Tax Planning in a Recession
Author:
Maria Doherty
Ireland is now facing its most difficult period since high unemployment and emigration hit in the 1980s. Businesses are having to cope with a recession that is gathering momentum daily. For such businesses, cutting costs and maximising cashflows is a priority. With this in mind, Maria Doherty explores ways in which tax practitioners can advise businesses on how their cashflows can be improved from a corporation tax, income tax and VAT perspective and highlights certain possibilities from an estate and succession planning perspective to take advantage of declining asset values.
Cash is King for Businesses
With no sign of the credit crunch abating, clients are discovering how important it is from a business perspective to have access to cash. Outlined below are a number of methods by which cashflow can be improved.
Corporation Tax
Preliminary Tax Payments for Companies
Firstly the preliminary tax payment obligations of a company should be reviewed to identify any potential cashflow savings to be made. A company is currently obliged to pay preliminary tax within one month of the end of its financial year end. If it is a ‘small company’, i.e. its prior year corporation tax liability did not exceed €200,000, the company can base its preliminary tax payment on the lower of 100% of its prior year corporation tax liability or 90% of the current year corporation tax liability.
A ‘large company’ is obliged to pay 90% of its current year corporation tax liability in order to satisfy its preliminary tax obligations for the financial year in question. A small company would have traditionally availed of the option of basing its preliminary tax payment on 100% of the prior year’s corporation tax liability on the basis that this meant a reduced compliance burden for the company in estimating its preliminary tax payment. However, going forward, assuming that a company is going to be less profitable, it will be more beneficial for a small company to base its preliminary tax on its current year corporation tax liability as this will mean a reduced tax payment.
The new preliminary tax payment rules for large companies introduced in Budget 2009 should also be borne in mind when advising large companies in respect of their payment obligations in 2009. For companies with accounting periods commencing on or after 14 October 2008, an initial preliminary tax payment will need to be made in the sixth month of the accounting period based on 50% of the corporation tax liability of the preceding accounting period or 45% of the current year corporation tax liability. The second instalment (bringing the total preliminary tax paid equal to 90% of the current year tax liability) remains payable in the eleventhmonth of the accounting period. A large company should choose the least costly payment option available in relation to the first instalment of preliminary tax.
Utilisation of Trading Losses
A second option available to companies that have generated current year trading losses is to carry back such losses against prior year trading profits. This should enable the company to secure a corporation tax refund in respect of the prior year. In order to secure this refund, the company will need to speed up its audit process and the finalisation of its financial statements before the relevant corporation tax filings can be made. Alternatively, a company can opt to shelter any current or prior year non trading profits (which includes rental profits or chargeable gains) on a value basis. There is a two-year window within which to carry-back current year losses commencing from the end of the accounting period in which the losses arose.
It should be noted that the prior year carry-back of losses option is also equally available to property rental companies that may have realised Irish rental losses in the current year, for example due to bad debts. As with the carry-back of trading losses, there is a two-year time limit in which to make this claim.
Reducing Taxable Profits
Practitioners should also seek to examine ways in which clients can maximise deductions so as to reduce their taxable profits. Of particular relevance to the property development or construction sector and in the context of rapidly falling land bank values, practitioners together with professional valuers should be reviewing both site and work in progress valuations included in the financial accounts of their clients to ascertain whether a more conservative valuation should be made. Under general accounting principles, stocks must be stated in the accounts at the lower of cost or net realisable value. In view of the declining values in the property market, it is probable that writedowns will be required by such companies. Such write-downs will have the effect of either reducing current year profits or increasing the losses of a company which could be carried back and offset against profits of the prior year as mentioned above.
However, consideration should be given to any banking covenants that the company currently has and the impact on the future borrowing power of the company.
Income Tax and Sole Traders
Similarly, sole traders should also seek to maximise their cashflow position where possible. Most sole traders are obliged to make a preliminary income tax payment every year based on either 100% of their prior year income tax liability or 90% of their current year income tax liability. To the extent that profits are lower for the current year, it is recommended that the sole trader bases his preliminary tax payment on his current year income tax liability.
However, the sole trader will need to reasonably project his/her profits for the last couple of months to ensure that the preliminary tax payment for the year is not underpaid. If the individual carries on a property dealing or development trade, similar thought should be given as to whether a write-down of trading stock is appropriate in arriving at the individual’s accounting profit or loss. To the extent a loss is made, this loss could be available for offset against the total income of the current year.
There is no carry-back provision for trading income losses for an individual. Furthermore, it should be noted that the total income of an individual can only be sheltered by the trading loss provided that the loss did not arise to a limited partnership trade. This would be a partnership in which the individual would not be regarded as an active partner. An active partner in relation to a partnership trade means a partner who works for the greater part of his time on the day-to-day management or conduct of the partnership trade.
