The taxation of SMEs in 2023

Writing for Tax Journal, BKL tax consultant David Whiscombe explores key points of interest for SMEs in 2023, including disputes over partnerships, goodwill, distributions and VAT.

One of the most significant changes for (some) SMEs came late in the year with the proposal to remove the ‘cash basis’ turnover limit and eliminate some petty restrictions, thus both greatly extending the range of businesses eligible to use it and making it more attractive to do so. Announced as part of the Autumn Statement (but partly foreshadowed in the Spring Budget), the change is said in part to be a response to ‘the behaviour of many businesses that currently use the cash basis without officially electing to do so’ – an uncharacteristically coy euphemism! It’s an interesting approach to compliance: if enough people get it wrong, we’ll change the rules to make wrong right. Wonder what other areas of law could benefit from that approach? However, it seems more likely that this is an attempt to soften the blow of ‘Making Tax Difficult’ by rendering quarterly reports marginally less unmanageable for small businesses. Note to HMRC: there are some things which, by tradition and repute, you can’t polish.

The cash basis changes don’t affect companies. But companies are affected by another change occurring at the other end of the year: the increase in the main rate of corporation tax from 19% to 25%. A significant number of SME companies won’t be much helped by the small profits limit of £50,000, especially if profits are being extracted by way of dividend (noting that dividend tax rates haven’t been reduced to take account of higher corporate tax rates); and the reduction of the limit where there are associated companies makes it even less attractive to continue to operate through a company.

The complete removal of the pensions lifetime allowance in the Spring Budget was unexpected. In truth, SME owners were effectively ‘collateral beneficiaries’ of a policy change which was blatantly aimed at removing the politically embarrassing tax charges arising to NHS consultants as the notional value of their pension arrangements reached stratospheric levels. It seems that a prospective Labour government may leave the change in place for its target audience, but reinstate the lifetime allowance for everyone else, which has reportedly tempered SMEs’ enthusiasm for making large additional contributions. By contrast, the increased annual allowance of £60,000 looks more likely to survive any change of government.

Venture capital reliefs end the year in a better position than they started it. The amount a company can raise under SEIS is now £250,000 (was £150,000); the limit at the date of share issue on a company’s gross assets is £350,000 (was £200,000); and the annual limits that apply to the investment amount on which individuals can claim income tax and CGT reinvestment reliefs have doubled to £200,000.

Partnerships

A couple of cases involving partnerships were of particular interest to SMEs.

Anderson [2022] UKFTT 457 (TC) has been the first case to come before the First-tier Tribunal (FTT) on TMA 1970 s 12ABZB. This permits a partner to refer to the FTT a dispute as to the quantum of taxable profit allocated to him in a partnership tax return, provided that the dispute is not ‘in substance about the amount (before sharing) of the partnership’s profits or losses for the period’.

The taxpayer claimed that the partnership of which he was a member had incorrectly treated as a share of his trading profit an amount which was as a matter of fact a (non-taxable) payment in settlement of a damages claim he had made in connection with his compulsory retirement from the firm. Somewhat surprisingly, the FTT held that the dispute fell within the proviso and declined to rule on the merits of the case. The decision has been criticised as appearing to rob s 12ABZB of much of its practical application.

Equally surprising – but this time in favour of the taxpayer – was the decision made (as it happens, by an identically constituted tribunal) in the ‘IR35’ case of Lineker [2023] UKFTT 340 (TC). In this case, the services of Mr Lineker were provided to end-users via a partnership of which he was a member. Although it was accepted that IR35 could potentially apply to services provided via a partnership, it was held that because Mr Lineker had himself signed each contract (albeit in his capacity as a partner), it followed that the services were provided not under the kind of ‘intermediary’ contracts with which IR35 concerns itself but under contracts made directly with the worker and so outside the scope of IR35.

The notion that the IR35 rules are or are not capable of applying to a partnership depending on which partner signs the contract on behalf of the partnership is a surprising one. It will be interesting to hear what the Upper Tribunal have to say about it on the appeal which is due to be heard in February 2024.

Goodwill and distributions

Another case of interest to SMEs is Smith & Corbett [2023] UKFTT 912 (TC), dealing with the knotty question of who owns the goodwill in a small business wholly dependent on its owners – and one which may be of particular relevance to businesses disincorporating in response to the corporation tax changes noted above.

The case concerned a company carrying on business as financial advisers which was owned by its directors who, it appears, were the only registered IFAs working for it.

When the business was transferred to an LLP owned by the same people, HMRC sought to charge tax on the basis that there had been a distribution of valuable goodwill from the company to the LLP.

The FTT accepted that on the facts of the case the client relationships (and thus the goodwill) resided not with the company but with the individuals: there had thus been no distribution of the goodwill since the company had no goodwill to distribute. The same principle may apply in other cases of dis-incorporation, particularly of small professional practices: though the larger the business the more difficult to demonstrate that the client ‘belongs’ to an individual rather than to the organisation.

