A Summary Of Current Tax Issues For Companies - October 2006

A recent Special Commissioner’s decision has given further ground to Her Majesty’s Revenue & Customs (HMRC) in its campaign to apply tax and Class 1 National Insurance Contributions (NICs) to the full amount of payments made in lieu of notice.

HMRC established some time ago in EMI Group Electronics Ltd -v- Coldicott that an employment contract that permits an employer to make a payment in lieu instead of serving proper notice of termination of employment means that the payment is an emolument of the employment and thus fully liable to tax and NICs.

In this latest case, the employer issued Written Statements to employees (under the Employment Rights Act 1996) setting out what would happen in the event of redundancy. The court ruled that the content of the Written Statements, even though it did not form part of the employment contract itself, was sufficient to dictate that a payment made on redundancy in respect of notice not served was an emolument and thus fully liable to tax and NICs.

This development highlights the importance for employers to keep all documents available to staff under review in order to avoid unfortunate consequences when terminations occur.

By far and away the biggest fraud being perpetrated in the UK, and much of Europe, relates to Missing Trader Intra Community fraud, often referred to as carousel fraud. In Business Brief 14/06, HMRC provides further details on its proposal to introduce a reverse charge on a range of small-volume/high-value goods such as mobile phones and computer chips. However, in order to bring in any new rules, the UK requires approval from Europe as it involves a derogation from a key VAT Directive. It is now believed that the European Union will be unable to provide the necessary support as soon as it had hoped, and therefore implementation of any changes is unlikely to be before December 2006.

While most businesses will support the government’s efforts to stamp out such fraud it is clear that a large number of traders will be affected by these measures. HMRC realises that major changes to software systems and accounting processes will need to occur for businesses to cope with the new rules. Therefore, it has promised to take a ‘light touch’ approach until businesses have time to adapt.

Companies may find this an attractive plan to offer to senior employees to supplement an HMRC-approved Share Incentive Plan or to run it independently. The plan is particularly attractive for retaining and motivating key staff by encouraging them to buy shares in the employing company at a preferential price. The purchased shares are enhanced with a ‘free’ share. The acquisition of the shares can be made easier through interest-free funding by the company.

The plan will impose a period of forfeiture thus acting as a long-term incentive arrangement and only after that period has lapsed will all restrictions be lifted and the shares attain their full open-market value. The tax implications of the plan are such that it is attractive to both the company and employees.

Circumstances vary from case to case, type and length of development, and commercial plans, but in short, our ideas are ideally suited for land deals over £2m, including simple land sales, property refurbishments and major construction projects.

Employment status and the new CIS
Article by Inez Anderson

The new Construction Industry Scheme (CIS) is due to go live on 6 April 2007. This scheme was originally intended to be implemented from April 2006 but was postponed due to concern that the industry and HMRC were not ready. The new CIS is not an amendment of the existing scheme but a totally new system and thus there are areas within the new CIS where a company may be at risk due to differences between the two systems. One of the main potential risk areas is employment status. HMRC may challenge the self-employed status of CIS workers with the aim of reclassifying subcontractors as employees. The new scheme includes a monthly return incorporating a ‘status declaration’. This declaration requires employers to verify that they have reviewed the employment status of all their workers and that they have correctly classed the workers as either self-employed or employed. It is imperative that employers consider all the relevant factors in determining employment status, as incorrect classification could result in substantial Pay As You Earn (PAYE) and NIC liabilities, in addition to interest and penalties. Furthermore, HMRC seems to be taking a harder approach to refusing certificate renewal applications due to non-compliance.

Would your share option scheme get a clean bill of health?
Article by Kiki Stannard

We have recently witnessed a change in HMRC’s attitude towards what in the past may have been regarded as minor errors and/or delays with the tax compliance of share or share option awards.

Our experience shows that whilst employers are aware of the importance of ensuring that the right key employees benefit under share or share option schemes, the ongoing compliance and tax reporting responsibilities are not always fully understood. Furthermore, since administration of the awards often falls between the human resource and finance (payroll) departments, certain aspects of the tax compliance are often overlooked. For instance, HMRC-approved option schemes, such as the Company Share Option Plan and Enterprise Management Incentive Scheme, have specific limits on the level of participation for each employee, as well as strict rules relating to other aspects such as end-of-year reporting requirements. Incorrect application of these rules or missed deadlines could result in the loss of approved status for all, or some, of the options. This can lead to an unexpected demand for unpaid PAYE and NICs, together with interest and penalties. Given the potential risks and costs of getting it wrong, employers need to implement the right procedures. Improving staff awareness, updates and training new staff will be money well spent.

Many more companies could now be making Research and Development (R&D) tax credit claims with respect to qualifying design costs following a recent successful claim from HMRC. The design council has also been looking at ways in which companies can claim R&D tax credits on various design costs.

Small or medium-sized companies can claim a tax credit equal to 150% of qualifying expenditure on R&D. This can either be set against taxable profits or, if none exist, the company can claim a cash repayment equal to 16% of the tax credit. For large companies the relief is 125% of qualifying R&D expenditure, although they cannot claim the cash credit.

In order to qualify for R&D tax credits projects must seek to resolve scientific or technological uncertainty. Design activities that are undertaken to achieve these purposes will generally fall within the scope of R&D for tax purposes. Care must be taken however to correctly identify the R&D activity in design, construction and testing work, as once the scientific or technological uncertainties have been resolved, any further work will not qualify as R&D.

The grandfathering provisions for existing private equity-backed businesses and debt expire on 1 April 2007. As a result, companies need to revamp many of the old financing structures in order to maximise corporation tax relief on borrowings. The new rules require arms-length levels of debt. There is still much uncertainty about how these rules will be interpreted but companies should not delay preparation, as these issues should be addressed sooner rather than later.

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.