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Profit extraction via interest on Director loan account

Small company owners can lower their tax bill by charging interest to their own companies.

Where company owes money to shareholders. Shareholders can charge interest to the company on the outstanding loan balance.

In case interest is charge on a loan for a period less than a year there is no need to deduct tax and complete form CT61.1

Interest rate should be a commercial rate i.e. few points above BOE base rate. In case, rate charged is too high HMRC can treat it as remuneration or dividend.1

Company gets relief in the accounting period when interest is actually paid or within 12 months after its end. So simply crediting interest amount in Director Loan Account will not work.2

Interest Income received by the director will be added to his taxable income but it is taxed on receipt basis.2

Main advantage of this interest over dividends is:

  • No tax on starting rate of savings upto £5,000. So directors save income tax.
  • Company gets deduction for interest paid.

Notes on form CT61

  • In case loan is for a period over one year, 20% (basic rate) tax will need to deducted and deposited with HMRC using Form CT61.
  • CT61 returns are filed every quarter.
  • Nil returns not needed.
  • Return cannot be downloaded. A structured email needs to be sent to HMRC; they will send the form in post.
  • Both Returns and Tax deducted are due within 14 days from the end of the return period.
  • Company can issue Form R185 to the person whose tax has been deducted.

Source:
1. Para 1.148 Bloomsbury Tax Planning Book.
2. Para 2.47 Peter Rayney’s Tax planning for owner managed companies.

Compulsory purchase of land in India and second Private Residence Relief

This article focuses on compulsory purchase of land in India, basic concept is same in case land is situated in any country including UK.

Background

Our client’s ancestral home was partly acquired by the government in India to widen the road. Client lives in UK, but the Indian house is occupied by his widowed mother.

What is compulsory purchase of land?

Compulsory purchase is where land is acquired by an authority possessing compulsory purchase powers. Example a highway is being broadened and government acquires part of your front garden.  Compensation received from authority is `sale proceeds` in this case. [see CG72100]

What is the date of disposal?

Date of disposal is date when compensation is agreed. [see CG72101]

Does land in India treated as same as land situated in UK?

UK Capital Gains Tax is not normally dependent on where in the world an asset is situated but there are some exceptions to this rule. [see CG12400P] These exceptions are not applicable in our case, as client is tax resident in the UK.

Since 6 April 2020 , individuals (not companies) selling UK land need to report and pay capital gains tax to HMRC within 60 days. Overseas land disposals are reported in Self-assessment tax return only. Source Litrg.org.uk.

Are there any reliefs available?

Yes, besides the usual CGT reliefs (like EIS investment etc.) there are three reliefs available:

  1. Small disposal relief

Where disposal proceeds are less than £3,000 or 5% of the Market Value of the land. No gain arises and compensation is deducted from the purchase cost. [see CG72200]

2. Roll over relief

Simple guidance on this relief is given in HS290 ; for detailed guidance see CG61900P.

Basically, if sale proceeds are used to acquire another land, capital gain tax can be deferred.

Conditions:

  1. New land must not be used as tax payers main residence within 6 years from date of acquisition. [section 13 HS290].

[Practice notes – Where new land is acquired which seems suitable for use as a private residence by the new owner but which at the time of the roll-over relief claim is not used as a private residence by the owner, a forward note should be made to review the position at, say, the three or six year points after the date of acquisition in order to ensure that the property has not become the only or main residence of the landowner.] [see CG61906]

  • Period of reinvestment 12 months before, or 36 months after the disposal of the old asset.

This relief – you can be claimed provisionally as well.

How to claim this relief? See section 18 and 19 of Helpsheet HS290 also see Example 17 and 18 for computation of relief.

3. Principal private residence relief (PPR).

Simple guidance on this relief is given in HS283 ; for detailed guidance see CG64200c.

If you dispose of a house which was any time your main residence you get this relief. If the dwelling house has not always been your only or main residence, you will need to split the gain as [Period of occupation1 + final 9 months2] / [Period of ownership1].

  1. Both period of occupation and ownership starts from 31st March 1982 if property owned before this date.
  2. The final 9 months of your period of ownership always qualify for relief, regardless of how you use the property in that time, as long as the dwelling house has been your only or main residence at some point.

Residence provided for a dependent relative – Second PPR Relief

A second PPR relief may be available on disposal of a residence which was provided to a dependent relative if certain conditions are fulfilled see [CG65550+.] . Main condition is that the residence was acquired for the dependent relative before 6th April 1988.

Conclusion:

In our case, as interest in the property was acquired by tax payer and his widowed mother before 1988 and they also full filled other conditions. So no Capital Gains Tax was payable.

For further reading on UK India taxation see our Worldwide blog

Indian Provident fund and UK taxation

Method to calculated tax on foreign pension lump sum with example. This blog post focuses on lumpsum received from India.

Summary

Withdrawal from Indian Provident fund by a UK tax resident will be taxable in the UK.

In India, payment from provident fund is usually (see note below in case of tax deduction in India)1 exempt income under section 10(11/12) of Indian Income Tax Act2.

But in case an individual who is a UK resident who takes a lumpsum from it, he will need to pay UK income tax on it3.

