What's all this about 'disincorporation' of small companies?

Some people assume that everyone who is in 'business' runs a company, but this is not correct. There are actually four quite distinct common forms of business structure in the UK:

• a sole trader;
• a conventional partnership (where the individual works with one or more partners in the business);
• a limited liability partnership - LLP - (this provides the individual and their partners with the protection of limited liability, just as with a company); or
• a limited company.

Someone running their own business MIGHT be running a limited company, but often they are not. There are many practical, administrative and tax differences between businesses that are run as limited companies and those that are not.

Many people mistakenly run their business through a limited company when this is not really the most suitable or convenient option. Others only 'incorporated' their business into a limited company because there seemed to be some tax savings. These will vary each year as the relevant tax rates change.

The tax system recognises that someone might want to 'incorporate' their business. As a result, as long as the right steps are taken in the right order, there need be no tax charges when the business moves into a limited company. The position is quite different however when a business owner wants to 'disincorporate'. Essentially this means they want to continue their business without continuing with the limited company. The absence of specific tax rules, reliefs and allowances means there are a number of tax traps that often result in unwelcome tax charges.

The Office of Tax Simplification recently issued a discussion paper to clarify the level of interest in disincorporation reliefs. The paper identifies a number of situations where this might be of benefit:

• The company with little or no value in capital assets, probably a one person operation, which might find life simpler if it was operated as a sole trader.
• A slightly larger business, perhaps run by friends or a husband and wife or wider family, which has goodwill and so may benefit from a narrow form of relief, ensuring a tax neutral transfer across to the disincorporated trade, probably continued as a partnership.
• A larger company with capital assets as well as intangible assets may need a wider form of relief, to enable a claim to hold-over the chargeable gains on transfer of the assets to the disincorporated trade, which may be carried on as an LLP or as an unincorporated business or partnership.

There are also capital gains tax issues for the shareholders in all cases, though only in the last situation are these likely to be significant.

The discussion paper invites responses by 7 October 2011. The next step is as yet unclear. Suffice it to say that there is no immediate prospect of a 'disincorporation' relief being introduced.

In the meantime let me just repeat the warning I give whenever I speak on this subject. Ignoring the potential tax charges when a business disincorporates is storing up trouble for the future. Many people find a way around the administrative and legal issues. It is unwise to proceed without also being very clear as to the tax rules which are commonly misunderstood.

Barclays paid 1% in apples of tax on its pears of profits

Another day, another spurious tax statistic enters common parlance. I have heard three separate references today to the 'fact' that Barclays paid "only one per cent in corporation tax on its 2009 profits of £11.6 billion". The People, for example, are fanning the flames here.

According to the Guardian, the 1% rate was first disclosed by Chief Executive Bob Diamond in a letter sent to Labour MP Chuka Umunna. This seems unlikely as the letter was less than clear as it referenced all of the tax paid by Barclays, including PAYE and NIC deducted from staff salaries.

I am indebted to Christie Malry, who has explained on the FCAblog, five reasons why the 1% tax rate is a misnomer. It involves comparing apples and pears. Most obvious is the fact that corporation tax paid in 2009 does not relate to the profits earned in 2009. It largely relates to the profits of 2008. And the profits figure of £11.6b is a worldwide figure so of course UK corporation tax will not come to anything close to 28% of that sum. Only profits arising in the UK are subject to tax here.

Barclays 2009 accounts by the way show (PBT) profits of £4.5b and a tax charge of just over £1b - a rate of 23.4% NOT 1%. Not even close. Mind you I have yet to trace the origin of the figure of £113m corporation tax being quoted by the press.

Oh - and lest anyone should forget, profits made in 2008 (and 2009) were subject to tax in accordance with the tax regime put in place by the last Labour Government.

Guardian suggests no more tax relief for interest

Was surprised to read this at the end of a piece in the Guardian online yesterday. The journalist, Nils Pratley, began his piece by referencing Vince Cable's recent speech which proposed a review aimed at curbing short-termism in the City. Towards the end of his piece Nic then says:

"if the coalition really wanted to reverse the trend towards short-term thinking, it would change the rules on the tax-deductibility of interest since the current rules encourage companies to load up with debt to reduce their tax bills"

Nic goes on to explain the impact that a change in the rules would have on leveraged buyouts and takeovers.

At first I was confused. After all, the fact that interest is tax deductible simply reduces the cost of servicing debt. The full amount of the interest payable still has to be funded out of cashflow. If the business is not generating sufficient cash to cover the interest cost the tax relief is irrelevant. It simply reduces the corporation tax payable at a later date - and if the business is loss making there is no tax payable anyway.

On reflection I assume that some takeovers and leveraged buyouts are funded by special debt instruments. The interest accrues as normal and can (indeed 'must') therefore be deducted from annual profits. But perhaps payment of the interest is deferred until the new projects, that are being financed, generate sufficient cash. And as this is so risky for the lenders the interest rate is high and so the tax deduction is particularly valuable. In such cases I can accept the rationale for Nic's argument.

There are also situations where the borrowings are drawn from a group company which will not pay tax on the interest earned (eg: if located in a tax haven). So the group as a whole simply reduces it's UK tax bill by reference to the intra-group interest payable to the offshore group company. So far as I can recall the 'loan relationship' rules do not prevent this type of mismatch.

