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."

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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With the Brexit deadline looming we are finding greater amounts of interest from overseas businesses wishing to set up in the UK. For some of these businesses (e.g. those based in the Republic of Ireland) the reasons for expanding into the UK are self-evident. Others come to the UK for more subtle reasons, such as benefiting from the relative weakness of Sterling.

Ease of company incorporation in the UK

Features of the UK landscape are the ease of company incorporation and the ability to have company directors who are all non-UK residents. When compared to the Republic of Ireland our 17% corporation tax rate is unattractive. However this does not appear to dampen the appetite for Irish businesses setting up subsidiaries in the UK.

Structuring for expansion into the UK

When considering expansion into the UK there are a number of decisions which have to be taken about structure. As identified in my blog on the development of the UK corporate tax landscape it is important to model the impact of financing on the UK results as well as modelling the quantum of any opening year losses.

Withholding taxes after Brexit

Typically Irish ownership would access the benefits of the EU Interest and Royalties Directive in order to avoid withholding taxes on intra-group interest payments. In advance of the UK withdrawal from the EU in 2019 the terms of the UK tax treaty may be more relevant and making it more important to register as a borrower under the treaty passport scheme.

As the UK does not have an outbound dividend withholding tax, our departure from the EU does not make dividend withholding taxes a concern. Although this may be efficient as a mechanism for the repatriation of profits out of the UK the impact of dividend income receipts in the home state would still need to be understood.

UK Boards and non-UK Directors

Many inward investment groups have non-UK directors on their UK Boards and this is a common mechanism to enable commercial control of the UK subsidiary by home state persons. Like many countries the UK has a concept of management of control for company tax residency and the impact of our domestic rules should be considered when determining directors numbers, residence and their powers.

Audit requirements

Even if the UK company may not be expected to be particularly large, one still has to consider consolidated accounts and their audit requirements in the home state. This may lead to obligations to audit the UK subsidiary and for the UK auditors to have tight reporting deadlines in order to fit in with group timetables. Typically our audit teams are required to audit the financial statements of the UK subsidiary which have been prepared under UK GAAP and provide GAAP adjustments for overseas parent consolidation. Although this is not necessarily relevant for investment from the Republic of Ireland it can be an important factor to timetable into UK work when reporting to other countries, such as the US.

Future visa requirements

No business is a success without the right people. Expansion into the UK regularly results in staff coming to the UK to manage the early development of the UK subsidiary. Nationals from EU countries have not had to consider visa issues. This may change in the future. The group parent should not assume that its employees can come to the UK without visas. For example an Irish parent company may second staff to the UK to manage the early stage of the UK subsidiary without considering that the staff are, say, Australians working in Dublin. Visa requirements for any secondments need to be explored.

Sending staff to the UK

The UK has tax breaks for movements of staff which may be of benefit. The extent to which the transfer is a temporary matter of a few months or a long term matter should be identified at the outset. This is to ensure that social security is paid to the right country and any relevant terms of bi-lateral social security agreements are applied. Even a short term transfer may result in PAYE obligations or reporting requirements which need to be managed.

Longer term staff transfers inevitably result in the individuals falling into the UK income tax net. Planning for salary equalisation is important when offering the individual a long term transfer. Also whilst developing their total remuneration package it is important that the impact of share options granted to secondees is understood in the UK and home state.

For both secondees and UK employees the HR policies associated with UK employment need to be identified and where appropriate, group policies flexed to meet UK employment laws.

Plan for setting up in the UK

The decision to come to the UK is a relatively easy one for many overseas businesses faced with the uncertainty of Brexit. For our friends in the Republic of Ireland it is possibly an easier decision to make, especially given our close histories, legislative approach and common language. However that does not prevent the need for planning by any group considering coming to the UK at both the tax level and the employee level. We are finding that the most successful businesses are those which engage with us on these matters at an early stage.

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The UK hospitality sector is facing some significant challenges and opportunities at the moment, due to a number of different factors.

How Reorganisation can help

Reorganisations can help in a number of ways, including facilitation of financing, asset protection and performance improvement.

Reorganisation for Financing

Quality real estate is still well regarded by sophisticated investors such as pension funds. UK real estate continues to trade at historically high levels compared to bond yields making property both attractive as an investment class and a viable option for investment diversification.

Quality UK properties are attractive as the market is liquid, sterling is weak and the legal consequences of property ownership well understood. These factors have increased the demand for UK real estate amongst those seeking annuity incomes or higher yields, including international investors.

