Are contributions payable in respect of rental income?

Whether rental income attracts Class 2 NI contributions has always been a complicated matter. Thankfully a change made in 2015 has brought some clarity to the issue. What do you need to advise your clients to do in respect of NI on their rental income?

PRE-APRIL 2015

Under the old rules Class 2 NI contributions were due in respect of any “business” activity. The simple letting of a single property is investment income and so would never amount to a business. Landlords who had larger portfolios would often have problems though, with HMRC contending that the size of the portfolios must mean that keeping on top of it all was more akin to a business.

GREY AREA

So with “investment” landlords at one end of the spectrum and “business” landlords at the other, the problem was always determining where exactly the line marking the change from one to the other was to be drawn.

In more recent years HMRC began issuing demands for up to six years’ Class 2 NI countributions, sometimes to landlords with only a handful of properties. This coincided with the change in HMRC’s doctrine from collecting the right amount of tax to collecting as much as possible. Naturally some didn’t argue and just paid up – possibly unneccesarily.

WRONG?

The issue of whether a rental portfolio was a business was considered in Rashid v Garcia [2002] UKSC SpC 348 (see Follow up ).

Case law. Mr Rashid owned four let properties, which he and other family members spent around 20 hours per week managing. He was arguing the case that this did constitute a business, as he wanted to use Class 2 contributions as a relatively cheap way to accrue social security benefits – such as state pension entitlement. The Special Commissioners (the forerunners of the Upper Tribunal) rejected his claim and asserted that no liability was due from him. The activities were not substantial enough to constitute a business.

A demand received by a client who simply happened to own more than one let property could be rebutted with relative ease by citing the Rashid case.

POST-APRIL 2015

Change came in the form of the National Insurance Contributions Act (NICA) 2015 . Following this, Class 2 NI is only due on income which is subject to Class 4 NI.

Pro advice. Since rental income is never chargeable to Class 4 NI, no liability will now be due – even if the property letting activity is a business.

You can therefore inform any client who has concerns that they do not need to pay Class 2 NI in respect of any rental income, regardless of how involved they are.

FINAL TWIST

Those landlords who are operating as a business have the option to pay Class 2 NI voluntarily. The term “business” is still not defined, but for those whose involvement is substantial, this may be a good option if they have no other means of accruing benefits through NI contributions.

Are you ready for the new savings allowance?

A new personal savings allowance (PSA) will be introduced in 2016. It is a relatively minor change, but one which could have far reaching implications. What exactly is happening and what do you need to look out for with your clients?

WHAT’S CHANGING?

From April 2016 the new personal savings allowance (PSA) (see Follow up ) allows basic rate taxpayers to receive up to £1,000 in savings income before tax is due. Higher rate taxpayers get a £500 band; additional rate taxpayers have nothing. This is expected to take 95% of savings out of the tax net. At the same time, the tax deduction scheme for interest (TDSI), under which basic rate income tax has been deducted from most savings accounts, stops. What happens to non-TDSI savings income has yet to be decided.

APPLICABILITY

PSA applies to savings income (defined in s.18 ITA 2007 ) – a definition far from straightforward. It covers:

  • interest (per ch.2, ITTOIA 2005 ; excluding relevant foreign income charged on remittance basis)
  • purchased life annuity payments (under ch.7, pt.4 ITTOIA 2005 )
  • profits from deeply discounted securities (under ch.8 ITTOIA 2005 )
  • accrued income profits (under ch.2, pt.12 ITA 2007 ); and
  • gains from contracts for life insurance (under ch.9 ITTOIA 2005 ).

Not all savings income falls within s.18 . Therefore, it’s going to be harder to know what’s taxable and what isn’t.

PITFALLS FOR YOUR CLIENTS

Clients moving between basic, higher and additional rate bands will find more savings income becomes taxable, as it progressively falls outside PSA.

Pro advice. Watch out for clients moving between basic, higher and additional rate bands, as the additional tax will be higher than expected.

