Although tax mitigation is usually the key aim of most company directors performing this task, they should not overlook the impression the accounts will give to other recipients:
- Credit Rating Agencies,
- Future Customers or Suppliers,
- Current Customers/clients (finances looking too rosy or too weak ???)
- Business Partners,
- Agencies (such as preferred supplier lists) who assess the type of contracts that you are eligible to tender for,
- Potential Buyers of the Business,
- Ex Business Partners or Family Members,
- HM Revenue & Customs, at a later date potentially, when, after the business has been sold or the owner has died, determine whether the business is a trading company or investment company (re entitlement to entrepreneurs relief and/or business property relief).
The financial picture presented by the accounts will probably be summarised within the following key performance indicators, which you should now seek to influence:
- Gross Profit Margin,
- Taxable Profit,
- Retained Profit,
- Net Asset Position.
Once a clear picture has been established of what results the company would like to report, and you have decided on how ‘aggressive’ a grooming exercise you now wish to undertake, various areas can be reviewed, to achieve this outcome. If tax minimisation is the key ‘driver’, care should be taken to leave sufficient cash in the business to:
- Leave positive distributable reserves,
- Settle normal trading liabilities, as they fall due for payment,
- Settle normal tax liabilities, as they fall due for payment,
- Fund any period of trading at a loss, if expected after the year end,
- Cover any ‘special projects’ that are being planned for the new financial year,
- Leave sufficient ‘rainy day money’ in the business, as an emergency operating buffer reserve,
- Enough cash, and overdraft facility, to fund the business’s normal working capital needs
Any cash/profits held over and above the aforementioned needs, is available to either reinvest in the business or to withdraw from the business, by taking deliberate pre year end planning actions.
Influencing the Timing of Transactions
The timing of sales around the year end can often be delayed and, in some circumstances, accelerated. Consideration should be given to an alternative pattern of invoicing customers, such as interim billing. Do not forget that unfinished projects, being undertaken to customer/client order, will be valued at selling price, not cost, so the timing of invoicing is irrelevant for profit recognition.
Some discretionary ‘spends’ can be influenced in a similar manner. This is particularly true for:
- Repairs and Renewals,
- Advertising and marketing,
- Recruiting (particularly where a recruitment commission is payable),
- Product Development (particularly if it qualifies for the generous Research & Development tax rules),
- Directors and other Staff Bonuses (even if only ‘minuting’ entitlement),
- Stationery and Other Office Supplies,
- Charitable donations,
- Employer pension contributions.
- Consideration should also be given to writing doubtful debts out of the sales ledger, to ensure that tax relief is obtained, and to avoid any possible arguments with the Inspector of Taxes over potential add-back adjustments for doubtful debt general provision movements.
Influencing the timing of profit recognition is usually undertaken for the cash flow benefit of delaying when tax is paid. Where tax rates are changing this can also be used to shift profits to a lower tax period.
Research & Development
Where there are eligible new products being developed, activities and spends should be structured to maximise entitlement to the extremely generous R&D tax relief.
Amending the Profit Extraction Policy
By its very nature, the means by which shareholder/directors remunerate themselves, is a deliberate decision. As well as considering the overall corporate and personal tax consequences of the remuneration structure, consideration should also be given to the commercial risk of leaving cash in the business and of how the mix and timing of the following remuneration streams affects the financial picture presented in the statutory accounts:
- Minimum salary (higher if IR35 is applicable),
- Employer contributions into Pension Scheme (including SSAS’s and SIPP’s),
- Tax free benefits in kind,
- Profits can be retained in the company, to build up cash reserves, to avoid the possible higher rate personal tax that would be incurred if profits were extracted as dividends. Company then liquidated, to distribute profits as a more tax efficient capital repayment,
- Taxable benefits in kind,
- Bonus (can be paid up to 9 months after the year end if a contractual or constructive obligation existed at the year end). Quite helpfully, under certain circumstances, deciding on the level of Bonuses can actually be left, within specified time limits, to after the year end, when perhaps draft accounts are available to assist in making this decision.
