Self-employed – How to calculate your payments on account

Self-employed – How to calculate your payments on account

The deadline for filing the self-assessment tax return for 2018/19 is 31 January 2020. This is also the date by which any outstanding tax for 2018/19 must be paid and, where payments need to be made on account, the date by which the first payment on account of the 2019/20 liability must be made.

What is a payment on account?

As the name suggest, a payment on account is an advance payment towards a taxpayer’s tax and Class 4 National Insurance bill. Where payments on account are due, the tax is payable in two instalments on 1 January in the tax year and on 31 July after the tax year rather than in full in a single instalment of 31 January after the tax year.

As the payments on account are based on the previous year’s liability, it is not an exact science – there may be more tax to pay or the taxpayer may have paid too much. Any balancing payment must be made by 31 January after the end of the tax year. If the taxpayer has paid too much, the excess will normally be set against the next year’s payments on account or refunded if none are due.

When must payments on account be made?

Payments on account must be made where tax and Class 4 National Insurance for the previous tax year was £1,000 or more, unless at least 80% of the tax owed has been deducted at source, for example under PAYE.

Payments on account are not required when tax and Class 4 National Insurance bill for the previous year was less than £1,000.

Calculating the payments on account

Each payment on account is 50% of the previous year’s tax and Class 4 National Insurance liability.

Class 2 National Insurance contributions are not taken into account in calculating the payments on account and must be paid in full by 31 January after the end of the tax year.

Example

Richard is a sole trader. In 2018/19 his profits from self-employment were £30,000. He has no other income.

His income tax liability for 2018/19 is £3,630 (20% (£30,000 – £11,850)) and his Class 4 National Insurance liability is £1,941.84 (9% (£30,000 – £8,424).

His combined tax and Class 4 National Insurance liability is thus £5771.84.

As this is more than £1,000, he must make payments on account of the 2019/20 tax year of £2,785.92 on 1 January 2020 and 31 July 2020. Each payment is 50% of the previous year’s liability of £5771.84. If the liability for 2019/20 is more than £5,771.84, the balance must be paid by 31 January 2021, together with the Class 2 National Insurance for 2019/20.

Beware fluctuating years

Where the tax and Class 4 liability is under £1,000 one year but not the next, the payments can fluctuate widely – this may hit the taxpayer hard.

Example

Tim has a tax and Class 4 National Insurance liability of £900 in 2017/18. As a result, he is not required to make payments on account for 2018/19. However, 2018/19 is a good year and his tax and National Insurance liability is £4,000. As payments on account were not made, the amount is due in full by 31 January 2020. Also, because it is more than £1,000, he must make payments on account for 2019/20.

As a result, he has to pay £6,000 on 31 January 2019 – the full liability for 2018/19 (£4,000) and the first payment on account of £2,000 (50% of £4,000) for 2019/20. The second payment on account for 2019/20 of £2,000 is due by 31 July 2020.

Reduce payments on account

If the taxpayer knows that income in the current year will be less than the previous year, they can ask HMRC to reduce the payments on account. However, interest is charged on the shortfall if the payments are reduced below the level they should be.

Can we deduct entertaining expenses?

Can we deduct entertaining expenses?

The tax rules on the deductibility of entertaining expenses are harsh and often misunderstood – the fact that the expenditure is incurred for businesses purposes does not make it deductible. Subject to certain limited exceptions, no deduction is allowed for business entertaining and gifts in calculating taxable profits.

What counts as business entertainment?

Business entertainment is the provision of free or subsidised hospitality or entertainment. Hospitality includes the provision of food drink or similar benefits for which no payment is made by the recipient. It also extends to subsidised hospitality whereby the charge made to the recipient does not cover the costs of providing the entertainment or hospitality.

Examples of business entertaining would include taking a supplier to lunch, taking customers to a day at the races, or inviting them to a box at rugby match, and suchlike. The definition is wide.

Exception 1: Entertaining employees

One of the main exceptions to the general rule that entertaining expenses cannot be deducted is in relation to staff entertainment. A deduction is allowed for the cost of entertaining staff, as long as the costs are incurred wholly and exclusively for the purposes of the trade and the entertaining of the staff is not merely incidental to the entertaining of customers. So, for example, a company would be able to deduct the cost of the staff Christmas party in calculating its taxable profits. However, if a company takes customers to Wimbledon, the fact that a number of employees also attended is not enough to guarantee a deduction as the entertaining provided for the employees is incidental to that for customers.

