Lecture 10 - Corp tax

8/7/2019 Lecture 10 - Corp tax

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Taxation

DFA 3004

Lecture 10


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Corporation Tax

Company: any corporate body (limited or unlimited) orunincorporated association, e.g. sports club

Corporation Tax: tax that companies pay on their profits

A companys chargeable profits include its income and

its chargeable gains Corporation tax is charged in respect of accounting

periods

Important to distinguish between: Accounting period: period for which corporation tax is charged

Period of account: period for which a company prepares set ofaccounts


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Accounting Period

An AP starts when: Company starts to trade (or receives income chargeable to CT) or

The previous AP ends

AP ends on the earliest of: 12 months after beginning of AP

The end of the companys period of account The date the company begins or ceases to trade

Important: length of AP can never exceed 12 months. If a companyhas a period of account exceeding 12 months (a long period), it issplit into 2 APs: the first 12 months and the remainder

E.g: If X ltd prepares accounts for the 30 months to 31 March 2010,

the AP are: 12 months to 30 Sept 2008, 12 months to 30 Sept 2009 and 6 months

to 31 March 2010


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Financial Year

Tax rates are set for financial years

A financial year runs from 1 April to the

following 31 March. For e.g. the yearended 31 March 2010 is the Financial year

2009 (FY 2009)

This should not be confused with a tax

year, which runs from 6 April to the

following 5 April


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Residence of companies

Company is UK resident if: It is incorporated in the UK or

If it is incorporated abroad and its central management andcontrol are exercised in the UK

Central management and control are taken to be wherethe board of directors meet

E.g: Smallville is a company incorporated in France. Ithas its head office in London where the Board ofDirectors meet monthly. It trades throughout the

European Union.

Is Smallville resident in the UK?


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PCTCT

Computation of Profits Chargeable to

Corporation Tax (PCTCT):

Trading income xInterest income x

Dividends from non-UK companies x

Property business profit x

Chargeable gains x

Total profits x

Less: Gift Aid donations (x)

PCTCT X


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Trading income

Important: dividends received from UK residentcompanies are usually exempt and so notincluded in PCTCT

Trading income of companies is derived fromthe net profit figure in the accounts, just as forindividuals

There are some minor differences

Gift Aid donations are paid gross by a companyand deducted when computing PCTCT


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Profits

A company pays corporation tax on its profits chargeable tocorporation tax.

Profits is PCTCT plus franked investment income (FII)

Although we tax PCTCT, another figure needs to be calculated(profits) to determine the rate of corporation tax to use to tax

PCTCT FII: grossed up (x 100/90) amount of dividends received from UK

and non-UK companies

Exception: Dividends which are received from a company which is a51% or more subsidiary of the receiving company or from acompany of which the recipient company is a 51% or more

subsidiary of the paying company. These dividends are completelyignored for corporation tax purposes.


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Rates

Rates of corporation tax are fixed for financial years

It is determined by: The financial year

Profits of the company

If profits are < 300,000 (the lower limit), the small companies rateapplies and PCTCT is charged at the small companies rate

If profits are > 1,500,000 (the upper limit), the full rate appliesand PCTCT is charged at the full rate

In exams, the rates will be provided.

Where profits are between 300,000 and 1,500,000, a specialmarginal relief applies.

Note: Although corporation tax is calculated on the PCTCT, it is theprofit figure that determines which rate to use.


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Marginal relief

Small companies marginal relief applies where the profits of an APof a UK resident company are over 300,000 but under 1,500,000.

Step 1: Calculate the corporation tax at the full rate (PCTCT x fullrate)

Step 2: Deduct the marginal relief from the corporation tax where

marginal relief is: (M-P) x I/P x marginal relief fraction

Where M = upper limit (currently 1,500,000)

P = profits

I = PCTCT

The marginal relief fraction is 7/400 for FY 2009 and FY 2008.

All this information is given in exams but need to remember what M,P and I stand for!