- In certain situations it may be possible to structure the money extracted from the business such that it is taxed under the more generous capital receipts regime (eg where an exit is also involved, by liquidation or purchase of own shares),
Where commercially justified, it may be possible to pay other family members, and utilise their tax allowances and lower rate tax bands.
Financial audits are undertaken either due to statute, contractual obligations (such as bank lending covenants, funding agreements or shareholder agreements) or on a voluntary basis. The main issues to consider pre year end are:
- Can the results be influenced to stay below the turnover and gross asset thresholds where a statutory audit is mandatory ?
- Is there commercial benefit in undertaking a voluntary audit ?
Reviewing the Company’s Accounting Policies
One of the responsibilities of Directors is to decide on the accounting policies most appropriate for calculating the financial results. These policies, therefore, should be determined with a view to prudence and commercial correctness, but also, with a view to achieving the company’s overall financial aims:
- Income Recognition,
- Expense Prepayments,
- Capitalisation of Fixed Assets (particularly intangible fixed assets),
- Expensing or capitalisation of R&D costs,
- Fixed asset revaluation,
- Amortisation of Intangible Assets,
- Valuing Stock,
- Recognising Profit on Long Term Contracts,
- Deferred Tax,
- Providing for Doubtful Debts and Obsolete Stock,
- Provision Accounting for future warranty, lease dilapidation and other future costs.
Interaction with Associated Businesses
Where there are associated or other group companies, the financial planning exercises of all concerns should be considered together, to see whether Management Charges, Group Relief claims, etc, could be used to move profits around, to benefit the combined interests. Such charges should take into account the commerciality of the transaction and the Transfer Pricing tax anti avoidance rules.
Consideration should also be given to whether there are any loss making ‘activities’ currently being carried out outside of the business which could perhaps now be consolidated. Care should be taken to understand the potential possible benefit in kind implications of such a structure.
In order to minimise the number of associated companies for corporation tax purposes, it is sometimes helpful to review and equalise any shareholders loans at the balance sheet date.
All options should be reviewed in financial planning, the following of which may be considered more structural in nature:
- Consider changing the year end, to capture or exclude a period of good or bad trading results (Many business owners wish to maximise the time between earning profits and paying tax on it, or conversely, minimise the time between suffering a loss and claiming tax relief or a refund),
- Consider whether trading through a single company is still the optimum trading medium. Other options include use of a group structure, other independent companies or an unincorporated business,
- Restructuring of personal borrowings to ensure maximum tax relief is obtained on interest costs,
- Changes to the share structure, including reclassification of existing equity holdings into ‘alphabet’ shares..
Strengthening the Balance Sheet
Consideration should be given to improving the impression given by the balance sheet as at the year end date by undertaking transactions beforehand:
- Consider recapitalising the company:
- as a paper only transaction, by either:
- capitalising stakeholders’ loan accounts, or
- undertaking a bonus issue,
- Introducing fresh funds into the company to clear any overdrawn directors loan accounts,
- as a paper only transaction, by either:
- Controlling the timing of paying creditors, to influence the amount of cash disclosed as held at the year end,
International Tax Status
If acceptable from a practical perspective, consideration should be given to actions which will result in future transactions being taxed via a more generous offshore tax regime:
- Individually reducing your time spent in the UK, to become non-resident,
- Changing your individual domicile to another tax jurisdiction,
- Controlling the company from outside of the UK, so that it has a permanent establishment overseas and hence is no longer liable to UK corporation tax.
Where there is a strong appetite for tax reduction and an appreciation of the associated risks, the option always exists to purchase a marketed tax scheme.
As well as influencing the detail contained within annual statutory accounts, directors should also manage how this information is released into the public domain, at Companies House. The 2 key aspects which can be controlled are:
- The timing of releasing this information. Efficient administration can expedite this, if desired, or use of the full filing period, can delay this, depending upon whether you wish to delay bad news or speed up good news,
- Often you will wish to speed up submission of poor results, if these release a tax refund.
- Whether full or abbreviated accounts are filed.
We fully encourage our larger corporate business clients to undertake the above annual pre year end financial review. This should ideally form part of managing a medium term business plan. We have much relevant expertise in this area, and welcome the opportunity for you to instruct us to undertake such an exercise with you.