In this post, we look at the tax liabilities directors may have in relation to the company they work for.
Tax Owed by Directors on Non-Cash Benefits
Directors (and other employees) are liable to tax on non-cash benefits they receive from the company that employs them. We shall refer only to “directors” in this post for simplicity.
The whole area of employee benefits is a complex and specialised branch of tax, but this chapter attempts to give some guidelines on the pitfalls to avoid, and one or two opportunities as well.
Directors are also potentially liable to tax on any business expenses that the company reimburses to them, (but not if they were incurred for business purposes, generally speaking – i.e., the potential benefit of a reimbursement is cancelled out if the director can claim a business purpose for his or her expense that is being reimbursed).
Tax on Expenses Incurred by Directors.
Directors may incur expenses when on the company’s business. The most common example is travelling expenses.
Tax Treatment on: Travelling expenses
The cost of business travel is an allowable expense, subject to certain exclusions. The one that most commonly causes problems is travel from home to work.
Travel from your home to your normal place of work is “ordinary commuting” and the cost is NOT allowable as a business expense. This can be a particular problem for the typical small family company.
If the company has a headquarters, such as a rented office in a town, or a yard where it keeps its building equipment, then travel from home to that place is unlikely to be an allowable expense.
If, on the other hand, the company’s base of operations is the home of the controlling director, travel from his home to anywhere that the company’s business is being conducted – such as a building site, or a property being refurbished – is usually an allowable expense.
If a property investment company uses a letting agent to administer the properties it lets, then it is likely that HMRC will argue that the business is being administered through the agent, and that therefore the director’s home is just a home, and not where the company’s business is carried on, even if he brings paperwork home occasionally.
Any company whose directors are incurring significant travelling expenses should check with a Tax Adviser to confirm that the expenses are allowable – getting it wrong can be expensive, as we shall see in chapter 15, which deals with tax investigations.
Tax Treatment on: Cars
Most travelling expenses involve the cost of running a car.
It used to be a good tax planning idea to have the company own a car, and to allow the director to use it for both business and private purposes, as the rules for taxing directors on their private use of a “company car” used to be quite generous.
These rules have been made progressively more punitive over the years, and it is now very unlikely that it will be beneficial for a director who also owns the company to have a company car.
There is no substitute for doing the calculations specific to the individual director and car, but it nearly always turns out that he or she will be better off owning the car privately and charging the company for any business mileage, as below.
Tax Treatment on: Using Your Own Car for Business
A director who uses his or her own car for business mileage can be reimbursed tax free by the company at a rate of 45p per business mile for the first 10,000 business miles in the tax year (year to 5 April), and at 25p per mile for any further business mileage.
Note that this is now the only reimbursement that is allowable for employee tax purposes. If the director instead claims the actual cost of his business mileage from the company – by keeping records of all running costs and of his business and private mileage – then, when the company pays him for these expenses, the payment is taxable. Where amounts paid by the company are less than the HMRC-approved rates, then the difference can be reclaimed on your tax return – provided you maintain adequate records of the business mileage incurred.
Tax Treatment on: Using Cars for Sole Traders and Partnerships
A sole trader or partner in a property business can keep full records and claim the actual cost of the business miles, or he or she can opt for the flat rate mileage allowances described above.
Three Important Differences to Remember for Directors
This is an excellent example of three important differences between the tax treatment of companies and their directors, when compared to sole traders/partners:
- The relationship between a company and its director is more formal than that between a sole trader/partner and his business.
- The rules for directors tend to be more restrictive and punitive, when compared to sole traders.
- The differences between the two sets of rules defy common sense!
Other Taxable Expenses on Directors
Motoring expenses, providing the rules described above are followed, are not taxable on directors, but many other expenses potentially can be – for example:
- The company pays the director’s train fare to visit a development site where the company is building some buy-to-sell properties.
- The director has to attend a meeting to close a deal on a new property, and because it is a long journey from his home, the company reimburses him for the cost of an overnight stay in a hotel.
- The director uses his own credit card to pay for goods or services for the company, and claims the cost back from the company.
- The director takes herself and her spouse on a night out to celebrate finishing a challenging development project, spending £500 in total.
