UK: Tax Focus – A Summary Of Current Tax Issues For Companies, February 2007

Last Updated: 14 March 2007

Reporting employee benefits and expenses

Due to various legislative changes over the past 12 months, it is advisable to consider the following points before reporting your employee expenses and benefits on P11D forms, both this year and next.

Company vans and private usage
The taxation of vans provided to employees has changed a few times over recent years. The first welcome change, implemented in April 2005, was to allow for limited private use without triggering a benefit charge. But the next change, which comes into effect on 6 April 2007, could result in a 700% increase on the cost of the taxable benefit. The new tax treatment will result in a significant increase in the tax charge payable for unrestricted private use and introduces a private fuel benefit.

From 6 April 2007, the van and private fuel benefits combined will be £3,500 – the maximum taxable amount is currently £500. For an employer to avoid these charges, the van should be provided mainly for the employee’s use on business travel with private use restricted to commuting and insignificant trips. The cost of fuel for private use must be borne by the employee.

If employers have not already done so, these changes should be implemented if the current benefit is accepted but the new one is too expensive – either in terms of the employee’s tax or the employer’s Class 1A NIC.

Retirees’ benefits
The Government took the opportunity presented by the new pension regime to eliminate an unintended advantage enjoyed by retired employees whose ex-employers provide them with benefits in kind. These benefits were, in most cases, exempt from tax, but as of A-Day (6 April 2006), they became fully liable. The most commonly supplied benefit in retirement is private medical insurance, but the provision of benefits such as company cars is not unusual.

Employers who provide these benefits are required to submit a report to HMRC, similar to a form P11D, for each retired recipient by 6 July 2007. Although it’s not a legal requirement, employers should inform retired employees of the new situation.

Mobile phones and computer equipment
New rules regarding mobile phones and computer equipment provided to employees for private use were announced in the 2006 Budget. Since 6 April 2006, mobile phones and PDAs/Blackberries provided for private use have been chargeable to tax and have to be disclosed on forms P11D for 2006/07.

Transitional relief was granted for employees already in possession of mobile phones and/or PDAs/Blackberries at the time, such that they can retain them without incurring a tax charge, provided all upgrades/replacements occur under the existing supplier contracts.

Reporting dispensation
It is not too late to make an application for a form P11D reporting dispensation effective for 2006/07. If an employer can show that reimbursed employee expenses (for travel and subsistence, business entertaining, business calls on private phones and possibly others) are adequately controlled, HM Revenue & Customs (HMRC) may be prepared to give a dispensation that would eliminate the need for those items to be entered on forms P11D. The application would have to reach HMRC before the end of the tax year.

Business entertainment

Following the end of the seasonal festivities, it is important to note the basic VAT rules relating to business entertainment. In general, any VAT incurred on goods or services relating to business entertainment cannot be reclaimed. Business entertainment includes any kind of hospitality for the entertainment of clients or potential clients (anyone who is not an employee), and covers meals, accommodation, travel, visits to the theatre, nightclubs, etc.

HMRC accepts that where the purpose of an event, such as an office Christmas party or a celebratory lunch, is to maintain and improve staff relations, the input VAT on staff entertainment costs is recoverable in full. Where guests are present, the VAT on costs should be apportioned so that only input tax attributable to the entertainment of employees is recovered. Only where a charge is made to guests may the related input VAT also be claimed. Entertainment provided solely for partners/directors is not for business purposes and therefore any related VAT is not recoverable.

HMRC consultation on penalties for incorrect tax returns

HMRC has issued proposals to introduce a new single penalty regime for incorrect tax returns covering income tax, corporation tax, Pay As You Earn (PAYE), National Insurance (NI) and VAT. It has issued draft legislation and guidance notes, and has invited comments on these proposals by 13 March 2007. It is likely that these proposals, once agreed, will form part of the legislation included in the 2007 Finance Bill.

The proposed single penalty regime would allow for penalties to be issued based on percentages of tax and NI underpaid. The consultation document does not indicate what these percentages will be. The penalties will increase in stepped rates, depending on the conduct of the taxpayer and the gravity of the failure to make a correct return.

At one end of the scale, no penalty will be incurred if the taxpayer has taken ‘reasonable care’ to complete the return correctly but has made a mistake which understates the tax liability. HMRC has indicated that it will provide guidance on what it deems to be reasonable care. A moderate penalty will be levied if a taxpayer understates his/her liability by failing to take reasonable care, and the penalty will increase if the taxpayer deliberately understates his/her liability. The highest level of penalties will apply if the taxpayer has made a deliberate understatement and tried to conceal it.

HMRC would like to encourage taxpayers to disclose any irregularities and is consequently suggesting that there are likely to be substantial reductions, or a waiver of penalties, if they do. Small reductions will be available if taxpayers disclose an irregularity at a time when they had reason to believe HMRC suspected one existed.

Suspended penalties may be available for taxpayers who fail to take reasonable care when completing their tax return but agree to take steps to ensure that the problem will not recur. However, a suspension of penalties will not be available if there is evidence of any deliberate understatement.

In addition, HMRC is proposing some new penalty measures which are currently not incorporated within the existing penalty regime. These include issuing penalties:

  • if losses are overstated or where group relief is used to mitigate penalties
  • if an incorrect return results in a delay in payment of tax rather than an absolute tax loss
  • for failing to inform HMRC of an under-assessment or a mistake in a return within a reasonable time frame
  • to an officer of a company where an incomplete or inaccurate return was due to the deliberate action of that officer.

Tax deductions on the sale of a company

When employees acquire shares at less than market value, the company is entitled to a tax deduction equal to the ‘profit’ made by the individual. This can be used to create additional value in the sale of a company as:

  • the tax recoverable from the deduction increases the sale price if the deal is net asset related
  • it enables employees to participate in company proceeds in a tax-efficient way.

For example, if shares are held by an existing employee benefit trust (EBT), it is better for the shares to be allocated to employees and then sold, rather than the EBT selling the shares to a buyer and distributing the cash to employees.

Alternatively, if a proprietor wishes his/her employees to share in the benefit of the sale, he/she should consider using his/her personal shares to grant the employees appropriate share rewards in order to generate a company deduction.

Compensation or consideration?

The European Court of Justice (ECJ) recently released the Advocate General’s opinion on a French case involving hotel deposits. The question posed to the ECJ was how deposits paid by hotel customers who make a reservation and then cancel it, thus forfeiting their deposit, should be treated. The taxpayer argued that the deposits are compensatory in character and constitute no consideration as the taxpayer retains the deposits due to a customer breach of contract. However, the Advocate General recommended treating these deposits as consideration for the service of reserving the hotel room and therefore subject to VAT.

In the UK, forfeited deposits are normally not regarded as consideration and are therefore outside the scope of VAT. It remains to be seen whether the ECJ will adopt the Advocate General’s recommendation, which would lead to a change in the current VAT treatment. Businesses such as hotels, restaurants and hairdressers requesting deposits on reservation should watch this space.

[Société thermale d’Eugénie-les-Bains, ECJ – Opinion C-277/05, 13 September 2006]

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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