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Tax facts and legal lore

Passing JO3, tax and legal aspects of business, shows that advisers know the problems faced by businesses. The Chartered Insurance Institute provides exam tips and tells advisers where they need to concentrate efforts

Passing the tax and legal aspects of business unit, known as J03, demonstrates to clients that you have the knowledge to understand the main issues faced by small businessowners and managers. Anyone who has set up a business and employed people, made up accounts and paid tax will find much of the syllabus familiar.

There are seven major areas to the syllabus:

1 Legal forms of business

Know the major differences between partnerships and limited companies. Examiners will often ask you to compare the two under headings such as:

  • Relationships between the partners or shareholders
  • Relationships with third parties
  • Extent of personal liabilities

Examiners may ask how a limited liability partnership compares with traditional partnerships or a limited company or may ask what are the pros and cons of being a sole trader.

Learn how partners and directors can bind their business and their legal obligations under the Partnership Act or the Companies Act.

2 Accounting

Learn who must prepare accounts (all businesses except sole traders with very low turnovers), who must publish them (limited companies) and how detailed they must be (not very unless you are a large limLearn what must go into a directors’ report and the differ-ences between partnerships and limited companies ited company). Learn the thresholds to be treated as a small company. Understand what comprises a set of acc-ounts and what they show:

P & L: Income and expenses over a period

Balance sheet: Snapshot of assets and liabilities on a given day

Cashflow: Where money has come from and where spent

Learn what must go into the directors’ report for a limited company. Remember, only medium and large companies require their accounts to be externally audited.

Learn the accounting principles:

  • Accruals basis
  • Match income with related expense
  • Going concern
  • Consistency and comparability
  • Prudence
  • Reliability
  • Adhering to accounting concepts

And basic accounts ratios (and what they tell you):

  • Gross profit
  • Working capital
  • Acid test
  • Gearing
  • Return on capital
  • Debtor/creditor days

3 Financing

Put simply, a business – big or small – can only be financed by borrowing money from owners or third parties or by raising capital from owners.

Loans can be drawn such as overdrafts and directors’ loans or issued such as corporate bonds or debentures.

Loans pay interest (except for directors’ loans and partner’s current accounts) and may be secured by a fixed charge or by a floating charge over a class of assets or by all assets.

Capital defines ownership. It has no strings attached and is last in a winding up and last in getting the business income. It is either partners’ capital or company shares.

When asked how a businessowner should inject his finan-cing, the general answer is to provide as little capital as is necessary for the balance sheet, and lend the rest, it is more secure.

Because of “qualifying” interest, you may be asked about borrowing money to fund businesses. Think carefully about what the examiner means wherever you see the words “loan” or “borrowing”. Many candidates get confused and write about a businessowner borrowing money when the question actually refers to the owner lending the money to his or her business.

You do need to learn how to perform a discounted cashflow calculation to answer net present value calculations.

4 Taxation

Understand the basics of calculating income tax and capital gains tax and learn the following:

Corporation tax

Calculated by taking company profit, adding back disallowed items (for example, depreciation and entertaining), adding back charges on income (for example, charitable donations and interest paid) and deducting capital allowances, investment gains and income to ascertain trading profits.

Discount any brought forward losses to arrive at adjusted trading profits. Add investment income and gains and deduct allowable charges on income. This is taxable profit. Multiply this by the corporation tax rate in the tables.

Capital allowances

Learn the different classes and appreciate that you have both a first-year allowance and a general allowance.

VAT

Learn the threshold and rates in the tax tables and the difference between cash accounting and accruals accounting.

Business-specific capital gains tax issues

Learn the difference between rollover and holdover relief. Entrepreneur’s relief is now at 10 per cent. The previous fraction of 4/9th of the gain no longer applies.

Business-specific inheritance tax (IHT) issues

Understand what comprises a business asset, the two rates of relief and how it all applies.

Profit extraction
When comparing a dividend with a bonus, always remember the employer’s NI to be paid and learn how to calculate it from a gross cost of, say,

£100,000:
£100,000 £100,000
________ = _______ = £88,653
(1+12.8%) 1.128

Remember, if the company has £100,000 profit, it pays £21,000 corporation tax so what you need to compare is a bonus of £88,653 and a dividend of £79,000.

5 Employment Law

Employees must be given terms and conditions providing basic information such as:

  • Who they work for
  • Where and when they work
  • Pay and holiday.

Employers must pay the minimum wage or above and observe the working hours rules. Extra leave for sickness or maternity allowance must be paid and there are health and safety and employer’s insurance obligations.

Discrimination can occur on a number of grounds, including gender, sexual orientation, disability, ethnicity, religious belief and age.

You can dismiss employees through redundancy, retirement, capability, (mis)conduct or at the end of a fixed-term contract. Get that wrong and you have committed unfair or wrongful dismissal, which will You can dismiss employees through redun-dancy, retire-ment, capability, (mis)conduct or at the end of a fixed-termcost you extra money at a tri-bunal. If you want to sell your business, you need to get the new employer to accept everything you have done to your employees previously, under TUPE & ICE regulations.

6 Business protection insurance

Examiners will talk of shareholder protection arrangements and agreements. Arrangement refers to life policies and trusts. An agreement will be a cross option, buy and sell or automatic accrual.

You need to be aware of the problems with life policies under GWR and Poat rules.
Learn the rules governing tax relief on premiums and the calculation for a proportion of profits sum assured.

7 Insolvency

Simply put, people go bankrupt because they are insolvent. Equally, incorporated businesses are liquidated because they are insolvent. Companies can also enter receivership or administration.

All insolvency actions can be sued by creditors or the debtor themselves, invariably by application to a court. Both individuals and companies can make voluntary arrangements, sanctioned by the court and supervised by an insolvency practitioner (nominee), if 75 per cent of creditors agree.

Directors cannot trade while a company is insolvent but owners of unincorporated businesses can, but cannot sell assets under value, or show preferences between equally ranking creditors. Directors are punished for wrongful trading or fraudulent trading.

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