Hotel occupancy rates, particularly in the big cities, continue to be strong and meet expectations. This gives investor confidence about acquisition of hotels as an asset class.

This presents an opportunity for those looking to grow their hotel business.

Financing requires a reorganisation to offer the lender security on real estate assets. If monies are to be raised by sale of a real estate asset then separation of that asset from the trading activity can be beneficial.

Reorganisation for Asset Protection

The Brexit vote and the fall of sterling has reduced the pool from which the sector traditionally recruits, whilst margins are being squeezed due to the higher cost of imported raw materials.

For restaurants this is exacerbated by the impact of the delivery operators as well as punitive business rates. This has resulted in a number of high profile restaurants faltering.

The current number of high profile restaurant failures would suggest that company reorganisation for asset protection may be a positive strategy.

Reorganisations for asset protection can involve separation of properties from the trade so that if there is a failure of the trade it does not necessarily mean the property is at risk. Group structures can help. Alternatively, more formal measures such as demergers can facilitate this planning.

Reorganisation to focus on performance

Management theory dictates that individuals should be incentivised on matters which they can control.

Property rich activities such as the hotel and leisure sector can lead to increasing share values due to property price increases rather than improvements in the underlying trade. It is therefore possible that management interests grow in value due to property prices rising rather than underlying trading improvements.

Reorganisations such as demergers can create structures which provide vehicles for management to focus and be incentivised based solely on trading performance. If properly structured these can also attract approved tax treatments such as the EMI share option reliefs.

Conclusion

In conclusion, the different strands of the hotel and leisure sector face different challenges and carefully structuring for particular situations can help manage risk and provide management reward opportunities.

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The objective behind CIS

The current iteration of the Construction Industry Scheme (CIS) came into effect on 6 April 2007 but it has been refined in the years since its introduction.   All permutations have been created to try and overcome the belief that many payments in the construction industry were not reported for tax purposes.  CIS prevents this by operating a system which is not dissimilar to PAYE.  The payer has an obligation to consider the status of the party to whom payments are made and, in certain circumstances, withhold tax from the payments.  As the operation is similar to that of PAYE, it is the PAYE section of HMRC which administers CIS.

What is covered by CIS?

CIS applies to the labour element of a construction contract.  Construction contracts are defined in legislation and go beyond simply building structures.  Examples of construction operations include painting and decorating and preparative work such as site clearance and scaffolding.

Who is affected by CIS?

The legislation specifically excludes some operations from CIS.  Examples include the professional work of architects and surveyors, and security installation.  However, if any of those parties take part in the management of construction work then they are within CIS.

For CIS to apply,  operations must take place in the UK, including the UK territorial waters, and can include marine construction.  The residence of the parties is not relevant; it is the location of the works which are important. This can be overlooked by non-UK businesses seeking contracts in the UK.

Managing CIS

CIS applies to the labour component of construction.  If there is one contract that covers all construction operations then CIS considerations will be relevant to the entire contract.  This applies even if separate invoices are raised for separate parts of the contract.  It may be necessary to split the project into separate contracts so that there is a single contract for labour and CIS would only apply to that contract.

CIS responsibilities for contractors

CIS applies whenever there is a contractor and sub-contractor relationship.  The legislation defines both and gives an extensive list of those persons who are treated as contractors for its operation.  If CIS is relevant, then the contractor has an obligation to verify the status of the sub-contractor and apply the relevant regulations to payments made to them.  It is the impact of payments which is particularly important to understand.  This is due to the cashflow impact for the sub-contractor.

If the sub-contractor is not registered with CIS then the contractor must deduct tax at 30% from payments to the sub-contractor.  If the sub-contractor is registered then the deductions falls to 20% unless the sub-contractor is registered as a gross status party in which case no deduction is required.  The deduction is against the VAT exclusive payment and does not apply to the cost of materials of the sub-contractor.  If the sub-contractor does not confirm their cost of materials then the contractor should make a reasonable estimate.

There are regulations which define how the contractor must verify the status of the sub-contractor and the frequency of CIS Returns.  All of these administrative tasks must be done online.

If the sub-contractor is a company then tax deducted from payments received by it can be offset against its own PAYE and  National Insurance Contributions, deductions under CIS from payments made to its own sub-contractors and Corporation Tax on its profits.  If the sub-contractor is not a company then tax deducted is offset against its Income Tax liability and National Insurance Contributions.  The sub-contractor who is not a company will therefore claim relief for deductions at a later time than a corporate sub-contractor.

