The reason that salaries might be cut or bonuses deferred is to save the business cash and therefore the solution would be to offer staff non-cash consideration as part of their package. Shares would be an obvious example of a non-cash payment that could be part of the salary package.

Of course, what I’m considering here is a commercial business which is not already employee controlled. Therefore, I’m not describing a business which has, for example, a John Lewis model. I’m describing the situation with the vast, vast majority of UK businesses where employees are not necessarily shareholders.

The issue that needs to be overcome is that if an employee simply received shares in the business for less than their market value, for example, they are given shares in the business, then there’s a tax charge. It would be reasonable to assume that the employee would go to the employer and say, please provide me the funds to pay the tax charge.

Of course, if you’re trying to save cash, that is not really an effective mechanism to do so and therefore what we’re finding is we’re entering into conversations about share option schemes because they bridge the gap between providing the employee with a package that incentivises them and the employer saving cash.

Catriona: Okay. Thank you. So what sorts of share option schemes are there?

Graeme: In the UK there are three share option schemes that one looks to adopt for private businesses. They are enterprise management incentive, sometimes called EMI, Company Share Option Plan, sometimes called (CSOP) or the unapproved share option plan. Unapproved in this instance does not mean anything other than they don’t come with any special tax breaks.

Catriona: So how would anyone know which one to choose?

Graeme: In the private company arena, EMI is always looked at first. In fact, EMI is often described as the gold standard of share option scheme. If EMI is not possible, then CSOP is generally considered next. If CSOP is not possible, then employers look unapproved share option schemes.

Catriona: So if EMI is the gold standard, why wouldn’t that be the one that everyone would go for?

Graeme: Not all companies could issue EMI options. There are certain tests about the eligibility of the employing company. These tests include tests of size and activities. Only trading companies can issue EMI options. I’ve already referred to the differentials between some of the tax reliefs between trading and non-trading companies and this is another example where there are differences. If EMI is not possible, then one looks to CSOP, this is because the range of companies which can issue CSOP options are broader than the range which can issue EMI options.

Catriona: Okay, so you’ve explained clearly the benefits to the employer, but what’s in it for their employees?

Graeme: Certainly for CSOP and EMI, there are special tax rules that give them benefit if they receive an exercise share options. If the employer grants options to the employee which are exercised at the current market value of the company, then as long as the employee pays that sum, when they exercise the option, there’s no tax charged to them for receiving the shares. So for example, if the business is worth £1 per share today and options are granted and the exercise price of £1, then it doesn’t matter that the individual exercises the options say in five years’ time when the shares are worth £10 each.

The employee would only pay £1 for the shares, but they would receive shares worth £10. Both EMI and CSOP, therefore give an incentive for the individual to work hard and grow the value of the company. Reverting back to the comments made earlier about the depressed economic climate, company shared values are more likely to be lower at the moment and therefore the price at which the individual can be granted shares is lower, and if those shares do grow in value in the next few years, then the gain to the employee is greater.

Catriona: Lovely, thank you. So that sounds like certainly something to consider for those who’ve got a robust plan for the longer term. Is there a limit to the value of the shares that can be transferred to employees?

Graeme: Generally, companies can issue more EMI options to their employees than CSOP options. Again, it’s another reason why you look at EMI first.

Catriona: What are the differences to the employees when they get the shares?

Graeme: Again, there’s a difference between EMI and the other share option plans. Entrepreneurs’ relief is the lowest rate of tax in the UK. It’s a 10% rate and an EMI option can allow the individual to obtain entrepreneur’s relief when they sell the shares.

In my experience, this 10% rate of tax is rarely available when shares are rising under either CSOP or unapproved share options. This differential was deliberately introduced by the government to enhance the attractiveness of EMI.

I’ve given you a little insight into some of the conditions for the share option schemes. There are others and tailored advice should be sought based on the specific circumstances of the employing company.

Catriona: So to sum up you’ve highlighted some of the benefits to employers, but obviously this sounds like something that the employers could be looking at. Are there any other benefits you would flag?

Graeme: There is one other benefit that’s regularly highlighted and that’s the corporation tax relief available to the employing company. Going back to my earlier example where options were granted for £1 and exercised at the time when the shares are worth £10, the  £9, as I’ve already highlighted is tax-free for the employee, the employing company gets tax relief on this £9 even though there’s no tax on the employee.

This is a great benefit to the employing company as it doesn’t have to spend money paying staff and yet it gets tax relief on the shares which were issued to staff. Again, this is deliberate to make EMI share option planning attractive.

If we reflect on discussions to date, the trading company status of the company is paramount. There are differences between gifting shares on trading and non-trading companies and EMI share options require the company to be a trading company.

Catriona: And you mentioned in the introduction that people can accidentally find themselves in a position of not being a trading company. If companies find themselves in that position, what can they do then?

Graeme: That’s absolutely right and yes, it’s possible to take a company or a group and separate it out into its component parts so that you separate the trading activities from the non-trading activities. So let’s use an example of a single company with a trading section, but over years it’s used its spare cash to start investments, perhaps property investment. It’s then possible to split that company into two new structures. One, its trading activity and the other, the investment activity. It’s then possible to incentivise employees through, for example, EMI share options on the trading activity. These separations are called demergers.

Is there anything I can do to protect key assets in my business?

Catriona: I know you’ve been doing a lot of demerger work already grown long before the Covid crisis. So before we get into why they might be useful particularly now, can you just give us some examples of why people might want to demerge?

Graeme: There are a variety of reasons why demergers occur. They allow gifting through generations or option planning are adjust two examples. It’s not unreasonable to see demergers occur prior to management buyout, prior to retirement, prior to seeking external funding or as a mechanism to allow different shareholders to grow the businesses in different directions.

