Winters Newsletter Summer 2002

Welcome to our Summer 2002 Newsletter

Please contact us about any of the matters raised in this newsletter
Remember - we're here to help!

PLEASE NOTE: This article was correct at the date of going to press, but details and rates described are liable to change over time – please check the tax rate section of our newsletter for up to date details.

Home and Business

We give some thought to two of the most important assets in your estate, namely your home and your business. House prices rise (and fall) with the market place, but how do you value your business?

HOME

Your home is your castle, your fortress or just a millstone around your neck depending on your circumstances and viewpoint. Whatever your situation, you hope that when you come to sell your home and move on it will have rewarded you with significant capital growth.

In many cases, such capital growth will be tax-free, being protected by the valuable capital gains tax (CGT) ‘principal private residence’ (PPR) exemption. The basic scope of the exemption is clear enough; no CGT on any gain, however large, made on the sale of your (main) private residence. However, as is so often the case with tax reliefs, there are sometimes issues or complications which can result in a restriction of the relief. See the article below for a run through of the important points.

BUSINESS

Have you ever considered how businesses are valued or wondered how much your own business is worth? The simple and short answer is that it is worth whatever anyone is willing to pay for it. If the company or business is being sold the price will be a negotiated one based on many factors including the parties’ respective bargaining positions. The basic approach is usually to determine what the business can earn or realise.

See below for a brief overview of the key methods of business valuation.

As ever, please get in touch if you wish to discuss any of the points raised in this newsletter.

The new Second State Pension (S2P) replaced the State Earnings Related Pension Scheme (SERPS) in April this year. Virtually all employees earning at least £3,900 a year will be affected. Although middle and high earners will eventually be worse off under S2P, it will enhance the state pensions of employees who earn between about £3,900 and £11,000 a year. Employees in this pay range will generally be treated as if their earnings were equal to the S2P lower earnings threshold of about £11,000.

Rewarding your spouse tax-efficiently

The introduction of S2P will therefore increase the benefits of business owners paying a modest salary to their spouses. For example, where the salary paid does not exceed the personal allowance (£4,615 for 2002/03) it will not be liable to national insurance (NIC) and may well also be tax-free. Notwithstanding the modest salary, such employees are able to have a personal pension. Since April 2001 an employer can contribute £3,600 (gross) per annum to an employee’s stakeholder or personal pension irrespective of the employee’s (modest) earnings. The payment is free of both tax and NIC and so is often more efficient than paying the employee additional salary out of which they fund their own pension contributions. The salary package for the spouse including any pension contributions needs to be commercially justified. Otherwise there is a danger that the payments will not be tax-deductible in the business.

It may be that the spouse already receives dividends from the company but remember that these do not accrue state pension benefits and if the spouse has little or no other income then dividends are generally less tax-efficient than salary.

The self-employed

A Government think-tank has proposed that the self-employed should contribute to S2P. Currently the self-employed pay less national insurance than employees but only qualify for the basic state pension on retirement. However, any such change is likely to take several years to implement.

Home (capital gains tax free?) is where the heart is

In this article we consider the important points you need to think about to ensure that, when the time comes to sell your house, any tax bill is minimised.

Garden or grounds - the capital gains tax (CGT) main residence exemption (referred to as PPR) covers your house and garden or grounds up to half a hectare (approximately 1.23 acres). The half a hectare includes the area on which the house itself stands. Larger gardens or grounds may be covered by the exemption but only if the larger area is needed for the ‘reasonable enjoyment’ of the property. As you can imagine this is a very subjective area and, furthermore, it is not generally possible to use the exemption when you sell off part of your garden for development, the argument being that you clearly didn’t need it to enjoy the property.

Other buildings - if your home has a separate staff cottage or granny annexe this may or may not be exempt on sale depending on the geographical layout of your property.

Business use - many of us have offices at home these days but if any part of your home is used exclusively for business purposes, the PPR exemption does not apply to the business part.

Two properties - if you own two homes and spend some time living in each of them - eg a flat in town during the week and a cottage in the country at weekends, the exemption will only extend to one of the two. Broadly you have the choice as to which one benefits from the exemption but it is important to ‘pre-select’ your choice by notifying the Inland Revenue within certain time limits.

Occupation - broadly the exemption requires ongoing occupation of the property. There are complex rules which may operate to restrict the relief on sale if you have been away from your home for significant amounts of time during your period of ownership. However it is not usually a problem if there is a delay, of up to one year, in taking up residence on purchase of the property because, say, work is being done on it. Likewise the final three years of ownership will be covered by the exemption whether or not you are living in the property. For example, you may already have moved into a new property.

Other - the rules relating to PPR also cover a number of other situations - for example, how the relief operates for husbands and wives and what happens if a couple separate. We could go on! However we recommend that you talk to us soon if any of the points raised are of interest or concern to you.

After all selling your home is a stressful enough activity without having to add CGT concerns to your ‘to do’ list.

Contents

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Relief for companies

Back in 1998, when the capital gains tax (CGT) regime was reformed and taper relief introduced, the Government made it clear that the regime would not apply to gains realised by companies. Individuals can now benefit from a 75% reduction in the taxable gain on a business asset once it has been owned for two years giving a maximum tax rate of 10% on such gains. Corporate gains are not eligible for taper relief and, indeed, have very little in the way of reliefs available to them. They continue to get ‘indexation allowance’, a relief for inflation based on the cost of the asset, but this is of little benefit where the asset has a low cost. The simple example below demonstrates the differences:

Sale proceeds	Business Asset
	Owned personally	Owned by company
	£	£
	50,000	50,000
Cost (1999)	(1,000)	(1,000)
Cost (1999)	49,000	49,000
Indexation (say 10%)		(100)
Taper relief (75%)	(36,750)	(100)
Gain	£12,250	£48,900
Taxed at 40%⁽¹⁾/20%⁽²⁾	£4,900	£9,780
⁽¹⁾ Higher rate taxpayer ⁽²⁾ Small companies rate of corporation tax

Gains on business assets can be deferred using ‘rollover relief’ provisions so long as the proceeds of sale are used to acquire replacement assets for use in the business. However, not all assets are eligible for relief and it has never applied to shares in a subsidiary company.