Do Lenox e.g


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Example

Lenox Ltd has the following for the year ended 31 March 2010:

PCTCT 296,000

Dividend received 1 Dec 2009 12,600

Calculate the corporation tax liability.

Small companies rate: 21%

Full rate: 28%

Lower limit: 300,000

Upper limit: 1,500,000

Marginal relief fraction: 7/400


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More on AP

An AP may fall within more than one Financial Year FY

If rates and limits for corporation tax are the same in both FYs, taxcan be computed for the AP as if it fell within one financial year

If rates and/or limits for corporation tax are different in the Financialyears, PCTCT and profits are time apportioned between the

Financial years. This will be the case where a company is a small company with an

AP partly in FY 2008 and partly in FY 2009.

Important: It is necessary to adjust the upper and lower limits.

Do the Elliot e.g.


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Short APs

If an AP lasts less than 12 months, the upper and lower limits whichare used to determined tax rates are pro-rated on a time basis.

E.g: Spot Ltd prepares accounts for the 6 months to 31 March 2010.PCTCT for the period were 200,000 and no dividends werereceived.Calculate the corporation tax for the period;

Solution: Upper limit 1,500,000 x 6/12 = 750,000

Lower limit 300,000 x 6/12 = 150,000

As profits fall between the limits small companies marginal relief applies.

CT (FY 09) is 200,000 x 28% = 56,000

Less Small companies marginal relief:

7/400 x (750,000 200,000) = 9,625Therefore, CT = 56,000 9,625 = 46,375


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Long Periods of Account

Remember: an AP cannot be more than12 months long

If period of account is >12 months, it mustbe split into two APs, the first fo 12 monthsand the second of the balance

Need to pro-rate the upper and lower limits

on a time basis for the second (short) AP


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Trading Profit

Earlier, we adjusted a sole traders trading profit for taxpurposes

Rules for companies are similar: Disallow expenditure which is not wholly and exclusively for

trade purposes Disallow entertaining (except entertaining staff)

Disallow expenditure on capital items

Adjust for expensive leased cars

Adjust for gifts to customers

Disallow depreciation Adjust for profits/losses on disposal of capital items

Adjust for non-trading income

Add back Gift Aid donations


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Trading profit

Differences are: Private use adjustments:

Any private use of assets by director/employee is ignored inthe capital allowances calculation.

Private expenses of director/employee are fully allowable

Interest payable/receivable: For companies, we have the loan relationships rules

If a company borrows or lends money, including issuing orinvesting in debentures or buying gilts, it has a loan

relationship Trading loan relationships are dealt with as trading income.

Non-trading loan relationships are dealt with as interestincome.


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Trading profits

Trading loan relationships:

Any interest payable or other debt costs, charged

through its accounts are allowed as a trading

expense and are therefore deductible incomputing trading profits

Any interest income or other debt returns, arising

on a trading loan are treated as a trading receipt

and are taxable as part of trading profit. This is

not common.


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Trading profits

Non-trading loan relationships: Any debits and credits must be pooled.

For e.g, a company paying interest on a loan

taken out to purchase an investment property willnot be able to deduct the interest from tradingprofits for tax purposes.

Instead, this non-trade debit must be netted offagainst non trade credits such as bank interest

A net credit (i.e. income) on the pool ischargeable as interest income.

Relief is available if there is a net deficit (i.e.loss)


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Trading profits

Dividends payable Dividends payable by a company are an

appropriation of profit and are not allowable as atrading expense

Capital allowances A companys accounting period can never exceed

12 months

If period of account > 12 months, it is divided into

two: one for the 1st 12 months and one for thebalance. Capital allowances must be computed foreach period separately.


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Classwork

Xenon Ltd makes up an 18 month set ofaccounts to 30 September 2010 with thefollowing results. Trading profits 180,000

Property income: 18 months @ 500 accruing permonth 9,000

Capital gain (1 Aug 2010 disposal) 250,000

Gift aid donation (paid 31 March 2010) 50,000

Question: what is PCTCT for each of the accountingperiods based on the above figures?