Looking at each of these in turn. A demerger could allow family business to separate into a trading arm and the investment arm with a view that the younger generation are gifted shares in the trading arm tax-free and using the gifting reliefs while the older generation retain the investment side and that becomes a quasi-pension pot for them to finance their retirement.

Alternatively, the business might be looking for external funding and a demerger allows funders to take security on investment assets in a ring-fenced manner.

I’ve come across situations where the family have brought in non-family members who are senior management and don’t want those management to participate in the growth of the value of the company that simply arises from its investment portfolio. A demerger allows management to take a stake in the trading arm of the business, potentially through EMI. Whilst the investment side is wholly retained by the family to finance their lifestyle.

If the business was, say, a manufacturing concern and it owned its factory or an advisory business and it owned its office block, then those property assets could be transferred with the investment assets and the family rent the business to the trading company at market rent. If the trading business failed at some time during the future, for example, as a result of Covid-19 or the actions of the external management, then the family still have the rental business to generate future income.

Another example of where a demerger has been appropriate is when a shareholder dispute occurs, because some shareholders want to take a business down one direction, whilst other shareholders want to concentrate on a separate business stream. The demerger allows the shareholders to separate the businesses amongst themselves and they can develop each business stream in the way that they wish.

Catriona: And that also happens in family businesses when you’ve got two subsequent generations and they’ve just got to the point they just wanted to go in two different directions. So it can happen for positive reason too?

Graeme: Oh, absolutely.

Catriona: So all of those examples involve trading activity. But what about people whose entire business is investment? For example, property investors.

Graeme: Demergers are equally appropriate in those scenarios. For example, in the last couple of years I’ve dealt with a number of families who own property investment businesses and looking to separate those businesses. For example, one situation was two families each own 50% in the shares in a group which had numerous residential properties. The family’s finances were therefore intertwined and they wanted to unlock their financial dependence on each other. What we did was to separate the properties into two separate businesses with one family taking one business and the other family taking the other business.

In another situation the relationship between a brother and sister deteriorated. In order to allow them to lead separate lives, they demerged their investment business with the brother taking some of the property assets and the sister taking the rest.

A further example is a family which had a dispute about the future of a particularly valuable piece of land, one sibling wants to spend time and money on that land seeking property development opportunities. Whilst the other siblings wanted to concentrate on the rental income that other properties were generating.  Again, the siblings split the company, so the individual who wanted the development site was able to take it and do what he wished with it whilst the other siblings took the remaining properties and continue to make rental profits from them.

Finally, there’s the common situation in which families need to offer security for borrowing. This is not security for company borrowing. It’s security for private borrowing. It might be security to help finance a separate business in which they have an interest or security to allow them to buy an asset such as a family home.

A demerger can occur to take the valuable asset out of a trading company into a separate company and allow that separate company to be offered as security without any impact on the day to day activities of the trading company.

Catriona: And are you seeing an increase in interest in demergers as a defensive reaction to the situation we’re in now?

Graeme: I’m certainly seeing many conversations about demergers. No two demergers are the same and they have to be structured in accordance with the specific facts of the business and the commercial wishes of the shareholders.

With share values falling and incomes falling I’m entering into more conversations about their use as a mechanism to allow families to achieve their objectives and protect the wealth in a way that’s appropriate for each separate family member.

Catriona: You’ve talked a lot about family businesses, are demergers appropriate for enterprises that are not owned by families?

Graeme: I’ve already hinted that demergers are appropriate as a structuring for a management buyout, and that same principle applies to other situations where there may be external investment into existing businesses, and so the answer is yes.

Catriona: Thank you very much, Graeme.

I hope you all enjoyed that. We are obviously trying to share the issues as they happen, but everything is happening really fast at the moment. So always check our website, which is goodmanjones.com for up-to-date information. But if you have any questions you’d like to put to Graeme or anyone else, do please get in touch either by the website or through LinkedIn or Twitter. Thanks very much.

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Research & Development tax credits: A boost for cashflow

If grants are not used to finance innovation, then there may be business costs which can be subject to Research and Development tax credits.

As we cope with the crisis, the primary focus of many businesses is likely to be retaining customers and managing cash. Despite this the expenses incurred in innovation should be captured in a way that allow for easy identification. This is because those costs may to be basis of an R&D credit claim. This can be a valuable boost for cashflow,and in our experience, one that can be available quite quickly after application.

If the Finance Bill 2020 is enacted as drafted, the Research and Development Expenditure Credit (RDEC) payable to larger businesses increases to 13% from 1 April 2020 with the enhanced deduction from the SME sector being unchanged at 130% of the qualifying expenditure.

As part of the COVID-19 response HMRC has confirmed that it remains their priority to process 95% of SME tax credits within 28 days of receipt. For the loss-making SME the credit can be surrendered to HMRC for a payment of almost 33p in the pound.

Legislation requires HMRC to offset some of the credit against any taxes owing to themselves and only repay the balance. It has been suggested that HMRC have no discretion about varying this in respect of RDEC claims. This is because the legislation covering administration of RDEC is heavily dependent on the claimant being up to date with their taxes. The same formulaic rigidity does apply to claims from the SME sector and it is hoped that HMRC will be flexible and support SMEs which are looking for funding through the R&D credit process.

Legislation also requires the claimant company to be a going concern, as expressed in the latest published accounts. For most companies this will be accounts prepared before the COVID crisis and therefore going concern should not be an issue. With the extension of Companies House filings by three months it may be possible for companies to defer their audit and therefore release of published accounts. With a delay in the audit the risk is that going concern may be difficult to demonstrate resulting in audit opinions making adverse comment, and there being a knock-on effect of an inability to make R&D credit claims.