Such fancy arrangements are not common however in the SME marketplace. Indeed I'm sure that the vast majority of SME businesses only build up debt if they absolutely have to do so. The fact that tax relief is available for the interest is not the motivation as the interest has to be paid in full to a third party regardless. Taking on more debt increases the costs of doing business. SMEs do not do this unless they have no other option. It's not "short-termism", it's business.

Fortunately there is no realistic prospect of tax relief being removed in respect of the interest payable by SMEs (or larger businesses).

Tax Directors say iXBRL will drive takeup of corporate tax software

Over 60% of Tax Directors who responded to a recent survey anticipate making greater use of corporate tax software due to new iXBRL obligations.

This is one of the conclusions from Winmark’s third benchmarking survey of in-house Tax Directors.

Out of over 100 respondents to the Tax Director Network survey, 15% said that they do not currently use corporate tax software and a further 12% said they use such software only to a very limited degree. When asked whether they anticipate that their departments will make greater use of corporate tax software in the coming year, 60% said “yes, due to the new iXBRL efiling obligations”.

The move to iXBRL is clearly fueling greater interest in the benefits of corporate tax software. A surprising number of organisations still seem to rely on spreadsheets although this may be due to perceived constraints in the currently available software.

Clearly the requirement for consistent iXBRL tagging will mean that more organisations will be using corporate tax software by this time next year.

Copies of the executive summary of the survey report are available on request from Winmark Research. The full report will only be available to members of the Tax Director Network and to others who completed the survey.

Tax Policy Making - Oxford University Tax Conference

I was already looking forward to attending the Oxford University's Centre for Business Taxation Summer Conference on 2 July 2010. The keynote speech will be presented by David Gauke, Exchequer Secretary to HM Treasury. This is quite a coup as it is his name that appears as the signatory on page 3 of the June Budget Consultation document "Tax Policy making: a new approach."

As indicated in my last blog post I consider this to be an ambitious and welcome set of proposals to move far away from the increasingly crazy process that the last Government permitted - if not encouraged.

There is no charge for attending the Oxford business tax conference which takes place on 2nd and 3rd July 2010. Programme and booking details here.

Anticipating the Emergency Budget - Corporate Tax Directors

I spent last night at a private dinner discussing the forthcoming 'emergency' Budget with a number of Corporate Tax Directors.
Their hopes and fears can be summarised as follows:

Fears expressed about the content or consequence of Budget announcements:
- an immediate increase in the standard rate of VAT;
- an extension of the proposed bank levy;
- international companies expanding elsewhere in preference to UK;
- further increases in personal taxes that lead to a brain drain;
- restriction to basic rate tax relief for personal pension contributions;
- property companies being picked on due to a perception that they are wealthy and don't employ many people;
- a big hike in VAT over time with stepped interim increases;
- bringing forward the dates on which CT quarterly instalments are due, so as to create a windfall gain for the Treasury;

The following hopes were shared as regards the Budget:
- evidence of a coherent strategy and framework for corporation tax (CT);
- reduction in the rate of CT;
- more competitive CFC regime;
- evidence of joined-up thinking;
- a more internationally competitive corporate tax system;
- dropping plans to further reform the taxation of non-doms;
- a further con doc prior to introduction of a GAAR. (It was noted that in Germany companies have to pay €90,000 for the equivalent of Revenue clearances); and
- the deferral of any VAT increase until at least 1 October;

A lower rate for Corporation tax in Northern Ireland?

The new Northern Ireland secretary, Owen Paterson, says he would back an inquiry into whether the province should have lower rate of corporation tax than applies in the rest of the UK. How odd.

Ever since corporation tax was introduced to the UK in 1965, the rate has been consistent across all the regions. I don't recall every hearing previously of any suggestion that this should change.

I am aware that Politicians and business leaders in Northern Ireland have been lobbying for a dramatic cut in corporation tax. They point across the border to the Irish Republic, whose corporation tax is only 12% — among the lowest in the western industrial world.

Companies and political parties in the north claim that Northern Ireland operates at a severe disadvantage when trying to attract multinational capital in competition with the republic. Of course this is no different to the rest of the UK. Is the enquiry intended to be a genuine intent to consider all of the issues? Or is the outcome already clear - as may seem obvious to anyone who understands our corporation tax system? Or am I being too limited in my thinking?

Let's assume it were possible to determine a simple way to determine the extent to which corporate tax profits earned in NI were subject to a lower rate than in the rest of the UK. Three simple challenges occur to me immediately:

• What would stop existing companies from seeking to relocating there or simply establishing subsidiary companies or branches there to benefit from the lower rate?
• How about the additional administrative burden of requiring 'transfer pricing' adjustments as between the different parts of a group based on the mainland and in NI?
• And, despite the best efforts of HMRC, companies will shift profit out of the rest of the UK and into Northern Ireland and pay less tax overall as a result.Who will pick up the increased burden?
  

And then, what next? A lower rate for companies based in Scotland? And then for those in Wales? The Cornish Nationalists would have something to say about such a policy too.

Maybe the North of England would be next, then the Midlands? Indeed, everywhere other than London and the South-East?

I tend to think that the outcome of the inquiry, were it to be undertaken, is already quite obvious and inevitable. There can be no differential corporation tax rate as between different parts of the UK. I would imagine the Treasury knows this too.

What about you?