Author Archive: Muhammad Zia

Solicitors need to give careful consideration to client interest increase

The Bank of England’s decision to raise interest rates in the first half of 2023 might not have been well-received by those with mortgages or other debts, but it presents a beneficial situation for those accumulating interest in bank accounts.

This is particularly true for law firms, which often hold substantial client funds in interest-bearing accounts.

Funds in designated client accounts, including accrued interest, are considered the client’s property. Any movement of these funds and the interest they generate falls outside the scope of VAT.

In contrast, when client money is kept in a general account and the law firm is entitled to the interest earned, this constitutes exempt income for the firm.

Law firms dealing with both taxable income (like client fees) and exempt income (such as interest on client funds) fall under the partly exempt category for VAT purposes.

They must calculate the proportion of VAT reclaimable from HMRC based on their costs. VAT linked directly to making taxable supplies (like fees) is fully recoverable. However, VAT incurred in earning exempt income (like client interest) is typically non-recoverable.

The VAT on general overhead costs will depend on the proportion of taxable income to total income, a method known as partial exemption calculation. Law firms can also negotiate a special method for this calculation with HMRC in writing.

For partial exemption calculations, financial transactions incidental to the main business activities are excluded from exempt income considerations.

However, HMRC views interest earned on client money held for ordinary business activities as non-incidental and includes it in these calculations.

If the interest earned is substantial, it could limit the VAT recoverable on a firm’s overhead costs. Given the rise in interest rates, law firms might consider negotiating a special method with HMRC or re-evaluating any existing agreements if the rate increase significantly impacts their business.

Act now

It is advisable to re-evaluate your current VAT partial exemption approach. An upswing in interest earned from client funds in general, undesignated accounts could notably alter your VAT recovery stance.

The interest retained from these accounts is likely to be classified by HMRC as exempt income, not merely incidental.

This classification can lead to a reduced recovery percentage on overhead costs under any income-based VAT recovery method.

Previously, you might have qualified for full VAT recovery under the ‘de minimis limit’. This applies when the total VAT on costs linked to exempt activities is less than half of the total VAT incurred and is below £7,500 annually.

However, the spike in interest rates may push you past this threshold, potentially leading to the need to repay exempt input tax incurred over the year and in future tax returns.

Even if you have an existing special method agreed with HMRC in writing, remember that all such agreements contain a clause mandating a review in case of significant business changes.

If the increase in interest rates considerably affects your business, it’s crucial to consider reviewing and possibly renegotiating your method or documenting why the current method still ensures a fair and reasonable recovery of input tax.

To find out more about how this affects law firms and the actions they should take, please contact our dedicated tax team today.

Savings interest for self-assessment – The impact of rising interest rates

In the current climate of rising inflation rates, many savers are seeing significant returns on their savings and investments.

However, there is often confusion about how to report these earnings to HM Revenue & Customs (HMRC), particularly for earnings outside of an ISA or in addition to income reported via PAYE.

Understanding the tax implications for savings interest is key. It’s essential to know that while the principal amount in your savings isn’t taxed, the interest it generates might be taxable.

Generally, interest on savings is paid without tax deducted, known as receiving interest ‘gross’. In the UK, there’s a specific amount of interest you can earn each tax year tax-free. The tax year for which you’re liable for this interest is based on when you can access it, not when it was earned.

For joint accounts, the interest is typically considered split equally between holders for tax purposes. If your interest exceeds your tax-free allowance, HMRC usually adjusts your tax code for automatic tax collection.

However, if you’re completing a self-assessment tax return, you need to declare this interest yourself. The tax rate on savings interest depends on your usual income tax rate, which could be 0 per cent, 20 per cent, 40 per cent, or 45 per cent.

Taxable savings interest includes interest from banks, building societies, credit unions, investment companies, trusts, peer-to-peer lending, bonds, and certain annuity payments and life insurance contracts.

Your tax on savings interest is based on your total annual income, encompassing all income sources and any applicable reliefs or exemptions. For those earning up to £17,570, calculating your allowance involves your Personal Allowance (usually £12,570) plus £6,000 for the maximum starting rate band for savings and the Personal Savings Allowance.

You then subtract any non-savings income from this total. For instance, someone with a £6,500 salary could earn up to £12,070 in tax-free interest, whereas someone with a £14,500 salary could earn £4,070 tax-free. Beyond these allowances, the basic tax rate of 20 per cent applies.