Some clients may be used to receiving a refund of tax deducted at source, and so are eager to file their returns as early as possible to speed this up. From April 2016 savings income will normally be received gross – increasing tax bills. Some clients will therefore receive a bill for rather than a refund of tax. This may mean they no longer have an incentive to file early, which may increase pressure for you in January.

Pro advice. Not all tax deduction at source was through TDSI. HMRC has suggested alternatives, but it’s possible that all tax deduction at source on savings income will stop. Self-assessment tax bills will then increase for clients with significant savings income.

The R85 system will also cease, so unexpected tax liabilities on survivorship joint savings accounts is again a possibility. A surviving party receiving all the income may incur a liability, where half-shares didn’t.

Transfers of trading stock or intangibles

The rules which impose market value on appropriations to or from trading stock are generally well understood. But transfers between related parties may trigger transfer pricing rules and new provisions have applied since 8 July 2015. What do you need to know?

THE MARKET VALUE RULE – BASICS

Where a company appropriates, i.e. takes and uses, any of its trading stock for a non-trading reason, it’s treated for tax purposes as though it had been sold in the open market at the time of the appropriation. The deemed consideration is the open market value. Any actual consideration received in respect of the same stock is then left out of account.

Similar rules apply where an unincorporated trader appropriates trading stock for a non-trading reason. The trader is treated for tax purposes as though the trading stock in question had been sold in the open market at the time of the appropriation, and the value of anything given for it is left out of account.

Example. Bob builds and sells designer furniture. He takes finished goods with a selling price of £5,000 for his own home, putting £500 into the business account in exchange. On his return he would need to include £5,000 as sales and ignore the £500.

PRECEDENT TO LEGISLATION

This market value principle was established in the case of Sharkey v Wernher ([1955] 36 TC 275) (see Follow up ). After more than half a century, it was enacted in 2008 without any change in its effect and is now contained in s.157 CTA 2009 for corporation tax and s.172B ITTOIA 2005 for income tax.

Market value also applies where a company or an unincorporated business (such as a sole trader) owns something that is not trading stock and then takes it into trading stock. In this case the cost of that trading stock for tax purposes is the amount that it would have realised if sold in the open market at the time of the appropriation. See s.158 CTA 2009; s.172C ITTOIA 2005 .

Pro advice 1. The market value rule doesn’t apply to services rendered to the trader personally or to members of the trader’s household, or the value of meals provided for proprietors of hotels, boarding houses, restaurants, etc. and members of their families. In such cases the cost is not incurred wholly and exclusively for the purposes of the trade, so it would be disallowed under s.34 ITTOIA 2005 .

Pro advice 2. Market value doesn’t apply to expenditure incurred by a trader on the construction of an asset intended from the outset to be used as a fixed asset in the trade.

Pro advice 3. Furthermore, market value doesn’t apply where profits of a small unincorporated business are calculated on the cash basis under s.25A ITTOIA 2005 . In this case a just and reasonable adjustment must be made to reflect the non-commercial nature of a transaction.

NON-TRADING DISPOSALS OR ACQUISITIONS

A business may dispose of or acquire trading stock by means of a transaction not made in the course of its trade, and separate but related provisions deal with such situations. Examples might include gifting trading stock to a charity, or taking over trading stock from a related business when it ceases to trade.

If trading stock is disposed of otherwise than in the course of a trade without being appropriated by the trader for another purpose, it may be accounted for under UK GAAP at cost or at the price paid, but it is treated for tax purposes as though it had been sold in the open market at the time of the actual disposal.

Likewise, if trading stock is acquired otherwise than in the course of trade without being appropriated by the trader from another purpose, the cost of the stock is taken to be the amount which it would have realised if sold in the open market at the time of the acquisition.

INTANGIBLES

In a similar vein, under the intangible fixed assets regime which applies specifically to companies, transfers of intangible fixed assets between a company and a related party are generally treated as taking place at market value for tax purposes under s.845 CTA 2009 .

