Getting started in business

Share Ownership for Employees – EMI

Posted by Kath Docherty on October 16, 2017  /   Posted in Business start ups, Employers, Getting started in business

Enterprise Management Incentives (EMI)

Retaining and motivating staff are key issues for many employers. Research in the UK and USA has shown a clear link between employee share ownership and increases in productivity. The government has therefore introduced a variety of ways in which an employer can provide mechanisms for employees to obtain shares in the employer company without necessarily suffering a large tax bill. Provided the company meets the qualifying conditions, EMI can be one of the most tax efficient and flexible means available.

EMI allows selected employees (often key to the employer) to be given the opportunity to acquire a significant number of shares in their employer through the issue of options.  Whilst an EMI can offer significant tax advantages, the key driver for any incentive arrangement should be the commercial objectives of the business.

This factsheet outlines the rules for EMI.

Tax problems under normal rules

If shares are simply given to an employee the market value of the shares will be taxed as earnings from the employment. This is expensive for the employee as he may not have any cash to pay the tax arising.

In order to avoid this immediate charge, options could be granted to an employee. An option gives the employee the right to obtain shares at a later date. Provided that the terms of the option are that it must be exercised within ten years, any tax liabilities will be deferred until the time the options are exercised.

This may still be expensive for the employee if he is not then in a position to sell some of the shares in order to pay the tax arising.

What does EMI offer?

EMI allows options to be granted to employees which may allow the shares to be received without any tax bill arising until the shares are sold.

How does it work?

Selected employees are granted options over shares of the company. The options should be capable of being exercised within ten years of the date of grant.

In order to qualify for the income tax and national insurance contribution (NIC) reliefs, the options awarded need to be actually exercised within ten years of the date of the grant. There is also a statutory limit of £250,000 in respect of options granted on or after 16 June 2012, which maximises the value of the options which may be granted to any one employee. No employee may hold unexercised qualifying EMI options with a market value of more than £250,000. The market value is taken at the date of grant.

What are the tax benefits to employees?

The grant of the option is tax-free.

There will be no tax or NICs for the employee to pay when the option is exercised so long as the amount payable for the shares under the option is the market value of the shares when the option is granted.

The EMI rules allow the grant of nil cost and discounted options. However, in these circumstances, there is both an income tax and an NIC charge at the time of exercise on the difference between what the employee pays on exercise and the market value of the shares at the date of grant.

Following the acquisition of the shares, when the option is exercised, an employee may immediately dispose of, or may retain the shares for a period before selling them. At such time there will be a chargeable gain on any further increase in value. The CGT liability will depend on the availability of any reliefs and annual exemption.

  • CGT at the rate of 10% applies to gains where net total taxable gains and income are below the income tax basic rate band
  • CGT on any part of gains above this limit will be charged at 20%.

In certain circumstances, in respect of shares acquired through exercising EMI options, Entrepreneurs’ Relief may be available to reduce the CGT liability to 10%. Although the Entrepreneurs’ Relief conditions have to be satisfied they are modified so that:

  • the 5% minimum shareholding requirement does not apply
  • and the 12 month minimum holding requirement is allowed to commence on the date the option is granted.

These rules apply to shares acquired on or after 6 April 2012.

What are the benefits to employers?

  • Employees have a potential stake in their company and therefore retention and motivation of these employees will be enhanced.
  • Options will not directly cost the employer any money in comparison to paying extra salary.
  • There will normally be no NICs charge for the employer when the options are granted or exercised or when the employee sells the shares.
  • A corporation tax deduction for the employer company broadly equal to employees’ gains.

EMI: Points to consider

There are a number of issues to consider in deciding whether EMI is suitable for your company.

  • Does the company qualify?
  • Which employees are eligible and who should be issued options?
  • What type of shares will be issued?
  • When will the rights to exercise options arise?
  • The costs of setting up the option plans are not tax deductible.

Does the company qualify?

EMI was introduced by the government to help small higher risk companies recruit and retain employees with the skills that will help them grow and succeed. The company must therefore:

  • exist wholly for the purpose of carrying on one or more ‘qualifying trades’
  • have gross assets of no more than £30 million
  • not be under the control of another company (so if there is a group of companies, the employee must be given an option over shares in the holding company).