It should be noted that unless an exemption is in point, employees may suffer a benefit in kind tax charge on any entertainment provided.

Exception 2: Normal course of trade

The disallowance does not apply where the business is that of providing hospitality, and as such a deduction is allowed for the costs incurred in providing that hospitality as long as they are incurred wholly and exclusively for the purposes of the business. Businesses such as restaurants and events management companies would fall into this category.

Exception 3: Contractual obligation to provide entertainment

Where entertainment is provided under a contractual obligation, this is not treated as business entertainment and a deduction is allowed for the cost. A common example would be where hospitality is provided as part of a package. However, the business should be able to demonstrate that they have received a full return for the entertainment provided.

Exception 4: Small gifts carrying an advert

The provision of business gifts is treated as business entertaining with the result that a deduction for the costs is not generally allowed. However, there is an exception for gifts costing not more than £50 per year per recipient which bear a conspicuous advert for the business. An example of a deductible gift would be a diary or a water bottle featuring an advert for the business.

Remember…

Just because entertaining is incurred for business purposes does not mean that it is allowable – business entertaining needs to be added back in the corporation tax computation.

Joint tenants v tenants in common – Does it matter?

Joint tenants v tenants in common – Does it matter?

There are two different ways of owning property jointly – as joint tenants or as tenants in common. The way in which the property is owned determines exactly who owns what and also what happens when one of the joint owners dies and how any income is taxed.

Joint tenants

Where two or more owners own a property as joint tenants, they jointly own the whole property rather than owning individual shares. Each owner has equal rights to the whole property. When one of the joint owners dies, the remaining joint owners own the whole property. The deceased is not able to pass his or her share on to someone else.

Example

Helen and Harry are married and own their family home as joint tenants. The couple have three children. If, for example, Harry dies first, his share of the property automatically passes to Helen. Harry cannot leave his share of the property to his children.

Where a property that is owned as joint tenants is rented out, the income is treated as arising in equal shares as all owners have an equal stake in the property. For spouses and civil partners this is the default position; however, there is no possibility of making a Form 17 election (see below) as the property owned as joint tenants can only be owned equally.

Tenants in common

Tenants in common own individual shares in the property and have more flexibility than joint tenants as to what they do with their stake in the property. On death, their stake does not automatically go to the other joint owners; rather it will follow the provisions of the will (or, if there is no will, the intestacy provisions).

It will be beneficial to own property as tenants in common if you want to leave your share of the property to someone other than the other joint owner.

Example

Jack and Jane are married. Each have children from previous relationships. They own a holiday cottage as tenants in common. In their wills, they have each made provision for their share to pass to their own children.

Where the property is let out, owing the property as tenants in common provides more flexibility as to how the income is allocated for tax purposes. Where the joint owners are spouses or civil partners, the income is treated as arising equally. However, where the actual beneficial ownership is unequal, they can elect (on Form 17) for the income to be taxed in accordance to their ownership shares where this is beneficial. If the tenants in common are not married or in a civil partnership, the income is taxed by reference to their actual stake in the property.

Changing ownership status

It is relatively easy to change the type of ownership, for example, if the property is owned as joint tenants it may be desirable to own it as tenants in common to enable each owner to leave their share to someone else. A property can also be changed from sole ownership to joint ownership – ether as tenants in common or joint tenants.

When and how to incorporate

When and how to incorporate

Over the last decade, corporation tax rates for most companies – irrespective of size – have fluctuated between 19% and 21%. The main rate of corporation tax is expected to be cut to 17% from April 2020.

Current corporation tax rates are still pretty favourable and are indeed generally lower than those paid by many individuals. In addition, there are other areas where company formation may help save tax. Although the costs and regulations involved with running a company are usually greater than trading as a sole trader or in partnership, and more administration is generally needed, using a company as a vehicle through which to trade remains a popular choice.

The starting point for dealing with companies and company directors is to remember that a limited company exists in its own right, which means that the company’s finances are separate from the personal finances of the company owners. Strict laws mean that the shareholders cannot simply take money out of the company whenever they feel like it.