Two years ago, the Government attempted to improve the position by allowing corporation tax relief at 20% on acquisitions of minority shareholdings in qualifying trading companies - ‘Corporate Venturing Relief’. The relief has proved unpopular and complex to operate so few companies have benefited.

For many years, some other countries have exempted from tax the capital gains made by companies on the disposal of certain shareholdings in other companies. The UK is seen to have fallen behind and the lack of protection against tax on such gains has been harmful for the UK when competing with other countries. As a result, for disposals from 1 April 2002 there is an exemption for gains and losses realised when one company disposes of a ‘substantial shareholding’ in another company. Substantial is defined as 10% or more and both companies must be trading companies. Furthermore, the shares must have been held for at least 12 months.

Although the new rules are targeted mainly at large groups of companies they may also potentially apply to groups of family companies or owner-managed companies. The downside of the new rules is, of course, that no relief is available where shares are disposed of at a loss. Also it is clear that the rules are limited to gains and losses made by companies and have no relevance to individuals’ shareholdings.

Please talk to us if you wish to discuss any of the points raised in this article in more detail.

How much is my business worth?
How would you go about valuing a business?

The key methods of business valuation are:

Multiple of earnings or ‘capitalised’ earnings
Value of assets
Discounted cash flow basis
Accepted industry benchmark valuations

The usual starting point for business valuations is to look at future maintainable/sustainable earnings. The past is normally used as a starting point. Many factors will be relevant in arriving at an appropriate figure or figures. Clearly the task is made more difficult if the business is volatile.

The amount that a purchaser is then willing to pay for the business will depend on the required rate of return. This in turn will depend upon the rates available elsewhere and the level of risk inherent in the investment.

Example

The future maintainable earnings of a business have been estimated as £100,000 a year. A prospective purchaser has a required rate of return of 12.5%. On this basis, the business would be valued at £100,000/12.5% = £800,000.

The value is therefore based on a ‘multiple of earnings’ of 8. This is often referred to as the ‘price/earnings ratio’ or ‘p/e ratio’.

The future earnings and acceptable p/e ratio are likely to lie within a range of values so that one would normally have a range of values for the business.

An assets based valuation can then be used to act as a check. This method of valuation involves calculating the total current value of the company’s assets less its liabilities. Although the basis is once again subjective it ignores the risks inherent with future earnings.

In this article we have only been able to give you a brief overview of the complex area of business valuations. We would be delighted to talk to you if this is an area of interest for you or if you have any questions or issues arising from the article. Remember we are only a phone call away.

Contents

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Mileage allowances

Business mileage rates

If you are an employee using your own car for business purposes, or are thinking of doing so, are you aware of the possible tax consequences?

Employers often reimburse their employees for business mileage in their own cars. The Inland Revenue specifies the maximum rate that may be paid tax-free. Where an employer pays less than the specified rate the employee can claim tax relief on the balance. Until 5 April this year, the scheme was voluntary.

Changes have been made with the scheme moving on to a statutory basis on 6 April this year. The old and new rates are summarised in the table below. The new regime is designed to provide an incentive to drive cars with smaller engines. Drivers of smaller cars will certainly benefit under the new regime. Those driving cars with engines over 2000cc will lose out and they no longer have the option of substituting actual business motoring costs for the authorised rates.

Call us soon if you wish to discuss any aspect of the new regime either because you are an employer making mileage allowance payments or because you are an employee using your own car for business mileage.

VAT on mileage allowances

A recent European Court of Justice case has called into question the practice of allowing the recovery of VAT on the basis of business mileage rates paid to employees. In the case it was decided that the Dutch practice of VAT-registered employers deducting, as input tax, 12% of allowances paid to employees for business use of a private car was not in accordance with EU law. It was held that the percentage paid was imprecise and could not be related to the VAT incurred. Also, the employer did not have a VAT invoice to support the claim. It remains to be seen how, or whether, Customs will react to this decision.

Mileage Rates

2001/02

Cars-engine size Up to 4,000 miles Over 4,000 miles

Up to 1500cc 40p 25p

1501 - 2000cc 45p 25p

Over 2000cc 63p 36p

2002/03

All cars and vans Up to 10,000 miles
Over 10,000 miles

40p 25p

Wrongful trading - directors are you at risk?

Is your company facing a financial crisis? Is it struggling to remain solvent? If your company were to fall into insolvent liquidation could you prove that you took all possible steps to minimise the loss to the company’s creditors from the moment insolvency became inevitable?

If not, the courts could require a personal contribution from you in order to meet the company’s debts. You could also face being disqualified from acting as a director for up to 15 years and incur significant costs (which could run into thousands of pounds) in defending the claims.

The key to avoiding any action being taken is to face up to potential solvency problems at an early stage. An important weapon in the defence of wrongful trading, and indeed as a means to keep your company afloat, is a sound business plan that shows an awareness of your trading position.

By producing a formal plan, including budgets and forecasts and then by closely monitoring results, you will give your company a good chance of trading out of its problems.

If you feel that you or your business are at risk from solvency problems you must act early and take professional advice.

If you do not have a business plan or would like help in developing one, please get in touch. We can then discuss what course of action will be best for you and your business.

Contents

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Disclaimer - for information of users
This newsletter is published for the information of clients. It provides only an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material contained in this newsletter can be accepted by the authors or the firm.