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Keith Gordon MA, ACA, ATII reminds readers of some incidental advantages of incorporation.
It is generally accepted that for many businesses the most tax-efficient way of extracting profits is by way of dividend. However, for many small businesses the additional cost of running a company can make incorporation a less attractive proposition. The arguments for and against running a business through a corporate entity are well-rehearsed and cover issues wider than tax bills. This article is not going to consider these; instead, it will look at some of the marginal taxation advantages that incorporation may have over leaving a business unincorporated.
Schedule E exemptions
There are a number of tax exemptions that apply to office holders and employees which are not available to the self-employed. While the original intention may have been to encourage certain behaviour among employers and employees, there is no reason why directors of small businesses should not take advantage of them.
In recent years, there has been a tax exemption for mobile telephones, computers and bicycle equipment.
Mobile telephones
The mobile telephone exemption (section 44, Finance Act 1999 inserting section 155AA, Taxes Act 1988) did more than remove the £200 scale charge introduced in Finance Act 1991. It provides that wherever a mobile telephone is owned by the employer and provided to the employee (or a member of the employee's family) there is no benefit-in-kind. A family company could, therefore, provide each family member with a mobile telephone and (for outgoing calls at least) dispense with the conventional land-lines. All costs of running the mobile telephones (including the cost of calls, rental charges and repairs) would be tax-free on the employee.
It does not matter whether there is no business use of these telephones. It is not even necessary for one to show a commercial rationale for providing the telephones, because section 168(3) provides that 'all such provision which is made by [the] employer, [is] deemed to be paid to or made for [the employee] by reason of his employment'.
There is a general presumption that the cost of employing staff is allowable for tax purposes and so the full cost of the provision of the mobile telephones should qualify as 'wholly and exclusively for the purposes of the [employer's] trade'. Any capital costs would qualify in full for capital allowances. Furthermore, because there is no cash benefit in providing these benefits, there are no Class 1A National Insurance contributions payable on them either. Also the VAT on the charges would be recoverable in full by the company, assuming it to be VAT registered.
When the mobile telephone exemption was introduced in 1999, there was some confusion as to whether it covered all the employer's costs or simply the overheads. The wording of the statute reads: 'Section 154 [the general charging provision] does not apply where the benefit consists in a mobile telephone being made available' (section 155AA, Taxes Act 1988 as introduced by section 44, Finance Act 1999).
In the writer's opinion, this provision could be read in two different ways in respect of the costs of private calls made by employees which are not reimbursed to the employer. One interpretation would consider the exemption as only applying to the making available of the telephone to the employee and not any consequential use; the second takes a broader approach and considers the use of the apparatus as intrinsically tied up with the making available of the telephone so that the costs incurred would be included in the exemption.
Whilst reference to Hansard should be seen as a last resort following Pepper v Hart, this provision may justify the option. And there it will be seen that the exemption is meant to cover the call costs as well:
'We shall abolish the tax completely. When an employer provides a mobile phone for the use of an employee, no charge to income tax or to National Insurance contributions will arise. It will not be necessary for the employer unless he chooses to do so to require the employee to keep records or to analyse the bills of the telephone company to ascertain which calls have been made for business and which for private purposes.'
Computers
The exemption for computer equipment also introduced in Finance Act 1999 (section 45 inserting section 156A, Taxes Act 1988) is more limited in scope. In particular, the exemption only applies if the provision of computer equipment is not 'on terms that are more favourable in some or all of the cases where the employee in question is a director of a company than in one or more cases where he is not' (section 156A(2)(b)).
For one-person companies, it might be necessary to show that the provision of computer equipment would apply to all employees if there were any, so as not to fall foul of section 156A(2)(a). This might be achievable by employing a family member (not as a director) with a nominal salary and providing that person with a computer, although many clients would probably consider this to be rather a drastic solution. Alternatively, it might be appropriate for the employer to draw up a staff manual or standard job specification which shows that all employees are entitled to the private use of computers which is in accordance with section 156A(2)(b).
However, small family businesses are effectively allowed up to £2,500 of computer equipment to be used for private use without giving rise to a tax charge provided that they are incorporated. Unincorporated businesses would have to make adjustments for non-business use a task which is commonly performed by using a rough and ready percentage and that is wide open to attack under self assessment record-keeping and disclosure requirements.
Cars, motorbikes and bicycles
It cannot generally be said that the taxation of car benefits encourages corporate ownership of cars, motorbikes and bicycles. What is more likely to prove attractive is the ability to receive tax-free mileage allowances of up to 63 pence a mile while the employee retains personal ownership of the vehicle. If the vehicle were owned for a self-employment, then these scale allowances would only be available if the business turnover were below the VAT threshold (April 1996, Tax Bulletin). If the business is run through a company, an employee may use the mileage rates notwithstanding the business turnover.
Although the Tax Bulletin article refers specifically to cars, it is assumed that the recent extension of the mileage scheme to bicycles (from 1999-2000) and motorbikes (from 2000-01) would be treated consistently.