The Government’s Coronavirus Business Interruption Loan Scheme (CBILS) for SMEs is a state aid and acknowledged as such. R&D tax relief claims cannot be made on costs which are subject to state aid. Currently the interaction of state aid and R&D credit claims is unclear. It would seem logical to conclude that CBILS loan monies which are used to finance R&D would restrict the ability to make an R&D credit claim. One would like to think that CBILS loans which are applied to support a company generally would not restrict the tax credit claims. This is evolving thinking and it is hoped that more clarity will be delivered in due course.

In conclusion, the innovation that British companies are experiencing should be identified and quantified as they may be the basis of a Research and Development tax credit claim and that claim could help finance the future of the business.

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CR: Hi everyone. Since the beginning of this Covid crisis, we’ve been in constant conversation with company directors about the impact on their businesses and on themselves. The focus to date has been on what government support is available and Graeme Blair, who is head of our business tax team is with me today to actually go through some of the questions that our clients have been asking us and try to address some of them. So Graeme, what are the main things that company directors of owner managed businesses have been asking you?

GB: Well, the government has provided four different types of support and if you look at all four of them, they are really cash flow driven, ie that they are trying to maintain the cash inflow of the business so that it doesn’t have to shed staff and lose sales. The government has four different types of support that help businesses maintain their viability and ultimately maintain their staffing.

The four areas are VAT deferral, statutory sick pay relief for SMEs, the coronavirus business interruption loan for SMEs and the job retention scheme.

VAT Deferral

Looking at the VAT deferral first, this is relatively straightforward. Any VAT liability coming out of a return for the quarters ended February, March or April are automatically deferred until 31 March, 2021.

The return has to be submitted in the normal way. It’s simply automatically deferred and the business does not have to pay that liability until March, 2021 at the latest. It can obviously choose to pay the liability at an earlier date.

Statutory Sick Pay

CR: Okay, great. And then I think the second one that people were talking about was the statutory sick pay.

GB: Statutory sick pay was one of the first announcements from the government. The government was recognising the employees were going off sick and they brought forward the date from which statutory sick pay can be claimed off the government. It’s a relatively modest relief, but when you have large numbers of employees, the benefit can mount up.

Coronavirus Business Interruption Loan Scheme (CBILS)

CR: So, obviously as you said at the beginning, cash flow is the most important thing for everyone and everyone’s very keen to get their loans through from the government. Can you tell me what the issues are and what people are asking about that?

GB: The first question I’m being asked is, am I eligible? This is a turnover test and the support package under the coronavirus business interruption loan scheme or CBILS for short applies to SMEs with a turnover of up to £45 million. If you have a business with turnover in excessive of £45 million, there’s a different scheme that we could come onto later. This is a government backed finance scheme where up to £5 million, is offered over a six year period with the government covering the financing costs. That being interest and setup fees for the first 12 months, 80% of the loan is guaranteed by the government and as long as the loan is less than 250,000 pounds, there are no personal guarantees required of the shareholders.

CR: Because there was some confusion about that earlier, wasn’t there? About the personal guarantees.

GB: There was. And to be fair to the government, they stepped in quickly when they saw that the personal guarantees were being asked in situations that were not expected and clarified the legislation.

CR: Is it just loans or are there other facilities?

GB: It’s not just loans. Most businesses, it’s fair to say, are probably looking at loans, but the government support covers loans, overdrafts, invoice discounting and asset finance.

CR: Okay. What about loans in excess of £250,000?

GB: For loans of more than £250,000, it is the decision of the lender whether they seek personal guarantees or not. Even if personal guarantees are requested, there’s some protection for the shareholder as the personal guarantee cannot cover the lender’s personal home. The logic behind the government, excluding the primary home from the personal guarantee is to give some form of comfort that the shareholder will never be destitute, even if the loan goes bad.

CR: And how do companies and company directors go about applying for these loans?

GB: Well, interestingly, the guidance says that one should approach one’s lender in the normal way. Now the practical problem is lenders have been the same as other sectors and staff for self-isolating. This means that the numbers of staff at the banks who can process the applications is relatively limited and this has generated some discomfort amongst the directors who are looking for faster decision making than is currently being offered.

The lenders are short staffed at the moment for obvious reason and they are directing that potential borrowers apply via the website. The websites are generally asking for the normal information that one would anticipate in respect of a loan such as accounts, cash flow forecasts and evidence of the continued sustainability of the business.

CR: And is that the same for all lenders? There has been some chat about different lenders taking very different approaches. Have you seen any of that and would you have anything to say if someone wasn’t getting the answers they wanted and perhaps wanted to go to a new lender?

GB: Certainly different lenders are looking at different lending criteria, but that’s normal. In normal times you go to two different banks and what they look at or their credit committee looks at is subtly different. So at the fine margins, yes there will be a slight difference, but as a generality, the sort of information that lenders are looking for is pretty standard. If your own bankers do not provide the service or turn you down, well there’s always the opportunity to go to another one of the accredited lenders.

However, I have seen one corporate financier make the comment that why would one bank take on another’s problem? And what he meant by that was if the business is primary bankers were on the accredited list and turned down a loan application because they didn’t meet the appropriate criteria, why would another bank take on that customer and have that same potential risk?

CR: Okay. So given what you just said about resourcing within banks and the speed of turnaround, when do you think some businesses might be seeing the benefits of these loans?

