Host
Philippa Lamb
Guests
- Sally Baker, Head of Corporate Reporting Strategy, ICAEW
- Caroline Miskin, Senior Technical Manager, Digital Taxation, ICAEW
Transcript
Philippa Lamb: Hello, welcome back to the Insights podcast. I’m Philippa Lamb with our monthly roundup of accountancy news. This time we’re discussing upcoming changes to company size thresholds and what they mean for reporting requirements. Also today, a particularly hot topic in the news, capital gains tax on primary residences – how exactly does it work? To discuss those two, I’m joined by Sally Baker, Head of Corporate Reporting Strategy, and Caroline Miskin, Senior Technical Manager for Digital Taxation. Hello both, thanks for coming in.
Sally, should we start with company size thresholds? What’s happening?
Sally Baker: The UK government has announced plans to lay some legislation before parliament this summer to increase by about 50% the monetary size thresholds that are used to determine company size, with an intended effective date of accounting periods beginning on or after 1 October 2024. So, just to clarify, there are currently three thresholds that are used: turnover, total assets, and the number of employees. And it’s just the monetary threshold, just the turnover and the total asset numbers, that are being uplifted. The employee numbers will stay the same. To illustrate, at the moment, to qualify as a micro-entity, the threshold limit is set at turnover of £632,000, that’s going to go up to £1m, and the total assets currently sits at £316,000, and that’s going to go up to half a million. Similar thresholds in terms of small companies will go up to £15m turnover, and £7.5m for total assets. The distinction between medium and large, that threshold will move to £36m of turnover and £27m of total assets.
PL: These sound like quite significant rises.
SB: They are, they’re about 50%. That is partly due to inflation, but there’s also an element of future proofing in there as well.
PL: How many companies are we thinking will be affected?
SB: The impact assessment produced by the government estimates that around 130,000 companies in total will be affected. About 5,000 large companies might now qualify to be medium, about 13,000 medium might now qualify to be small, and perhaps most significantly, about 113,000 small companies could end up qualifying to be micro-entities.
PL: So quite large numbers. What led up to this?
SB: The original thresholds have been in place since about 2016, and they were bought in as part of the EU accounting directive, so there is an element of reassessing the thresholds and making sure that they’re appropriate for the UK following Brexit. Clearly, having been in place since 2016, there has been considerable inflation, so it is a case of just making sure that they are fit for today.
In May 2023, the Department of Business and Trade issued a call for evidence to gather views around the UK as non-financial reporting framework, and part of that call for evidence very much focused on thresholds and whether they needed to change. So that’s what’s been driving the uplift. There’s also been changes in the European thresholds. They have already moved their thresholds by 25%, they estimated that the inflationary change since around 2016 was 25%. The UK government has gone further, they’ve gone to about 50%, so there is that element of future proofing built in.
PL: What’s the ICAEW view on this? Are these welcome changes?
SB: We generally welcome those changes. In our response to the consultation to that call for evidence, we did suggest that the micro thresholds stayed the same, but we certainly recommended a review of the thresholds overall and are happy to see that they have been updated to reflect inflation and a bit more.
PL: In practical terms, what is this actually going to mean in terms of reporting requirements, changes to that?
SB: One of the key features of the UK’s reporting framework is around proportionality, that the reporting requirements change based around the size and the complexity of the business. For smaller, simpler businesses, there are less reporting requirements compared to larger, more generally complex businesses. So, by changing these thresholds and allowing more companies to move into a lower category, if you like, a smaller category, then there will be less reporting requirements that they have to comply with.
PL: But am I right in thinking the benefits might be limited for some companies?
SB: Yeah, there is an element of that. For example, if you are a company and you are relatively close to the thresholds, and you’re on a bit of a growth trajectory, then you might find that at the moment – assuming, of course, that this all does go through – in the next year or two you might drop down a band, but then you might find that after a couple of years you need to go back up into the original band that you were at. And if you’ve already got reporting systems and processes in place to cope with those additional reporting requirements, then moving down may not be seen as such an advantage after all.
PL: It’s quite onerous.
SB: There are also some concerns within the accountancy profession around the micro-entities regime. I mentioned that we recommended that those thresholds actually stayed where they were, and that’s because we’d like to see a broader review of the whole micro-entities regime.
PL: And why is that?
SB: Many people believe that micro-entity accounts provide so little information that they are essentially meaningless in terms of assessing the performance, the position and the future prospects of a company. There are also question marks around the deemed true and fair idea within micro-entity accounts. So, there are concerns about the micro-entities regime, and to have 113,000 small companies being able to qualify for that may not be considered beneficial by all. And I think the other thing to bear in mind is that there are other moving parts within the corporate reporting landscape at the moment. I’ve spoken previously on these podcasts about the changes in filing requirements for smaller micros that are coming in due course as a result of the Economic Crime and Corporate Transparency Act. Those changes are going to see a requirement to file a profit and loss account for small and micro, so on the one hand, being able to move down into the micro category and benefit from lower reporting requirements will then change when those reporting requirements get upped by having to file a profit and loss account in the future.
