Common Business Tax Mistakes: Case Studies

Alan Pink provides case studies highlighting a selection of tax ‘don’ts’ – and some corresponding ‘do’s’.

On the principle of ‘forewarned is forearmed’, I thought it would be useful to give some common situations where, in my experience, taxpayers have accidentally increased their tax bills by failing to appreciate certain features of our unbelievably complex tax code – so that the reader can avoid making the same mistakes. 

He who knows no history is condemned to repeat it; so, here’s a salutary history lesson or two.

A lot of entrepreneurs seem to take a perverse delight in dealing with paperwork in a careless and messy fashion. Jack is a good example of this. 

Jack is a high level ‘travelling salesman’. He’s not knocking on people’s front doors selling hairbrushes, but meeting managing directors (now universally termed CEOs) to clinch deals for the high-level services of his company. This means travelling not just all around the UK, but all around the world. His journeys abroad are obviously expensive, and Jack likes to live it up wherever he is. So, he stays in the most expensive hotels and visits the most expensive restaurants whilst away on these business trips.

His long-suffering PA has given up asking him for expense vouchers to cover the meals he takes out, taxi fares, etc. But, on average, he does 20 or 30 business trips a year and spends anything up to about £500 on each such trip on incidentals. On a conservative estimate, that’s £10,000 of expenses for which he can’t show any corroborating evidence. 

If he gets reimbursed (which of course he does) for these costs by the company, the reimbursement is simply taxable, as if it were his income. Putting £10,000 effectively through the payroll, when it could have been an expense, costs the company £1,380 in employer’s National Insurance contributions, and Jack himself £4,700. So, Jack’s carelessness has enriched HMRC by more than £6,000.

Think of all of your expense chitties and invoices as so much money and consider whether you would throw away bank notes to the tune of £6,000 in a year. 

Although Jack’s example is an extreme one, the same principles apply to all expenses, particularly those incurred ‘on the hoof’ where it’s irritating and fiddly to keep all those little bits of paper. 

From a commercial point of view, it makes a lot of sense to hold valuable assets like the office, warehouse, or factory from which your business is conducted, in an entirely separate company. If anything, disastrous happened to the trade (and anyone who is in business knows that the whole world is gunning for them), you could end up with liabilities which push your business into the red. Any valuable assets held within the trading entity, like a trading limited company, would then be potentially vulnerable to attack by or on behalf of the creditors of the business. 

It's for this reason that an awful lot of business people decide they will buy the property used by the trade in a separate company. Here’s a case study.

Albert and Bertram run a successful architectural practice, and the opportunity comes up for them to buy their offices, in a swanky part of London’s West End. The price of the offices is £1 million, and, with the aid of retained profits of the company, they are able to come up with a sufficient amount to act as the deposit for the purchase of the offices, with the bank providing the balance. Because their fear of uninsured disasters is so great, they buy the property in a newly-formed company, Albertram Properties Limited, in which they own 50% of the shares each. The trading business could, therefore, go bust, but leave the value of the offices untouched. 

Error; buying the property in this way has basically deprived Albert and Bertram of all the trade-related tax reliefs which should have been available for the offices from which they carry on their business. 

For a start, the shares in Albertram Properties Limited are fully chargeable to inheritance tax should either of them die. Because the property company is treated as purely an investment company, that is a landlord, and the connection with the trade is ignored, there is no business property relief for the value of the offices, even though they are fully trading in nature. 

Secondly, if the offices were ever sold for a gain, it would not be possible to ‘roll over’ that gain into the purchase of a new property, again because the property is treated as if it was an investment for tax purposes. 

Thirdly, entrepreneurs’ relief wouldn’t be available on any realisation of the property company shares. And so on.

A straightforward way of getting around this problem might be to have the property-owning company also owning the shares in the trading company. Hence the property itself, and the trade, would generally be treated by the tax rules as part of an overall trading group, and to all intents and purposes, the commercial protection provided by this structure can be the same. 

Mostly the purchase of a new commercial property is a tax ‘nothing’, as we’ve commented before in these pages. There’s no tax relief for buying bricks and mortar these days, even if you are buying industrial or agricultural buildings. But there is still relief for the inherent fixtures, in any kind of commercial building.

Stephen buys an office building from Peter for £500,000. The purchase is dealt with by way of Stephen’s usual solicitor, who’s never done anything like the conveyancing of a commercial property before – he’s always just dealt with people buying and selling houses. So, he doesn’t realise that (following April 2014) there are strict rules about how you determine the element of the purchase price which relates to fixtures, which are eligible for tax relief in the hands of the purchaser. The purchaser and the vendor have to get their heads together, before the sale, to agree what this proportion is; and if they don’t, the purchaser risks losing all relief for genuine expenditure that he has incurred. Note that the fixtures element can be 30% or higher, depending on the type of property. 

The initials ‘SDLT’ stand for stamp duty land tax, which has been the tax you pay (instead of stamp duty) when you buy a property in England, since 2003. 

George and Harry own the property in Newcastle from which their company, Insipid Limited, has traded for many years. They decide that it would be a good idea, for various reasons, to formalise the arrangement under which Insipid Limited occupies the property, so they ask their solicitor to draw up a formal lease. This lease provides for a rent of £100,000 a year for 20 years, which the solicitor, for want of any specific reason to do otherwise, suggests is a likely set of commercial terms to find in practice – even though the landlords and the company are closely connected. 

It’s not until some months after the lease has been drawn up that someone points out that signing a lease of this sort is chargeable to SDLT. SDLT is based on the discounted present value of all of the rents payable over the term of the lease. George and Harry end up paying a back-tax bill of over £20,000. 

This is an eminently avoidable error. Even if the bank insists on a formal lease as a condition of their lending (which is often the case), there’s no reason for that lease to provide for a long period and an excessively high rent. Make sure your solicitor (and indeed the bank) are aware of the potential unnecessary tax charge. 

There are at least two ways that you can make a present to the taxman of 10% of the gain on selling your family company. 

Charlotte runs a highly successful recruitment consultancy company, which she has set up with the aid of capital provided by her parents. Her parents have insisted that the shares should be owned 50% by Charlotte and 25% each by her sisters Emily and Ann. But Emily and Ann aren’t involved in the business in any way and are merely passive investors. 

Along comes a purchaser, who offers £10 million for the business, which Charlotte gratefully accepts. Both Charlotte and the purchaser are in a hurry to do the deal, and so this goes through three months after the original offer is accepted. 

Emily and Ann find that the capital gain that they make on selling their shares in the company is taxable at 20% - twice the rate that Charlotte is paying on her shares. The reason for this is that they aren’t directors (or employees) of the company and, therefore, fail to meet the conditions for entrepreneurs’ relief (ER). It would have been quite straightforward to make them either directors or employees of the company, and for that position to have applied for at least a year prior to the sale. This would have halved the tax that Emily and Ann have to pay, because they would be chargeable to capital gains tax under the ER regime at 10%, rather than paying the 20% rate that applies where there isn’t any ER.

Yohann hasn’t made the same mistake. His two sons, John and Carl, are both directors of the company, Leipzig Limited, even though they own fairly small shareholdings and even though Yohann, in practice, rules the roost entirely. But again, they lose the ability to claim entrepreneurs’ relief when Leipzig Limited is sold because they each have less than 5% of the shares. OK, the arrangement under which they had smaller shareholdings has been very tax-efficient from the point of view of the income tax on dividends paid by the company over the years; but restricting their interest to less than 5% has, again, deprived the sale of the benefits of ER. 

Forward planning can often result in tax traps being safely navigated, and transactions taking place in a tax-efficient way.