The main trades excluded from being qualifying trades are asset backed trades such as:

  • property development
  • operating or managing hotels
  • farming or market gardening.

Which employees are eligible and who should be issued options?

An employee cannot be granted options if they control more than 30% of the ordinary share capital of the company. They must spend at least 25 hours a week working for the company or the group, or if the working hours are shorter, at least 75% of their total working time must be spent as an employee of the company or group.

Subject to the above restrictions, an employer is free to decide which employees should be offered options. The sole test is that options are offered for commercial reasons in order to recruit or retain an employee.

What type of shares will be issued?

EMI provides some flexibility for employers. For example, it is possible to limit voting rights, provide for pre-emption or set other conditions in respect of shares which will be acquired on exercise of an EMI option. The shares must, however, be fully paid ordinary shares so that employees have a right to share in the profits of the company.

When will the rights to exercise options arise?

The options must be capable of being exercised within ten years of the date of grant but there does not have to be a fixed date.

Examples of circumstances in which the options could be exercised include:

  • fixed period
  • profitability target or performance conditions are met
  • takeover of company
  • sale of company
  • flotation of company on a stock market.

Options can be made to lapse if certain events arise, for example the employee leaves the employment.

How we can help

Whilst an EMI can offer significant tax advantages, the key driver for any incentive arrangement should be the commercial objectives of the business. There are a variety of alternative arrangements which can be used each with their own conditions and advantages. We can help you decide whether EMI is appropriate for your business and whether the business will qualify. Please contact us for advice on the best options available for your business.

Research and Development

Posted by Kath Docherty on October 16, 2017  /   Posted in Business start ups, Employers, Getting started in business

Research and development (R&D) by UK companies is being actively encouraged by Government through a range of tax incentives. The government views investment in research and development (‘R&D’) as a key to economic success. It is therefore committed to encouraging more smaller and medium sized (‘SME’) companies to claim R&D tax relief

The incentives are only available to companies and include:

  • increased deduction for R&D revenue spending and
  • a payable R&D tax credit for companies not in profit.

The government is committed to improving access to R&D highlights the need for more SME companies to understand what relief is available and how the process of claiming tax relief works. Recent changes to R&D scheme rates have increased the relief available so a clear understanding is needed to ensure that companies are aware of how the tax rules work.

What are the tax reliefs available for SME companies?

A company can claim enhanced deductions against its taxable profits for expenditure which is qualifying R&D expenditure. The amount of the enhancement has increased over the years. The rate was 125% for expenditure incurred before 31 March 2015 and has increased to 130% from 1 April 2015. This amount is in addition to the actual expenditure (ie a 230% total deduction from 1 April 2015). R&D enhanced relief represents an additional corporation tax reduction of 26% of the expenditure incurred.

If the R&D claim creates a tax loss, then the company may be able to surrender the loss for a cash repayment. This is 14.5% for expenditure incurred on or after April 2014. A surrendered loss could therefore give a repayment of up to 33.35% of the expenditure.

Where the company incurs qualifying R&D expenditure before it starts to trade, it can elect to treat 230% of that expenditure as a trading loss for that pre-trading period. The pre-trading loss created by the R&D relief can then be surrendered, as above, which could provide much needed cash flow for new companies.

Qualifying R&D capital expenditure incurred by a company would be eligible for 100% research and development allowance. Details of this allowance are not provided in this summary.

Example of R&D claim

A company has adjusted net profits of £50,000 before an R&D claim and allowable R&D expenditure of £70,000.

The enhanced claim is therefore £70,000 x 130% = £91,000.

Deducting this from the adjusted profits gives a loss of £41,000.

The company decides to surrender this loss for a cash repayment. The amount they would receive is £41,000 x 14.5% = £5,945.