Registering for Gross Status

There are obvious advantages to registering for gross status and there are conditions which must be satisfied before gross status can be attained.  These include the method of operating in the UK, turnover thresholds, group structure and demonstrating a good compliance history with HMRC.  If the compliance history is damaged during construction operations then HMRC can revoke gross status which may have a catastrophic impact on cashflow.  Maintaining a good compliance history with HMRC is therefore paramount.

How we can help

We have considerable experience of CIS matters including split contracts, definitions of contractors and sub-contractors, the practical impact of professionals providing project management services and preventing loss of gross status.  All of these ensure that the cashflow impact of CIS is minimised.

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The report on employee ownership, “The Ownership Dividend” has been published.  It has been compiled following over a year of independent review and having heard evidence from more than 100 employee-owned businesses and advisers . A copy can be found at www.theownershipeffect.co.uk.

Benefits of employee ownership

The conclusion is that employee-owned businesses have advantages to both the employee and their employer; including higher employee engagement, motivation and wellbeing. The employer experiences increased productivity and efficiency. At a time when employee engagement levels are dropping, morale is felt to be low and UK productivity is lagging behind our global competitors, the benefits of employee ownership are more pronounced.

There are well known examples of employee ownership, with probably the best known being the John Lewis partnership, Arup and PA Consulting. Despite this there are relatively few employee owned businesses compared to the numbers of businesses in which employees have equity participation, but not overall control.

Tax reliefs of employee ownership

It is acknowledged that the numbers of entrepreneurs who gift ownership of their business to employees is limited. To promote employee ownership there is an exemption from capital gains tax for an entrepreneur who transfers a controlling interest to employees and exemptions for the employee on receipt of benefit connected with the shares. Despite these tax reliefs, far greater numbers of entrepreneurs retain control of their business and allow staff some equity interest in it. I believe that the 10% rate of capital gains tax makes it more attractive for the entrepreneur to retain control of the business and have the business grow to a point where it can then be sold. This exit becomes the fruits of the entrepreneurs’ labour and can represent life changing amounts.

Tax legislation provides incentives when offering shares (but not control) to employees. Tax advantaged share schemes can be categorised as either those which are “all-employee” or those which can benefit specific employees, or groups of employees. Typically, the latter schemes are only offered to directors and senior managers. There are other niche schemes for specific circumstances, such as university spin outs.

Share incentive plans and share option schemes

Share incentive plans and savings related share option schemes are all-employee schemes which, if operated correctly, provide tax breaks to the employees who receive shares. These schemes have limits on the tax advantages and generally result in large numbers of employees owning small numbers of shares.

Company Share Ownership Plans  and Enterprise Management Incentives

Company Share Ownership Plans (CSOP) and Enterprise Management Incentives (EMI) can be issued on a selective basis to key employees. CSOP has tax advantages but subject to a ceiling of £30,000 of shares per employee. The limit of £30,000 is sometimes felt to be an impediment to use of CSOP for incentivising senior executives.

EMI is by far the most popular approved share incentive plan in the UK. Smaller trading companies can issue options worth up to £250,000 per employee with the scheme being selective and therefore able to restrict ownership to senior executives. There are no costs to the employee of receiving options and growth in the company during the ownership of the option can be tax free for the employee. This is on top of generous tax reliefs for the employer. EMI can be structured to make it highly beneficial for the employee to grow the value of the business, especially if the option can be exercised immediately prior to a company sale. The tax reliefs available on company sale mean it is possible for the senior executives to receive a percentage of the sales value at a 10% rate of tax. For many this is a compelling reason to use EMI to incentivise senior people to grow the business and participate, together with the controlling entrepreneur, on its sale.

In conclusion

In summary, the benefits of share ownership as set out in The Ownership Dividend are valid. However, employee ownership is relatively rare, especially when compared to the numbers of businesses in which employees have a non-controlling interest. I believe that the tax breaks associated with approved share schemes are a factor in this differential. EMI has generous tax breaks for both the employee and employer. Statistics suggest that it is by far the most common share scheme and my considerable experience of share scheme structuring makes me feel that the statistics are accurate.

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Why the VAT Reverse Charge is being introduced

In 2017 the Government floated the idea of a change to the VAT treatment of certain elements of the construction industry supply chain. They believe that criminal gangs were offering specific supplies in order to perpetrate “missing trader” or “carousel” fraud. A Government paper indicated that this was losing the Exchequer an estimated £100m a year.