Therefore, if the individual has a number of business interests, he may not qualify as an active partner. Any trading losses arising in a limited partnership trade are only available for carry forward and offset against profits arising to that partnership trade and are therefore effectively ringfenced.
It should also be noted that to the extent an individual may have generated a rental loss in the current year, the individual is only permitted to carry that rental loss forward against future rental profits. This contrasts with the corporation tax position which permits a company that has generated a similar loss to carry back the loss to offset against prior year rental profits.
VAT Improvements to Cashflow
Small businesses can also improve their cashflow from a VAT perspective through opting to avail of the ‘cash basis’ of accounting for VAT. Typically businesses operate an ‘invoice/sale’ basis of accounting for VAT which means that the business would become liable for VAT at the time of issue of invoices to their customers regardless of whether or not they have received payment from those customers. However, the ‘cash basis’ is only available to certain types of businesses, namely businesses who supply 90% of their goods or services to unregistered persons or to persons who are not entitled to claim a full deduction for VAT charged to them or businesses whose annual turnover does not exceed or is not likely to exceed €1 million. Any VAT registered person who is eligible to use the cash basis of accounting must apply in writing to the relevant Revenue district for authority to switch their method of accounting for VAT.
Businesses should also consider their entitlement to claim bad debt relief where customers have defaulted in paying invoices. Bad debt relief enables businesses to recover VAT which would have been previously paid over in the VAT period in which the original invoice was issued to the customer. In order to be entitled to claim bad debt relief, a number of conditions must be satisfied, as set out in the VAT (Amendment) Regulations 2007. These are namely that the business must have taken all reasonable steps to recover the bad debt, the bad debt must be allowable for tax purposes and must have been written off as a bad debt in the financial accounts of the business. Additionally, the person from whom the debt is due cannot be connected with the business in order to qualify for the relief.
Capital Acquisitions Tax
Passing Wealth on to Next Generation
Rapid decline in property and equities’ values should be highlighted to your clients and with it that ‘now is the time to gift’ to their families. As all taxes on gifts, i.e. Capital Acquisitions Tax (CAT), Capital Gains Tax (CGT) and Stamp Duty are calculated by reference to the market value of the assets being transferred, it follows that while property and share values are low, it is an opportune time to make a gift. The advantage of gifting property to children now is that any future increase in the value of the property will accrue to them directly. Children can receive gift(s) or inheritances from their parents up to the current maximum lifetime taxfree threshold of €521,208 (2008 threshold) without becoming liable to CAT. If CAT arises on the transfer of property which also gives rise to CGT for the parent, the CGT can be credited against the CAT in most cases, thereby reducing the overall charge to tax to 22% (ignoring stamp duty). In order to avail of this CGT/ CAT credit, the property transferred must be held by the child for a period of two years or the relief is clawed back.
Following Budget 2009, a lower stamp duty cost will arise on the transfer of non residential property of 6%. This rate can be reduced further for transfers between relatives through availing of consanguinity relief which applies to halve the stamp duty bill to 3% of the value of the property being transferred. It should be noted that the stamp duty cost arising on the transfer of shares remains at 1% of the market value of the shares as consanguinity relief is not available in respect of share transfers.
Capital Gains Tax and Capital Losses
A further benefit can be gained by clients as a result of falling asset values, through crystallising capital losses now that will be available to carry forward indefinitely against future taxable gains. It is necessary for a person to make a disposal to an unconnected third party so that the loss can be used to shelter any future capital gains of the individual. If, for example, a parent crystallised a capital loss on the disposal of shares to a child, this capital loss is regarded as a connected party loss and can only be used against gains on other asset disposals to the same child. A more tax efficient option for the parent would have involved the parent selling the shares in the open market and gifting the proceeds to the children on the condition that they use the proceeds to purchase shares. By doing this, the parent will not be restricted in utilising the capital loss generated and the children still effectively receive a gift of shares.
Summary
Given the current economic climate, clients may be inclined to focus less on tax on the basis that thei respective businesses may not be as profitable as before and therefore tax planning is less of a priority to them. However, as you can see from the above, there are certain opportunities to be taken advantage of in particular when it comes to optimising a client’s cashflow position. Cash is at a premium for businesses today as a result of the credit crunch. Any suggestions that a tax practitioner can make which assist clients in improving their cashflow position can only serve to highlight the valueadded service provided.
Maria Doherty, ACA, AITI is a senior tax consultant with Purcell McQuillan Tax Partners.