Jet Accountancy

For inheritance tax (IHT), there are potentially two nil rate bands available. The first – the nil rate band – is available to everyone and is set at £325,000 until 5 April 2026. An estate does not have to pay any IHT up to this amount.

The second nil rate band is the residence nil rate band (RNRB). This is available where the main residence is left to a direct descendant, such as a child or grandchild. The RNRB is set at £175,000 until 5 April 2026. However, unlike the nil rate band, the RNRB is tapered where the value of the estate is more than £2 million. The RNRB is reduced by £1 for every £2 by which the value of the estate exceeds £2 million, meaning that it is not available to estates valued at £2.35 million and above.

Spouses and civil partners

An IHT inter-spouse exemption means that no IHT is payable on anything that a person leaves to their spouse or civil partner.

Each spouse/civil partner has their own nil rate band and RNRB for IHT purposes. The IHT rules also allow any portion of the nil rate band or RNRB which is not used on the death of the first spouse/civil partner to be transferred to the surviving spouse/civil partner and claimed by their executors on their death. This is useful where a couple wish to leave their estate to their surviving spouse/civil partner in the first instance and to their children following the surviving spouse/civil partner’s death, but do not want to waste their nil rate bands.

Transferring the nil rate band

The percentage of the nil rate band that was not used when the first spouse/civil partner died can be used by the surviving spouse/civil partner’s estate as long as:

• the couple were married or in a civil partnership when the first death occurred; and
• the unused nil rate band is claimed within two years of the death of the surviving spouse or civil partner.

It is important to note that it is the unused percentage of the nil rate band that is transferred, not the absolute amount. This provides an automatic adjustment if the nil rate band changes between the first death and the second death.

The way in which the claim is made depends on whether a full IHT return (IHT400) is needed. If a full return is required, the claim should be made on form IHT402, which should be sent to HMRC with the IHT400 (and any other forms that are required). The IHT400 should be sent to HMRC within 12 months of the date of death.

If the death occurred after 1 January 2022 and the estate is an excepted estate, the transferable nil rate band can be claimed when applying for probate.

Transferring the unused RNRB

As with the nil rate band, the unused percentage of the RNRB is available on the estate of the surviving spouse or civil partner. Again, this must be claimed. This is done on form IHT435 which should be sent to HMRC with the IHT400.

Example

Polly died in June 2017 leaving her estate valued at £600,000 to her husband Paul. At the time of her death, the nil rate band was £325,000 and the RNRB was £100,000.

Paul dies in May 2022. He leaves his entire estate, valued at £1.4 million to his daughter Poppy. In addition to his nil rate band of £325,000 and his residence nil rate band of £175,000 his estate is able to claim the unused portion of Polly’s nil rate band and RNRB, which is 100% in each case. Consequently, Paul’s estate is able to benefit from a further nil rate band of £325,000 and a further residence nil rate band of £175,000. As it is the unused percentage that is transferred, Paul’s estate benefits from 100% of the RNRB at its value of the time of his death (i.e. £175,000), rather than the absolute value of the RNRB at the time of Polly’s death (i.e. £100,000). Consequently, IHT is only payable to the extent that the value of his estate exceeds £1m (2x £325,000 + 2 x £175,000).

No-one wants to pay more tax than they need to. Consequently, it is important to keep good records of business expenses so that deductible expenses are not overlooked.

General rule

The basic rule is that a deduction is allowed for expenses incurred wholly and exclusively for the purpose of the trade, profession or vocation. Unlike the equivalent rule for employment expenses, there is no requirement that the expense is ‘necessarily’ incurred. This means that as long as an expense is incurred for the purposes of the business and only for that purpose, a deduction is given.

Private expenses are not deductible

No deduction is given for private expenditure and under no circumstances should private items be `put through the business’. It is good practice to keep private and business expenditure separate and to have a separate bank account for business expenses. If you run your business as a limited company, the company should have its own bank account.

Mixed use expenses

If you incur an expense for both business and private purposes, you can deduct the private element if this can be separately identified. This may be the case if you use a phone for business and private calls. Any apportionment should be on a just and reasonable basis. If you cannot separate out the private use and the expense has a dual purposes (such as work clothes which also provide warmth and decency), the expense should not be deducted.

No deduction for drawings

If you operate your business as a sole trader or other unincorporated business and you pay yourself a salary or take drawings from the business, you cannot deduct these when working out your profit. You pay tax on your profit and are free to use the profits as you please. However, if you operate as a personal or family company, you can deduct any salary that you pay yourself (together with any employer’s National Insurance and employer pension contributions).