When to incorporate

The question of whether to incorporate commonly arises as a business expands – the limited liability status that company formation provides is often needed to start winning contracts with bigger companies. However, incorporating may not be such a good deal in the early days of trade, or if there is no intention to grow beyond the status of a solely owned business. This may be particularly relevant if losses are envisaged in the early years of trading – for sole traders and partnerships, it is possible to carry back losses made in the first four years and offset them, where applicable, against personal income of the three preceding years. This often results in a substantial refund of tax becoming due and may offer a much-needed cash boost to the business.

How to incorporate

Firstly, the company must choose a name, which cannot be the same as another registered company’s name. If it is too similar to another company’s name or trademark it may have to be changed.

The company must have at least one director who is a natural person, and a public company must have at least two directors. A private company need not appoint a company secretary, although in practice many choose to do so.

There must be at least one shareholder or guarantor, who can also be a director.

The company will need to prepare a ‘memorandum of association’ and ‘articles of association’, as provided for by Companies Act 2006. Broadly, these documents set out how the company will be run.

Private limited companies are also required to maintain a register of those persons who have significant control of the company – known as a ‘PSC Register’. The function of the Register is to increase corporate transparency for the purpose of combating tax evasion, money laundering and terrorist financing.

The company must register with HMRC for corporation tax and PAYE as an employer at the same time as registering with Companies House. This must be done within three months of starting to do business. The company may also be required to register for VAT if it meets the registration criteria.

Although there are disadvantages to incorporating a business, the lower tax rates and other reliefs currently on offer still make it an attractive proposition. Some advantages worth considering include:

  • ability to pay dividends to shareholders, which may in turn reduce liability to National Insurance Contributions (NICs)
  • flexible succession planning, particularly for inheritance tax purposes
  • great investment opportunities, for example potential to raise money through tax-efficient schemes such as the Enterprise Investment Scheme (EIS)
  • limited liability status for shareholders, although directors may be asked to give personal guarantees of loans to the company and may still be held liable for the debts of a company
  • potential increased saleability

Business owners are recommended to evaluate the advantages of incorporation on an on-going basis.

Nominating your main residence

Nominating your main residence

Private residence relief shelters a gain on the sale of a residence from capital gains tax while the property has been the owner’s only or main residence. Where a property has been an only or main residence at some point, the final period of ownership (currently 18 months but reducing to nine months from 6 April 2020) is also exempt from capital gains tax.

Only one main residence at a time

As the name suggests, the relief is only available in respect of the only or main residence. Thus, where a person has more than one home, only one of those homes can be the ‘main residence’ at any given time.

However, as long as certain conditions are met, the taxpayer is free to choose which property is classed as the ‘main’ residence for capital gains tax purposes – it does not have to be the one in which the owner spends the majority of his or her time.

Only one main residence per couple

A couple who are married or in a civil partnership and who are not separated can only have one main residence between them.

Property must be a residence

Only properties that are lived in as a home can be a ‘main residence’ – a property which is let out can’t be a main residence while it is let.

Making an election

Where a person has only one residence, that residence is their only or main residence. Where they acquire a second residence, they have a period of two years to nominate which residence is the main residence for capital gains tax purposes. Where residences are acquired or sold, the clock starts again from the date on which the particular combination of residences changes, and the taxpayer then has another two years in which to elect which residence is the main residence.

The election should be made in writing to HMRC. The letter should include the full address of the property being nominated as the main residence and should be signed by all owners of the property.

No election made

In the absence of an election, the property which is the main residence will be determined as a question of fact and will be the property in which the person lives in as their main home. For example, if a couple has a family home and a holiday home, in the absence of an election, the family home will be treated as the main residence.

Advantages of flipping

There are a number of advantages to a property being the main residence at some point in the period of ownership as not only is any gain while the property is the only or main residence exempt from capital gains tax; the final period of ownership is also exempt. Where the property is let, occupying the property as a main residence at some point may open up the option of lettings relief (although it should be noted that the availability of lettings relief is to be seriously curtailed from April 2020).

Once an election has been made to nominate a property as a main residence, this can be varied any number of times (‘flipping’). This can be very useful from a tax planning perspective, for example, occupying a property as a main residence after it has been let but before it is sold can shelter some of the gain. Flipping properties and making use of the capital gains tax annual exempt amount to shelter any gain that falls into charge when the property is not the main residence can be beneficial in reducing the tax bill.