· 72,000 reports in the last twelve months

· Calls rarely lead to extra tax revenue and can embroil businesses and individuals in unnecessary investigations

 HMRC’s Tax Evasion Hotline received 72,000 tip-offs over the last year – roughly 300 calls per day – according to our survey. The high volume of calls reflects the public’s increased concerns over tax evasion. The Tax Evasion Hotline lets members of the public and businesses inform HMRC of suspected cases of tax evasion.

Martin Casimir, Managing Director of Bloomsbury Professional, comments: “The sheer volume of calls to the hotline is astounding. People are clearly keen to ensure that no-one cheats the tax system and that everybody pay their fair share of tax.”

“For many people, wages have flatlined in real terms over the last few years whilst at the same time the tax burden has increased. That makes them especially indignant and motivated to call the helpline if they suspect tax evasion.”

Calls rarely lead to extra tax revenue

Although the volume of calls to the Tax Evasion Hotline is extremely high, it does not necessarily mean that large amounts will subsequently be recouped through investigations.

Martin Casimir explains: “HMRC is already on a stretched budget. There’s a question mark over whether HMRC has the manpower to deal with all the complaints that it receives.”

Casimir says that HMRC would not disclose how many of the calls they received directly led to successful investigations into tax evasion. However, he believes the figure is likely to be extremely low.

The National Audit Office has identified the Tax Evasion Hotline as the least cost-effective method of detecting tax evaders. It yields just twice the amount of money it costs to operate it. In 2006/7, HMRC took back just £2.6 million from calls made to the Hotline. The original estimate was £32.5 million that the helpline had hoped to recoup.

Martin Casimir comments: “HMRC should be concerned about how few calls actually reveal a tax evasion case of note.”

“Whilst people are now more sensitive to the possibilities of any tax irregularities, it can lead to people being over-keen and making calls that are misguided.”

As well as HMRC being unable to deal with the sheer volume of calls, many of the calls it receives reveal only small amounts of tax evasion.

Martin Casimir says: “It’s a rarity that calls to HMRC reveal a large-scale evasion of tax. Many of the calls relate to tradesmen being asked to be paid cash-in-hand, for example. The loss of tax for HMRC is rather small.”

“Investigating tax evasion cases can be a costly procedure so HMRC has to weigh up the benefit of the amount of tax they can potentially reclaim versus the cost of actually pursuing the tax.”

“It is also worth remembering individuals or businesses that are found not to owe any additional tax are usually not entitled to compensation so fighting unfounded tax investigations can be a costly nuisance.”

Press enquiries:

Martin Casimir
Managing Director
Bloomsbury Professional
Tel: +44 (0)1444 416119

Nick Mattison or William Bray
Mattison Public Relations
Tel: +44 (0)207 6453636

An article by David Cohen

With a rising tide of anger, among both politicians, the media and the general public, against executive pay and tax avoidance, it is remarkable that the Finance Act 2013 has brought about a 64% reduction in the rate of capital gains tax payable by a major category of executives who exercise share options. However, as with any tax relief, there are pitfalls which can cause the relief to be lost. Woe betide an adviser whose client is tripped up by one of these pitfalls. Diligent readers of EMI Share Options – a Complete Guide should be saved from such a fate.

Enterprise Management Incentives (EMI) share options can be granted to selected employees by independent trading companies with gross assets of no more than £30 million and less than 250 employees. An individual can hold EMI options over shares worth up to £250,000 (increased last year from £120,000) and the exercise of such an option will generally be exempt from income tax and national insurance contributions (NICs). However, gains made on the sale of shares acquired by exercising an EMI option were almost always subject to capital gains tax at the higher rate of 28%.

In theory, this could be reduced to 10% if the conditions for entrepreneurs’ relief were met but this would have required an employee to hold at least 5% of the ordinary share capital and to control at least 5% of the voting rights. Furthermore, the shares would need to have been held for at least a year whereas EMI options are often exercised on an exit event and the shares are immediately sold.

The Finance Act 2013 removes the 5% condition for EMI participants and allows them to count their period of ownership from the date on which the option is granted. This might suggest that provided an employee can hold onto his option for at least a year, he should be home and dry. But this is to overlook the potential impact of a disqualifying event. There are 10 such events of which the most likely to occur are the EMI company losing its independence or ceasing to carry on a qualifying trade or the employee ceasing to be employed by the EMI company or no longer working for it for sufficient hours per week.

If an EMI option is not exercised within 90 days of a disqualifying event (increased from 40 days for disqualifying events occurring on or after the date of Royal assent to FA 13) any gain arising between the date of the event and the date of exercise is subject to income tax and possibly NICs. But that is not all. Failure to exercise within 90 days will also mean that the special EMI route to entrepreneurs’ relief will be closed off. Hence, apart from in the unlikely event that the option holder has held at least 5% of the ordinary shares in the company for 12 months, CGT will be levied at 28%.

Even where an option is exercised within 90 days of a disqualifying event, entrepreneurs’ relief may still be lost. This is because the occurrence of a disqualifying event will mean that the 12 month period between option grant and share sale will instead end on the date of the disqualifying event. Suppose, for example, an EMI option is granted in May 2014 and that the option is exercised and the shares are sold in June 2015. If the option holder becomes a non-executive director (a disqualifying event) in April 2014, he will not qualify for entrepreneurs’ relief, even though the exercise is within 90 days, because the period from grant to event is less than 12 months.

Difficult issues may arise if the EMI company is taken over within a year of an EMI option being granted. If the option holder is forced to take cash, he will not benefit from entrepreneurs’ relief. If he exercises his option and then exchanges his shares for new shares in the acquiring company, those shares will not be treated as “relevant EMI shares” so the 10% tax rate still be out of reach.

