There’s been a recent sorry tale of an EIS investor who invested £50k for shares in a qualifying company under EIS. All seemingly went well and he sold his shares for – what he thought would be – a CGT free disposal.
But there was a problem…
He had failed to make a claim for income tax relief on his investment which is a requirement of the EIS relief – his reasoning was that he had little, if any, taxable income in the relevant period. He was denied the opportunity to file a late claim for income tax relief so his case was dismissed – with a full CGT liability…
So the moral of the story for EIS investors is to make a claim for income tax relief on investments even if the income tax saving might appear pitiful – because the CGT saving might not be ;)
HM Revenue & Customs kindly provides companies with a form that can be used to apply for advance assurance that a company is a qualifying investment for Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS) purposes.
Obtaining such assurance in advance of a share issue under either scheme is highly valuable to prospective investors – in fact, most sophisticated investors will insist upon sight of such an assurance before parting with their cash.
But there is a problem with the form – its dual status means that if you simply fill it out without specifying which of the schemes you are applying under then you are leaving it to HMRC to guess which you are after – which isn’t the best plan in a formal tax clearance!
Admittedly there are a couple of tick boxes that relate specifically to SEIS but you would be well advised to draft a separate letter spelling out your requirements or seeking professional assistance – after all the difference between 50% income tax relief and 30% could free up extra investment for your fledgling company.
If you are looking at starting a new hi-tech venture then the timing has never been better in utilising the latest available UK tax incentives.
Consider a scenario where say 4 enterprising entrepreneurs are looking at building a new state of the art technology platform.
They budget it will cost c£1m to get to market but know they can prove the concept with c£100k-£150k.
But there’s a problem – cashflow is tight….
This is where a bit of forward tax planning can help.
Firstly, they could set up a new company to undertake the venture. They could then structure the shareholdings such that no shareholder and director has more than 30% of the shares and subscribe for shares under the Seed EIS Scheme (SEIS). The company would need to obtain certification that it is SEIS qualifying and it would be well advised to seek advance assurance from HMRC.
A company can raise £150,000 in total under SEIS so each of the four shareholders could subscribe £37,500 for 25% of the ordinary shares.
Under SEIS, each shareholder would be able to reclaim 50% income tax relief on their investment – so £18,750 income tax relief could be claimed by each shareholder amounting to a total £75,000 tax saving.
But there’s more….
The company could use the funds to engage in a qualifying SEIS trade of preparation for a trade by carrying out R&D activities. The R&D work could fall within the R&D tax credit regime which allows for a 125% uplift in qualifying spend for SMEs and capacity to claim a tax refund in situations where the company is loss-making – this will almost certainly be the case based on our facts as the company is pre-revenue.
So say the company invests the £150,000 into qualifying R&D in its first year then the company would be eligible to deduct a further £187,500 for tax purposes i.e. 125% * £150,000.
The company would suffer a tax loss of £337,500 and could either carry this loss forward to offset against future taxable profits or it could elect to surrender the tax loss in return for a tax refund. The refund is restricted to 11% of the enhanced R&D tax spend which equates to £37,125 cash back from HMRC.
Once the SEIS cash has been exhausted they can seek further funding under the less favourable (but still hugely attractive) Enterprise Investment Scheme (EIS). Further R&D tax credits should be available in later years too whilst the R&D activities continue.
So our new venture has succeeded in deploying £150,000 of funding and expenditure at a net cost to the founders of just £37,875. SEIS and R&D tax incentives have effectively provided the additional £112,125 cash funding!
This scenario does not take into account the possibility of some or all of the SEIS shareholders taking advantage of the one-off capital gains exemption on gains reinvested in the tax year to 5 April 2013 – we’ll leave this for another post as the tax savings are staggering!
Hopefully this illustrates that with just a bit of forward planning and by seeking some professional advice, it is amazing how you can conjure up much needed additional cash to fund worthwhile ventures.
You have the opportunity to structure your business finances in ways that preserve more of the wealth that you create. This takes advance planning. Don’t miss this opportunity.