Your tax-free allowances each year include your Personal Allowance, up to £5,000 from your starting rate for savings, and a £1,000 allowance for savings interest from the Personal Savings Allowance. If your non-savings income exceeds the Personal Allowance, the starting rate for savings decreases by £1 for every £1 earned over this limit.

For earnings between £17,571 and £125,140, the allowance for savings interest is fixed at £1,000 for earnings up to £50,270 and £500 for earnings between £50,271 and £125,140. Above £125,140, there is no tax-free allowance for savings interest.

Tax payments on savings and investments depend on individual circumstances. If employed or receiving a pension, HMRC usually adjusts your tax code for the extra tax due. For savings interest, this adjustment is typically automatic, but you must inform HMRC if you earn between £1,000 and £10,000 in dividend income. Earning over £10,000 from savings and investments requires a self-assessment tax return.

If you self-assess, report any savings or investment income in your regular tax return. If neither situation applies, HMRC will contact you regarding any owed tax on savings interest.

As the deadline for tax returns approaches, if you need to report savings income this year via Self-Assessment, please get in touch with us for assistance.

Tax basis – Getting ready for the end of the transitional year

Are you a sole trader or a member of a partnership? Here is what you need to know about the upcoming tax basis period reforms.

HM Revenue & Customs (HMRC) is introducing changes to how it assesses and collects business taxes relating to the basis period.

At the end of the 2023/24 financial year, these changes will come into effect – altering the way that sole traders, partnerships and other unincorporated businesses pay tax.

Basis period reform – What you need to know

If you are a business owner or self-employed worker, you will use or have used a traditional basis period.

This is a specific period used to calculate taxable profits for a particular tax year, meaning the basis period is typically the corresponding accounting period to the financial year.

Under current regulations, established businesses and sole traders pay tax on qualifying profits in the 12-month accounting period which ends in that tax year – regardless of whether it corresponds to the financial year.

For example, if your accounting period starts on 1 January and ends on 31 December, the financial year would end the following April. This means that your tax return for this period would be due in January two years afterwards.

Under new regulations, from 2024/25, all unincorporated businesses will be taxed on profits from each financial year – 6 April to 5 April the following year.

This will apply regardless of an individual business’ accounting period.

For the example above where the accounting period ends on 31 December, this change means that the business will have to assign profits from two accounting periods to fit into the 6 April to 5 April timeline.

If the accounts are not completed by the tax return submission deadline, it will be necessary to use estimated profits in their place for the three months to 5 April.

At the end of the 2023/24 financial year, the transitional year for the basis period ends.

Businesses will then be taxed on this longer tax period ending in April 2024 to bring their tax years in line with the financial year.

HMRC has introduced regulations to allow tax liabilities accrued during this period to be paid over a period of five years to reduce the burden of additional tax payments.

Navigating your opening year

The rules are slightly different if this is your first year trading as a business. Instead of paying tax on a full year of earnings, your business will be taxed on qualifying profits earned between the date you began trading and 5 April (the end of that financial year).

This means that you’ll have ‘overlap profits’ for your first one to two years of trading. Your profits earned between the end of the financial year and the end of your accounting period will be counted in two tax returns.

These new rules will also apply to new unincorporated businesses.

Preparing for 5 April

As explained, the new regulations mean that businesses with an accounting period that is different from the financial year will need to divide profits between two different tax payments, where their accounting period doesn’t already align with tax year-end.

This could increase the room for error in your tax calculations, resulting in penalties or a heavy tax burden at a later date.

Aligning your accounting period with the financial year could help you streamline your finances and stay on top of your tax calculations in future.

You can shorten your company’s financial year to achieve this, by a minimum of one day and as many times as you like.

Staying on top of your accounts and financial records can help you stay in good fiscal health and maintain tax compliance.

We can help you to understand your tax obligations and make your accounting period work for you.

Need help understanding the changes to the basis period? Contact us today.

Putting the brakes on excessive National Insurance payments through car allowances

Businesses may be able to reclaim significant amounts of National Insurance Contributions (NICs) and plan for future savings because of a recent Tribunal ruling on how car allowances are taxed.