Research and Development Expenditure Credit scheme (RDEC)

R&D relief under the SME scheme is not available if the R&D project has had the benefit of a grant or subsidy. There may, however, be an alternative claim available to the company. This is known as the Research and Development Expenditure Credit scheme (RDEC). RDEC allows the SME to claim a taxable credit of 11% of eligible expenditure. As this amount is taxable it is known as an ‘above the line’ credit. The government has announced an increase in the rate of the R&D expenditure credit which applies from 11% to 12% where expenditure is incurred on or after 1 January 2018. The credit received is used to settle corporation tax liabilities of the current, future or prior periods subject to certain limitations and calculations. Where there is no corporation tax due the amount can be used to settle other tax debts or can be repaid net of tax.

The RDEC relief is also available to an SME for expenditure incurred on R&D that is contracted to it by a large company.

Qualifying projects

R&D relief can only be claimed by companies that have incurred expenditure on qualifying R&D projects that are relevant to the company’s trade. A project should address an area of scientific or technological uncertainty and be innovative. The innovation needs to be an improvement in the overall knowledge in the relevant field of research, not just an advancement for the company. Qualifying projects could include those which:

  • increase the life of a battery
  • create a new type of material in an item of clothing
  • develop new spark plugs for use in an existing engine.

An important point to appreciate is that the activity does not have to create something completely new from scratch. It could include:

  • developing a product that exists but where there is some technological uncertainty which can be improved
  • making an improvement to a product or process eg exploring new cost effective materials which will allow a product to perform better.

Companies should document the uncertainties and planned innovation at the start of a project to provide evidence to support an R&D claim.

Relevant activities on R&D

Once the company is comfortable that R&D is taking place, then the next step is to identify the activities of the business that relate to the R&D activity.

There are essentially two types of activities:

  • those that contribute directly to achieving the advancement
  • certain activities that indirectly contribute to achieving the advancement.

Examples of direct activities are:

  • scientific or technological planning
  • scientific or technological design, testing, and analysis
  • activities which design or adapt software, materials or equipment.

Examples of indirect activities are:

  • information services eg preparation of R&D reports
  • indirect supporting services eg maintenance, security, clerical
  • ancillary services eg paying staff, leasing laboratories and equipment.
  • Indirect activities would all have to be undertaken for the R&D project.

Once the project begins to be involved in the production process, any R&D activities are treated as having stopped as development has finished. It is therefore beneficial for companies to keep a timeline of activities and their purposes to detail when the business starts to move into the production phase and therefore optimise their claims.

Types of expenditure

Qualifying expenditure which is incurred on activities which are either directly or indirectly related to the R&D project fall into different categories. These are as follows:

  • staffing costs
  • software
  • expenditure on consumable or transformable materials
  • costs of work done by subcontractors and externally provided workers
  • costs of clinical trial volunteers.

To be eligible, expenditure must be revenue in nature and paid by the time that the R&D claim is accepted. This means any accruals for expenditure have to be monitored carefully after the year end to make sure that they are paid and not written back to profit.

Further detail on some of these categories is provided below.

Staffing costs

The staff costs include employees and director staff costs ie salaries, employer pension contributions, employers’ NIC but not non-cash benefits-in-kind. Where an employee or director only spends part of their time on an R&D project then the costs are apportioned. The relevant staff are those involved in the directly and indirectly related activities highlighted above.

The indirect activity list included categories for ‘supporting’ and ‘ancillary’ services. The staff who perform these services should be providing supporting or ancillary services for the R&D project and not for the other people who are directly involved in the R&D project.

Examples

  • The salary costs of a maintenance worker working full time on maintaining laboratory equipment used for R&D can be claimed.
  • The salary costs of an accountant keeping a record of the maintenance work done including the laboratory maintenance cannot be claimed.

If directors are taking dividends from the company rather than salaries it may be more beneficial to change this for any directors involved in R&D.

Consumable transformable materials

Materials that are consumed or transformed in the R&D activity are eligible expenditure. Items included would have to be items which were consumed or transformed so that they were no longer usable in their original form. This would therefore include:

  • water
  • power
  • fuel
  • a chemical substance which is transformed
  • an electrical component.

For expenditure on or after 1 April 2015, any consumables or transformable materials that are included in a product that is sold, transferred or hired out will not be qualifying expenditure for R&D relief.

Costs of work subcontracted out and externally provided workers

Where the SME subcontracts qualifying R&D work to a subcontractor, the SME can claim a deduction for the cost of the subcontractor work. The amount that can be claimed depends on whether the SME is connected to the subcontractor but generally it is 65% of qualifying costs. Similar rules apply to externally provided workers.