GB: Well, that unfortunately is the million dollar question. There are stories at the moment about the difficulty of making contacts with banks. I saw an article in one of the broad sheets very recently that said in the first few days of the CBILS loan scheme, more than 100,000 applications had been made. Now even in normal times banks don’t have the staff to process that level of application and therefore I think there is going to be a slight delay in actually receiving the money and the message out there for directors is; you must talk to your customers and talk to your suppliers.  If your suppliers are pushing for payment, actually give them the confidence that you are going through the application process but it is not being resolved yet.

One banker pointed out, banks were just given a few hours’ notice of the introduction of CBILS and expected to have the systems and processes and staff available to meet the demand and yet the government’s job retention scheme, which we’ll come onto shortly. The government are giving themselves possibly as many as six weeks to get the scheme up and running and therefore it’s no wonder that the banks are feeling slightly frustrated at any criticism that they are being slow in responding.

Coronavirus Large Business Interruption Loan Scheme

CR: In the introduction, you were talking about CBILS being available for businesses with turnover below £45 million. What about those private businesses that do turnover more than that?

GB: There is quite a separate scheme called the Coronavirus Large Business Interruption Loan Scheme for businesses with turnover of between £45 million and £500 million. The details of the scheme are not known yet and the scheme will be open sometime in April. Current indications are that the sort of information that the CBILS scheme is expecting for credit committees to approve loans will probably be the same sort of information that the banks and lenders will look for, for the large business scheme.

However, there has been a concern that when the large scheme was first announced, the government said, and I quote, “lenders are expected to conduct their own usual credit risks”. Now, anyone who’s been through financing through credit committee and through the banking relationship knows that credit committees can take a long time to make a decision and therefore if lenders are expected to conduct their usual credit risk, there is a concern that this large business scheme will take a considerably large amount of time to come to fruition.

Job Retention Scheme

CR: Okay. But no doubt we’ll update people when that happens. So let’s move on to the thing that I know has occupied most of the conversations, which is the job retention scheme. Can you outline that for us and how that’s going?

GB: Of course, the whole basis of the job retention scheme is the government’s stated desire to prevent employers making people redundant. And so what the government are doing is they’re providing funding to allow employers to retain individuals on salary through the P.A.Y.E system without having to make them redundant. Effectively, the employer pays wages through the payroll. And some of those wages are subsidised by the government. The amounts of claim per employee is 80% of their wages up to a maximum of £2,500 per month. And wages for these purposes include employer’s national insurance, and any auto enrolment contribution that is made.

CR: Okay. Can you clarify what furloughing means for me?

GB: Furloughing is an expression that means an individual is still employed, but they’re simply frozen in their requirement to do duties. So effectively furloughed individuals are being paid not to work.

CR: So how does that affect, for example, family businesses where they might be company directors that still have duties to perform?

GB: That’s a very good question and one that has been clarified recently. For family businesses with more than one director, it’s possible to furlough some directors and retain other directors on the payroll in the normal way undertaking director’s duties. For husband and wife companies, it’s possible that one spouse could be furloughed and the other remain in employment undertaking company activities. The difficulty is single director companies. It’s recently been confirmed that these individuals can furlough themselves, but part of the requirement is that one does not work when one is furloughed.

And therefore if one is a director of a single director company and one furloughs oneself, one cannot do trading matters. Trading matters, some of them are obvious such as making sales or dealing with suppliers, others are less so obvious such as VAT returns and company secretarial matters. What has recently been confirmed is that the statutory obligations of companies such as company secretarial matters are not considered trading if one is furloughed and therefore a director can furlough themselves and still run the company at the administrative side but they can’t deal with trading matters.

CR: Okay, so could you phase your furloughing to qualify it has to be three weeks, isn’t it? So could you furlough yourself for a period and then work for a week and catch up on what your duties require you to do and then furlough yourself again?

GB: Certainly that has been a suggestion as the furloughing process is still relatively new based on the legislation or the announcements that is a possibility. And actually with time we will see how the government reacts to that proposal.

CR: So we’ve talked about company directors. Can you furlough partners in partnerships?

GB: If you have partners who are subject to P.A.Y.E and national insurance and that generally applies to salaried partners or partners who are taxed under P.A.Y.E because of something called the salaried members legislation that you can furlough them.

CR: Is there anyone you can’t furlough?

GB: Individuals who provide their services through personal services companies are not employees and therefore cannot be furloughed.

GB: What those individuals will have to do is consider whether their own company will furlough themselves as previously discussed.

CR: Lots of clients who are in the hospitality and leisure sector, which obviously has been severely hit early on. What about the national minimum wage considerations when furloughing staff in that sector or others?

GB: National minimum wage increases on the 1st of April every year and 2020 has been no different for the over 24 the minimum wage is £8.72 per hour. There are plenty of sectors that traditionally pay national minimum wage with hospitality and leisure being the most often quoted. So if you have a scenario where employees are being asked to take a 20% reduction in salary so that their salary is covered by the government grant, they will therefore be paid less than national minimum wage.

Is this a concern? Well, the government has already picked up on this question and they have indicated that national minimum wage applies to payments for work. Furlough is a payment not to work and therefore they have confirmed that national minimum wage will not apply to furloughed persons.

CR: And another thorny issue. What actually constitutes pay for the purposes of working out the calculation of what the government is likely to contribute?

GB: There’s been some uncertainty about the definition of pay for these purposes. The government have confirmed that any regular payments that you are obliged to pay your employees are included within the definition. This includes, for example, wages, over-time, fees and compulsory commission payments. However, discretionary bonuses and for example, tips in the hospitality and leisure sector are specifically excluded from the definition of salary for these purposes.

The government have tried to make the calculation of qualifying pay easier by stating that if an employee has been employed for 12 months or more, then you can claim on the hire of either the same month’s earnings from the previous year or the average monthly earnings for the year to 5 April 2020.