To help, here are 10 pre-year end tax planning tips that entrepreneurs should be actively considering to reduce corporation tax, income tax and national insurance costs:
- Don’t pay corporation tax at the highest rate of 29.75%. Calculate your full year budgeted profits as soon as possible so that you plan around this rate. If you are a standalone company and your estimated taxable profits exceed £300,000 (but are less than £1.5m) then you fall into what’s called the corporation tax ‘marginal rate.’ This is not a good place to be. This rate is higher than the rate of tax applied to large companies (with profits in excess of £1.5m) who pay tax at 28% and much higher than the 21% rate your company would otherwise pay if you kept profits below the marginal band. If this applies to you, then you need to consider tax planning ideas to reduce your corporation tax payable – see further below.
- Make a pension contribution from your company into your (and possibly your spouse’s) pension fund. I am not going to go into the pros and cons of pensions and the detail of the recently introduced (and hideously complex) anti-forestalling provisions that currently apply for ‘super earners’ (broadly those with personal income of £130,000+), suffice to say that pensions can play an important role in year end planning for owner managed businesses. The benefit of pensions is that income tax relief is received at the individual’s highest rate of income tax. Certain restrictions apply for ‘super earners’ and new rules will be coming into force from April 2011, however, where implemented carefully, pension planning allows for a corporation tax deduction in the company and no income tax or national insurance payable by the owner managers. Pensions can also be an important lever in managing the company taxable profits e.g. if hovering above the £300,000 standalone company profit watershed. And don’t forget you must pay the pension contribution by the year end in order for it to be tax deductible in the company in that period – so don’t leave it to the last minute!
- Optimise the tax on your remuneration. Generally, a small salary (within the personal allowance – so no income tax or national insurance is due) will have been paid during the year with regular dividends to cover living expenses. Spouses, who ideally take an active role in helping run the business, can receive a small salary and dividends (subject to shareholdings) to maximize the use of both husband and wife personal tax allowances. With the year end approaching, now is the time to consider whether a final bonus or dividend should be awarded depending on available distributable profits, taxable profits and how much needs to be left in the business for future reinvestment etc. There are normally a number of factors to consider in making final awards of cash from the company, therefore it is important to crunch the numbers. Normally, a dividend will be the most tax efficient means of extracting profits for most business owners (up to the £150,000 personal income limit and 50% additional tax rate – see further below). Care should be taken in awarding dividends to spouse shareholders as HM Revenue & Customs still have their eye on husband and wife companies despite having lost a landmark case on this issue related to maximising both spouse’s income tax allowances. Some demonstrable activity in the business by both spouses is therefore recommended to mitigate this risk.
- Watch the 60% marginal income tax rate for income over £100,000. Total personal income of £100,000 is a new watershed for business owners as income received between £100,000 to £112,950 attracts a marginal rate of 60%! This is due to the personal allowance being phased out for income above £100,000. So if your total remuneration package is likely to be around this area, you might be well advised to limit your income to £99,999 to avoid this horribly expensive marginal rate.
- Watch the 50% additional rate for ‘super earners’. For those successful entrepreneurs with earnings in excess of £150,000, getting the right balance of remuneration is even more important as income tax is levied at 50% on salary or bonuses compared to 36.1% on dividends (a 25% increase in tax on salary income is matched (or not?!) by a 44% increase in dividend tax rate – work that one out?!). So rather than take a dividend from the company beyond £150,000 total income, business owners could consider taking a loan from the company and the company paying the due tax at a rate of 25% on the loan – something akin to what the shareholder would have paid on a dividend. Note that there could also be benefit in kind tax charges where no interest is paid on the loan but this could still work out to be the cheaper overall option.
- Optimise the timing of dividend and bonus payments for cashflow and tax rates. Dividends and bonuses are taxed on business owners on a receipts basis. If your income is already high for the 5 April 2010/11 tax year then you could defer paying out a dividend until 6 April 2011 so that it falls within the following year’s tax allowances and limits. Also, you can accrue a bonus in the 31 December 2010 accounts and don’t have to physically pay it until 30 September 2011 but you still receive the corporation tax deduction upfront. This gives a useful cash-flow advantage and the bonus timing is applicable for all employees i.e. not just business owners.