Methods of claiming tax relief

Companies can claim R&D tax relief in the tax return for the period when the expenditure is charged in the accounts of the company. HMRC have specialist offices which are able to offer advice on R&D claims.

Further support for businesses

.A number of measures have been announced in the Autumn Budget 2017 to support business investment in R&D including:

  • a pilot for a new Advanced Clearance service for R&D expenditure credit claims to provide a pre-filing agreement for three years
  • a campaign to increase awareness of eligibility for R&D tax credits among SMEs
  • working with businesses that develop and use key emerging technologies to ensure that there are no barriers to them claiming R&D tax credits.

How we can help

There are a number of areas in this briefing where you may need specific advice depending on the circumstances of R&D activities and expenditure so please do not hesitate to contact us.

Preparing for your Accountant

Posted by Kath Docherty on October 16, 2017  /   Posted in Book keeping, Business start ups, Getting started in business, Tax returns

Whether we are producing your accounts or carrying out your annual audit, being prepared for us will ensure our work is carried out smoothly and efficiently and with the minimum disruption to yourselves.

You may also be able to help by preparing some of the routine schedules for us. This will mean our time can be better spent advising you on the running of your business.

We highlight below many of the ways in which you can help.

It is however important for you to discuss these ideas with us since all of the suggestions may not be applicable.

Setting the scene

Keeping us informed

We will be better prepared ourselves if we know of any changes within your business which could affect our work. These could include changes in your:

  • product or market
  • business strategy eg pricing policy
  • bookkeeping system
  • key personnel.

What we need

If you know what information we need to be able to complete our work you can make sure it is available.

We can decide together what you can prepare for us and what we will need to prepare for ourselves.

Better communication between us will help to minimise misunderstandings and avoid unnecessary work.

Timetable

We need to agree a suitable timetable in advance. This gives us both a chance to be properly prepared.

However, if you find yourself behind schedule let us know as soon as possible so that the timetable can be rearranged if necessary.

How you can help

Books and records

Setting up and maintaining your books in an organised manner will help us to extract quickly and easily the information needed to prepare or audit your accounts. It will also enable you to see at a glance the state of your business.

Consideration of the following points may improve the organisation of your records:

  • totalling and balancing your books at regular intervals will help you spot and correct any mistakes
  • analysing your payments and receipts so that information can be easily extracted
  • filing your invoices in a logical order (numerical, alphabetical or date) to make it easy to find any one of them.

Procedures

By establishing and maintaining certain procedures you will be able to keep a better control over your records and your business. It will also mean we can cut down on the work we need to do which may save you some money.

We can help you set up these procedures initially and once established you will be able to carry them out yourself. These procedures will include control accounts, reconciliations and stocktaking.

Control accounts

Control accounts record the movements of cash, debtors and creditors by using the monthly totals from your cash book and sales and purchases summaries.

The cash control account will show how much cash the business has at the end of each month.

The debtors or sales ledger control account will show how much your customers owe you at the end of each month.

The creditors or purchase ledger control account will show how much you owe your suppliers at the end of each month.

Reconciliations

Reconciliations help to ensure that the figures in your books are complete and accurate. Therefore if produced on a regular basis they will help you spot any errors which can then be corrected before we examine your records. Some of the records which will need reconciling are:

  • bank accounts
  • control accounts
  • suppliers’ statements.

Stocktake

If your business carries any stock you will need to count it at least once a year. To ensure that the count is carried out efficiently and accurately you should consider the following points:

  • stock items should be stored neatly and logically to make counting easier
  • all staff involved in counting should be given clear instructions
  • try to minimise the movement of stock during the count. If possible deliveries in and out should be withheld until the counting has finished
  • spot checks should be performed during the count.

If you hold large amounts of stock we may need to attend the stocktake and perform our own checks.

Schedules

There are a number of schedules which have to be produced in order that the accounts can be prepared and/or audited. We can prepare all of these schedules ourselves but obviously if you were to produce them it would save time and money.