CR: For those who haven’t already had to furlough some staff. What are the key areas you think people should consider?

GB: Obviously the most important area is the motivational effect on staff. One would have to treat the furlough process with great sensitivity. That’s a given. From an employment law perspective, the key message is that one has to be reasonable about choosing the candidates to furlough. You need to think of discrimination, for example. So let us pretend the business had 40 employees and only needed 20 of them. If there were 20 females who were furloughed and the 20 males remained in work, then there’s probably an element of discrimination there.

And therefore when one considers whom to furlough, one should retain evidence of the decision making process to show that with the benefit of hindsight it’s reasonable. There is a school of thought that says not withstanding age discrimination legislation, it is possible to furlough older staff for their own protection. For example, if you had workers over 70 with the government looking for those individuals to self isolate, you could probably furlough all your over seventeens without any risk of discrimination. That’s current thinking and obviously the fullness of time will show how accurate of you that is.

Another important feature of the furlough process is that it should be documented in writing that you have the agreement of the staff to be furloughed. From a legal perspective, this is because it’s a change of their terms of employment and therefore changes of terms of employment should be documented in writing. This is especially important if there is a likelihood of reduction of salary at the same time. Again, you need the employee’s consent. At present it’s quite challenging to get that consent in signed letter form and therefore current thinking is that email approval and email consent is appropriate.If one is looking for a staff signature of course one can’t assume that all staff have scanners and that’s probably further credence to the view that email confirmation is acceptable.

CR: So what about holiday entitlement?

GB: That’s an interesting question. There are two aspects to that question. The first is does holiday accrue to an individual who is furloughed? The second is can one force staff to take holiday during a period of furlough? Turning to the first question, yes it is a requirement that they accrue holiday whilst they are furloughed. Turning to the second question is that you can require staff to take holiday during a period of furlough. There are steps in employment law that one must follow when one is forcing staff to take holiday and the relevant employment conditions should be followed.

CR: So it sounds to me as if the employment lawyers are going to get quite a lot of enquiries coming out of this then

GB: They certainly are. If you look at a lot of the podcasts, they are all employment lawyers.

CR: So we act for lots of international companies. What about people who’ve got employees on work visas or who are not UK residents? Does that apply?

GB: That is the question of the week. That is a question that is exercising many brains at this very moment. Typically employment visas are only valid whilst the individual works for their sponsoring employer. The question is if you’re being furloughed ie: you’re being paid not to work, does the visa automatically cease to be valid? At present there’s no guidance to that question. From a practical perspective, I guess if a visa is likely to cease and there are restrictions on travel, how would an individual leave the country?

CR: What about the risks associated with having all of the staff working from home? Have people been asking about that?

GB: Yes, and there were a number of risks. Most of them are practical, but there’s a few statutory risks. Employers have an obligation to ensure that staff are safe in their workplace. At present, individual’s homes are becoming their workplace and there is very little guidance as to how employers can ensure the employees are safe in their own homes.

There are data protection concerns obviously where you have individuals working from home, they might be sending information to their home printer and they might, for example, share a flat with others who can have access to that same printer.

So there’s concerns about privacy of information and there are concerns about data security in those situations where individuals start sending work emails to private email addresses or start replying to work emails from their private email address. We’re hoping that we’ll get more guidance from the government in due course.

CR: So that was great Graeme, thank you very much. Are there any other final thoughts you would say to company directors who are mulling all these huge issues over?

GB: Well, as we said at the start, these government supports are all about cash flow support. However, the director should not consider just the short term. It’s been proven that some of the best businesses come out of these short term problems, leaner and stronger than they went in, and therefore the director should not lose focus on the longer term growth of the business just because of management of the short term crisis.

CR: So now’s the time to be thinking forward and scenario planning and making sure you’re in the best place possible.

GB: Absolutely.

 

These updates are changing very fast so please check back to our Covid website for up to date details

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We are now less than six months away from the start date for the legislation known as the “Off-payroll working in the private sector”.

Personal Service Companies

As a reminder, the current private sector off-payroll working rules (often referred to as IR35) allow an individual to provide their services through, typically, a Personal Service Company (PSC) in order to modify the payroll tax consequences of payments to the individual. If that individual were to provide services directly to the customer (called the “end user”) then that individual would be an employee and PAYE and National Insurance (NIC) would apply. By using a PSC then a payment from the end user to the PSC only gives rise to income tax and National Insurance on the amount called the “deemed employment payment”. This is a calculated amount which generates a lower PAYE/NIC liability than if the individual was an employee of the end user. It is possible for the worker and the end user to agree a rate which splits this saving so that both parties benefit from the use of the PSC.

From 6 April 2020 there is to be a change in the mechanics for tax payments and the administration associated with off-payroll working.

Under the present regime it is the PSC which calculates the deemed employment payment and pays any tax liabilities.

From 6 April 2020 the organisation which pays the PSC will be required to include the individual on their payroll and account for PAYE and National Insurance as if they were an employee. The calculation of the amount on which PAYE/NIC is paid will change from the current calculation in a way that the tax and national insurance will be higher than under the current regime.

In many cases the organisation in the supply chain which pays the PSC will be the business who receives the services of the individual. In group situations, or in situations where agencies are used, this will not necessarily be the case. The new legislation has prescriptive rules which track obligations through chains of companies to give certainty about the company which will have the PAYE/NIC obligation.