- Plan your spend on capital items to get tax relief quicker. Expenditure on computer equipment, desks, chairs etc attracts a write off against tax up to £100,000 spend per year. This reduces to £25,000 from April 2012. Make sure you bring forward any expenditure to reduce your taxable profits especially if the company profits are hovering around the standalone company £300,000 mark.
- Get tax deductions now for provisions against stock and debtors etc. Consider the valuation of any stock or debtors at the year end and make specific provisions where the likely recoverable value is less than the original amount recognised. Provisions against specific items (on a line-by-line basis) are tax deductible for corporation tax purposes.
- Claim loss carry backs as soon as possible to get refunds. If you have a forecast tax loss then you can carry this loss back to obtain a refund from HM Revenue & Customs of the corresponding amount of tax suffered in the preceding accounting period. You may wish to get your skates on with the year end work so that you can promptly file the accounts and tax return and get the cash back as quickly as possible.
- Don’t get time barred from lucrative tax incentives. Review available tax incentives such as R&D tax credits, capital allowances on fixed asset expenditure, loss carry back claims etc as the majority of such tax breaks have a 2 year time limit for you to be able to claim them with HM Revenue & Customs. So, for example, many available tax incentives for the year end to 31 December 2008 will be time barred from 1 January 2011.
If you would like more ideas for growing your business and structuring your finances so that you keep more of the wealth you create, then please join the mailing list in the side-bar.
Given that the 5 April 2010 UK tax year end is imminent, we are busy advising our UK entrepreneurial clients on ways in which they can arrange their tax affairs to pay the right amount of tax – and not a penny more!
Here are just some of the issues we’re discussing – remember, you should seek advice specific to your circumstances as these are general points only:
- For those typically earning more than £150,000 per year, the new 50% super higher rate of tax will hit hard when it is introduced on 6 April 2010. So we are advising those likely to be affected either to bring forward bonus payments or, where they are shareholders and sufficient distributable reserves exist in the company, to pay a dividend by 5 April 2010. An accelerated dividend payment is preferable in most cases as this is normally more tax efficient plus there are National Insurance savings. A word of caution – watch out for the pension anti-forestalling provisions if you are taking steps now that might increase your total income above £130,000….
- From 5 April 2010, the personal allowance available to all UK individuals will be tapered away for earnings in excess of £100,000. This means that for those with income falling between £100,000 – £112,950 in the 2010/11 tax year, the effective income tax rate will be a whopping 60%! Taking steps now either to advance salary payments to pay the current highest rate of 40% or to structure arrangements to fall outside these bands will save hard cash.
- Making pension contributions (either personally or via the entrepreneur’s company) can still make good financial and tax sense, however, beware of the restriction on higher rate tax relief for high earners from 6 April 2011 – in an attempt to stop savvy folk from piling cash into their pensions in advance of these measures, the Chancellor introduced some hideously complex rules called the pension anti-forestalling measures that limit higher rate tax relief on contributions for those whose income exceeds £130,000 (either now or in previous recent tax years) to £20,000 (or up to £30,000 in certain circumstances). Seek professional advice if you think you might be affected.
- Consider transferring income generating assets to spouses in cases where the spouse is a non-earner. Given that every individual receives a tax-free personal allowance and a 20% tax band up to c£45k it makes sense to consider splitting income where possible – be wary of splitting dividend income in husband and wife companies where only one spouse is active in the company.
- Every individual has a capital gains tax-free annual allowance of £10,100 (in 2010/11) so make use of this to crystallise gains where possible – if you don’t use it, you lose it.
- The highest rate of capital gains tax is still only 18% compared to 40% (soon to be 50%) for income. Also, compare the income annual personal allowance (c£7k) with the capital gains tax allowance (c£10k). Could this influence your investment strategies going forward to favour capital growth rather than income? Beware of the time horizon though as this gaping difference is unlikely to endure for long… [Update: 22 June 2010 Budget increased highest rate of CGT to 28%]
- Every individual (over 16) can invest in a tax-free wrapper called an Individual Savings Account (ISA) in which interest income on cash or capital growth and dividends on shares is tax free. Most have a £7,200 allowance to 5 April 2010 and this goes up to £10,200 from 6 April 2010. Drip-feeding savings provides the benefit of cost-pound-averaging which can provide better returns than piling in lumps sums on 5 April each year!