Training costs
Another exemption given specifically to employees relates to training costs met by an employer. Under section 200B, relief is available for work-related training costs incurred by an employer for an employee. A common example of such costs would be those related to training for associateship of The Chartered Institute of Taxation, which under normal principles would not satisfy the conditions of section 198 as incurred wholly, exclusively and necessarily in the performance of the duties.
Where the conditions are met, the expenses incurred by the employer do not count as emoluments.
It is a requirement of this provision that the cost of the training must ultimately be borne by the employer. Costs met by an employee do not qualify for relief (and therefore must be met out of taxed income), although many employees and their employers may be able to negotiate a commensurate reduction in salary to get around this. In many cases this could prove beneficial from a VAT and National Insurance perspective as well. In most cases, there should be no problem obtaining a Schedule D deduction in the employer's tax computation in respect of such costs.
To contrast, if the owner of an unincorporated business were to undertake work-related training, it is probable that the costs would not be deductible under section 74(1)(a).
Removal expenses
If a self-employed individual were to relocate (whether for commercial or domestic reasons) and move home in the process, no expenses would be allowable for Schedule D (MacKinlay v Arthur Young McLelland Moores & Co [1990] 2 AC 239).
If the business is run through a company, however, the employee might be able to take advantage of the £8,000 exemption in section 191A and Schedule 11A, Taxes Act 1988. However, it is necessary for the employee to show that the sums are paid 'by reason of [the] employment' (paragraph 1(1). If the business relocation is simply a corollary of the employee's domestic move, there is an argument that the sums are not paid by reason of the employment. The all-embracing definition of this expression in section 168(3) does not cover the relieving provisions in Chapter IV of Part V of Taxes Act 1988. On the other hand, it would be difficult to argue that the sums would not be paid by the company if it were not for the fact that the company were the employer.
If the payment qualifies for relief under Schedule E, it would also qualify for exemption from National Insurance contributions (SI 1979/591 regulation 19(z)(c)(i)).
Disallowable expenses
The use of a company can also be beneficial with respect to expenses that are specifically disallowable for tax purposes. This is the flip-side of the double tax charge that arises when extracting profits from a company. The most likely area for this to arise is with respect to business entertaining, as the Example shows. The example demonstrates that it is better for even a disallowable expense to be incurred by a company than for the cost to be borne individually.
Example
X is self-employed and a higher-rate taxpayer. He wishes to spend £1,000 entertaining some friends who are also some of his clients. Notwithstanding the partial commercial justification for the expenditure, section 577, Taxes Act 1988 precludes a deduction from being allowed. Therefore the true cost to X is £1,000.
If X were trading through a company, X Ltd, the cost to X Ltd would also be £1,000. However, by channelling the cost through the company on the basis that it involves the entertainment of the company's clients X avoids the need to be taxed on an extraction of the funds from the company. If a dividend would otherwise have been used to obtain the £1,000, (distribution £1,333.33, tax of £333.33) would have been necessary.
If an employee were to pay personally for the employer's entertaining, it would appear from a first glance of section 577(1)(b) that the employee would be unable to obtain a deduction under section 198 against the emoluments of the employment. However, in cases where such expenditure is then reimbursed by the employer, section 577(3) disapplies the effect of section 577(1)(b).
Working overseas
The rules concerning qualifying periods of absence from a principal private residence include references to work-related absences. In section 223(3)(c), Taxation of Chargeable Gains Act 1992, the allowable absences include:
'any period not exceeding four years throughout which the individual was prevented from residing in the dwelling-house in consequence of the situation of his place of work or in consequence of any condition imposed by his employer requiring him to reside elsewhere, being a condition reasonably imposed to secure the effective performance by the employee of his duties.'
This clearly relates to both the self-employed and to employees, and the Revenue's Capital Gains Tax Manual confirms that its practice is in accordance with this (at paragraph CG65044).
There is an additional exemption which is not restricted to four years where the person works overseas. However, the statute specifically restricts this to employees (section 223(3)(b)), and in the absence of any statement equivalent to that in paragraph CG65044, one can only assume that the Revenue adheres to this distinction.
Some readers may remember a subtle change some years ago in the booklet IR20. Paragraph 2.2 explains that someone who leaves the United Kingdom to work full-time under a contract of employment can be treated as not resident and not ordinarily resident if, inter alia, the absence includes an entire tax year. Paragraph 2.4 extends this treatment to people who leave the United Kingdom to work full-time for a trade, profession or vocation.
However, before the 1996 edition, this extension was not publicised. Practitioners used to advise their self-employed clients to set up a company to employ them while overseas. At the time of the change, it was suggested that it had always been Revenue practice to treat the self-employed in the same way as employees. As far as principal private residence relief is concerned, however, where the conditions are statutorily listed, it would be unwise for tax advisers to assume that a similar concession would apply.
Capital gains tax
Now that all unquoted shares in trading companies benefit from the business taper, there is no longer the need to rearrange shareholdings to take advantage of the best taper rates between spouses. Although non-working business partners could always benefit from business taper, the new rules allow ownership of businesses to be spread among family members without the risks of unlimited liabilities.
Keith Gordon is a director of ukTAXhelp Ltd and can be contacted by e-mail on keith.gordon@ukTAXhelp.co.uk. The views expressed in this article are those of the author.
