Paying
dividends does not always pay dividends
Chased
by the Inland Revenue: you can run but you cannot hide
In recent months
it has been well documented that the Inland Revenue has
changed its stance on how it is interpreting and applying
the settlements legislation, and is using it to target husband
and wife businesses in particular. The Inland Revenue's
argument is that where one spouse is principally responsible
for earning the income of the business, but the other spouse
receives a substantial share of that income, say in the
form of dividends, then this arrangement constitutes a settlement
under the provisions of section 660A of the Income and Corporation
Taxes Act 1988. This will have the effect of treating the
whole income of the settlement as if it was the settlor's
income, who then may be liable to a higher rate of tax than
the spouse.
The Inland Revenue's
stance has been challenged by the legal case referred to
as "Arctic Systems" Having been made redundant, Mr Jones,
a software engineer, decided to set up his own limited company
and he and his wife each acquired one share. Mr Jones was
appointed sole director and his wife was appointed company
secretary. Mrs Jones undertook all of the book-keeping work,
liaised with the external accountant and the bank, organised
business insurance, completed the VAT returns, paid supplier
and other bills, prepared and issued company invoices, received
telephone calls from agencies to arrange appointments for
interviews, discussed new contracts and contract renewals
with her husband, and signed the company's statutory accounts
in her capacity as company secretary. On average Mrs Jones
worked between four and five hours each week on company
business.
Mr and Mrs Jones
tended to receive low salaries and the company distributed
the remaining profits in the form of dividends.
The appeal hearing
was heard by two commissioners who ruled that Mrs Jones
was properly rewarded for her role in the business by a
salary and that the remaining profits, out of which the
dividends were paid, were earned by Mr Jones. Therefore
the commissioners were of the opinion the Inland Revenue
were correct to have applied the settlements legislation
in this case.
An important point
to bear in mind is the fact that the two commissioners could
not agree, and their conclusion was reached only after the
senior commissioner used her casting vote to rule in the
Inland Revenue's favour. The case would have been clearer
had a majority decision been reached.
The case has been
appealed to the High Court and will be heard in March. The
final outcome is unlikely to be determined for some time
and has an equal bearing on family partnerships in terms
of income generation and distribution.
This is an important
issue which could result in significant additional taxes
being payable, bearing in mind the tax liability could cover
the last six years should the Inland Revenue open an inquiry
and their view of the settlement legislation be upheld.
In the interim
it is suggested that careful thought is applied to your
business structure in order to determine if it would withstand
an Inland Revenue challenge. If the view is that it might
not, don't stick your head in the sand or hope you won't
get noticed. If the Inland Revenue decide to take a close
interest in your business, you may be able to run for a
while, but they won't let you hide forever. You should consult
your tax advisor at the earliest opportunity for advice.
Return
to top
The
Pensions Bill 2004 - Key Aspects of Pensions Simplification
In the March 2004
budget the Chancellor confirmed that as of 6 April 2006
there will be only one set of tax rules governing all types
of pension arrangements.
The purpose of
this article is to give you a reminder of the key changes,
highlight the opportunities associated with them and to
make you aware of issues that may need addressing prior
to the changes.
What are
the changes?
The Lifetime
Allowance
This is the new
limit to the amount of pension savings (including contracted-out
benefits) anyone can make during their lifetime without
tax penalty. The Lifetime Allowance will be £1.5 million
initially and will increase to £1.6m in 2007/08, £1.65m
in 2008/09, £1.75m in 2009/10 and £1.8m in 2010/11
and then it will be reviewed every five years.
The Annual
Allowance
From April 2006
total payments to pension schemes each year will, in theory,
be unlimited. However for both individual and total payments
there are limits on tax relief. The Annual Allowance for
individual payments which will attract tax relief is £3,600
or 100% of earnings, whichever is higher. The Annual Allowance
for total payments which will attract tax relief is £215,000
in 2006/07 and will increase by £10,000 each year
to reach £255,000 in 2010/11.
In the year before
retirement there is NO limit to the contributions
allowed for tax purposes. We expect the Annual Allowance
to be reviewed every five years.
