Jordi is a director and shareholder of Traiste Ltd. He has asked for your advice in connection with the forthcoming redundancy of an employee, the sale of shares in Traiste Ltd by his sister, Kat, and the payment implications for Traiste Ltd of alternative ways for Jordi to extract profits from the company.
Traiste Ltd:
– Is a UK resident unquoted trading company.
– Has two shareholders, Jordi and Kat, who each own 50% of the 1,000 £1 shares in issue.
Traiste Ltd – proposed redundancy package for an employee:
– An employee, Esta, will be made redundant on 30 June 2017.
– Esta will receive statutory redundancy pay of £12,000 and an ex-gratia payment of £36,000 from Traiste Ltd.
– Traiste Ltd will continue to lease a motor car for Esta’s personal use until 31 December 2017, although she has no contractual entitlement to this.
– The monthly lease payments are £420.
– The motor car has CO2 emissions of 178 grams per kilometre and is petrol powered.
– The motor car is currently worth £10,300. Its list price when new was £18,400.
Kat:
– Is resident and domiciled in the UK.
– Is 58 years old.
– Is a director and shareholder of Traiste Ltd.
– Will receive employment income of £34,000 from Traiste Ltd and dividends from other UK companies of £4,000 in the tax year 2017/18.
– Has already used her annual exempt amount for capital gains tax purposes for the tax year 2017/18.
Kat – proposed sale of shares:
– Kat subscribed for her 500 shares in Traiste Ltd at par on the incorporation of the company on 1 March 2013.
– She wishes to sell all of her shares before the end of 2017, and retire from the company.
– Kat’s brother, Jordi, has offered to buy these shares for £47 each. He is not prepared to sign any tax election in relation to this offer.
– Alternatively, Traiste Ltd will buy these shares for their market value of £52 each.
Jordi:
– Is resident and domiciled in the UK.
– Is 53 years old.
– Is a director and shareholder of Traiste Ltd.
– Is paid a gross annual salary of £50,000 by Traiste Ltd.
– Wishes to extract an additional cash sum of £30,000, net of all taxes, from Traiste Ltd, to be paid on 31 March 2018.
– The additional sum will be extracted as either a bonus or a dividend.
– Will not receive any other taxable income in the tax year 2017/18.
Required:
(i) Explain briefly the income tax implications for Esta in respect of each of the three components of the proposed redundancy package.
Note: Calculations are NOT required for this part.
(ii) Calculate the corporation tax deductions available to Traiste Ltd in respect of the redundancy package provided to Esta.
Redundancy package provided to Esta
(i) The statutory redundancy pay is exempt from income tax as it is within the £30,000 exemption available for termination payments.
To the extent that the ex-gratia payment exceeds the remainder of the £30,000 exemption, the excess will be charged to income tax at Esta’s highest marginal rate of income tax.
The continuing use of the company car will be valued according to the normal rules for calculating the cash equivalent of this taxable benefit. It will be wholly taxable as the £30,000 exemption is initially allocated, and has already been applied, to the cash receipts.
(ii) The amount deductible by Traiste Ltd in respect of the redundancy package for Esta is as follows:
Explain, with reference to the after-tax proceeds in each case, why Kat should accept Jordi’s offer to buy her shares in Traiste Ltd, rather than sell her shares back to Traiste Ltd.
Kat – proposed sale of shares
To Jordi
On the sale of the shares to Jordi, a chargeable gain will arise, calculated by reference to the market value of the shares as Kat and Jordi are connected persons. A chargeable gain of £25,500 (500 x (£52 – £1) will therefore arise on the disposal.
As Kat has held more than 5% of the shares in Traiste Ltd for more than 12 months, and works for the company, entrepreneurs’ relief applies.
As Kat has already used her annual exempt amount for 2017/18, there will be a capital gains tax liability of £2,550 (£25,500 x 10%).
Kat’s after-tax proceeds will be £20,950 ((500 x £47) – £2,550).
To Traiste Ltd
As Kat wishes to sell her shares before the end of 2017, the disposal will not qualify for capital treatment as she will not have owned the shares for the requisite five years until 1 March 2018. She will therefore be taxed on the receipt as a dividend.
She will be treated as receiving a dividend of £25,500 (500 x (£52 – £1)). This will be taxed as follows:
Explain, with supporting calculations, the amount of any payments to be made by Traiste Ltd to HM Revenue and Customs (HMRC) in respect of each of the two ways for Jordi to extract the additional £30,000 cash from the company, and state the due date of any such tax payments.
Jordi – extraction of profits
Payment of bonus
Traiste Ltd will have to account for income tax and class 1 employee’s and employer’s national insurance contributions (NIC), under the PAYE regulations.
Jordi will suffer deduction of income tax at the rate of 40%, and employee’s NIC at the rate of 2% on the gross amount of the bonus. The gross amount payable will therefore need to be £51,724 (£30,000/0·58).
The total amount payable to HM Revenue and Customs (HMRC) by Traiste Ltd will be:
