Profit Extraction and Companies

Every week we take a look at what is trending in the accountancy and tax press and share items that we think will interest you. However, these are only outlines and where they relate to tax planning should not be acted upon without looking into them more completely as everyone’s circumstances are particular to them. You need to take specific advice appropriate to your own circumstances.

While every effort is made to deliver accurate, informative and balanced articles this content is general in nature and should not be used as the sole basis for making decisions.

Profit Extraction and Companies

Over the last two decades or more, incorporation was an efficient way to reduce the tax leakage from your business. However, HMRC never liked this, and you can see why. It took until 2016 for them to find an effective strategy to curb the number of tax related incorporations.

Before this, dividends were treated as being received net of a notional tax credit. This was deductible in the self-assessment tax computation and meant any dividends that fell into the basic rate band did not actually suffer any tax.

Until 2016 dividends were therefore effectively tax free if they fell within your basic rate band. Now they are subject to the new dividend tax currently 8.75% in the basic rate band but rising to 33.75%, or higher.

It has not totally ruled out tax related incorporations, because you only pay the dividend tax if you take the money out of the company.

Currently, there is a single rate of corporation tax of 19%. However, from April 2023, the main rate of corporation tax will increase to 25%. Companies with profits not exceeding £50,000 will continue to use the small profits rate of 19%.

This change will have a significant impact on the decision to incorporate going forward. It is unlikely to be worth doing so from a purely tax-motivated angle.

However, if profits are not being withdrawn then they could be used by the company to make investments in its own name. Ultimately there could still be a tax issue on eventual extraction but that could be some time away.

You could also make employer pension contributions which would be deductible for corporation tax, but would be locked away until pensionable age,  unless you use a SIPP or SSAS where you can borrow out of the fund for the business, or you could invest in commercial property, such as your own trading premises, which would be held by your pension.

Another strategy would be to bring a spouse or civil partner in as a second director/ shareholder. This may have the added benefit that the employment allowance would then be available. It would also have a drastic effect on the corporation tax and income tax charges. Splitting a director’s salary and dividend may well illuminate personal higher rate taxes altogether.

The NI payment thresholds are being increased from the current tax year. For 2022/23, the optimum salary for a director with no other income outside the salary and dividends will be £11,908. If the employment allowance is available, it will be very slightly more efficient to increase this to £12,570, but in practice the difference is minimal, and it is much less hassle to use a lesser level so that no NI is payable.

SEISS Overpayments

In order to qualify for the grants the business owner’s taxable profits should not have exceeded £50,000 in 2019/20 or 2020/21 or the calculated average in the years 2016/17 – 2019/20. A turnover test also applied.

There were five grants starting from July 2020 and a final one ending on 30 September 2021. The maximum instalment was £7,500, except for the second grant which was capped at £6,750. The grants are taxable in the years of receipt (2020/21 or 2021/22) and subject to National Insurance contributions too.

Business owners whose entitlement to the fourth and fifth grant has reduced by more than £100 have started receiving assessments to collect the overpaid amounts.

Repayments should be made within 30 days of the assessment date and there are late payment penalties each of 5% of the overpaid amount depending how late you are making the repayment.

Till Fraud

HMRC officers now have the right to access businesses and check their tills for potential fraud. The first arrests have already been made.

Businesses involved in making, supplying or promoting electronic sales suppression (ESS) systems that help users hide or reduce the value of till sales, now face fines of up to £50,000 and criminal investigations. Users also face fines as HMRC increases efforts to target the tax evasion practice.

ESS users will either have access to specialist software or will configure their electronic point of sale (EPOS) device in a specific way that allows them to consciously hide true sales and the resulting tax that is due. Sales processed through the till give the impression they have been recorded as normal, however the end of day report is deliberately manipulated behind the scenes to reduce reported takings.

HMRC can also recover tax evaded and launch investigations that could result in criminal convictions.

Small Company Accounts Formats

An announcement was included in the plans for the overhaul of the audit profession but no further details were published.

There are no further details at this stage although earlier in the year, as part of plans for reform of Companies House, the government indicated that it would strengthen the reporting requirements for smaller businesses with requirement to file balance sheet details with their limited accounts.

R & D Tax Incentives

The regulations for R&D Tax credits continue to evolve, with changes to varying degrees seemingly every year.

