The title of this piece may read like an oxymoron, but if you persevere, I believe you will see that this really could be a very good time to engage in some tax planning.

After almost a decade of sustained economic growth we have witnessed a significant downturn in the last twelve months and at the time of writing this article there is little positive news to suggest that a dramatic turnaround is imminent.

In this context the impact of taxation on the financial position of taxpayers changes and they must alter their perspective to manage their tax affairs actively to best insulate themselves against the unpleasant effects of a recession.  Saving tax is conventionally associated with success and profitability, but this conventional view is matched with using taxation defensively in a downturn to minimise cost and enhance cash flows whenever possible.

This plan must start with the realisation that just as the profits and gains of economic prosperity create tax liabilities, a downturn presents opportunities to reduce, defer and perhaps even eliminate exposure to tax in its various forms.  These opportunities exist for investors, employers and companies as they can all take advantage of the recession to improve their situations, by reducing tax bills and to preserving precious cash. 

Tax is primarily levied on the creation and enhancement of economic value so the negative corollary of this proposition is that the reductions in values experienced in a recession may be used to pay less tax or even generate cash repayments of tax already paid.

This article gives an overview of the tax opportunities that avail themselves to investors, employers, employees and businesses in a downturn to demonstrate that in a recession, ignoring your taxation affairs is as perilous as doing so in a boom.

Investors

It is a gloomy time for most of those who invested over the last eighteen months or so but there are opportunities now to review portfolios and crystallise tax losses to set against gains or, in some circumstances, income.

Obviously stocks currently sat at a loss compared with their cost may, in time, appreciate and generate profits and gains but there are opportunities to use those latent losses now.  This can improve cash flow by accelerating tax relief, allowing losses and current gains to be netted off rather than investors paying tax now and waiting to benefit from their losses later.   

For those investments where all has been lost and the stocks have become completely worthless, and may have been suspended or de-listed, then securing tax relief for the loss must not be overlooked as cold comfort only.  In some cases, it is possible to use losses on shares to obtain a repayment of tax on income, so there could be an immediate cash flow benefit even if there are no capital gains on the horizon.  

This managed approach to crystallising and utilising losses in an investor’s portfolio, while seemingly common sense, is not always recognised, especially when investors are focused on the long-term recovery.  While an investor’s tax exposure may not decrease in the very long run as a result of securing losses, it should have an immediate positive cash flow impact.

Employers and Employees

Share based reward and incentive plans have become increasingly prevalent as a key part of employers’ attempts to recruit, incentivise, reward and retain employees in a tax advantaged manner.  Normally such remuneration mechanisms use the market value of shares as a strike price and give the future capital appreciation of those shares to employees. 

The last few years were characterised by large gains on options and very quickly share plans became a key point of remuneration packages across industries and throughout all the hierarchical layers of organisations.

In a downturn, the strike price, (the price at which the employees can buy shares, is often greatly in excess of the market price making their options wholly ineffective as an incentive until the share price improves.  While the share price is depressed this can lead to employees reassessing their packages and seeking a greater part of this to be cash rather than options.  In recessionary times this is another unwelcome pressure on an employer’s cash flow as well as further eroding morale.  

There is however an opportunity here to use the economic situation tax efficiently to find a silver lining to the dark cloud.  Re-pricing share options, while not always possible or popular due to scheme rules and market perception, can re-fresh and rejuvenate option schemes and hence improve reward and retention without generating a tax liability for the employee or a cash cost for the employer. 

In addition to re-pricing options, the depths of a recession can also be the best time to issue new options as this maximises the upside for the employees when the share price recovers.

Companies

While re-pricing options can help employers improve their employees position there are also areas where the company’s corporate tax position can be actively managed in adverse economic conditions.

Again these are primarily value driven actions that may seem like nothing more than sensible housekeeping.

Securing losses based on poor trading, capturing and crystallising losses arising from the fall in value of assets and maximising tax reliefs and allowances are all actions that companies must integrate even more into their finance function when times are tough and cash is short.  It is possible to access and have refunded tax paid in an earlier more prosperous year or to reduce current payments on account, both of which will help cash flow.

Summary

A Tax bill  may be an unwelcome sign of prosperity and profitability that everyone likes to reduce, but when there is an economic downturn the active management of your tax affairs, whoever you are, is just as important.

This active approach to taxation in a recession view as taxation in its true light as a cost that minimising is, if anything, more critical in depressed times than in a boom.

 

Pat Billingham is a former UK Inspector of Taxes and has been a partner in Ernst & Young for five years.  Pat is Head of Foreign Direct Investment in Ernst & Young’s Entrepreneurial Services London Office.  She has a wide range of experience in advising inbound clients on their tax affairs, including corporate structuring, cross boarder employee issues and UK tax compliance.

Pat’s team of FDI specialists consists of 60 financial and tax specialists, plus a group of experience project managers to facilitate the expansion plans of international businesses.

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