- Many entrepreneurs are unaware that they can invest in pensions on behalf of their non-earning children and still obtain basic rate tax relief up to £3,600 – so you need only invest £2,880 and HM Revenue & Customs will kindly top it up to £3,600!
- Those with furnished holiday lets that haven’t performed to expectations have a short window of opportunity to obtain business asset tax treatment on a sale of the property up to 5 April 2010 – this allows for more tax advantageous income and capital gains tax treatment but time is running short… [Update: 22 June 2010 Budget extended this opportunity for a further 12 months]
- Useful additions to an entrepreneur’s investment tools include Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCTs) which offer differing but welcomed income tax and capital gains tax benefits.
Above are just 10 tax planning ideas that we are busy discussing with our entrepreneurial and family owned business clients. Hopefully your accountant is doing likewise. If not, please contact me and we can discuss your specific circumstances.
Take steps NOW to review your tax position. Time is running out for the 5 April 2010 tax year!
The above analysis is a general summary of some tax planning opportunities available for UK individuals in the run up to 5 April 2010 and should not be relied upon. Please seek professional advice specific to your circumstances.
Photo credits – Roll the dice
James Dyson hits out at the existing “lacklustre” UK R&D tax credit system and its “botched” implementation by HM Revenue & Customs.
Dyson is right in his assertion that the recent tightening of policy in restricting certain claims (e.g. for prototypes that are eventually sold) is fundamentally flawed, however, my experience of working with the specialist R&D HMRC units has been positive overall.
Sure, the legislation is complex in parts but this is inherent in a system that seeks to adapt for ever-changing claims in line with the emergence of new industries. It should be added that much of the complexity has arisen from attempts to enhance the attractiveness and availability of the research and development tax credits for UK companies!
Dyson suggests that a new improved R&D tax credit scheme be implemented that is simpler to apply and that should be targeted at small, high tech companies. Although I sympathise with the principle of helping many of our future innovative small businesses, such a policy is misguided in its laser focus as it omits larger, more diverse companies that can equally contribute to the UK economy from successful R&D.
An increase of the R&D tax credit rate to 200% (from a current rate of 175% for SMEs) could further increase the attractiveness of the UK as a place for internationally mobile companies to do business – the UK currently ranks 19th internationally for the attractiveness of its R&D incentive regime.
To shift from recent murmurs of a Conservative government (if elected) abolishing the R&D tax credit scheme (in order to simplify the UK company corporation tax regime) to actually improving the regime if the recommendations from this report (commissioned by the Tories) are implemented is welcome news.
Enterprise Investment Scheme (EIS)
Meeting the funding gap for start-up and fast growth hi-tech technology companies has always been tricky given the higher risk of failure – the recent credit crunch has made this a whole lot worse. Angel investors (or micropreneurs) have frequently come to the rescue as, not only can they bring their expertise to the table (particularly if they made their money in a similar sector), but they can also invest in smaller tranches to meet this funding gap where the companies are too small for larger private equity or venture capital funding – and where the banks prefer to look the other way.
Despite the existence of UK angel funding, Dyson notes that over £3.5bn would have been invested if the UK kept parity with angel investment in the US – actual investment in the UK was a disappointing £1bn in 2007.
Tax incentives are available to encourage private investment in UK fledging companies including EIS which provides 20% income tax relief subject to qualifying holding requirements and company types. Dyson calls for an increase in the income tax relief to 30% which should be welcomed, although how far this would go in encouraging wealthy individuals to part with their cash to invest in start-up tech companies remains debatable – unless they have a deep understanding of the sectors.
Overall, James Dyson calls for a change of perception towards science and technology from grassroot levels with greater focus on such subjects at school. He cites a frightening statistic that:
4% of teenage girls want to be engineers
14% want to be scientists
32% want to be models
There is clearly much work to be done!
Welcome your views. You can download the Ingenious Britain report here.
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