The Government believes that this fraud typically occurs when sub-contractors are set up to provide workers. The sub-contractor charges their customer for the supply of people and legislation requires this cost to have VAT added to it. However the cost to the sub-contractor is the payment of wages which does not have any VAT liability. The sub-contractor collects VAT from their customer and then disappears without paying it to HMRC. As the sub-contractor might have been set up for a single site this makes it difficult for HMRC to track the perpetrators.

Consultation with the construction sector

The Government consulted the construction industry on the impact of a reverse charge mechanism to prevent this fraud. A reverse charge was suggested as it has been used to prevent other forms of missing trader/carousel fraud.

The Government estimate that there are 300,000 business at different points in the supply chain and therefore the impact of a reverse charge would be more widespread than its other applications.

When will the Reverse Charge apply?

It has now been confirmed that the reverse charge will come into effect from 1 October 2019. HMRC feel that they have listened to UK businesses requests that they are given a considerable lead time to review and amend their systems in advance of this change.

Who will be affected by the Reverse Charge?

The reverse charge mechanism will only apply to construction services and HMRC will use the existing definition of construction services from the Construction Industry Scheme (CIS). This use of a pre-existing tax definition is welcomed as it would be illogical for there to possibly be one definition of labour for CIS purposes and a different definition for VAT purposes.

The reverse charge process would vary the billing profile of a sub-contractor as they would no longer charge for construction services with VAT. Instead they would issue an invoice requiring their customer (the main contractor) to self account for the VAT that would otherwise be due. One would not normally expect this to put either the sub-contractor or the main contractor in a worse position.

Winners and Losers

However, when one looks at cashflow there may be winners and losers. Using the example of a construction service with a value of £1m then presently the sub-contractor would charge their customer £1.2m (£1m plus VAT). That sub-contractor would account for the £200k to HMRC. Depending on payment terms and commercial agreement it is possible that some sub-contractors would receive the £200k VAT before having to pay it to HMRC and others would need to finance the £200k whilst they wait for payment of their invoice. Applying a reverse charge would have a negative cash flow impact on the former whilst a positive impact on the latter.

Similarly, the main contractor could sometimes be in a position to make an input tax claim on a VAT return before having to pay the sub-contractor or vice versa. As can be seen, either party could win or lose.

A significant complication is that not all construction services will be caught by the new provisions. Only standard and reduced rated supplies will be effected, which makes sense. There can be no tax loss to missing trader fraud where the supply doesn’t have any VAT on it in the first place. Further, certain related party transactions will be excluded as will supplies to end users such as developers. The new rules only apply to contractors supplying to other contractors. This will require contractors to seek confirmation of status from their customer before engaging to ensure that the correct VAT treatment is applied.

Contractors and Sub-Contractors

Contractors will need to consider the definition of labour more carefully than they have to date. It is reasonable to assume that larger contractors use sub-contractors who are gross status payers for CIS. This means that larger contractors have not had to worry about the definition of labour.

Invoices received from sub-contractors may have components with VAT charged on some services but not others. This will lead to complexity for the contractor especially when approving payment of an invoice. The concern for the contractor is that if they are charged VAT incorrectly then they cannot recover it even if they have inadvertently paid the invoice and their supplier has accounted for that VAT to HMRC. The only mechanism to overcome this error would be to renegotiate with the sub-contractor. However if the sub-contractor is an overseas entity or is created for a single development then they may not be in continued contact with their customer.

Make sure you’re ready in time

In summary there is a considerable shift in VAT compliance from October 2019 which has an impact for both contractors and sub-contractors down to the entire construction supply chain. Businesses should use the period to October 2019 to review contracts, update systems and understand the definition of labour for this purpose.

Our property and construction team would be pleased to talk to you about how this will affect you.

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In the past corporate non-resident landlords have experienced a beneficial tax profile for UK property profits. Rental profits are taxed a flat 20% rate of income tax, capital gains were exempt from UK tax and there were no inheritance tax consequences for the company owner.

Over time these advantages have been eroded. For example, non-resident corporate landlords are now subject to UK capital gains on gains made on residential properties. In 2017 the Government announced that non-residents would be liable to capital gains tax on disposals of commercial sites from April 2019. This brings all disposals into UK tax. The advantage that rental profits are taxed to the flat 20% rate remains.

