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Switch to digital tax is leading to reform of late penalties

05 March 2018 by Russell Cockburn

Switch to digital tax is leading to reform of late tax penalties - Read more

Late submission of tax returns and payments will be handled differently for digital, amid changes on turning assets into stock and loan charges

HMRC plans to revise the existing penalties for the late submission of tax returns, replacing it with a new system including a ‘points based’ regime. This will apply to the late submission of tax returns by both individuals and businesses.

The change to existing penalties is a radical one, and a direct consequence of the proposed move the to the new digital taxation regime. VAT is set to become part of the digital tax world first, from April 2019, with other areas planned for introduction from 2020 for most businesses.

Under HMRC’s proposals, the new penalty regime will enter force for VAT from April 2020, while for other direct taxes it will be introduced in stages.

Late returns

The basic proposal is that when a company submits a tax return late, it will be given a punitive point – one for every late submission.

Once a designated number of points have been collected by the business then a financial penalty will be imposed on the business or other taxpayer. Details of the threshold are yet to be finalised, but will cover the number and frequency of failures in a set period.

After this, there will then be a probationary period where the compliance of the business is closely monitored. Provided no more points are earned during this period the accrued total will be reset to zero.

The aim is thus to reward good behaviour but penalise persistent bad behaviour in a given period, with a lifespan for penalty points after which they are cancelled. Initially, it looks as though this period will be set at two years, but this is being debated.

“Once a designated number of points have been collected by the business then a financial penalty will be imposed”

Even so, one might query the ‘reward’ aspect of this new system. Although it looks better than the current system, because it gives business significant warning of the potential penalties and a grace period to fix things, it is still arguably all stick and little to no carrot.

Some observers have suggested that HMRC might introduce a points and rewards system where penalties are awarded for failures but some modest tax discount is given for persistent good behaviour. This may be too much to hope for.

Late payments

On late tax payments, HRMC has also proposed that no penalty will be charged once the late payment has been settled or where a ‘time to pay’ arrangement has been made promptly by a business with HMRC, defined as within 15 days of the tax due date having passed.

The authority suggests that penalties will be halved if paid within 30 days of the due date or if a time to pay arrangement has been agreed. If payment is not made within 30 days of the due date then automatic penalties will arise, with further late payment or interest surcharges charges arising for further delayed payment cases.

These proposals were mostly approved of during consultation. But the final details have yet to be worked out and it is uncertain whether they will give businesses a real – or at least better – incentive to comply with the deadlines for payment and submission of returns.

Turning assets to stock

A small but important change to the corporation tax regime came in last year, drawing little attention but laying a potential trap that could ensnare some businesses over the long term, particularly for those with property assets.

Normally where an asset is transferred from fixed assets to trading stock by a company – an ‘appropriation’ – the law requires a chargeable gains computation to be done, referencing the market value of the asset at the time of the appropriation.

However, an election – or choice about how an asset should be taxed – could previously be made so that the asset passes into stock at its historic cost. This avoids the crystallising of the taxable profit at that stage, effectively meaning the tax would be paid later, upon the actual sale of the property.

But it appears that HMRC is afraid that some businesses might be using these rules to deliberately create losses where it was not intended in the original legislation, or was outside the spirit of it.

“The new rules make tax planning slightly more rigid”

HMRC has now acted to prevent this election being used when a loss would arise on the appropriation of an asset to trading stock. From March 2017, this form of election is no longer available in cases where a loss arises.

The election can still be used where there is a chargeable gain. Alternatively, companies should consider crystallising the taxable gain at a lower rate of tax than will perhaps apply to the eventual profit on a property development project using an existing fixed asset.

By effecting a transfer from fixed assets to stock without making the election, the company would be able to use any accrued indexation allowance. This would establish a higher base cost against the eventual ‘income’ sale than would otherwise be the case.

Where the transfer being considered goes the other way – from stock to fixed assets – businesses should be careful, as such a transfer can trigger a large tax liability if the property has increased in value. This is because there is no comparable election available in these circumstances to defer tax until the asset is sold.

It is unclear how common it was for companies to create a capital loss on an appropriation from fixed assets to trading stock, but the new rules make tax planning slightly more rigid.

At worst it takes an option away from companies with a property asset sitting in their balance sheet at a current capital loss, which could otherwise not be used for the foreseeable future.

Loan charges

Many close companies that have used employee benefits trusts in the past to reduce the tax and national insurance contribution liabilities on the pay of their top-earning staff face various new tax rules. Introduced over the course of the past few years, these mean that in many cases large tax bills are now beginning to materialise.

One of these rules is the new ‘loan charge’ on the employee – normally a shareholder or director of the company – or in some cases on the employer company, for ‘disguised remuneration loans’. This tax charge will in most cases arise on 5 April 2019.

An individual will almost certainly have to pay this new loan charge for any loan made after 6 April 1999, where they are a company employee and they received a loan through a disguised remuneration tax avoidance scheme and that is still outstanding on 5 April 2019.

“An application to postpone the loan charge payment date can only be made if approval is obtained from HMRC”

In some cases, someone affected by the loan charge may be able to postpone the date on which it needs to be paid to HMRC. To do this an application for postponement will have to be made by 31 December 2018.

Where a company or the person concerned has already registered an interest with HMRC to settle the outstanding liabilities for a disguised remuneration scheme, such as an employee benefits trust, then they or their advisors should normally speak to their existing contact in HMRC to see if they can apply to postpone.

An application for postponement of the loan charge payment date can only be made if approval is obtained from HMRC.

The department will determine that the loan in question is classed as a qualifying fixed-term loan, or that HMRC has already been paid before the application deadline for the income on which the loan charge is based, in amounts equal to or more than the outstanding loan balance.

Only the legal or actual person liable for the loan charge can apply for postponement. If it is the company, the relevant documents must then be dealt with by the employer, who must make the application to postpone to HMRC.

An application for postponement may be possible if the outstanding loan qualifies as ‘an approved fixed-term loan’, but again this requires prior approval from HMRC.

A loan qualifies if it was made before 9 December 2010, had a term of 10 years or less and is not an ‘excluded loan’. An excluded loan is one that was replaced by another after being granted, or one whose terms have been altered to meet the 10-year term or change the date when it must be fully repaid.

To apply to postpone the loan charge for this reason, HMRC must agree that:

  • The loan repayments are ‘qualifying payments’ – meaning the individual must have made regular repayments at intervals of no more than 53 weeks and be able to send HMRC evidence
  • The loan is a ‘commercial loan’, made by a lending business, or on terms that are comparable to loans that were available to members of the public.

An application to postpone a loan charge can also be made if an accelerated payment for the same loan has already been made to HMRC. To qualify, the amount of the loan outstanding at 5 April 2019 must be equal to or less than the value of the accelerated payment.

Russell Cockburn is an independent taxation consultant, and a former inspector of taxes

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