Brought by Wilmott Dixon and Laing O’Rourke in their capacity as employers, the Tribunal upheld the firms’ argument that car allowance payments should qualify for Class 1 National Insurance relief.

HM Revenue & Customs (HMRC) subsequently repaid approximately £146,000 to these businesses as a result of the Tribunal.

It has further stated that it will not appeal the decision – an announcement which carries significant implications for other employers that provide a car allowance.

What is the car allowance?

A car allowance is a type of benefit that may be provided to employees in place of a company car.

It is typically a monetary benefit on top of an employee’s salary to allow them to lease or buy a car for work purposes or to maintain the one they own owing to additional, work-related use.

An employer can provide a car allowance to any employee, but most are given to those who spend a lot of time travelling, such as sales staff or managers who oversee more than one site.

It may also be given as an attraction and retention benefit.

Is the car allowance taxed?

Because they are paid as part of an employee’s salary, car allowance payments are normally subject to tax and NICs – for both the employer and employee.

However, work-related travel is also subject to a fuel or mileage allowance.

This is a reimbursement which is not subject to tax if paid at or below the ‘approved amount’ – 45p per mile for the first 10,000 miles and 25p after that.

What decisions have been made?

The Tribunal ruled that a car allowance should be defined as ‘relevant motoring expenditure’ (RME) and can, therefore, be used to offset below-standard mileage reimbursement.

For example, if your company car policy states that employees will be reimbursed at 20p per mile and an employee drives 500 miles, this leaves a difference of 25p per mile – totalling £125.

When you come to pay the car allowance for this person, the first £125 will be taxable as part of the employee’s salary but will not be subject to National Insurance.

This could represent a significant saving for employers that provide a car allowance in place of a company car.

How will this affect me?

If you offer mileage reimbursement and a car allowance to your employees, you could stand to save a substantial amount on your employer NI contributions.

It could also open the door for business owners to reclaim overpaid NICs under this latest clarification.

The Tribunal also accepted that, if your business policies state that a certain number of miles are not reimbursable, then these miles must also be offset against other RMEs.

Benefits all round

The Tribunal’s ruling could make car allowances an attractive benefit to both employers and employees over, for example, a company car.

Tax regulations regarding benefits and NICs can be complex and are likely to change further as these new precedents take effect.

To stay compliant, it is important to remain updated on your tax obligations and work with your accountant to ensure you are paying the correct amount of National Insurance.

For tailored advice on benefits, company cars, travel allowances and tax, please contact us today.

Please leave a message – HMRC dispute resolution hotline restricted to answerphone

HM Revenue & Customs (HMRC) has made a significant change to the way that some taxpayers access its alternative dispute resolution (ADR) scheme.

Where applicants for ADR could previously speak with a call handler, they will now be asked to leave a voicemail on the new 24-hour service.

Available to anyone seeking to settle a dispute via ADR, the voicemail service will require claimants to leave their name and phone number.

A mediator will then contact the claimant within 30 days to discuss their application.

The ADR scheme explained

ADR is a crucial part of navigating tax disputes with HMRC. It is often a useful option for businesses and individuals who seek to meet their tax obligations without overpayment or early or late payment.

You can apply for ADR when you have an ongoing dispute with HMRC, where it has opened an investigation into your tax affairs.

ADR covers a wide range of scenarios but is typically used when:

  • Both parties are unable to reach an agreement
  • A compliance check is taking place
  • There are disputes over the facts of a case
  • Communications have broken down
  • There may have been a misunderstanding
  • HMRC has made a decision you don’t agree with or understand

HMRC will let you know within 30 days of submitting your application if ADR is right for you and how your claim is being progressed.

Will this change impact me?

Many individuals and companies, particularly those with a tax adviser or accountant, will use the existing online form to submit their application.

However, if you cannot access this form due to, for example, poor internet connection, you are likely to be affected by this change.

Both ways of applying carry a 30-day time limit, so it is unlikely to disadvantage phone applicants over online applicants.

The most significant impact is likely to be the difficulty in speaking to an adviser if you have a question regarding your application.

Additionally, you may struggle with the inability to track a phone application as opposed to an online submission.

The best way to avoid the frustrations of a telephone submission is to seek support to submit an online application to the ADR.

We can provide advice and apply on your behalf should you be subject to an HMRC investigation.

Contact us for further guidance on tax disputes with HMRC and the ADR scheme.