Tax changes coming

From April 2020 there will be a transition by non-resident corporate landlords from income tax to corporation tax. Many will find this attractive as the flat rate of corporation tax will be 17%. The Government’s intention is to make this technical transition seamless and therefore capital allowances are expected to transfer between the taxes at tax written down value and any rental losses should be available to carry forward into the new environment.

Currently there is uncertainty about the compliance process. Income tax is calculated to 5 April annually whilst corporation tax is determined with reference to the company’s year-end. If the company does not have a 5 April year-end then in 2020 there is likely to be some element of time apportionment between income tax and corporation tax. The filing deadlines for these taxes differ. In addition, the dates of payment of corporation tax differ from those of income tax. Depending on the company’s profile this may accelerate or defer payment of tax on rental profits.

It seems slightly perverse that non-resident corporate landlords are subject to capital gains tax on all sales from April 2019 and subject to a shift in tax treatment from April 2020. Logic would suggest that these two changes should happen simultaneously.

Beware the potential sting in the tail

Although the move from a 20% tax regime to a 17% regime appears attractive there can be a sting in the tail for leveraged property acquisitions. For the non-resident corporate income tax does not have any restriction for interest deductions. From 2020 non-resident corporate landlords will be subject to the Corporate Interest Restriction (CIR) Regulations. These can restrict the interest deduction which a company can claim if its annual interest charge is more than £2m. In group situations the £2m is spread across the group. Larger property acquisition can easily result in interest payments in excess of £2m and therefore companies and groups may find that a move to corporation tax increases annual tax burdens. This is despite the reduced headline rate of tax.

Be prepared

Businesses should be using the period to the change to consider their strategies for a revised compliance environment and model their tax burden based on the corporation tax rules, including the impact of the corporate interest restriction.

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Philip Hammond, the Chancellor, had promised that his Spring statement would not contain tax announcements. He was true to his promise, well almost.

Amongst the usual statements about economic growth, employment prospects and borrowing needs there were congratulatory comments about the numbers of persons that have benefitted from first time buyer stamp duty reliefs and further suggestions that a litter levy may be enacted. On the theme of waste there was also a call for evidence on how the tax system could be used as an incentive to reduce reliance on certain plastics.

Of relevance to the SME sector is the announcement of a consultation on extending the availability of Entrepreneurs’ Relief. The Government are concerned that bringing external investors into a family business can dilute the founders down below a 5% stake in a company. As the 5% limit is the minimum required for Entrepreneurs’ Relief the Government feel that some businesses may not seek external funding specifically to prevent the founders falling below 5%. The 5% threshold may therefore hold back the seeking of external funds and therefore hold back growth in a business.

There is a consultation which closes in mid-May about the practicalities of allowing the founders to be treated as selling their shares and immediately reacquiring them at the point that they would otherwise be diluted down 5%. This would therefore allow the entrepreneur to “bank” the 5% rate before they are diluted below it.

The cynic may think “well that is just a way of getting money in earlier and leaving reduced tax take for a future Government”. The consultation suggests otherwise as it is making noises about the resulting gain not being payable until such later time as the shares are actually sold and the entrepreneur has cash to pay the tax.

This is certainly a novel solution for a perceived issue and the Chancellor should be applauded for facing it head on.

 

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Recently I had the opportunity to speak at a Partnership Tax Conference on the subject of Partnership Losses. One would normally think that partnership losses are a minority sport which are only relevant for the bad days. It never ceases to amaze me the number of occasions that partnership loss planning is necessary, even on a successful project. Typically it might be that the priority share partners have such a large guaranteed profit share that the project can return a profit but after payment of guaranteed profit some partners experience a loss.

Tax allocation across the partners

If the partnership is operating a trade in the UK then the first task is to reallocate profits and losses so that no partner can be receiving a share of loss whilst others are taxed on profit. This is a tax allocation and not related to drawings. The practical implication being that it is possible for a partner to be entitled to profit (for example due to a guaranteed profit share) but have no tax liability as they have had another partner’s loss allocated to them. Very rarely do partnership agreements consider the extent that one partner compensates the other for the tax which the former does not need to pay. Even if there was a compensation clause in the partnership agreement then the debate moves to a fair mechanism to determine the compensation. Should it, for example, be the amount of tax that the benefiting partner does not pay? If so, when should the payment be made? For example should it be at the time that the benefiting partner would have ordinarily paid tax to HMRC?