Status Determination Statement

Under the current regulations it is the PSC which determines if the off-payroll working rules apply. From 6 April 2020 it will be the end user who will need to carry out the determination as to whether the individual should be subject to the new regulations. The end user will need to provide a status determination statement setting out the outcome of their analysis, including the reason for the decision they have reached. All interested parties in the supply chain have the right to receive this statement. The regulations have a requirement that the end user put in place a process for dealing with disagreements as to the conclusion of the status determination.

The process for disagreement requires the end user to reconsider conclusions reached and reconfirm their decision within forty five days of representation being received from interested parties. The legislation is light on practical application of the dispute process and does not necessarily give a chain of escalation up to HMRC. It has even been suggested that HMRC have tried to avoid being involved in any dispute resolution due to lack of resource.

Check of Employment Status for Tax (CEST)

One of the criticisms of the proposals is that there is little guidance about how the end user should carry out the determination and how they can protect themselves against suggestions that they have not taking reasonable care in this regard. An obvious solution would be to rely on the HMRC online Check of Employment Status for Tax (CEST) tool. However this tool has been subject to much criticism for being inflexible, for not being up to date with recent employment status tax cases and being developed by HMRC rather than an independent party. In response to this criticism HMRC have agreed to modify the CEST and will put in place mechanisms for support to around 17,000 businesses who may be affected by the change in rules. However even HMRC’s own statistics imply that CEST will be able to make a determination in only 85% of cases.

Who is affected?

The off-payroll changes will not apply to “small” end users. The Companies Act has been used to determine the definition of “small” which is a company for which at least two of the following are satisfied:

• A balance sheet total of not more than £5.1m
• Turnover of not more than £11.2m
• No more than fifty employees

There is some concern about the mechanism to transition a company which is small into the new legislation as the company grows.

Review Now

In conclusion the changes apply from 6 April 2020 and businesses which employ intermediaries should review the supply chain and analyse the extent that payments to the intermediaries need to attract PAYE and National Insurance. They should be doing that review now to ensure that all details required to operate payroll, for example, National Insurance numbers and home addresses, are known. In addition records should be requested in order for the end user to make determination of the extent to which the new regulations will apply. All of these actions need to be done in sufficient time for the consequences to be understood before 6 April 2020.

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Charlotte’s excellent commentary on family businesses and the need to look at succession planning strategically identifies the particular complexities that family businesses experience. As she says “It gets complicated by the personalities, relationships and the emotions of the people involved. That’s why it has the potential to go devastatingly wrong”

The tax tail should never wag the commercial dog. Despite this, tax is always a concern for a family business. There is an argument that family members are more concerned about tax than professional management within a larger business. This is because any tax payment ultimately comes from the family’s pocket, even if this is reflected in a reduction in the value of the family business.

Tax planning must support the long term aspirations of the family

Charlotte’s blog reinforces the need for a long-term understanding of the family’s aspirations. Long-term impacts should be factored into any advice. For example, clients often instruct us to assist on share option planning and efficiency of external funding. Both of these can result in share capital being owned by non-family members. The long-term aspirations of the family need to be understood given there is a risk that non-family shareholders have an interest in driving the business towards a sale.

Trading Status of a family business

Goodman Jones’ tax team are regularly being asked to give advice on the trading status of family businesses. Trading status is important as trading businesses have access to valuable reliefs which provide for efficiency of succession planning. For example, exemption from inheritance tax and the ability to tap into gifting reliefs are valuable tools in the family business setting.

Entrepreneurs’ Relief

Even if there is no intention to sell the family business, access to Entrepreneurs’ relief is seen as crucial by many families. Should the family be given an offer for the business they can’t refuse, then there is a desire to ensure that they can access the 10% rate of capital gains. Differing classes of shares, bespoke Articles of Association, unusual share rights and trust structures are all common in family businesses. They need to be managed and understood to ensure the continued availability of entrepreneurs’ relief. At a more basic level, even advice about the use of surplus funds owned by the business can ensure continued eligibility to entrepreneurs’ relief.

Structuring for growth

Family businesses are more dynamic than their larger counterparts. A family business can react to an opportunity more quickly than a traditional corporate environment. We have many discussions with our clients about structures for new opportunities and how to maximise the tax-efficiency of the upside whilst protecting the family against the risk of an unsuccessful venture. Family business members are often more sensitive to downside risk than shareholders of larger corporates as the impact on the family wealth is more directly linked to the company’s performance and downsides can be disastrous for the family.

In conclusion, all aspects of a family business have tax consequences, including ensuring continued access to trading reliefs. Sophisticated family business advisers such as Goodman Jones work with their clients to understand the long-term aspirations of the family and help shape business decisions which are congruous to those long-term aims.

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Following on from my previous blog and the issue of alphabet shares discussed there, HMRC have revisited Entrepreneurs’ Relief and amendments were made to the Finance Bill as it made its way through Parliament. This softened the effects of the restrictions that were originally proposed in the Budget. The Finance Act received Royal Assent on 12 February 2019 and these revisions are now final.

Equity Holders

Under the new rules introduced by the Finance Act 2019 an individual would need to be an ‘equity holder’ to obtain Entrepreneurs’ Relief on their shares. An equity holder is a term which is rather wider than holders of ordinary share capital and includes holders of convertible loan notes, or debt securities with equity like characteristics. So a holder of ordinary share capital could have found their entitlement was diluted below the 5% threshold when other rights were taken into account. Additionally the rights of the ‘equity holder’ are not restricted to checking that they have at least 5% of the ordinary share capital which controlled at least 5% of the voting rights. The 5% test is extended to considering the individual’s entitlement to the distributable reserves of the company and assets on a winding up of that company.