Another case involving distributions (though in a completely different context) was Shinelock [2023] UKUT 107 (TCC). Here, the owner of a company had funded his company’s acquisition of a property on terms that instead of paying him interest the company would account to him for any capital gain made on selling the property. Overturning the FTT’s decision, the Upper Tribunal held that the loan was a ‘special security’ such that a payment made in respect of it counted as a distribution. It emphasised the breadth of the relevant provision as one which ‘applies to a company’s business, which is a wider concept than trade. It applies to any part of that business. The words “results of” are wider than profits, and encompass both income and capital items. Finally, it applies where the consideration depends “to any extent” on those results.’

VAT

VAT hasn’t been without interest. On the first day of 2023 changes to the rules on penalties were introduced, with a new ‘totting-up’ procedure coming into effect.

For accounting periods starting on or after that date, failure to submit a VAT return by the due date (usually a month and seven days after the end of the return period) will earn you a ‘penalty point’. Accumulate enough penalty points in, broadly, any two-year period and your reward is a penalty of £200. ‘Enough penalty points’ means four points if you file quarterly, two if annually and five if monthly. Once the penalty threshold has been reached, each subsequent failure also produces its own £200 penalty unless you can demonstrate a ‘reasonable excuse’.

You leave the penalty regime and start afresh with a ‘clean licence’ only once you’ve established an unbroken succession of timely returns – four if you file quarterly, two if annually and six if monthly.

There were also a couple of tribunal cases on VAT of particular interest to SMEs.

What happens if, in order to raise money to be used to fund a fully-taxable business, you make a supply which is itself exempt: can you recover input tax suffered in connection with the making of that supply? It’s an interesting question on which the reasoning and jurisprudence have evolved considerably over the years and which the Upper Tribunal addressed in Hotel La Tour [2023] UKUT 178 (TCC).

The answer is that if, looking at the evidence objectively, the purpose of the sale is to raise money to fund the business, and the funds raised are later used to make taxable supplies, then the associated VAT is recoverable. It’s only if the cost of the services is incorporated into the (VAT-exempt) price of the asset sold that the link is broken and the right to recover is lost. This will seldom if ever be the case on a sale of shares – the price isn’t normally affected by the professional costs of sale.

Although the Hotel La Tour case was about the sale of shares, the same principle would appear to apply in any case where funds are raised for use in a taxable business by the making of an exempt supply which meets the criteria described above. The most obvious example is an exempt sale of land. Worth remembering.

In Ashtons Legal [2022] UKFTT 422, HMRC’s inexplicable challenge to an established and sensible practice approved by the VAT tribunal nearly 20 years ago was, reassuringly, rejected by the FTT. The Law of Property Act 1925 s 34, in limiting to four the number of people who can jointly hold legal title, creates a practical and commercial challenge where real property is owned by a partnership. A firm of solicitors had sought to address them by arranging for the lease on the premises from which it carried on business to be held by a dormant nominee company whose obligations were guaranteed by the partnership. HMRC declined to allow the partnership to recover VAT on the rent payable under the lease. The FTT said that HMRC were wrong. Hopefully the many other firms adopting the same structure will be reassured.

Penalties

The Rangers case ([2017] UKSC 45) continues to cast its long shadow over once-ubiquitous EBT schemes. In Currell [2023] UKFTT 613 (TC), HMRC were successful in asserting that a company should have operated PAYE on a payment made to an EBT ostensibly to provide a fund for future payment of discretionary bonuses to key employees but in fact immediately lent to the owner of the company interest-free for five years. In many cases, the point of contention over such schemes has now moved on from whether the scheme works (it will often have to be conceded that it doesn’t) but how any loan charge implications are to be dealt with, and – more worryingly – whether penalties are in point.

In that regard, one somewhat worrying development for SMEs and their advisers is the decision in Delphi Derivatives [2023] UKFTT 722 (TC). In this case, a company was penalised as having not taken reasonable care in filing its tax returns when a tax scheme it had implemented proved to be unsuccessful. This despite having sought advice from an impeccable and independent source before implementing the scheme. The problem was that the independent advice had identified a risk that the scheme, though ‘seeming to be effective’ and ‘stronger than many’ might not work (which is probably the best that could ever be said of any avoidance scheme); and the taxpayer had taken no steps to address that risk (though the FTT did not go so far as to say what steps would have sufficed).

Will HMRC take the decision as affording them the right to impose penalties in every case in which returns are filed on the basis of professional advice falling short of unconditional endorsement? We hope not.

This article was published in Tax Journal issue 1645 and is available to subscribers on the Tax Journal website.

NICOLA HALL

BILSHAN MENSAH

Sam Inkersole

In 2022, Sam won the Taxation’s Rising Star award at the Taxation Awards in and was named in the Accountancy Age 35 Under 35.

Jon Wedge

While Jon’s client work focuses on the financial services sector, he also oversees the firm’s assurance service, as well as supporting the trainees following in his footsteps.

ELANA DIMMER

Elana joined us in 2017 as an ACA trainee, after graduating from Durham University where she had studied languages. She is now a manager in our assurance team.

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