The Spring Statement and related commentary made reference to a planned increase in overall R&D investment to £20bn per year by 2024 and clarifies measures announced in the 2021 Autumn Budget.

From 1 April 2023 licence payments for datasets and cloud computing costs attributable to computation, data processing and software will be brought within the scope of qualifying expenditure for R&D tax incentives claims.

There is an expansion to the definition of R&D from 1 April 2023 to include pure mathematics as a qualifying cost and this will increase R&D claims in artificial intelligence, quantum computing and robotics.

During 2021, in the region of 100 additional R&D compliance staff were recruited by HMRC with the intention of improving the regulation of R&D tax incentives claims and the recruitment of additional R&D compliance staff is envisaged this year.

In 2021 and 2022 there has been an increase in the amount of enquiries from HMRC for R&D tax incentives claims.

Over the last 12 months there has been increased focus by HMRC regarding recording keeping substantiating R&D tax incentives claims. This includes the retention of technical documentation to support R&D project eligibility to substantiate that activities satisfy the qualifying criteria of seeking an advancement in science or technology through the resolution of scientific or technological uncertainty.

In addition, with effect from 1 April 2023 companies will need to inform HMRC in advance if they wish to submit R&D tax incentives claims. It is considered important that recording of project activities and associated costs is considered, starting from the project inception stage when projects are planned, e.g., consideration of tenders, technical feasibility, etc.

Have You Broken the Kittel Rules?

You need to be aware of the Kittel Principle, and the punitive penalties that await those who fall foul of the rules. Under Kittel directors are held responsible for VAT fraud throughout their supply chain.

The Kittel rule means that input tax recovery could be denied if a claimant knew or should have known that the transactions were connected to the fraudulent evasion of VAT. Directors are supposed to be aware of this and are expected to make appropriate checks.

Directors are legally obliged to demonstrate that their VAT returns and crucially, VAT charges by any suppliers or contractors, are accurate and truthful.’

The Kittel Principle, stems from a European Court Case in 2006 and set in UK law in 2017, and is being actively implemented by HMRC as the framework against which suspected VAT fraud is assessed.

Will MTD close the UK tax gap?

The UK tax gap figure for 2019/20 of £34.8bn equates to 5.2% of theoretical tax liabilities. It varies from year to year but remains around £30-35bn.Of this somewhere between £3bn and £5bn of the tax gap is attributed to failure to take reasonable care.

 was £5.5bn or 18% in 2018/19 and £3.1bn or 10% of the gap was attributed to error. HMRC hopes to reduce this through Making Tax Digital (MTD). 

In its stakeholder communications pack, HMRC states: “The move to digital integration will eliminate many of the existing paper-based processes, reducing errors and allowing businesses and their agents to devote more time to running their businesses.

On 10 March 2022, HMRC published a research paper which looked at businesses above and below the VAT threshold.

For the population below the £85,000 VAT registration threshold, the paper estimates that the average additional tax revenue from MTD is £19 per business per quarter representing a 2.2% increase.

For the population above the threshold, the estimated average additional tax revenue from MTD is £57 per business per quarter. This represents a 0.9% increase.

Extrapolating these results, the paper concludes that the estimated total additional tax revenue from MTD VAT in 2019/20 is around £185m.

In the same period the VAT gap grew by an estimated £2.3bn so the benefit of MTD seems minimal.

Furnished Holiday Letting

We have just come to the end of the 2020/21 tax return season that reflected the impact of the national lockdowns as a result of COVID-19. The issue here is the impact of the national lockdowns on the qualifying criteria for furnished holiday lets (FHLs) and day count tests for availability and actual letting.

The specific tax rules applying to FHLs have been in place for nearly 40 years. FHLs must be let on a commercial basis and:

  • be available for letting for at least 210 days (30 weeks) per year; and
  • let to members of the public for at least 105 days (15 weeks) per year.

Other than in exceptional circumstances, there is also a restriction so that a property must not be occupied for more than 31 continuous days by the same person and the total of such lets not exceed 155 days in a year.

The relevant year during which these day count tests are considered is usually the tax year. For a new business, the relevant year is 12 months from the first day the FHL is let by the person as furnished accommodation

The accommodation must meet the available test but you do not need to meet the actual let test every year. The “period of grace” relief means that a property must meet the actual letting requirement in at least one tax year out of every three tax years. In addition the accommodation is treated as available even if the Covid regulations prevented it from being used.


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