Update: tax

The highest profile tax issue over the past three months has been the government's effective climb down over the 10p tax rate. The starting rate was abolished in the 2007 Budget, but faced with furious opposition from within his own party the chancellor announced that for the 2008/9 tax year the personal allowance would be increased by £600 from £5,435 to £6,035. To ensure the higher rate taxpayers do not benefit from this, the basic rate limit will be reduced by £1,200 to £34,800.

Unfortunately the PAYE tables and software had already have been issued, including the tax rates for the year as originally proposed. Thus implementing the changes will cause yet more administrative cost for employers.

This is yet another addition to the chancellor's catalogue of woes. The furore over the tax changes for 'non-doms' and the abolition of taper relief, the credit crunch and Northern Rock debacle, the sudden collapse of the housing market in conjunction with steeply rising prices particularly for oil and food seems suddenly to have put the nation's finances into an extremely difficult position. Gordon Brown's 'golden rule' of balancing the Exchequer's books over the period of an economic cycle is beginning to look like a pipe dream.

Inheritance tax

At the end of April the Burden sisters lost their well-publicised case in relation to the potential inheritance tax on the home that they share.

The sisters were born in 1918 and 1925 respectively and have lived together all their lives in a house which they inherited from their parents. On the first death the value of their one half share in the property will be subject to inheritance tax and the sisters complained to the European Court of Human Rights that they were being discriminated against because such a transfer would be exempt in the case of a married couple or civil partnership. However the ECHR found against this.

The Burden sister's circumstances are relatively rare and the ruling of the ECHR is not particularly surprising. However it may serve as a timely reminder that couples who choose not to marry will be in a similar situation and, sadly, one cannot always assume that both parties to the relationship will live to a ripe old age. In such cases, it is generally advisable to take out a life assurance policy, written in trust, to cover the IHT liability on the first death.

Goods taken by trader for own use

It has long been the case that if a trader takes goods from their business for their personal use then they must pay tax as if the item had been sold in the normal course of the business.

This has often seemed a rather unsatisfactory state of affairs for a number of reasons.

Firstly the case establishing the precedent, Sharkey v Wernher, was decided over 50 years ago and concerned the appropriation of a race horse from a stud farm. This is long way removed from the retailers, publicans and restaurateurs who are among those frequently caught by the ruling.

In addition, under a Revenue statement of practice a number of situations were highlighted in which the rule was not considered to apply.

Many traders, and quite a number of tax advisers, find it difficult to accept the principle that it is possible to make a profit by trading with oneself. Finally with effect from 1998 taxable profits should be calculated by reference to UK accounting principles and those principles would not support a transfer at selling price in these circumstances.

Clause 34 of the Finance Bill aims to codify the Sharkey v Wernher rule, and a cynic might suggest that this indicates that HMRC were no longer confident that the Wernher case was still good law. There was a danger that if the proposals are enacted HMRC will find new ways of applying them to tax what are essentially fictional profits.

Tax cases

In Vinton and Another (executors of Dugan-Chapman deceased) (SpC 666) a claim to business property relief in respect of ordinary shares in a company failed because they had not met the requirement of two years' ownership prior to death. Where shares are acquired under a reorganisation of capital then the ownership requirement may be satisfied by reference to the original date of acquisition of the shares and not the date on which the new shares are allotted. However in this case it was held that there had been a simple subscription for new shares and the taxpayer's claim failed.

In Smallwood and Another (trustees of the Trevor Smallwood Trust) a valuable shareholding was sold by a trust at a time when the trustee was a Mauritian trust company. Following the sale, the Mauritian trustee resigned in favour of UK resident trustees. This was a relatively well-known tax planning scheme and it was claimed that the gain was not subject to UK capital gains tax under the terms of the double tax treaty between the UK and Mauritius.

However the special commissioners found that, in reality, while the administration of the trust was moved to Mauritius, it was still effectively being controlled from the UK and as a consequence the gain was subject to capital gains tax, and the scheme failed.