Alphabet Shares

These changes cause difficulties when there were different classes of shares – alphabet shares – which are often used to declare dividends between different classes of shareholders at different rates. Entrepreneurs’ Relief would not have been available if these new rules had been introduced without change as the discretionary levels of dividend would have meant that shareholders would not have had a guaranteed entitlement to 5% of the company’s distributable reserves.

This proposed change was not withdrawn. Instead, an additional and alternative, 5% test has been introduced which softens the impact of the change. The legislation looks at a shareholder’s entitlement to the proceeds if the whole company were sold, including a liquidation as well as a sale. One important difference here is that this test is applied as a snapshot considered at the date of the sale/liquidation rather than throughout the whole share ownership period. So in the case of alphabet shares, it would be possible to vary entitlement to dividends throughout the holding period, but provided the shares rank equally on a sale/liquidation and the holder is entitled to 5% of the assets of the company on a winding up then Entrepreneurs Relief is available. This revision only considers ordinary share capital, so the rights of other ‘equity holders’ are disregarded when considering this.

The revision could be beneficial to management in situations where outside investors have a preferential right to proceeds in the event of a sale of the company. At the beginning of trading, when the company holds little value, the preferential rights would mean that an ordinary shareholder (i.e. management) may not be entitled to 5% of the sale proceeds. However, as the company increases in value, the ordinary shareholder’s entitlement increase. If the company is then sold, the two year qualifying holding period will begin on the date of the first acquisition of the shares, but the test as to whether it is his qualifying personal company would only be applied on the date of disposal when the 5% test will be satisfied.

Clients should still review their position as shareholder and their company Articles. to see if they satisfy this new test now that the rules have been finalised but this is a welcome relaxation of the original proposals.

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James Hallett’s excellent blog on preparation for a No Deal Brexit highlights some of the practical consequences which should be considered by 29 March. James highlighted practicalities for import/export and financial reporting.

Group structuring and group cash flows may also be impacted by a No Deal Brexit.

Group structuring

Some EU countries’ domestic legislation provides specific reliefs if the counter-party is in the EU. These reliefs may have been relied upon for past transactions and reorganisations. As the UK may no longer be classed as an EU counter-party this may result in clawback of a relief which has been relied upon. Sticking to this theme, there may well have been migration involving the UK which has relied on tax deferrals under the EU freedom of movement. The UK’s departure from Europe may put the availability of those deferrals at risk and generate unforeseen tax liabilities.

At a more esoteric level the existence of a UK subsidiary, which is no longer within the EU, within a European group may adversely affect treaty benefit claims under double tax treaties involving EU countries and the US. The reliance on such treaties and the consequence of the UK’s departure from the EU should be considered.

Group cash flows

At a more basic level dividend, interest and royalty flows may rely on the EU Parent Subsidiary Directive or the Interest and Royalty Directive to prevent the application of withholding taxes. With the UK leaving the EU the ability to apply the terms of these directives would be at risk.

Without the benefit of the directive it would be necessary to consider the double tax treaty which the UK has negotiated with the counter jurisdiction to determine the extent to which there is a reduced rate of withholding tax provided under the treaty. This is particularly of concern if debt has been obtained from elsewhere in the EU and the terms of the loans include a gross up clause for interest. If the treaty reduces the domestic rate of withholding tax then the process to obtain treaty benefit would have to be followed. There are varying processes and varying time frames required to access treaty benefits.

Election to tax the overseas dividend

A solution which is relevant for dividends received in the UK is the election to tax the dividend received from overseas. This might be beneficial as a small number of treaties require dividends to be taxed in the UK in order to qualify for reduced rates of withholding tax. Mathematical modelling could be undertaken to determine if it is more advantageous to pay 19%/17% on dividend income and have a reduced withholding tax or have the dividend exempt from UK tax but suffer the foreign withholding tax.

The above are a flavour of the myriad of direct tax consequences of a No Deal Brexit and show that there is no one size fits all solution for business. Each business should review its structure, past transactions and internal fund flows in order to determine the cost versus the benefit of No Deal planning.

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Entrepreneurs’ Relief is considered one of the most attractive tax reliefs but we’ve worked with a few business owners recently who have assumed they qualify only to find to their horror that they don’t.

In the most recent Budget there has been a relaxation to the conditions associated with the relief and two further restrictions on accessing the relief.

Relaxation of Entrepreneurs’ Relief

The relief applies where a shareholder owns at least 5% of a company’s share capital. The Government have been sympathetic to individuals who find that their interest is diluted below the 5% threshold due to capital funding rounds. The funding is for the benefit of the business as it provides capital to expand but is detrimental to the shareholder as they no longer meet the conditions for Entrepreneurs’ Relief.

Draft legislation has been issued which allows the shareholder to be treated as if they dispose of, and reacquire, their shares immediately before the dilution. This allows them to bank their Entrepreneurs’ Relief before they cease to meet the 5% threshold test. This is an election and therefore not mandatory on the shareholder. If a capital gain is treated as realised, then there is a second election which allows the individual to defer payment of the tax on the gain until the shares are subsequently sold. This prevents the Entrepreneurs’ Relief claim on the deemed disposal giving rise to a tax liability but without having the money to fund it.

Some practitioners are questioning how the shares can be valued at the time of dilution. Of course, if there is dilution then there would normally be a third-party acquiring share at a known value. If that third party is acquiring shares at a negotiated market value, then it gives an indication of the basis for the deemed disposal.

The disadvantage of deferring the gain until payment of the tax is the risk that tax rates rise, or Entrepreneurs’ Relief is abolished prior to the eventual share sale.

New restrictions on Entrepreneurs’ Relief

There have been two restrictions. The first is the qualifying holding period has been extended from one year to two for disposals on or after 6 April 2019. This suggests that some shareholders are looking to make a disposal before the end of the current tax year as they know that they will not meet the qualifying condition immediately on commencement of the next tax year.