 Indeed, there may be a difficulty even if the option has been held for more than a year. This is because a share-for-share exchange will normally not be treated as a disposal for CGT purposes and the subsequent disposal will then be of shares which are not relevant EMI shares. Thankfully, there is a potential escape from this particular trap. The employee can elect for the share exchange to be treated as a CGT disposal as far as his shares are concerned. Making such an election will not always turn out to be beneficial. The electing employee may need to pay CGT (albeit at only 10%) before he receives any cash for his shares and he takes the risk that a fall in share price will mean that some of the gain on which he has paid tax evaporates, leaving him a capital loss when he may not have capital gains against which to offset it.

The position will be more promising if the bidder is prepared to offer option holders an exchange of their EMI options for equivalent new options over shares in the acquiring company. Provided the new options qualify as “replacement options”, any period for which the new options are held can be added to the period for which the original options were held when calculating the minimum 12 month period for entrepreneurs’ relief.

There is a very specific trap which lies in wait for an EMI option holder who exercises her option and then, in time honoured tax planning fashion, gives some of her shares to her husband or civil partner. The transferee will have their own CGT exemption but that benefit may well be outweighed by the loss of the entrepreneurs’ relief which, had she retained the shares, would have attached to 100% of her holding.

Finally, if all these obstacles can be overcome, there will be further complexity with which to grapple if an individual holds some shares acquired by exercising an EMI option and some other shares and is not selling the whole of his holding. Special identification rules apply to determine how many of the shares being sold are to be treated as EMI shares for entrepreneurs’ relief purposes. But that would be the subject of a whole new article!

EMI Share Options – A Complete Guide

ISBN: 978 1 78043 254 0

Publication Date: Aug-13
Format: Paperback
Availability: Not yet published
List price: £65

[Note – this article is based on legislation in the Finance Bill 2013, which is subject to amendment.]

The provisions imposing a 25% charge on close companies in respect of loans to participators (CTA 2010, Pt 10, ch 3) is well known to most tax advisers. The charge under CTA 2010, s 455 (commonly referred to as the ‘section 455 charge’) comes as something of a surprise to some company owners, whereas others have sought to avoid the charge using certain planning arrangements.

For some time, HM Revenue and Customs (HMRC) guidance has indicated some concern about arrangements to avoid the s 455 charge. Subsequently (and without notice or consultation it seems), the government and HMRC announced at Budget 2013 that measures would be introduced to close perceived “loopholes” in the loans to participator rules and prevent avoidance of the tax charge. In addition, in its technical note of 20 March 2013 (‘Close company loans to participators (loophole closures)’), HMRC stated the government’s intention to undertake a “wider review of the loans to participators regime”. A consultation paper on the subject will be published, but is still awaited at the time of writing.

The ‘loopholes’

The three types of arrangements which the government has sought to block are broadly as follows:

• Loans or advances via certain types of intermediary;

• Extractions of value to participators (directly or indirectly) other than as loans or advances of money;

• ‘Bed and breakfasting’, i.e. broadly arrangements in which a loan to a participator is repaid to the company before a s 455 charge arises, followed by the company making a new loan to the participator shortly afterwards.

Legislation to block these arrangements was subsequently published in Finance Bill 2013.

Loans via Intermediaries

HMRC guidance published before the above changes indicated that there were “doubts” about the application of ICTA 1988, s 419 (now CTA 2010, s 455) to loans to a partnership whose members include the company itself. Indeed, the guidance states (at CTM1515): “You should not contend that such loans are within the charge to [s 455] if there is a genuine partnership and you are satisfied with the bona fides of the arrangements”.

HMRC now state that they have “put beyond doubt” that loans to certain intermediaries are within the s 455 charge. This has been achieved simply by extending its scope, so that it applies if a close company makes a loan or advance to the following:

• Settlement trustees – if a trustee or beneficiary (actual or potential) is a participator (or associate) in the company; or

• A partnership (including a limited liability partnership (LLP)) – if a partner is a participator (or associate) in the company.

However, the above change only applies to loans or advances made on or after 20 March 2013. The fact that it has been necessary to introduce legislation to this effect means that some taxpayers may be encouraged to resist any HMRC challenge that a s 455 charge applies in such circumstances. It should also be remembered that there are certain (albeit limited) exceptions to the s 455 charge (in s 456), such as loans made in the ordinary course of a money lending business.

Extractions of value by participators

A new tax charge of 25% has been introduced to deal with perceived avoidance in this area. The type of arrangement envisaged by HMRC involves an intermediary.

The example given by HMRC is where an individual participator (M) and the close company (CC Ltd) form a partnership. The partnership agreement allocates the profits to CC Ltd. HMRC points out that some have previously argued that if CC Ltd leaves the profits undrawn in its capital account with the partnership, or if CC Ltd draws the profits but then pays them back to the partnership as a capital contribution, M could draw on those capital amounts without CC Ltd being subject to a s 455 charge.

The new tax charge (under s 464A) applies if there is a “tax avoidance arrangement” (i.e. broadly to avoid or reduce, or obtain relief from, a s 455 charge), and that arrangement results in a benefit being conferred (directly or indirectly) on an individual participator or associate. However, there is an exception from the 25% tax charge in s 464A if the benefit gives rise to a s 455 charge on the company, or if an income tax charge arises on the participator or associate.

Relief from a s 464A charge is claimable (under new s 464B) if a “return payment” is made to the company in respect of the benefit, for which no consideration is given. The relief must be claimed within 4 years from the end of the financial year in which the return payment is made. The new charge and relief both apply where the close company becomes a party to the arrangement on or after 20 March 2013.

Whilst this charge potentially affects (among other structures) partnerships comprising individuals and corporate partners, its scope is at least limited to tax avoidance arrangements. However, this is an “only or main purpose” test, and it may therefore be necessary for the close company to prove that there was no such avoidance motive.