PL: Thinking about this very likely being an election year, is there going to be parliamentary time to get this legislation through?
SB: Well, none of us know when the election is going to be just at the moment. And given the time that we are talking, with the local elections this week, there are some schools of thought out there that the general election might be sooner rather than later, but who knows on that? So, as it stands, the intention is for this to be laid before parliament over the summer.
PL: And looking ahead, you think there’s more work that could usefully be done? Definitions of turnover, assets?
SB: Yes, I mentioned the call for evidence earlier, and there was certainly a lot of work that came out of that that could be done. And the government, perhaps not surprisingly given that it’s a general election year, have been focused on those changes that they can implement quite quickly in the near term. Longer term, there are some other things that we would like to see. For example, the thresholds revolving around turnover, total assets, number of employees – are they the right thresholds? There are also some question marks about the definitions of those terms within the thresholds. They would all benefit from a review. Some people think it shouldn’t revolve around those thresholds, that it should revolve more around the company structure, ownership structure. So, owner managed versus companies that have different directors and different shareholders. Should shareholders have a say in the regime that gets applied? There are plenty of longer-term considerations as well.
PL: Thanks, Sally.
SB: Thank you.
PL: If you’d like to know more about all this, you’ll find a full breakdown of the changes on the By All Accounts hub, and you’ll find that on the website.
Capital gains tax now – much discussed in the news lately, so we thought a quick refresher might be not only timely but useful for listeners who don’t deal with this particular tax every day. So Caroline, what’s the situation with couples and residences for tax purposes?
Caroline Miskin: The reason this is important is that only our main residence relief, more commonly known as principal private residence relief, is one of the most significant reliefs in the tax system. It costs the government finances a lot of money. It is the relief which everybody uses if they buy a house, live in it and sell it – that is the relief which means that you don’t pay capital gains tax. When it comes to couples, married couples and civil partners can only have one main residence for capital gains tax. And that applies even if a married couple or civil partners live completely separate lives in separate houses. Unless they are formally separated they are probably considered to be living together for the purposes of this relief.
PL: And are they free to choose which is their principal residence for CGT purposes?
CM: Yes, they are. A married couple or civil partners who own more than one home and who occupy more than one home are absolutely free to choose which is their main residence for this relief by sending HMRC a nomination determining which of the residences they wish to treat as their main residence. This has to be done within two years of them having two available properties. They can choose either property. You don’t have to choose [the house] which is in fact your main residence, but you just have to have two properties, which they’re living in, and it has to be within two years, and then a nomination can be made.
PL: What happens if you never make a nomination?
CM: If you never make a nomination, then when you come to sell one of the properties and you’re considering whether there’s any tax due, HMRC will look at the facts as to which was your main residence. So, to start with, both have to be residences, but they will look as to which is the main one. That doesn’t just depend on the amount of time that you spend in the two properties, it can be to do with quality of occupation – which are you effectively treating as your main property. For example, if you have one property where all your family are, that is more likely to be treated as your main property. But again, it depends on the facts in each particular case.
PL: So, the fact of being married or in a civil partnership is key here, isn’t it? Is that unusual in our tax system?
CM: Yes and no. In the income tax system, we’ve had independent taxation since the early 1990s, and marriage and civil partnership is not particularly relevant for income tax other than marriage allowance. When it comes to the benefits system and things like the high income child benefit charge, then you’re looking at the household and who is living together, but the legal arrangements don’t make any difference. But when it comes to capital taxes, marriage and civil partnership is extremely important, and it’s generally a big advantage to be married or civil partnered. For example, for capital gains tax, spouses and civil partners can transfer assets freely between them on a no gain or loss basis without triggering a capital gain. Marriage or civil partnership is very significant for inheritance tax. So, this particular rule is a slight disadvantage in that you can only have one property, but it should be seen in the context of actually, overall, capital taxes tend to favour civil partners and spouses.
PL: We’ve been talking about residences here. I am wondering what actually constitutes a residence for this purpose.
CM: That is a tricky point on which a lot of people do trip up. Because before you even get into considering whether you’ve got two residences, whether it’s possible to make a nomination, you have to look at whether it’s actually a residence – are you living in it? That all comes down to qualitative tests rather than quantitative tests. So, it’s all sorts of things like what address your banks use. Are you actually living there? Does it feel like a home, essentially, even if only for part of the time?
PL: So, is the purpose of this to avoid the possibility of developers claiming to be in residence? Is that what that’s about?