Following the abolition of “dispensations” in 2016, it is down to the employer to determine if an expense has been incurred for business purposes and may be considered non-taxable. Otherwise, it must be reported and will probably be taxable. Of the four examples above, the first three will likely pass muster, and it is clearly the last that is problematic. There are in fact reasonably generous provisions relating to annual staff events and ‘trivial’ benefits in kind but the cost in this case would exceed those thresholds, and would need to be reported to HMRC.
Where taxable, they must either be reported on the company’s annual return of benefits provided to a director/employee (known as a Form P11D) or, in the case of cash payments, they should strictly be paid under deduction of PAYE. Employers have the option now to “payroll” some benefits rather than use the P11D reporting system.
Taxation of ‘Shares as Rewards’ for Directors
We have seen how the company is owned by its shareholders, and how their shares entitle them to their proportion of dividends paid and, ultimately, to a share of the company’s assets when it is wound up. For many years, shares have also been used as a way of providing rewards to employees, and in some cases as a means of trying to pay them in a way that escaped tax and NIC, or reduced their impact.
As a result, HMRC and the Treasury have introduced increasingly complex and punitive rules taxing employees and directors on the benefit of any “employment related securities” (including shares) which they are given. This is not the place for a detailed examination of these but the following case study illustrates the type of pitfall to watch out for.
Tax Case Study: Shares as Rewards for Directors
Mr Fox and Mr Hound each own very similar property development companies. They are both the sole shareholders, and they are both getting on in years.
Mr Fox has two sons, who both work in the business, and he decides he would like to give them 24% of his shares each – Mr Fox is a great family man, and says he believes in “keeping the family business within the family”. He will still have 52% of the shares, but if all goes well over the next few years, he will be able to hand over full control and enjoy a well-earned retirement.
Mr Hound is in broadly the same situation and has exactly the same plans, except that in his case he has only one daughter, and no sons. He does, however, have a very loyal manager (not related to him and, though on good terms with the family, not a close friend), who has worked for the company for many years, and who could be trusted to help his daughter in running the company – “she has a good eye for property, and he is an excellent project manager”, he explains. Mr Hound does exactly the same as Mr Fox – he gives 24% of his shares each to his daughter and the manager, with a view to handing over to them entirely in a few years if all goes well.
Because Foxco Ltd and Houndco Ltd are both trading companies, Mr Fox and Mr Hound can “hold over” the capital gains tax on their disposals of their shares – which is just as well, because the shares are now worth tens of thousands of pounds – both companies are doing well and have a number of profitable projects on the go.
The tax treatment of the recipients of the shares is very different, though.
In the Fox brothers’ case, HMRC will probably accept that the gift of the shares is covered by the only exception to the rules for “employment related securities”, which excludes shares given to employees “in the normal course of the domestic, family, or personal relationships” of the person giving them.
There are no income tax implications for the Fox boys.
Miss Hound and the manager, however, are in a very different position. Because Miss Hound received her shares at the same time as the (unrelated) manager, it may be difficult to argue that hers were “domestic, family, or personal relationships” shares.
It certainly cannot be argued that the manager’s shares were not in some way related to his job.
You will also notice that Mr Fox was careful to stress the importance of family, and to downplay the obvious fact that he hoped the boys would be motivated to put more effort into the company once they owned a large slice of it, whereas Mr Hound could not resist mentioning what a good job the manager and his daughter were doing.
As a result, Miss Hound and the manager are exposed to Income Tax on basically the market value of the shares they have been given and, in the particular circumstances of this case, there may even be a PAYE and NIC liability, which Houndco will have to pay, and then further tax liabilities if Miss Hound and the manager do not reimburse the company for that tax and NIC.
If you think the distinction between the way the two companies were treated is exaggerated, please note that both Foxco and Houndco are based on real cases.
It is never safe to assume that if an employee or director (or their close family) acquires shares in the company he works for, then there will be no tax implications.
Even if you acquire your shares following the setting up your own new company, it is possible that the company will be required to report the fact (on a “Form 42” or its online equivalent, by 7 July after the end of the tax year in which you acquired the shares).
There are some narrow exceptions to this rule, but they are very narrow exceptions.
Always ask your Tax Adviser before you enter into any transaction involving shares and employees (including directors) – this is a complicated and ‘dangerous’ area, but to look on the bright side, there is much that can be done to reduce the tax burdens involved.
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