‘Bed and breakfasting’

HMRC has also apparently been concerned for some time that the provisions allowing relief from the s 455 charge on the repayment of a loan (in s 458) were being exploited using a practice known as ‘bed and breakfasting’.

For example, the participator might repay a loan either before the end of the accounting period or within the following nine months, so that the s 455 charge is not due. The participator then withdraws a similar (or greater) amount from the company shortly thereafter. This practice was highlighted in HMRC’s Enquiry Manual (at EM8565) even before the anti-avoidance provisions, and also in the Company Taxation Manual (at CTM61615). At the time of writing, the latter guidance states:

“You may find that a participator’s indebtedness to the company is shown as reduced or eliminated immediately before the accounting date, or before the due date for payment of the [s 455] tax, only to be followed by a fresh loan or advance of the same or of a similar amount soon afterwards.”

“The temporary reduction in indebtedness is often brought about by the participator borrowing funds on a short-term basis from a third party such as a bank. But it may come from a transfer of assets to the company, or a transfer from another account with the company. You may come across other schemes for ‘bed and breakfasting’ the debt.”

Relief restrictions

A new s 464C denies (or withdraws) relief from a s 455 charge (which is given under s 458(2)), and also from the new charge under s 464A above (under s 464B(2)), broadly in two circumstances:

• A ’30 day rule’ – Where repayment(s) of £5,000 or more are made to the close company in respect of loans, advances, or benefits  which have given rise to a charge (under s 455 or 464A), and further loans, advances or conferred benefits amounting to £5,000 or more are subsequently paid within a 30 day period.

• Amounts of £15,000 or more – Where loans, advances or benefits from the close company are outstanding amounting to at least £15,000, and at the time of a repayment there are arrangements, or there is an intention, for a subsequent loan, advance or benefit, and at any time after the repayment such a return payment is made. Note that this relief restriction is not subject to a 30 day time limit.

The effect of s 464C is that relief is denied (or withdrawn, if it has already been given) for an amount equal to the lower of the amount repaid to the company, and the amounts redrawn (in the first bullet point above) or the new amount withdrawn (in the second bullet point).

However, the above treatment does not apply in either of the above circumstances if the repayment gives rise to an income tax charge on the participator (or associate) in respect of the loan, advance or benefit. This exception is presumably intended to cover circumstances such as where a dividend has been paid to clear the amount outstanding to the company, and the participator is charged to income tax on the dividend).

The new provision applies to any repayments (for s 455 purposes) and return payments (for the purposes of new s 464A) made on or after 20 March 2013.  

Conclusion

The HMRC technical note mentioned at the beginning of this article includes some illustrations of when the new anti-avoidance rules may apply (www.hmrc.gov.uk/budget2013/close-company-loans-loophole.pdf). The provisions are widely drawn. For example, the ’30 day’ test above does not require a tax avoidance motive, and therefore has the potential to catch ‘innocent’ loan repayments by participators unless, it seems, the repayment was of a kind (e.g. a bonus or dividend credited to the loan account) on which the participator (or associate) is liable to an income tax charge. Participators and their advisers will need to keep the anti-avoidance provisions in mind when dealing with close companies generally.   

Mark McLaughlin CTA (Fellow) ATT TEP

Twitter: https://twitter.com/charteredtax

Linkedin: http://www.linkedin.com/pub/mark-mclaughlin/11/811/12

Pentana have supplied industry leading Financial Disclosure Checklist technology via the Checker Software for over 20 years.

Now Bloomsbury Professional have teamed up with Pentana to offer you high-quality, digital, financial disclosure checklists at an industry-leading price.

Developed by dedicated industry experts, Bloomsbury Professional’s Disclosure Checklists are an easy-to-use, software-based alternative to paper checklists that will allow you to accurately complete complex assessments in faster and more cost-effective way.

How does it work? 

Disclosure Checklists use an intelligent tailoring process that takes key information about the company you are reviewing and uses it to quickly determine exactly which disclosures are required.

This expert tailoring system filters out all of the irrelevant information for you, so you no longer need to waste valuable time assessing questions that are not applicable to the accounts you are reviewing. By presenting you with only the disclosures that are relevant to your clients, it is possible to include a broader set of standards in each checklist.

Checklists available from Bloomsbury Professional

All checklists are available on an annual subscription basis and are for 1-3 users:

• Companies (private companies applying UK GAAP) £150.00
• Limited Liability Partnerships £75.00
• Charities £75.00
• Higher and Further Education Institutions £75.00
• Registered Social Landlords £75.00

Save time, save money and reduce risk

Bloomsbury Professional’s Disclosure Checklists will help you to save time, save money and reduce risk.

Be assured that you are up to date and compliant

The checklists are updated throughout the year in line with changes to Companies Legislation and UK accounting standards, including FRS 102 (or ‘new UK GAAP’) and relevant Statements of Recommended Practice (SORPS).

No need to start from scratch each year

Each completed checklist can be revisited and updated the following year, saving time and allowing you to quickly build a clear picture of a client’s year-on-year performance.

Complete professional work in a faster more cost-effective way

The intelligent tailoring within each checklist allows employees below Partner level to confidently carry-outcomplex assessments, freeing partners’ time to complete more in-depth fee earning work.

Extra assurance that the disclosures made are correct for your client

Additional information is provided with each question helping you to understand exactly why a particular question is being asked. This makes Bloomsbury Professional Checklists an excellent training tool, as well as a practical day-to-day resource.

No need for lengthy review processes and sign-off meetings

Users can raise queries and add comments to the checklist to illustrate why specific answers have been given, providing partners with all the information they need to quickly complete the sign-off process.

Get rid of paper checklists forever! Go digital and make sure that completing disclosure checklists is no longer a repetitive and time-consuming drain on your resources.

