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Is Time On Your Side

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Julie Butler - Expert Author

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14 November 2012

HMRC attack on Losses

It is understood that HMRC are increasingly taking a more detailed review at all sideways income tax loss claims. It is fair to say that the validity of income tax loss claims appear to be under attack from HMRC in respect of a number of areas, e.g. proof of commerciality and evidence of the potential to achieve a profit under the current business structure. HMRC have been raising questions about what each individual’s trade involves and have asked for sight of business plans that prove continuing viability.

The Time Commitment Test

HMRC have recently been taking a much closer, more in depth look at the involvement of the taxpayer in the businesses where income tax loss claims are made. In addition to checks on commerciality, there have also been questions raised on the compliance with the “ten hour” rule, i.e. the ‘time commitment’ test whereby it must be evidenced that the trader works an average of ten hours in the business. A recent First-tier Tribunal (FTT) case Johnson (TC2094) has provided a clear example of questions being raised over the “time commitment test”. HMRC place a particular focus on taxpayers who work “full time” or who are very actively involved in one or more profit making businesses, and therefore the questions of how the time commitment test can be achieved against the background of busy lives are raised with regard to any income tax loss claims made. So what are the facts of Johnson?

The taxpayer worked full-time for J and, in the remaining time available, also ran a yacht charter business. A management company was responsible for renting and chartering the vessel. The taxpayer claimed capital allowances on the yacht and applied to offset the losses against his other income under TA 1988, section 380. HMRC refused the claim, stating that the taxpayer was not substantially involved in running the trade of yacht chartering.

The taxpayer appealed against this decision. The FTT decided that the management company had acted as the taxpayer’s agent in arranging charters. It provided the lease of the yacht and various services inherent in that leasing. Therefore, the taxpayer could not set the losses arising from capital allowances against his general income because he had not met the time commitment test in ITA 2007, s75.

Perhaps the use of the terminology “full time“ job can be misleading. Full time generally means 37½ hours a week out of a total available of 168 hours per week with holidays of 4 to 6 weeks plus bank holidays. The success of the entrepreneur is often to work “smart not long” when it comes to hours for an alternative enterprise other than his/her place of full time employment. The principle of multiple businesses has, moreover, always helped the entrepreneurial ideal. It is essential that the fundamental ethos and spirit of commercial business is not lost with these restrictions of at least an average 10 hours a week being achieved.

Links to Inheritance Tax Relief's

The protection of the proof of potential profitability of any business and the need for active involvement are also linked to the IHT relief's of Business Property Relief (BPR) and Agricultural Property Relief (APR). In order to claim BPR the business must be a business carried on for gain s.103(3) IHTA 1984. The case of Balfour (RCC v Brander (as Executor of the Will of the Late Fourth Earl of Balfour) [2010] UK UT300 (TCC) looked at the active involvement of the deceased. Many APR cases likewise look at active involvement e.g. Arnander (Arnander v HMRC [2007] RVR 208). Engagement in farming activity was seen as key for the farmhouse to be deemed eligible for APR. The case of McCall (PN McCall & BJA Keenan (PR of Mrs McClean) v HMRC (2009) STC 990) looked at active involvement between a landlord and whether this role qualified as an active farmer. In protecting income tax relief's there is therefore also some form of IHT relief protection. The IHT preservation work can tie in so as to support work on income tax loss claims.

The cap on sideways loss claims

The HMRC aggressive approach to tax loss claims has possibly been taken a stage further with the 2012 Budget announcement about the “capping” of losses. The decision regarding any restriction or capping of losses was put on hold until the current consultation into the proposal could be considered. The deadline for this was 5 October. 2012

The consultation invited comments on the implementation and delivery of the loss restriction, including responses as to how an individual’s income will be defined and calculated for the purposes of the cap. It also looked at when the cap will apply, how relief's will be ordered, and the operation of the cap through income tax self assessment.

It is fair to say that many tax advisers and businessmen failed to appreciate the extent of the proposed claim.

The reliefs that are proposed to be capped are:

  • trade loss relief against general income;
  • early trade losses relief;
  • post-cessation trade relief;
  • property loss relief against general income;
  • post-cessation property relief
  • employment loss relief;
  • former employees deduction for liabilities;
  • share loss relief;
  • losses on deeply discounted securities; and
  • qualifying loan interest.

The current suggestion is to cap the relief's at £50,000 or 25% of income, whichever is the greater. Draft legislation is planned to be put before parliament very soon.

Tightening of the rules surrounding loss claims

Many would consider that HMRC have now tightened the conditions of income tax loss claims so “tight” there is very little room to move for manoeuvre for businesses with genuine losses. In very simplistic terms the rules are:-

a)    there must be evidence of commerciality, or the loss claim will be disallowed,

b)    there must be evidence of sufficient involvement in the business or the loss claim will be restricted to £25,000 – the “10 hour” rule,

c)    the loss claim must not exceed 25% of total income or it will be restricted to £50,000, subject to the current consultation.

Action Plan

The action plan to protect genuine sideways loss claims is that every taxpayer must “be prepared” for each of the areas of detailed enquiry by HMRC with good evidence and strong arguments. With regards to areas under attack:

a)    Commerciality – produce business plans showing that a profit can be made and it is anticipated. It is important to adjust the plans for actual results and show policy changes and action taken against any problems encountered.

b)    Active Involvement – document hours spent and work undertaken. Keep a diary – photographs can also help strengthen a case.

c)    25% cap – if the 25% cap does become law the focus will be forecasting income from all sources together with expenditure to ensure that the timing of any loss claim is correct. The outcome of the consultation is awaited with interest.

It has perhaps been taken for granted that loss relief will be allowed by the simple submission of the Tax Return but such claims must always be checked for validity when they are predicted through the business plan and realised in the Tax Return.


About the Author

Supplied by Julie Butler F.C.A. Butler & Co, Bennett House, The Dean, Alresford, Hampshire, SO24 9BH.  Tel: 01962 735544.  Email; j.butler@butler-co.co.uk, Website; www.butler-co.co.uk

Julie Butler F.C.A. is the author of Tax Planning for Farm and Land Diversification (Bloomsbury Professional), Equine Tax Planning ISBN: 0406966540, and Stanley: Taxation of Farmers and Landowners (LexisNexis).



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Article Published/Sorted/Amended on Scopulus 2013-01-18 09:06:17 in Tax Articles

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