UK: Business Taxes

Last Updated: 17 January 2012
Article by Rawlinson & Hunter

Sowing the seeds

The Chancellor announced during his Autumn Statement that a new scheme will be introduced from April 2012 to encourage investment in small and start-up businesses.

The Enterprise Investment Scheme ("EIS") is well established and is a scheme which the government is already busily enhancing the benefits of. However, the administrative and qualification headaches that surround EIS make it often something which is seen as perhaps too difficult to implement for smaller businesses which have limited resources available.

The proposed Seed Enterprise Investment Scheme ("SEIS") is a variant of the original scheme but is expected to be less encumbered by the criteria which cause issues with certainty around qualification for the original EIS. Under SEIS, for the 2012/13 tax year, investors are to be given a 50% income tax rebate (regardless of the rate of tax which they are paying). Further, any capital gains realised during the 2012/13 tax year will also be exempt to the extent that the proceeds are reinvested in SEIS qualifying investments. These benefits are expected to be limited to £100,000 of investment in the SEIS qualifying company.

All told, an investor could effectively receive tax relief worth 78% of the amount reinvested in an SEIS qualifying company. This is further enhanced by the likelihood that the investment would qualify for Business Property Relief for Inheritance Tax purposes.

At this point, the details of the SEIS are still to be made clear. What is apparent is that this move is clearly one in support of the smaller business and will hopefully free up capital for investment in such businesses which find traditional sources of financing, such as bank facilities, difficult to access at the present time.

We will provide you with further updates as and when information becomes available.

Annual Investment Allowance - beware the Trap

Businesses may be aware that, following the last Budget, the Annual Investment Allowance ("AIA") available to a business on qualifying expenditure incurred on plant and machinery is being reduced from the current rate of £100,000 to just £25,000 for expenditure incurred on or after 1 April 2012.

What may not be so apparent is the way in which this will affect businesses whose accounting period straddles this date, and in particular the "trap" which can impact on the allowances available for the unwary.

Where a company's accounting period begins before 1 April 2012 and ends on or after that date, the maximum AIA available for that accounting period is the aggregate of the amounts calculated as if the period was split into two parts, one before and one after 1 April 2012. For example:

A Company Ltd had an accounting period ending on 31 October. For the year to 31 October 2012 its maximum AIA entitlement is calculated on the basis of two periods: from 1 November 2011 to 31 March 2012, and from 1 April 2012 to 31 October 2012 ie:

152/366 x £100,000 + 214/366 x £25,000 = £56,148

However, there is a trap for those companies which do not incur any qualifying expenditure in the period to 31 March 2012. If in the above example A Company Ltd had not incurred any qualifying expenditure in the period from 1 November 2011 to 31 March 2012, but instead had bought qualifying plant worth £30,000 in the period from 1 April 2012 to 31 October, the maximum AIA available would be restricted to £14,583 (ie 7/12 x £25,000).

Businesses therefore need to consider their capital allowance expenditure carefully in the period up to 31 March 2012. Where possible, companies should ensure that expenditure is incurred in an accounting period prior to one which straddles 31 March 2012, in which case the full £100,000 AIA will still be available. Where this is not possible then they should try to ensure that there is pre 31 March 2012 expenditure sufficient to utilise the maximum available in that period.

Corporation tax and associated issues

Whether or not one company is associated with another for tax purposes can have a significant impact on the amount of corporation tax each pays. In particular, the small companies' rate of corporation tax (currently 20%) only applies to those companies with profits of £300,000 or less.

This limit, however, is shared between all associated companies. Therefore, for example, a company with five associates will only pay the small companies' rate if its profits do not exceed £50,000 (£300,000 / 6). Profits above this amount will be subject to the full corporation tax rate (currently 26%) subject to "marginal relief" which is designed to ease the transition between the two rates. It is therefore very important to understand whether particular companies are associated when considering the rate which applies to a particular company's taxable profits.

Generally it is very obvious that two companies are associated with one another. For example where one controls the other, or both are controlled by the same third company or person(s). However, there are circumstances where it is much less obvious that two companies are associated. For example, prior to recent changes, where a husband and wife each controlled their own company, those companies would have been associated even if each company was completely independent of the other.

Recognising that this may lead to an unfair result in certain cases, HMRC published revised legislation on 20 July 2011which takes effect for accounting periods ending on or after 1 April 2011 (and hence is relevant for accounting periods commencing on or after 2 April 2010). The changes now take account of the wider picture rather than just applying the rules mechanistically.

Broadly, the legislation has been amended so that two companies will only be associated for these purposes if there is "substantial commercial interdependence" between them. As a result, in considering whether two companies are associated or "linked" for these purposes, it is necessary to determine the extent to which the companies are:

1. Financially interdependent ie

  • one gives financial support to the other (directly or indirectly); or
  • each has a financial interest in the affairs of the same business

2. Economically independent ie

  • the companies seek to realise the same economic objective;
  • the activities of one company benefits the other; or
  • the companies have common customers

3. Organisationally interdependent ie the companies have common

  • management
  • employees
  • premises
  • equipment

It is likely that most companies will benefit from the change in the rules. However, where a company is likely to be adversely affected, it is possible for it to elect for the new rules to apply only for accounting periods beginning on or after 1 April 2011. This could be the case where, for example, two partners in the same partnership each have their own separate companies outside of the partnership and one makes a substantial loan to the other.

Previously such companies would not have been treated as associated unless there was a tax avoidance motive for the structure. However, the loan would make the two companies "substantially commercially interdependent" and hence could increase the corporation tax liability for each company. Making the election would defer the accounting period from which the new rules apply.

It should also be noted HMRC's view that where one company is caught then both companies are associated. In addition, they consider that "substantial" in this context is 10% (although it is questionable whether a figure this low would be accepted as such by the courts). As a result this could particularly be an issue where one company is much smaller than the other and hence what is "substantial" for one may not be so for the other.

The change from a mechanical test to one which is more flexible may well lead to an increase in compliance costs as it will be necessary to monitor the position in determining whether the small companies rate will be applicable in particular cases.

For those companies which may benefit from the change in the rules it is important to seek advice to ensure that any tax saving is maximised.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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