The case of Collins (SPC 675) was another set back for contrived avoidance arrangements. The taxpayer had realised a capital gain of nearly £2.4m in 1999/2000 and entered into an arrangement under which he claimed a capital loss of £2.2m in respect of the disposal of an endowment policy. The special commissioners found that the transactions were pre-ordained and that their main aim was to obtain the tax loss on the acquisition and disposal of the policy. The taxpayer's appeal therefore failed.

It is a long-established principle that for expenditure by an employee to be allowed as a deduction against their employment income, the cost must be wholly exclusively and necessarily incurred in the performance of their duties.

To appreciate how difficult this test is to meet, it is worth considering each individual element:

• wholly;
• exclusively;
• necessarily; and
• in the performance.

Every one of these conditions must be satisfied. If the conditions were applied literally it is difficult to see how any expense could qualify.

In Emms v Brown a professional rugby union prop-forward claimed a deduction for food and nutritional supplements which he claimed were purchased solely for the purpose of his employment. The special commissioners found that the expenditure did not meet the strict requirement of being wholly exclusively and necessarily incurred in the performance of the duties and the claim failed. They considered that the expenditure was incurred by Mr Emms to enable him to perform his duties rather than in their actual performance. Furthermore, the expenditure was not incurred exclusively and necessarily because:

• The 'necessarily' test was failed because the expenditure was not required by his employment contract.
• The 'exclusively' text was not met because the diet he followed had benefits for his health generally and did not solely relate to the duties of his employment.

This case serves again to underline the very strict criteria which apply to expenditure which may be deducted against employment income.

Tax return errors '“ penalty review

HMRC has introduced a new regime for penalties in relation to errors in returns and documents for VAT, PAYE, national insurance, capital gains tax, income tax, corporation tax and the construction industry scheme. The intention is to make penalties consistent across the various taxes. The new penalties come into force for return periods starting on or after 1 April 2008.

The intention is that:

• if people take reasonable care when completing their returns they will not be penalised;
• if they do not take reasonable care errors will be penalised and the penalties will be high if the error is deliberate; and
• disclosing errors to HMRC early will substantially reduce any penalty due.

More information is available at www.hmrc.gov.uk and in Revenue and Customs Brief 19/08 which was issued on 2 April 2008.

Two conditions must be satisfied before a penalty can be charged:

• the document given to HMRC must contain an inaccuracy that leads to an understatement of the person's liability to tax, an inflated statement of a loss, or a false or inflated claim to repayment of tax; and
• the inaccuracy must be careless, deliberate or deliberate and concealed; however a penalty may also be charged where, in the absence of returns, HMRC issue an assessment which is insufficient.

Tax paid by 'self-employed' workers

It is often the case that HMRC will seek to reclassify workers who claim self-employed status if their true relationship with the entity paying them is one of employee. Such workers will generally have filed tax returns declaring their self-employed income and will have paid tax accordingly. In the past it was commonplace for employers to take this tax into account when negotiating settlement of the PAYE liabilities arising from the reclassification.

However, this arrangement was thrown into doubt by the case of Demibourne Limited which was decided by the Special Commissioners in 2005.

HMRC have now come up with a solution to this difficulty, allowing an employers' PAYE liability to be transferred to an employee where certain conditions are met.

Offshore disclosure facility

The Offshore Disclosure Facility is the HMRC's preferred name for the 'amnesty' which operated at the end of 2007 and was designed to enable taxpayers with offshore bank accounts to voluntarily disclose details to them. HMRC have announced that 64,000 individuals notified an intention to disclose, but only 45,000 actually did so, and that the tax yield was £400m.

Where a disclosure was made, HMRC had until 30 April 2008 to raise further enquiries so those who made a full disclosure, and paid the tax in accordance with the terms of the disclosure facility should be safe to assume that the matter is now closed. However it is suggested that there are still tens of thousands of individuals about whom HMRC have details of income which has not been disclosed.

In addition, more details continue to be extracted from overseas banks. This is very much an ongoing project and many people who chose to ignore the amnesty may well live to regret their decision.