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• Improving morale important as it should lead to better service for taxpayers and accountants

Staff morale at HM Revenue & Customs (HMRC) is beginning to bounce back from recent rock-bottom levels*.

Our research says that HMRC staff surveyed in 2012 are increasingly positive about the organisation’s direction and management (see graph).

In particular:

• 21% of staff believe HMRC is ‘well-managed’, up from just 11% in 2009;

• 24% of staff believe that senior managers have a ‘clear vision’ for HMRC, up from just 15% in 2010;

• 23% of staff say they are ‘proud’ to work for HMRC, also up from just 15% in 2010.

Martin Casimir, Managing Director here at Bloomsbury Professional, says: “HMRC morale has been at record lows over the last few years, so it is encouraging to see that things are starting to turn a corner.”

“Staff morale is still low when compared to other major organisations, and HMRC is starting from a low base, but the momentum towards improvement is there. Staff are now happier with the organisation’s leadership and direction than they have been for a long time.”

Despite cuts to HMRC’s budget, HMRC staff are increasingly happy with their workloads. 62% of staff said their workload was acceptable in 2012, compared to 54% in 2010.

Martin Casimir says: “Staff happiness with workloads might suggest HMRC has been managing the effect of budget cuts on its staff better than expected. However, it’s important that heavier workloads do not mean a lower level of service for taxpayers. HMRC should make sure it finds ways to do more with less for its customers.”

Improvements in HMRC staff morale are important as they should lead to a better quality of service for taxpayers and accountants.

Martin Casimir says: “Hopefully, the internal signs of improvement will filter through into a better experience for the taxpayers and accountants that rely on an efficient and customer-focused HMRC.”

“Improved morale should also lead to better levels of staff retention and more experienced HMRC staff. One of businesses’ and accountants’ biggest complaints about HMRC recently has been its failure to adequately replace the experienced and knowledgeable staff that have left the organisation.”

Other findings from the HMRC staff surveys include:

•  The proportion of staff wanting to leave HMRC within the next 12 months has fallen from 29% in 2009 to 20% in 2012.

• Only 23% of HMRC staff feel their pay is reasonable compared to salaries for similar roles in other organisations, down from 25% in 2009.

•  Just 36% of HMRC staff said that poor performance is dealt with effectively at HMRC.

*HMRC’s overall ‘employee engagement score’ was 41% in 2012, up from 40% in 2011, 34% in 2010, and 32% in 2009

Press enquiries:

Martin Casimir

Managing Director

Bloomsbury Professional

Tel: +44 (0)1444 416119

A recent independent survey of professional tax advisors working across the north of England has indicated that despite recent adverse media comment regarding tax avoidance, a large percentage is still proud of the firm they work for.

“Over the last six months or so the reputation of the tax profession in the UK has taken a bit of a hammering from the media on the back of the reporting of widespread tax avoidance by high profile individuals and multinational groups” says Mike Longman, the Managing Director of Longman Tax Recruitment. “It has been hard to pick up a paper or listen to the news without being confronted by the seeming public outcry over the tax planning apparently undertaken by celebrities such as Jimmy Carr and multinational groups like Starbucks, Google and Amazon. However our recent survey suggests that this publicity has not undermined tax practitioners’ pride in the firms they work for”.

Mike adds, “We undertook an anonymous survey of tax professionals across the north of England and less than 20% stated that they were not proud of their employers’ brand despite the recent tsunami of adverse publicity (whilst almost half said they were either proud or very proud).

From my frequent discussions with senior people within the tax profession there is a real sense of frustration at how poorly informed much of the press comment on the tax avoidance debate has been. Perhaps the results of our survey show that those involved at the sharp end of the UK’s labyrinthine tax system, and who better understand the complexities involved in this debate, don’t recognise the image of the unscrupulous mercenary tax profession that the PAC amongst other has been promulgating.” The survey was carried out during January and February 2013 and there were 73 respondents from across a broad spectrum of the local tax profession.

To receive a free copy of the full survey please email mike@taxrecruit.co.uk

Join us on Friday for a free online essential skills session and live Q&A with our product and industry experts.

This session will give you a thorough overview of the newly launched Tax Toolkit, with explanations on product features and functionality, as well as offering you the chance to ask specific questions that relate to you and your practice.

Topic: Bloomsbury Tax Toolkit
Date: Friday,17th May 2013
Time: 14:00, GMT Time (London, GMT)
Meeting Number:958 809 699 
Meeting Password: Bloomsbury

To join in, all you need to do is:

1. At 14.00 on Friday 17th May, visit this link: https://bloomsburyprofessional.webex.com/bloomsburyprofessional/j.php?ED=214086212&UID=1598443067&PW=NN2ZkZGJhZWVj&RT=MTgjMjE%3D
2. If requested, enter your name and email address.
3. If a password is required, enter the meeting password: bloomsbury
4. Click “Join”.
5. Follow the instructions that appear on your screen

Note: This meeting will be hosted via Webex. It may be worth visiting the Webex site before the session starts to ensure that you have the appropriate software to participate. If not, it is all available to download free of charge from the site.

If you have any queries before the event please contact Pete Taylor on
01444 416119 or email pete.taylor@bloomsburyprofessional.com.

IHT: Mark McLaughlin discusses non-domiciled spouses and civil partners 

[Note - This article is based on the legislation published in Finance Bill 2013. At the time of writing (March 2013), the legislation is subject to possible amendment before Finance Bill 2013 receives Royal Assent.]

Individuals who are domiciled in the UK are liable to IHT on chargeable worldwide property. Non-UK domiciled individuals are also liable to IHT, but only on chargeable UK property. There is no statutory definition of ‘domicile’ for IHT purposes. Domicile is a concept of general law. However, in addition to the general law concerning domicile, there is also a ‘deemed domicile’ rule for IHT purposes (IHTA 1984, s 267). This rule broadly states that a person can be deemed to be domiciled in the UK if one of two alternative conditions is satisfied.