Once the loss has been reallocated then each partner is free to do with their share of loss what is appropriate for them.

New partnerships

If a partner was joining a new partnership or a new partnership was commencing then losses of the partner in the first four years of assessment could be carried back against total income of the three years prior to the loss making year. The carry back is on a first in, first out basis and so is carried back to the earliest year possible. The loss can be set against total income of the earlier year.

Terminal loss relief

Conversely losses in the last 12 months of trade, including an impact of overlap relief, can be carried back against to the previous three years. This is often called terminal loss relief and, unlike opening years loss relief, the loss can only be offset against profits of the same trade of the earlier years.

Sideways loss relief

The most common use of partnership losses is sideways loss relief which is an offset of losses against total income of the same tax year or total income of the previous tax year. The loss can also be offset against total income of both of those two years in which case the taxpayer can elect which year the loss is first used against. If the partner is in the early years or the last year of a trade then sideways loss relief can be claimed in addition to opening years and terminal loss relief.

Sideways loss relief and opening years loss relief are an offset against total income. Terminal loss relief is only against previous profits of the same trade. There is a restriction on use of losses against total income to the greater of £50,000 and 25% of total income of the profitable year. This is a general cap on certain reliefs, not just losses. In addition to the general cap there are specific caps which apply to losses. They are relevant if the partner is not active in the business or has little capital at risk in the business.

Non-active is defined in legislation. If this restriction applies then there is a cap of £25,000 use of the loss.

Restrictions

Certain partners are restricted in their use of loss to their capital contribution into the partnership. Essentially this is to cap the loss to the amount of their risk capital and this legislation is designed to reduce the scope for partners claiming losses where they have little economic downside of being a partner.

Offset against Capital Gains

As an alternative to using a trading loss against income then a partner can offset the loss against capital gains of the same tax year as the loss is recognised. Economically this relief is available to help partners who finance a loss making partnership by a sale of capital assets. With capital gains tax rates being lower than income tax rates then the partner needs to consider if it is beneficial to use an income tax loss against a capital gain.

Loss Planning

In summary loss planning is more common than most people appreciate and losses need to be considered in detail as there are many restrictions on their use. Conversely they can be used flexibly and this leads to planning opportunities.

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The push towards global transparency gained teeth on 30 September 2017, with the new corporate criminal offence for failure to prevent tax evasion. HMRC automatically receive information on overseas accounts from over 50 countries, and once evasion has been detected they will look up the chain to see who facilitated it. If that person is associated with your company or partnership then your firm can be prosecuted.

Weak links

The link does not have to be especially strong – an associated person can be an employee, agent or contractor – although they do have to be acting for your firm. The firm’s only defence is having preventative measures in place. It does not matter if the senior management were in the dark, and so measures must be embedded in procedures and communicated to everyone associated with your firm. Simply carrying out a risk assessment and putting it in a drawer will not protect your firm.

Broad scope

The scope of the rules is breathtakingly wide. There are two offences:

1. Evading UK tax

Even if your firm has no UK presence at all, it could still be prosecuted if you assist in evading a UK tax.

2. Evading foreign tax

If your firm has a person acting on its behalf in the UK, then if they facilitate foreign tax evasion when in the UK your firm could be prosecuted. However, the evasion must be a criminal offence in both the UK and the foreign country.

Consequences

A successful prosecution could be very damaging for your business. Not only is there the prospect of an unlimited fine, but it could prevent you from winning government contracts or operating is regulated markets.

What should I do?

The first step is to identify a person or team responsible for implementing preventative measures. A risk assessment should then be carried out, evaluating business operations identifying associated persons. It may be that you consider your firm to be low risk, but it is important to document why you came to this conclusion. Procedures, for example due diligence and reporting, should be designed and implemented, and then communicated to all associated persons identified in the risk assessment. Finally, it is important to keep everything under review.

What if I identify tax evasion?

If you find out that a person associated with your firm has assisted with tax evasion, this should be reported. UK tax evasion is reported to HMRC, and overseas tax evasion to the Serious Fraud Office. This does not give immunity from prosecution – the only defence remains the procedures you have in place – but it forms part of your defence and could mitigate penalties if your firm is convicted.

Whilst the new regime only covers evasion which has taken place since 30 September 2017, this includes evasion which started before then but is still ongoing. It is therefore important to act now and get preventative measures in place. Senior management must be committed to the process, and create a positive culture in the firm.

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