CM: There is a rule which means that if you buy a property with a view to making a gain, then this relief doesn’t apply at all. But it is to put limits on it for people effectively buying a property and developing it themselves and regularly selling it on using the relief, if they have more than one property and they’re trying to effectively use it to get a relief on a second property.
PL: So, the intention is very clearly for couples who occupy both properties. Got it. We’ve heard a lot in the press reports recently about allowable expenditure and improvements in this context. Can you just clarify what those terms actually cover, too, when you’re disposing of the residence?
CM: Allowable expenditure are exactly those expenses that you would expect to be able to claim for, the expenses that you incur when you buy and sell a property. So, things like the estate agents fee, stamp duty, any costs of a survey, the legal costs of conveyancing, anything to do with those transactions.
PL: OK, so that’s quite clear, but improvements, that’s more complex?
CM: Improvements is more complex. So, if you spend money on developing a property, then that potentially is another cost of the property which you can use to deduct when doing the calculation. But there are all sorts of rules about it. There is, to some extent some symmetry, because if you’re renting a property there are certain rules about what expenses you can deduct against rental income. Well, this rule means that those types of costs, that you couldn’t adopt, in theory, if you were renting it, you could potentially deduct because they are capital expenditure. So, they are things like improvements, like adding an extension, doing a loft conversion, something significant like that. The improvement does have to be reflected in the state of the property at the time you sell it. So, for example, if you put a conservatory on the back of your house, and then you decided a few years later, I don’t really like this, I’m going to demolish it and build a more full-blown extension, then you could deduct the cost of the full extension, but, because the conservatory is no longer there, you couldn’t deduct the cost of having built that. Abortive expenditure you cannot deduct either.
PL: What about decorating?
CM: Decorating wouldn’t be considered. That is a revenue expense rather than a capital expense.
PL: Obviously, it’s a tad complex. How much evidence do people need to keep if they want to be on the right side of this, to actually demonstrate what they have and haven’t spent and what they spent it on?
CM: Any accountant doing one of these calculations will be absolutely delighted if the client comes in with photographs, invoices, the more the better. Because first of all, you need to have the figures, but the before and after photographs are really, really helpful.
PL: And what if you don’t have those?
CM: If you don’t have those then you are potentially into a debate with HMRC as to try and prove the facts.
PL: A lot of what you’ve been describing sounds quite imprecisely defined. Is this why we see a lot of these cases coming up before tribunals?
CM: This relief certainly results in huge numbers of cases coming up at tribunal over the years. The law is reasonably clear. I think where the facts interact with the law can just get complicated. And frankly, people try to push the boundaries of what the relief is intended for. So, it’s the combination of the facts and the law.
PL: And presumably also, because the sums of all this can be really substantial, it’s worth arguing.
CM: They’re really substantial. It’s one of the most expensive reliefs for the government, after the personal allowance.
PL: There is a final complication, isn’t there, around a 60-day time limit?
CM: Yes, if you sell a residential property, then you’ve only got 60 days from the date of completion in which to report that gain to HMRC and to pay the tax.
PL: It’s a tight window isn’t it?
CM: It’s a tight window, and it was 30 days. This requirement came in in April 2020, right at the start of the pandemic, and we were all hoping that HMRC might defer it, but they didn’t. The limit has since been extended from 30 days to 60 days, which is a little more practical, but really you need to be set up and ready to do this before you actually sell the property, because often there isn’t enough time. It’s a really clunky system that HMRC has as well.
PL: Do people know about this? Are people missing this deadline?
CM: People are really missing this deadline. There’s been a lot of effort made to try and get the conveyancing industry to alert people to it, but tax tends not to be something that’s within their remit, and they just don’t want to get involved, even handing over a fact sheet or something like that. So, unfortunately, a lot of people are missing it, yes.
PL: And what happens then? There’s a penalty, presumably?
CM: The penalties are very similar to the self assessment penalties. It’s £100 after 30 days, with further penalties at six months and at one year. There are also £10-a-day penalties, similar to self assessment, but HMRC doesn’t actually charge those at the moment. And the late payment penalties mirror those for self assessment as well, so it’s 5% at 30 days and then further penalties for six months and 12 months.
PL: Thank you very much Caroline. I think we all understand it a bit better now, but it is complex, isn’t it?
CM: It certainly is.
PL: That’s it for this month. Head to the show notes for more information on both those stories. Join us later in the month for May’s In Focus podcast. Meantime, please rate, review and share this episode and subscribe to the whole series on whichever podcast app you prefer. You’ll find it everywhere. If newsletters appeal as well, you can also get daily, weekly or monthly newsletters from ICAEW Insights with all the latest accountancy news if you’d like to sign up for those too. Thanks for being with us.