Deemed domicile

The first condition is often referred to as the ‘three-year rule’. It broadly states that a person is treated as domiciled in the UK if he or she was domiciled here at any time in the three years immediately preceding the time when the question of domicile needs to be decided.

The alternative condition is commonly known as the ’17 out of 20’ rule. This is broadly that a person will be deemed domiciled in the UK when he or she has been resident here for 17 out of the 20 tax years ending with the present one. In determining whether an individual is resident in the UK for these purposes, it is necessary to look at the income tax rules on residence, bearing in mind that there is also a new statutory residence test in Finance Bill 2013.

As mentioned, if either of these conditions is satisfied, a person is deemed to be domiciled in the UK for IHT purposes.

Spouse exemption

The IHT spouse or civil partner exemption is contained in IHTA 1984, s 18. The general rule is that transfers of value between spouses are exempt transfers to the extent that the property in question becomes comprised in the estate of the transferor’s spouse. The increase in the recipient spouse’s estate is normally exempt for IHT purposes. However, the legislation then goes on to restrict the spouse exemption, by stating that if the transferor spouse is domiciled in the UK but the recipient spouse is non-UK domiciled, the transfer is exempt only up to an upper limit, less the value of any previous transfers which have taken place.

Prior to changes in Finance Bill 2013, for many years this upper limit was £55,000. The reason why the restriction was set at £55,000 is that it had been in place since 9 March 1982, when the IHT nil rate band was also £55,000.

It is important to note that the restriction in the spouse exemption applies only if the recipient spouse is non-UK domiciled. So if both spouses are domiciled in the UK, or if both spouses are domiciled abroad, or if the spouse making the transfer is non-UK domiciled but the recipient spouse is domiciled in the UK, there is no restriction in the spouse exemption.

If a lifetime gift exceeds the restricted spouse exemption, the excess will generally be a potentially exempt transfer (PET).

Example 1

Frank is UK domiciled. On 1 January 2011, he made a lifetime gift of assets worth £200,000 to his non-UK domiciled wife, Greta. No previous gifts were made. The first £55,000 of this gift is exempt for IHT purposes under the spouse exemption. The balance of £145,000 is a PET.

Unfortunately, Frank died in January 2013. He left his estate worth £500,000 to a discretionary trust for his family. When calculating the IHT on Frank’s estate, his nil rate band of £325,000 is reduced by that part of his lifetime gift to Greta which was not covered by the spouse exemption, i.e. the PET of £145,000. Thus only £180,000 of the nil rate band remains to be offset against the estate on death of £500,000, leaving £320,000 liable to IHT at 40%, i.e. £128,000.

One effect of the restriction in the spouse exemption is that it becomes more difficult for a UK domiciled spouse to transfer unused nil rate band to his or her non-UK domiciled spouse. For deaths before 6 April 2013, if the amount left on death exceeds £55,000 plus the available nil rate band, there will be no unused nil rate band left to transfer.

HMRC’s inheritance tax manual at IHTM11033 includes two further examples. The first example, involving Mr and Mrs Allsop, is similar to the example of Frank and Greta above, except that the husband’s lifetime gift to the wife is made more than seven years before the husband’s death. What this example illustrates is that the restriction in the spouse exemption applies without time limit as far as lifetime gifts are concerned. They do not fall out of charge after seven years in the same way as PETs.

HMRC’s second example involves a married couple, Mr and Mrs Costa, who were both domiciled outside the UK when Mr Costa made a lifetime gift of £500,000 to Mrs Costa, so there was no restriction in the spouse exemption at that point. However, Mr Costa subsequently becomes domiciled in the UK and makes a further gift of £100,000 to Mrs Costa. This example points out that the restricted spouse exemption is not available on the later transfer because of the earlier lifetime gift, despite the fact that both spouses were originally domiciled outside the UK when the gift of £500,000 was made. 

Lifetime and death elections

The Finance Bill 2013 legislation affecting the spouse exemption includes two main changes. The first change is that the spouse exemption upper limit for restriction purposes is increased from £55,000. The new upper limit is the nil rate band threshold at the time of the transfer. For example, if a gift is made from a UK domiciled individual to a non-UK domiciled spouse during the tax year 2013/14, the spouse exemption on that gift will be restricted to the nil rate band for that year, i.e. £325,000.

Returning to the above example of Frank and Greta, let us assume that Frank’s lifetime gift of £200,000 was made in 2013/14. Under the new rules, the gift would fall within the £325,000 upper limit, and would therefore be subject to the spouse exemption in full. This means that Frank’s nil rate band of £325,000 would be available on death. His estate of £500,000 would be reduced by a full nil rate band of £325,000, leaving £175,000 chargeable to IHT at 40%, i.e. £70,000.

The second change is a completely new provision. This is an election to be treated as domiciled in the UK for IHT purposes. There are two alternative conditions for the election to apply. The first condition applies to an election during the person’s lifetime. This condition is that he or she is not domiciled in the UK when the election is made, but that his or her spouse is domiciled in the UK at that time.

As indicated above, the effect of the election is that the person who makes it is generally treated as domiciled in the UK for IHT purposes. What this means in practice is that his or her spouse can make exempt transfers without the spouse exemption upper limit applying. The person making the election will continue to be liable to IHT on their UK situs assets, as they would be if they remained non-UK domiciled. However, the downside of making the election is that their non-UK situs assets will become liable to IHT. In other words, he or she will be liable to IHT on their worldwide estate, in the same way as a person who has always been domiciled in the UK.