You may wish to consider the preparation of some of the following schedules:

  • a detailed list of additions and disposals of fixed assets with a copy of the appropriate sales and purchase invoices attached
  • schedules showing each item of stock held, the quantity, unit value and total value. Indicate any stock items which are old or damaged
  • a list of your debtors at the year end including how much they owe you and how long they have been outstanding. Indicate any which are unlikely to pay you
  • a schedule of all bank and cash balances at the year end, together with all the bank statements for each bank account
  • a list of creditors which should include HMRC as well as the usual business suppliers.

Not all of these schedules will be applicable to your business and therefore before doing anything you may wish to discuss this with us.

How we can help

There are undoubtedly many advantages to be gained if you are better prepared before we commence our work.

We will be able to complete our work in less time. This will mean less disruption to you and your staff. In addition we will be better placed to provide you with useful and constructive advice regarding the development of your business.

However, perhaps the most rewarding of all these advantages will be the fact that your books and records will provide you with more useful information which will help you make better informed business decisions.

If you would like to discuss these procedures any further or would like us to provide further assistance with your monthly or quarterly accounts please contact us.

Business Structures – Which Should I Use?

Posted by Kath Docherty on October 16, 2017  /   Posted in Business start ups, Getting started in business

Having made the decision to be your own boss, it is important to decide the best legal and taxation structure for your enterprise. The most suitable structure for you will depend on your personal situation and your future plans. The decision you make will have repercussions on the way you are taxed, your exposure to creditors and other matters.

The possible options you have are as follows.

Sole trader

This is the simplest way of trading. There are only a few formalities to trading this way, the most important of which is informing HMRC. You are required to keep business records in order to calculate profits each year and they will form the basis of how you pay your tax and national insurance. Any profits generated in this medium are automatically yours. The business of a sole trader is not distinguished from the proprietor’s personal affairs so that if there are any debts, you are legally liable to pay those debts down to your last worldly possession.

Partnership

A partnership is an extension of being a sole trader. Here, a group of two or more people will come together, pool their talents, clients and business contacts so that, collectively, they can build a more successful business than they would individually. The partners will agree to share the joint profits in pre-determined percentages. It is advisable to draw up a Partnership Agreement which sets the rules of how the partners will work together. Partners are taxed in the same way as sole traders, but only on their own share of the partnership profits. As with sole traders, the partners are legally liable to pay the debts of the business. Each partner is ‘jointly and severally’ liable for the partnership debts, so that if certain partners are unable to pay their share of the partnership debts then those debts can fall on the other partners.

Limited company

A limited company is a separate legal entity from its owners. It can trade, own assets and incur liabilities in its own right. Your ownership of the company is recognised by owning shares in that company. If you also work for the company, you are both the owner (shareholder) and an employee of that company. When a company generates profits, they are the company’s property. Should you wish to extract money from the company, you must either pay a dividend to the shareholders, or a salary as an employee. The advantage to you is that you can have a balance of these two to minimise your overall tax and national insurance liability. Companies themselves pay corporation tax on their profits after paying your salary but before your dividend distribution. Effective tax planning requires profits, salary and dividends to be considered together.

There are many advantages as well as disadvantages to operating through a limited company. We have a separate factsheet on ‘incorporation’ which considers the relative merits as well as the downsides of operating as a company.

New companies can be purchased relatively cheaply in a ready-made form usually referred to as ‘off the shelf’ companies. There are additional administrative factors in running a company, such as statutory accounts preparation, company secretarial obligations and PAYE (Pay as You Earn) procedures. A big advantage of owning a limited company is that your personal liability is limited to the nominal share capital you have invested.

Limited liability partnership

A limited liability partnership is legally similar to a company. It is administered like a company in all aspects except its taxation. In this, it is treated like a partnership. Therefore you have the limited liability, administrative and statutory obligations of a company but not the taxation and national insurance flexibility. They are particularly suitable for medium and large-sized partnerships.

Co-operative

A co-operative is a mutual organisation owned by its employees. One example of such an organisation is the John Lewis Partnership. These structures need specialist advice.

How we can help

We will be happy to discuss your plans and the most appropriate business structure with you. The most appropriate structure will depend on a number of factors including consideration of taxation implications, the legal entity, ownership and liability.

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