The second restriction on Entrepreneurs’ Relief was brought in with immediate effect on 29 October 2018. Prior to this date the shareholder needed 5% of the company shares which represented 5% of voting rights. From 29 October 2018 the shares must also entitle the holder to 5% of the company’s distributable profits and 5% of the assets available to equity holders on a winding up. This change is to try to ensure that Entrepreneurs’ Relief is granted to individuals who have a genuine economic entitlement to 5% of the company. This defeats structures where classes of shares have been issued which are carefully structured to achieve Entrepreneurs’ Relief without genuine economic ownership.

Alphabet shares and family businesses

There has been debate within the profession about the impact of the new conditions on alphabet shares. Alphabet shares have often been issued in family companies to allow different shareholders the right to dividends without automatically requiring dividends to be paid to other shareholders at the same rate. These shares therefore allow individuals to receive dividends in sums which are tax efficient for themselves. Typically, the Articles of the company specifically state that the shareholder is not entitled to dividends in the company until such time as the Board declare dividends on their classes of share. This is to prevent the need for all classes to receive dividends at the same rate.

If the Articles state that a shareholder is not entitled to dividends, then some commentators have identified that alphabet shares may not be eligible to Entrepreneurs’ Relief as there is no entitlement to 5% of the dividends of a company in any 24-month period.

There are two schools of thought. The first is that HMRC did not intend the Entrepreneurs’ Relief changes to apply to alphabet shares and will confirm this in due course. The other school of thought is that HMRC were aware of the impact of the Entrepreneurs’ Relief changes to alphabet shares and they are leaving it to the shareholder to determine if they wish to keep the alphabet shares (and therefore have income tax efficiency) or to restructure (to generate capital gains tax efficiency after a further two years).

It is important that HMRC issue their views on Entrepreneurs’ Relief and alphabet shares as any restructure then has a two-year follow-on period before Entrepreneurs’ Relief is available on the shares which replace the alphabet shares.

Make sure you check your position against the new requirements.

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The Corporate Interest Restriction is one of two strands of the Governments modernisation of the UK tax system; with the other strand being the reform of corporation tax losses. My blog of 25 June made reference to the impact of the Corporate Interest Restriction (CIR) Regulations. Although it was mentioned in the context of both inward investment and property investment it is not restricted to those two arenas.

For many years the UK has been at the forefront of the Organisation for Economic Corporation and Development’s best practice, including measures against Base Erosion and Profit Shifting (BEPS). One of the strands of BEPS is prevention of excessive tax deductions for financing costs. Typically the financing would be intra-group with the lender being in a tax advantaged jurisdiction and therefore high levels of intra-group debt or higher interest rates would save the group tax.

CIR for groups with UK interest deduction over £2m

CIR came into force on 1 April 2017 and only has a fiscal consequence for groups whose UK interest deduction is more than £2m. £2m was taken by the UK Government as being a sum which excluded the vast majority of organisations from the legislation. If UK interest is more than £2m then there are formulaic calculations to determine the tax relief which can be claimed. Tax relief can be claimed on sums as great as 30% of EBITDA (as adjusted for tax). The Government acknowledges that this ceiling can be particularly restrictive for certain groups and therefore it is possible to apply a different ratio; one which is more dependent on external financing and UK profitability. However, this alternative strategy needs management and therefore the relevant election should not be made before medium term profit forecasts are developed.

When the interest restriction applies a group company should be appointed to notify HMRC of the group’s interest restriction and how the group wishes for that restriction to be allocated amongst the group companies. In the absence of the election HMRC can allocate the restriction pro-rata between the companies and HMRC’s allocation may not be appropriate for the group’s tax profile.

Corporation Tax Loss Relief

CIR was not the only new matter introduced on 1 April 2017. There was a revision to the fundamentals of corporation tax loss relief which became effective from the same date. Prior to 1 April 2017 unrelieved trading losses could only be carried forward and offset against future profits of the same trade. Other types of losses had their own specific restrictions.

From Spring 2017 there was a relaxation of the use of carried forward losses in a way to generate greater flexibility. However, conversely there was a restriction on the amount of the brought forward loss which could be offset in any one year. The relaxation applies to all corporates with the restriction only applying to larger, more profitable, companies. This mismatch is designed to assist the SME sector.

The relaxation allows losses to be carried forward against total profits of the same company and therefore makes them more flexible. Additionally losses can now be carried forward against subsequent profits of certain group companies, and not just the future profits of the loss making company. Before accessing this flexibility there are certain conditions to be met and those conditions cannot be assumed to be satisfied. They need to be checked.

The restriction occurs if losses exceed £5m. Prior to April 2017 brought forward losses could be offset against subsequent income without a ceiling. From 1 April 2017 the first £5m of brought forward losses can be used without restriction. However if profits of the later period are greater than £5m then only 50% of the profit above £5m can be offset by losses brought forward.

Although the Government feel that setting a restriction above £5m will remove all SMEs from the legislation I do not believe this is the case. It is common for our property development clients to have phenomenal years as sites come up for sale. If there are brought forward losses (e.g. due to the cost of financing in the period of building) then our clients cannot guarantee that all the losses are available for offset against subsequent profits. We are having regular discussions with property clients about sales forecasts and the extent that sales may occur over a number of years. Although a spread of sales is more common for residential development it may also apply to commercial sites.

1 April 2017 was a watershed for corporation tax in the UK with the introduction of both CIR and the group loss relief rules. Undoubtedly there are groups who will benefit greatly from the new rules and also groups which will experience restrictions.

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