As mentioned above, there are two alternative conditions for the election to apply. The second condition relates to an election following death. This condition is broadly that the person’s spouse or civil partner died on or after 6 April 2013 and was UK domiciled at the time of death, and that the other spouse or civil partner was not domiciled in the UK at that time. What the election means in practice is that on the death of a UK domiciled individual, the non-UK domiciled surviving spouse may elect to be treated as domiciled in the UK for IHT purposes. This will allow legacies from the deceased spouse to benefit from the IHT exemption without restriction. It also means, of course, that the recipient spouse would subsequently be liable to IHT irrespective of the location of their assets.

Example 2

Henry is domiciled in the UK, and his wife Ingrid is non-UK domiciled. Henry dies in August 2013. In his will, Henry leaves his entire estate to Ingrid. Henry’s estate comprises UK assets worth £625,000, and non-UK assets worth £425,000.

If no death election is made, Henry’s estate will be liable to IHT of £160,000, which is calculated as follows: his total estate is worth £1,050,000, but the first £325,000 passing to Ingrid is subject to the IHT spouse exemption. That leaves £725,000, the first £325,000 of which is subject to the nil rate band, and the balance of £400,000 is liable to IHT at 40%, i.e. £160,000.

If Ingrid makes a valid election to be treated as UK domiciled, there is no IHT payable on Henry’s death because the spouse exemption applies without restriction to the assets passing to Ingrid. As far as Ingrid is concerned, the effect of making the election to be treated as UK domiciled is that, in addition to UK assets which would be subject to IHT regardless of her domicile status, Ingrid will also be generally liable to IHT on her non-UK situs assets, subject to her IHT nil rate band, if available.

In determining whether or not an individual is eligible to make the election, it will be necessary to look at their domicile status without taking into account the ‘deemed’ domicile provisions in IHTA 1984, s 267. With regard to the election itself, it will need to be made to HMRC in writing, and HMRC have indicated that there will be no specific form for making the election. A lifetime election generally takes effect from the date of making it, and a death election from immediately before the death of the spouse or civil partner. However, an earlier date may be specified in the notice (not earlier than 6 April 2013) of up to seven years, if the couple were married or civil partners and the spouse or civil partner was domiciled in the UK throughout a ‘relevant period’ (i.e. broadly from the earlier date specified in the election). A death election must be made within two years of the death, although HMRC may allow a longer period at its discretion.   

Once a lifetime or death election has been made, it cannot be revoked. This is because, using Ingrid as an example, she would otherwise be able to make the election and save IHT of £160,000 on Henry’s death, but revoke the election later so that the non-UK assets worth £425,000 passing from Henry would not be subject to IHT in Ingrid’s estate due to her non-UK domiciled status.

Non-residence

However, the Finance Bill 2013 legislation provides a possible escape route whereby an election can cease to have effect. This is broadly where the person making the election later becomes resident outside the UK for income tax purposes for four consecutive tax years. In that case, the election will cease to have effect following the end of the fourth full tax year of non-residence. The purpose of this provision is to ensure that an individual who makes the election but leaves the UK does not remain forever liable to IHT on their overseas assets. However, care will be needed to ensure that the individual is not subsequently domiciled in the UK at that point, either under the general law of domicile, or under the ‘deemed’ domicile provision for IHT purposes in IHTA 1984, s 267. Otherwise, the individual may still be liable to IHT on their worldwide estate, even though the election has ceased to have effect.

Nevertheless, this ‘non-residence’ rule would seem to offer some flexibility for IHT purposes, where an individual intends leaving the UK following the death of their UK domiciled spouse. Taking the two changes together, i.e. the increase in upper limit of the spouse exemption, and the election to be treated as UK domiciled for IHT purposes, it will generally be necessary to ‘do the sums’ and take into account the assets and personal circumstances of the spouses or civil partners in determining whether it is beneficial to make the election. It will probably seem very attractive for (say) a non-domiciled widow faced with a 40% IHT charge on her late husband’s estate to make the election, in order to benefit from an unrestricted spouse exemption. However, it must be remembered that the whole of her estate will then be brought into IHT (subject to the ‘three tax year’ rule mentioned earlier), so this generally makes the IHT on her husband’s estate more of a deferral than a saving, unless some lifetime planning is undertaken by the surviving spouse.

Finally, even before these changes were originally proposed, there was serious doubt as to whether the restricted spouse exemption was compatible with EU law, on the basis that it discriminated against non-UK domiciled spouses. Some concern will still remain on this discrimination point even after the changes become law, although it may be that the provision for the domicile election to cease having effect after four successive tax years of non-residence has been introduced to ease some of those concerns.  

Mark McLaughlin CTA (Fellow) ATT TEP

Twitter: https://twitter.com/charteredtax

Linkedin: http://www.linkedin.com/pub/mark-mclaughlin/11/811/12

Penalties for late payment: Mark McLaughlin discusses time to pay 

There are certain ‘let-outs’ from penalties for late payments of tax (under FA 2009, Sch 56), which are potentially helpful for taxpayers.

One of these exceptions relates to ‘time to pay’ arrangements with HMRC. Its effect is broadly that if HMRC accepts a taxpayer request for time to pay, there is no penalty for late payment in respect of the period covered by the agreement, provided that the taxpayer does not break the terms of the time to pay arrangements. In other words, any penalty is suspended while the agreement is in place. However, if the taxpayer breaks the time to pay arrangements, HMRC can issue a penalty notice to impose the suspended penalty (FA 2009, Sch 56, para 10).

HMRC’s debt management and banking manual includes a whole chapter on time to pay (DMBM800000). It sets out three conditions for late payment penalties to be suspended where the taxpayer requests time to pay (DMBM803600):

1. Taxpayers must approach HMRC before they become liable to a penalty;
2. HMRC must agree the time to pay arrangement; and
3. Taxpayers must adhere to the arrangement and comply with any conditions of the
arrangement.