Contribution
and Tax Relief
Relevant UK individuals
who are active members of registered pension schemes will
be entitled to tax relief. An individual is a relevant UK
individual for a particular tax year if they are under 75
and
- they have relevant UK earnings chargeable to income
tax for that year; or,
- they are resident in the UK at some time during that
year; or,
- they were resident in the UK both when they became a
member of the pension scheme and at some time during the
previous five tax years; or,
- they or their spouse have, for the tax year, earnings
from overseas Crown employment subject to UK tax.
Unlimited contributions
can be made, but tax relief will be limited to the highest
of £3,600 and 100% of earnings. Tax relief on an employer
contribution is unlimited in most cases. Where contributions
exceed the Annual Allowance the excess will be taxed at
40%.
The option of
"carrying back" pension contributions to the previous tax
year will also be removed. This will have little effect
on an individual's ability to make large contributions to
a plan, but may have some tax planning effect .
Pension
Age
The minimum age
for taking benefits will increase from age 50 to age 55
by 2010, with pension schemes free to decide how to make
this change. This means that some providers may "step"
the age in over the period to 2010 (i.e. 51 in 2006, 52
in 2007 etc.) or just
change to 55 from
50 in 2010. We expect the latter to be the norm.
Retirement
Benefits
From 2006 up to
25% of a pension fund (up to the Lifetime Allowance) can
be taken as tax-free cash. This will allow schemes that
currently do not provide cash, (e.g. free standing AVC schemes)
to do so. The Department for Work and Pensions (DWP) have
recently confirmed they intend to allow tax-free cash of
25% to be paid from protected rights monies at retirement.
This should be confirmed when the Pensions Bill is passed.
The remaining
fund must be used to provide an income in one of the following
ways:
- Secured benefits - a guaranteed income (annuity purchase
or Scheme pension).
- Unsecured benefits - a non-guaranteed income prior to
age 75 (income drawdown). Minimum income figure is £0.
- Alternatively secured pension - this option will be
available to everyone from age 75.
If an individual
is going to be disadvantaged by the change in pension legislation
(i.e. they are eligible for more than 25% tax free cash,
or have a pension fund in excess of £1.5M) they will
be able to "protect" their pre-simplification rights.
Death
Benefits
Prior to
retirement - Lump sum death benefits of up to the
Lifetime Allowance will be paid free of tax. Where the Lifetime
Allowance is exceeded, there will be a tax charge of 55%
on the excess fund where this is taken as a lump sum. Where
the excess is paid as a pension to dependents, there will
be no recovery of tax.
In retirement
(before age 75) - When death occurs during drawdown
(unsecured) the whole of the remaining fund can be paid
out less 35% tax, or the whole fund can be used to provide
dependents' pensions, either via an annuity or continuing
drawdown.
The death benefits
from an annuity that gives value protection (before age
75) will be calculated as the purchase price, less instalments,
less 35% tax.
In retirement
(post age 75) - No lump sum death benefits are
permitted from lifetime annuities and scheme pensions, however,
a 10 year guaranteed annuity could be purchased at age 75
giving some protection.
When death occurs
whilst a member of an alternatively secured pension arrangement
any remaining fund must first be used to provide a spouse's
or dependent's pension. If there is no spouse or any dependents
then the residual fund can either be distributed amongst
other scheme members or paid to a nominated charity.
The Future
In the next issue
we will look at the major changes arising after "A-day"
and review the opportunities for individuals, pension schemes
and employers to take advantage of both the pre and post
changes in 2006.
The above article
was supplied by Scott Middleton of Professional Financial
Advisers Limited and Scott can be contacted by telephoning
01224 587582.
Return
to top
Planning
for a Successful Retirement
It is estimated
that around 30% of all business closures arise because of
the failure on the part of the owners to plan their exit
strategy and adequately consider succession. Lack of coherent
thought in this area inevitably causes the end of many,
hitherto, successful businesses, either through insolvency
or ill conceived management buy-outs.
