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What is the difference between tax evasion and tax avoidance. And what are the lessons for SMEs?

By Tony Golley on 08/05/2016 - 0 Comments

“In this world nothing can be said to be certain except for death and taxes”.

This is a much used quote by Benjamin Franklin, which takes on particular relevance now that tax havens and tax avoidance schemes come under the spotlight as individuals and corporations faced with high tax bills turn to illegal means to evade payment.

In the world of SME business it is fairly normal for a business owners to make financial decisions without full consideration of how their tax obligations can be minimised. As a result, many experience the cash flow ‘yo yo’ of funding quarterly VAT bills and the annual corporation tax.

What are the lessons to learn and how can businesses plan better to minimise tax? This article sets out some suggestions to help business owners to do this.

Firstly it is prudent to set the boundary of what is allowed by law in financial decision making. It is tax evasion that is illegal and is a usually a criminal office and is subject to a prison term or fine if one is guilty of it. Tax avoidance on the other had is perfectly legal and is subject to using tax system in such a way to reduce taxes. This is why issues such as changes to registration of companies to tax havens having different tax regimes such as the Cayman Islands have now come under the spotlight. However this hits murky water when the purpose of transfer of registration of company is primarily to avoid payment of tax, which is evasion.

In running a business there are many options available to the owner to enable them to plan their tax expenditure which are legal and within the boundaries of HMRC tax regulations. SMEs need to take into account tax implications to ensure that their businesses will stay competitive and grow. Any financial consequence due to tax implications which are unplanned or overlooked may add undue burden to the already tight cash flow of SMEs. At times, this may even be one of the causes for the business closure.

Set out below are some useful suggestions to help in tax planning in order to better mitigate tax spend:

1. Optimise the tax on your remuneration. Generally, a small salary (within the personal allowance – so no income tax or national insurance is due) will have been paid during the year with regular dividends to cover living expenses. Spouses, who ideally take an active role in helping run the business, can receive a small salary and dividends (subject to shareholdings) to maximize the use of both husband and wife personal tax allowances. As your year-end approaches, take time out to consider whether a final bonus or dividend should be awarded depending on available distributable profits, taxable profits and how much needs to be left in the business for future reinvestment etc.

2. Optimise the timing of dividend and bonus payments for cashflow and tax rates. Dividends and bonuses are taxed on business owners on a receipts basis. If your income is already high for one tax year then you may consider deferring paying out a dividend the following tax year so that it falls within the following year’s tax allowances and limits. Also, it may be possible to accrue a bonus in the current year, to be paid in the following tax year, but you still receive the corporation tax deduction upfront. This gives a useful cash-flow advantage and the bonus timing is applicable for all employees i.e. not just business owners.

3. Plan your spend on capital items to get tax relief quicker. Expenditure on computer equipment, desks, chairs etc attracts a write off. Make sure you bring forward any expenditure to reduce your taxable profits.

4. Get tax deductions now for provisions against stock and debtors etc. Consider the valuation of any stock or debtors at the year end and make specific provisions where the likely recoverable value is less than the original amount recognised. Provisions against specific items (on a line-by-line basis) are tax deductible for corporation tax purposes.

5. Claim loss carry backs as soon as possible to get refunds. If you have a forecast tax loss then it may be possible to carry this loss back to obtain a refund from HMRC. You may wish to get your skates on with the year end work so that you can promptly file the accounts and tax return and get the cash back as quickly as possible.

6. Don’t get time barred from lucrative tax incentives. Review available tax incentives such as R&D tax credits, capital allowances on fixed asset expenditure, loss carry back claims etc as the majority of such tax breaks have a time limit for you to be able to claim them with HMRC.

The key ingredient in the whole process is to keep your management accounts in order and to review these against plan on a monthly basis. Monthly cash flow planning is a vital ingredient which will help you to budget for each VAT period. Ensure you also get good advice to mitigate any potential tax you may incur in order to make sure your finances can be structured in such a way to maximise allowance and minimise the tax burden.

This is the vital ingredient of running a business effectively. Sound financial prudence and management will normally ensure you can stay in control of cash flow.

Tony Golley, May 2016

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