Capital expenditure

Capital expenditure can only be deducted in computing profits if you use the cash basis and the expenditure can be deducted under the cash basis capital expenditure rules. You cannot deduct capital expenditure if you prepare accounts under the accruals basis.

Common deductible expenses

The actual expenses that can be deducted will vary from business to business – what is important is that they are incurred wholly and exclusively for the purpose of the business. However, the following are example of common deductible business expenses.

1. Cost of goods sold, such as raw materials and goods brought for resale.
2. Distribution and packaging costs.
3. Office expenses, such as stationery and printing costs and phone bills.
4. Travel and subsistence expenses, such as fuel parking and fares for using public transport and hotel bills for overnight business trips.
5. Motor expenses, such as car insurance, MOTs and repairs.
6. Staff costs, such as wages, salaries, employer’s National Insurance and pension costs.
7. Rent and rates.
8. Gas, electricity and water bills.
9. Repairs to business expenses.
10. Advertising and promotion costs.
11. Bank interest and other finance costs.
12. Accountancy, legal and other professional costs.
13. Uniforms (but not general clothing even if only worn for work).

Non-deductible expenses

A deduction for certain expenses is expressly prohibited. This includes the cost of business entertaining, which if deducted in computing accounting profit must be added back to arrive at taxable profit. Likewise, depreciation (an accounting concept) is not deductible in arriving at taxable profit; instead relief is given in the form of capital allowances.

If their profits are high enough, the self-employed pay two classes of National Insurance contribution – Class 2 and Class 4.

Class 2 contributions are flat rate contributions of £3.15 per week for 2022/23. It is the payment of Class 2 contributions that enables a self-employed earner to build up entitlement to the state pension and certain other contributory benefits. Class 4 contributions are payable on profits in excess of the lower profits limit, but do not garner any pension or benefit entitlement.

Lower profits limit for Class 4

The lower profits limit for Class 4 contributions is aligned with the primary threshold for Class 1 National Insurance contributions. This is set at £190 per week for the period from 6 April 2022 to 5 July 2022 (equivalent to £9,880 per year), rising to £242 per week (equivalent to £12,570 per year and aligned with the personal allowance) from 6 July 2022. The annualised primary threshold is £11,908. Consequently, the lower profits limit for Class 4 is set at £11,908 for 2022/23.

Class 4 contributions are payable at the main rate, which is 10.25% for 2022/23, on profits between the lower profits limit and the upper profits limit, which at £50,270 is aligned with the upper earnings limit for Class 1 contributions. Any profits in excess of the upper profits limit attract Class 4 contributions at the additional Class 4 rate, set at 3.25% for 2022/23.

Higher starting point for Class 2

Historically, a liability to Class 2 contributions has arisen where profits exceed the small profits threshold, which for 2022/23 is set at £6,725. However, the starting point for Class 2 contribution is to be increased with retrospective effect from 6 April 2022 to align it with the starting point for Class 4 contributions. For 2022/23, this is £11,908.

As Class 2 contributions earn entitlement to the state pension, self-employed earners who have profits between the small profits threshold, set at £6,725 for 2022/23, and the new starting limit of £11,908 will be treated as if they had paid a Class 2 contribution. This means they get the benefit of having paid a Class 2 contribution, but for zero contribution cost. This move brings the position of the self-employed with low profits broadly into line with that for employed earners with low earnings who are treated as having paid Class 1 contributions at a notional zero rate on earnings between the lower earnings limit (£6,396 for 2022/23) and the primary threshold (£11,908 for 2022/23).

Self-employed earners with profits below the small profits threshold can opt to pay Class 2 contributions voluntarily to maintain their contribution record. At £3.15 per week for 2022/23, this is a much cheaper option that paying voluntary Class 3 contributions, which are set at £15.85 for 2022/23.

Looking ahead

The Class 4 rates were increased by 1.25 percentage points for 2022/23 only pending the introduction of the Health and Social Care Levy. The rates are due to revert to 9% (main rate) and 2% (additional rate) from 2023/24. However, the self-employed will also have to pay the Health and Social Care Levy of 1.25% on profits in excess of the lower profits limit from 2023/24, so the total hit remains the same in 2023/24 as in 2022/23. However, unlike Class 4 contributions, liability to the Health and Social Care Levy remains beyond state pension age.