Business owners
can no longer assume that their children will take over
the reigns on their retirement. These matters need to be
discussed well in advance in order to determine whether
or not they want to assume ownership, and if they do it
is important to invest time (and money) in developing the
skills they will require. It is also necessary to ensure
the correct management team is in place and that this team
will be able to support them when they take over.
Quite often, where
there are no children involved in the enterprise, the owners
assume the existing management team will be willing to buy
the business. However, when this is being considered the
following critical questions are often ignored:
- Does the existing management team have the right profile
in terms of skills, age etc;
- Will they be able to raise sufficient finance?
- Do they actually want to acquire the business?
Sale of the business
on the open market certainly has its attractions, but will
a suitable buyer be there when the business is up for sale?
Such an event also has to be planned for well in advance.
The key questions to be asked include:
-
Can the business
survive without the involvement of the existing owners?
-
Are all systems
in place to ensure the business' future success?
-
Has the value
of the business been optimised in readiness for a sale
on the open market?
There is often
a reluctance on the part of business owners to consider
succession issues, and when they do get around to considering
such matters it is often too late. These matters need to
be fully considered at an early stage and the business'
external accountant is well placed to offer practical advice
and guidance. To coin a phrase "it is never too early to
consult your business advisor".
The European Union
estimates that one third of all businesses within the EU
will change ownership during the next ten years and the
European governments are extremely concerned about the associated
risks. They are so concerned that funding has been made
available, through the local Business Link organisations,
to encourage business owners to invest in succession planning.
Recent
Case Studies:
Rely on
a friend: but not in business
We are well aware
of the market dominance of the major supermarket chains
which results in forced reliance by suppliers. Typically,
the result is that the dominant player forces a supplier
to provide a continually higher quality at an ever reducing
price/margin which can prove disastrous. The position worsens
considerably when a business becomes over-reliant on one
customer: notably where such reliance is not based on a
long standing friendship but on business principles. Meston
Reid & Co were recently asked for assistance in developing
a business strategy for a company which had become heavily
reliant on one customer: which accounted for nearly 85%
of annual turnover. Steps were taken to identify alternative
markets and business generation strategies but, without
warning, the major customer elected to use another supplier.
Even worse, because the major customer had provided verbal
assurances only rather than a signed contract, the supplier
had no right of redress and insufficient time to secure
other customers. The result was cessation of trading activities
with the loss of five jobs.
Taking
you eye off the ball
We assisted a
client who had approached us in terms of dealing with an
unsolicited bid from a major plc. The price offered for
the business seemed attractive to the owner and discussions
ensued. The owner began to take his eye off the ball in
terms of ongoing/future business development and began to
plan a future away from the corporate world. As can be fairly
typical in these situations, negotiations became rather
protracted and when the bidder formed the view that the
owner was fully committed to a sale, the price offered was
reduced substantially. Fortunately, the owner's company
was still in a strong enough position to reject the reduced
bid and formulate a strategy to return the company to its
former upward cycle, albeit with a six month hiatus in development
and profit generation.
It is always flattering
to be approached with the view to one's business being acquired
but, until the ink is dry on a signed contract it is inadvisable
to assume that everything will go according to plan: especially
when the bidder is a much larger entity with deep pockets
who can afford to wait for an opportune moment to strike.
Return
to top
Our
Services
As chartered accountants,
registered auditors and business advisers some of the other
services we offer are listed below:
Business
assurance Taxation services
-
Accounts Capital
taxes planning
-
Audit Corporate
tax
-
Corporate finance
Personal tax
-
Business plans
PAYE, NIC and VAT
-
Business valuations
-
Expert witness
-
Due diligence
-
Management
accounts
-
Payroll
Insolvency
services I.T. services
-
Personal insolvency
SAGE authorised reseller and trainer
-
Business rescue
and monitoring Computer consultancy and installation
-
Corporate insolvency
E-business solutions
-
Solvent liquidations
Interested?
Call Us Now
For further information
or to arrange a free consultation contact Bill Griffin on
telephone number 01224 625554.
We can also be
contacted by e-mail at griffinb@mestonreid.com
or by fax on 01224 626089, or visit our website at www.mestonreid.com
and complete our interactive questionnaire.
Return to Top