Main point to remember is value of Provident fund till 6 April 2017 may not be taxable. EIM 75550

Basic Method of calculating foreign pension income (ITEPA 2003 section 574A(3) as inserted by FA 2017 Sch 3 para 8-10) :

Foreign Lumpsum receivedsay £100
Less: Accumulated value before 6 April 2017say £40
Balance£60
Less: 25% of lumpsum£15
Taxable foreign pension£45

Source
Explanatory notes FA 2017; read Pages 46 to 49.

EIM 75550 has two good examples. Please use Internet Archive to see previous version of EIM75550.

Example 1 deals with personal pension plan tax computation, something similar to SIPPs in the UK.

In case of Public Provident Fund (PPF), as it does not satisfy the criteria of being a pension PTM021000 , it can be treated as a fixed deposit. As PPF can be foreclosed and money can be accessed after paying penalty, interest on PPF will be taxable in UK on yearly accrual basis – see Example 2 SAIM2440.

Example 2 deals with Employer Provident fund, calculation method is similar but eligibility for 100% deduction for accumulated value before 6th April 2017, depends on length of foreign service.

Conclusion

For many of us who may be forced to withdraw funds from their Indian provident fund, it is better to know that it is taxed at the highest marginal rate in the UK. Unless they withdraw it before coming to the UK.

Notes

  1. There are four types of provident funds in India – Statutory provident fund, Recognised provident fund, Unrecognised provident fund and Public provident fund each with their own detailed rules of taxation.

Source: Taxmann’s direct taxes law & practice by Dr Vinod K. Singhania para 56.

2. Source: ICAI Taxation of Non- Residents – Revised (2021)

3. Source: FA 2017 Sch 3 Part 3.

Bonus

  1. As per India UK DTAA Article 19 (2)- Any pension paid by Government of India to any individual shall be taxable only in India. Government of India means Union, State or Municipal – see Article 3 (1) (k). This is mainly useful for ex Indian defence force personnel now living in UK. Source: UK India DTAA Agreement – Synthesized text
  2. Pension annual allowance is restricted when taxpayer accesses their pension flexibly. Sec 227G FA 2004 defines when the restriction is triggered, it does not include lumpsum from foreign pension.

For further reading, visit our Worldwide Disclosure blog.

Types of pension schemes

There are three types of pension schemes:
1. Basic rate tax relief at source
2. Net pay arrangement
3. Salary sacrifice.

We see via example below the best option.

Example – Luca earns a monthly salary of £2,000 and makes a contribution of say £50 via employer’s occupational pension scheme.

Three different methods of Pension tax relief

  1. Basic rate tax Relief at source
TaxTax charged on gross salary i.e. £2,000
National Insurance Contribution (NIC) Both employer and employeeNIC charged on gross salary i.e. £2,000

In Basic rate tax Relief at Source scheme, pension company claims 20% tax back from HMRC and in case client is a higher rate tax payer, they will need to file a tax return and claim balance relief of 20% by increasing the basic rate threshold. Please ensure not to include employer’s contribution [link]. You should get details of your own contributions from your last payslip of the tax year.

No relief for extra NIC paid.

Please note NEST (UK State-sponsored) Pension scheme used by most small employer is a Relief at Source scheme.

2. Net pay arrangement

TaxTax charged on gross salary less pension deduction i.e. £2,000 – £50 = £1,950
National Insurance Contribution (NIC) Both employer and employeeNIC charged on gross salary i.e. £2,000

Relief for tax automatic as tax charged on wages less pension contribution but no relief for extra NIC paid.

3. Salary sacrifice: as per ITEPA 2003, section 308

TaxTax charged on gross salary less pension deduction i.e. £2,000 – £50 = £1,950
National Insurance Contribution (NIC) Both employer and employeeNIC charged on gross salary less pension deduction i.e. £2,000 – £50 = £1,950

Tax relief for both tax and NIC.

Thus, we will see that salary sacrifice method is the most beneficial way of contributing to employee pensions.

Limits to pension contribution

Contributions under Point 1 and 2 above can be between

Minimum             £2880 net 3600 gross

Maximum            Taxable earning of the employee

Note: Even when there are not taxable earnings like in case of non-working spouse, children or grandchildren. Minimum pension contributions can be made.

Under salary sacrifice scheme – Pension contribution can be higher than taxable earnings subject to Pension Annual Allowance, only condition is that director compensation (salary + pension) should be on commercial terms.

Note of Caution
Please note, these direct employer contributions are counted towards both Annual allowance and lifetime allowances.

Tax savings tips for self-employed and owner managed businesses

  • Conventional wisdom is running a business as a limited company is usually better than sole trader from tax perspective, not any longer see our calculator .
  • You may also our other blog re tax saving tips for PAYE individuals useful.
  • Employing family members
  • Shareholding to family members
  • Buying a van instead of a car.
  • Pensions1 – see blog
  • Renting part of home to the business.
  • Charging interest on Director’s Loan Account
  • Making use of Capital Allowances:
    Super Deduction
    Full expensing
  • Ensure to check your NIC Record
  • Sole traders can put excess funds in ISA or in an offset mortgage.
  • Buying assets for capital appreciation in children’s name (Bare Trust)as Parental settlement rules are not applicable for CGT. See blogs from Aberdeen and Step Journal.

Notes:

  1. Pension contribution lowers Income tax not National insurance contributions; unless it is salary sacrifice.