Penalties are not due if the terms of a time to pay arrangement are varied, provided that the taxpayer and HMRC both agree the terms. However, if the agreement is otherwise broken, the taxpayer becomes liable for penalties in respect of the time to pay period, in addition to any penalties incurred before or after that period (CH156600).

Request denied 

Individual taxpayers within self-assessment are liable to a penalty if the tax in question is not paid within 30 days from the due date (FA 2009, Sch 56, para 1(4)). The penalties broadly apply to late balancing payments of income tax and late payments of capital gains tax. Taxpayers in financial difficulty should therefore have up to 30 days from 31st January following the tax year to agree a time to pay arrangement with HMRC.

However, HMRC guidance warns (CH156600): “If a person is unable to make payment on time they can ask us to agree that they may defer payment of that amount of tax. They must make their request to defer payment before the due date for payment”.

In Brand v Revenue & Customs [2013] UKFTT 783 (TC), the taxpayer’s self-assessment return for 2010/11 showed a substantial capital gain on the sale of a property. The capital gains tax liability was approximately £40,000. However, the proceeds from the property sale had not been received. The tax return for 2010/11 was filed on 24th January 2012. On 9th February 2012, the taxpayer wrote to HMRC requesting time to pay, and explaining the situation. On the same day, he sent paperwork to HMRC about the property transaction. On 22nd March, HMRC wrote to the taxpayer refusing his time to pay application. The taxpayer subsequently approached a friend for a loan to pay the tax. HMRC charged a penalty for late payment of the capital gains tax. The taxpayer appealed.

The tribunal accepted that if the taxpayer had known about HMRC’s refusal of his time to pay request within two weeks of applying on 9th February 2012, he would have paid the capital gains tax by 2 March 2012 (i.e. within 30 days from the tax return filing date), and no penalty would have been incurred. The taxpayer’s appeal was allowed.

Reasonable excuse 

Penalties for late payment may be reduced by HMRC in ‘special circumstances’, although the inability to pay is specifically excluded (FA 2009, Sch 56, para 9). In addition, a defence of ‘reasonable excuse’ may be available. However, an insufficiency of funds is not a reasonable excuse, unless it is attributable to events outside the taxpayer’s control. If the taxpayer had a reasonable excuse which has ended, it is treated as having continued if the tax is paid without ‘unreasonable delay’ after the excuse ended (Sch 56, para 16).

As mentioned, in the Brand case, the tribunal considered that if the taxpayer had known about HMRC’s refusal of the time to pay proposal by 9 February 2012, he would have been able to raise the funds to pay the CGT before the penalty trigger date of 2 March 2012. The taxpayer had a “reasonable expectation” that HMRC would respond to his request within a two week timeframe. On that basis, the tribunal held that the taxpayer had a reasonable excuse.

As mentioned, insufficiency of funds is generally not a reasonable excuse. However, in the Brand case it would seem that this insufficiency was considered to be attributable to events outside the taxpayer’s control. The tribunal’s sympathetic approach offers somehope to taxpayers in a similar position.

Mark McLaughlin CTA (Fellow) ATT TEP

Twitter: https://twitter.com/charteredtax

Linkedin: http://www.linkedin.com/pub/mark-mclaughlin/11/811/12

An individual who is fortunate enough to have more than one residence may well find a main residence election useful in terms of optimising private residence relief. The legislation concerning the election is contained in TCGA 1992, s 222(5).

It states:

“(5) So far as it is necessary for the purposes of this section to determine which of 2 or more residences is an individual’s main residence for any period—

(a) the individual may conclude that question by notice to an officer of the Board given within 2 years from the beginning of that period but subject to a right to vary that notice by a further notice to an officer of the Board as respects any period beginning not earlier than 2 years before the giving of the further notice…”

Residence

Two key words here are ‘residences’ and ‘main residence’. The fundamental requirement for making the election is that each property must actually be the individual’s residence for private residence relief purposes. There is no statutory definition of the term “residence” in this context, and it is therefore often necessary to refer to case law for guidance. The
meaning of residence is beyond the scope of this article, but (for example) in ‘Tolley’s Tax Cases’ there are a number of cases in which courts and tribunals have had to consider whether a property was an individual’s residence or not. In addition, HMRC’s capital gains manual looks at the meaning of ‘residence’ at paragraph CG64420 and following.

In Regan & Anor v Revenue & Customs [2012] UKFTT 569 (TC), the tribunal said on the meaning of ‘residence’: “We consider that the issue of whether a property is or has been a residence is a matter of fact that should be determined by reference to the quality (and not merely the length) of the occupation.”

Main residence

Once it has been established that there are two or more residences, the election allows the individual to decide conclusively which residence should be treated as the main one. However, in a recent First-tier tribunal case, it appears that HMRC were rather confused about the effect of the election. In Ellis v HMRC [2013] UKFTT 775 (TC), a property was bought in March 1999 for £100,000, and let out until 31 August 2004. Mrs Ellis and her late husband then decided to use the property as a residence from 1 October 2004, and later that month they submitted a main residence election to HMRC under s 222(5). The property was subsequently sold in April 2005 for £187,500. Private residence relief was claimed on the property, but following HMRC enquiries into the tax returns of both individuals, tax assessments were raised. Those assessments were appealed against, on the basis that the property had been used as a residence, and that the main residence election was conclusive as to which residence amounted to the taxpayers’ main residence.

At the tribunal hearing, HMRC stated that that the point in dispute was whether the individuals’ occupation was sufficient to deem the property as a ‘main residence’ for private residence relief purposes. The HMRC officer accepted that the property was a ’residence’ of the taxpayers, but argued that the nature and extent of the property’s use did not permit the conclusion that it was their ‘main residence’.