TRANSFER PRICING EXCEPTIONS

Until 7 July 2015, if trading stock was transferred between related parties, or if intangible fixed assets were transferred between a company and a related party, the market value rule didn’t apply where the transfer pricing rules in TIOPA 2010, Pt 4 were in point.

Where the consideration for the transfer had to be adjusted under transfer pricing, or where the transfer was within the scope of transfer pricing even though no such adjustment was required, the transfer pricing rules took precedence under s.161 CTA 2009, s.172F ITTOIA 2005, or s.846 CTA 2009 . This meant, in effect, that the transfer price was used instead of market value.

These exceptions were designed to ensure that related parties were not unfairly disadvantaged for tax purposes when accounting for such transactions in ways that were in accordance with UK GAAP. However, in certain cases it was possible for businesses to obtain a tax advantage by fixing a transfer price which was lower than market value. Because of government concerns that the provisions could be abused, they have now been revised.

WHAT HAS CHANGED?

Amendments to be made by Finance (No 2) Act 2015 provide that where the transfer pricing rules apply to the disposal or acquisition of trading stock on or after 8 July 2015 (whether or not those rules actually require an adjustment), a further adjustment may be necessary to ensure that the acquisition or disposal proceeds are recognised at full market value for tax purposes.

They also provide that where the transfer pricing rules apply to the value of trading stock in connection with the cessation of a trade, a further adjustment may be necessary to ensure that the full value of the stock is brought into account for tax purposes.

A further amendment applies when intangible fixed assets need to be valued for tax purposes when they are transferred between a company and a related party. This provides that where transfer pricing applies, a further adjustment may be necessary to ensure that the full market value of the intangible asset is brought into account for tax purposes.

EFFECT OF THE CHANGES

The new changes aim to ensure that the correct overall value is brought into account for tax purposes when rules imposing market value for the transfer and separate rules for transfer pricing both apply.

The new measure will ensure that the tax rules applying to transfers of trading stock between related parties, or intangible fixed assets between a company and a related party, bring into account the correct values for tax purposes. The intention is to prevent attempted avoidance by ensuring that, as far as possible, values brought into account are equivalent to those that would be achieved in a sale to an unconnected third party.

This is achieved, where the new provisions apply, by bringing an extra amount into account for a disposal or acquisition, where this is needed to make the total deemed consideration equal to market value.

New VAT rules proposed for e-commerce businesses

It may be several years before the new rules are implemented, but the EU intends to make legislative proposals in 2016 regarding the VAT regime for e-commerce businesses. What are the key changes planned?

EXTENDING THE MOSS FACILITY

The current mini one stop shop (MOSS) facility that provides an alternative to registering for VAT in other EU countries only applies to sales of digital services to consumers. Currently, an e-commerce business selling goods to consumers in another EU country has to register for VAT there if its sales exceed the country’s distance selling threshold. A proposal being considered is to extend the MOSS facility to include sales of goods. If implemented this proposal should provide an administrative simplification for all e-commerce businesses that make intra-EU sales of goods to consumers.

INTRODUCING AN EU VAT THRESHOLD

The current distance selling thresholds for goods apply on a country-by-country basis and do not apply to sales of digital services. If an e-commerce business makes a single sale of a digital service to a consumer in another EU country, it’s currently required to register for VAT there or use the MOSS. A proposal being considered is to introduce an EU-wide VAT threshold that would apply to intra-EU sales of goods and services. This could help small start-up e-commerce businesses.

Cheers to the New Year!

As the holiday season is upon us, we find ourselves reflecting on the past year and those who have helped to shape our business. We would like to express our sincerest appreciation for the loyalty and trust you have placed in us, and looking forward to moving into the New Year together.

Wishing you great success in the year to come.

This holiday season, we can help you MAKE THIS A TRULY WONDERFUL TIME OF THE YEAR by saving you more taxes, via efficient tax planning and getting you more business by making use of marketing initiatives by exploiting the opportunities and resources available.

Let’s not forget our top Christmas offer-  No premium charge on the last minute Self-Assessment Tax Returns so hurry up and bring your boxes to us, for surely we don’t mind racing against time!