Effect of election

However, the tribunal pointed out that once HMRC had conceded that the property was a residence, and that the taxpayers had two residences, the effect of s 222(5) was to allow the taxpayers to make an election that determined which of the two residences was their main residence for CGT purposes. In other words, HMRC were unable to argue that the residence was not the taxpayers’ main residence. The tribunal judge pointed out that if HMRC’s arguments had been correct, it would have meant that an election under s 222(5) could never be conclusive, and he said that this was contrary to the plain meaning and effect of s 222(5). The appeals were therefore allowed. It seems rather strange that this case reached the tax tribunal in the first place. After all, it appears to be clear from the wording of s 222(5) that taxpayers can elect conclusively which residence is their main residence for CGT purposes. Presumably, the appellants did not ask HMRC for a statutory review by another HMRC officer, or perhaps were not offered one. It is also interesting that HMRC states the following in its own guidance at
CG64485: “When nominating which residence is to be treated as the main residence, an individual is not obliged to nominate the residence which is factually his or her main residence; they may nominate whichever residence they choose.”

There is no mention in the case transcript of an application being made to the tribunal for the award of costs against HMRC. One can only speculate whether the tribunal would have awarded costs to the taxpayers, on the basis that HMRC had acted unreasonably. It does seem (to me at least) that an award of costs was justified.

Points to note

With regard to main residence elections, the legislation specifies a two-year time limit in s 222(5) for making the election. In HMRC’s view that two-year period broadly starts from when the individual has a new combination of residences. For example, in practice the opportunity for making the election will often be triggered by buying another property and occupying it as a residence. However, the time limit does not necessarily run from the date on which the other property is acquired. The two-year period runs from the date that another property started to be used as a residence.

For example, in the Ellis case, having bought the property in 1999, the couple rented it out until August 2004. They then occupied the property as a residence from 1 October 2004. Thus they would have had until 30 September 2006 to make a main residence election. As mentioned, HMRC’s position on when the two-year time limit starts is that the main residence election must be made within two years from the date when there is a different combination of residences. This point is set out in the capital gains manual at CG64495. HMRC’s approach has not been universally accepted in the past, but HMRC’s guidance refers to the case Griffin v Craig-Harvey [1993] STC 54 in support of its interpretation of the legislation, in which the High Court reached a broadly similar conclusion. In terms of the election itself, HMRC lists a number of conditions to be satisfied in order to make a valid election in the capital gains manual at CG64520. For example, HMRC states that an election cannot be signed by the taxpayer’s agent. It must be signed by the taxpayer. In addition, HMRC’s guidance mentions spouses or civil partners who are living together, and refers to the legislation in TCGA 1992, s 222(6), which states that there can only be one residence or main residence for both of them, and that a main residence election affecting both spouses or civil partners must be made in writing and signed by both individuals.

Variations

Once an election has been made, it can subsequently be varied by giving notice to HMRC. This variation can be backdated by up to two years from the date on which it is made. In practice, the facility to vary elections is sometimes used for planning purposes to optimise private residence relief. For example, if a property has been the individual’s only or main residence for even a relatively short period of time, on a subsequent disposal of that property it is generally possible to claim CGT relief for up to the last 36 months of ownership, by virtue of s 223(1). HMRC’s capital gains manual at CG64510 famously includes the following example, which suggests that this planning is acceptable to HMRC: “…where an individual with two residences validly nominates house A, they may vary that nomination to house B at any time. The variation can then be varied back to house A within a short space of time. This will enable the individual to obtain the benefit of the final period exemption on house B with a loss of only a small proportion of relief of on house A.”

HMRC’s example does not indicate how short the length of time can be between variations. It has been suggested by some commentators that a period of one or two weeks may be all that is needed. Of course, there would be a loss of relief on the first property for the same period, although the gain will often be small, and may perhaps be covered by the individual’s annual CGT exemption. Generally speaking, where more than one residence is owned, it will generally be a good idea to make a main residence election, so that it can be varied later, if necessary. A protective main residence election should also be considered whenever there is a change in the residences owned, for the same reason.

Not too late?

Finally, satisfying the two-year time limit for making a main residence election can sometimes cause difficulties, in terms of identifying what constitutes an additional residence. For example, an individual may have a residence in London, but work in Manchester during the week. They may decide to rent a property in Manchester, occupy it from Monday to Friday, and return to London at weekends. HMRC’s view appears to be that if, in this example, the Manchester property is rented under a tenancy it is a residence for private residence relief purposes. However, the individual may not initially realise that they now have two residences for CGT purposes, and could have made a main residence election. By the time that they do realise, the two-year time limit for making the election may have passed.

Fortunately, HMRC recognised this potential difficulty, and introduced extra statutory concession D21, which states:
“Where for any period an individual has, or is treated by the Taxes Acts as having more than one residence, but his interest in each of them, or in each of them except one, is such as to have no more than a negligible capital value on the open market (eg a weekly rented flat, or accommodation provided by an employer) the two year time limit laid down by TCGA 1992 s 222(5)(a) for nominating one of those residences as the individual’s main residence for capital gains tax purposes will be extended where the individual was unaware that such a nomination could be made. In such cases the nomination may be made within a reasonable time of the individual first becoming aware of the possibility of making  nomination, and it will be regarded as effective from the date on which the individual first had more than one residence.”

The concession broadly allows the two-year time limit for making a main residence election to be extended to within a reasonable time of the individual first becoming aware of the possibility of making the election. However, note that there is an important condition for this concession to apply, which is broadly that one of the residences must have no morthan a negligible capital value on the open market, such as a weekly rented flat or accommodation provided by the employer.

It does seem a little strange that a main residence election may be relevant in respect of rented property, particularly if it has little or no capital value. Nevertheless, that appears to be the case. However, since 16 October 1994, the election has not applied to properties occupied under a licence, such as where an individual stays with friends at their house, for example.