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Corporation Tax

Chargeable gains for companies are computed

in broadly the same way as for individuals

However, indexation allowance applies and

there is no annual exemption

Companies do not pay capital gains tax

Instead their chargeable gains are included in

the PC

TC

T


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Corporation tax

Therefore, when computing chargeable

gains for companies, bear in mind the

following 3 major differences:

Relief for inflation is available. Relief is called

the indexation allowance.

No annual exemption is available.

Different matching rules for shares apply if theshareholder is a company.


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Indexation Allowance

What is its purpose?

To remove the inflation element of a gain from taxation

In economics, inflation is a rise in the general level ofprices of goods and services in an economy over a

period of time. Companies are entitled to indexation allowance from the

date of acquisition until the date of disposal of an asset

Indexation factor is: RPI for month of disposal RPI for month of acquisition

R

PI for month of acquisitionThe calculation is expressed as a decimal and is rounded to 3 d.p.


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Indexation Allowance

Indexation allowance is available on the

allowable cost of the asset from the date of

acquisition (including incidental costs of

acquisition) It is also available on enhancement expenditure

from the month in which such expenditure

becomes due and payable.

Indexation allowance is not available on the

costs of disposal.


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Illustration

An asset is acquired by a company on 15 February 1983(RPI = 83.0) at a cost of 5,000. Enhancementexpenditure of 2,000 is incurred on 10 April 1984 (RPI= 88.6). The asset is sold for 25,500 on 20 December

2009 (RPI = 207.2). Incidental costs of sale are 500.Calculate the chargeable gain arising.

Indexation allowance (IA) cannot create or increase anallowable loss: If there is a gain before IA, the IA can reduce that gain to zero

but no further If there is a loss before the IA, there is no IA


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Capital losses

Capital loss arises if proceeds for asset are lower thanthe allowable expenditure

Remember: IA cannot create or increase a capital loss

Where allowable losses arise, they are set off againstcapital gains arising in the same AP

Any loss remaining, is carried forward againstchargeable gains of futures APs, as soon as they arise

Capital losses can never be set off against any other

income of a company


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Shares and securities

There are special rules for matching shares sold

by a company with shares purchased

For companies, the matching of shares sold is in

the following order: Shares acquired on the same day

Shares acquired in the previous 9 days. If more than

one acquisition, on a FIFO basis

The shares in the same pool (s104 pool)


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Shares and securities

Nor Ltd acquired the following shares in Last plc:

Date of acquisition No of shares

9.11.02 15,000

15.12.04 15,000

11.7.09 5,000

15.7.09 5,000

Nor Ltd disposed of 20,000 shares on 15 July 2009. How to

match it?


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Share pool

The share pool for companies is different to the share pool forindividuals

The pool keeps a record of the: Number of shares acquired and sold

Cost of the shares

Indexed cost of the shares (i.e. cost plus indexation allowance) Disposals and acquisitions which affect the indexed value of the

share pool are termed operative events

Each purchase and sale is recorded in the pool, but the indexed costmust be updated before recording the operative event

When calculating IA in the share pool, the indexation factor is not

rounded to 3 d.p.


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Share pool

Bonus Issues: When bonus shares are issued, all that happens is

that the size of the original holding is increased

Since bonus issues are at no cost, no need to adjustthe original cost and there is no operative event

Rights issues: Size of original holding is increased

New shares are paid for and this results in an

adjustment to the original cost

When calculating the IA, expenditure on a rights issueis taken as being incurred on the date of the issue


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Securities and shares

Example:

S Ltd bought 10,000 shares in T plc in May 2000(RPI = 170.7) at cost of 45,000.

There was a 2 for 1 bonus issue in October 2002.There was a 1 for 3 rights issue in June 2006 (RPI= 198.5) at a cost of 4 per share. S Ltd took upall of its right entitlement.

S Ltd sold 20,000 shares in T plc for 120,000 in

Jan 2010 (RPI 206.8). Calculate the chargeablegain.


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Rollover relief

The only relief available to companies is roll-over relief

As for individuals, a gain may be rolled over by a company wherethe proceeds on the disposal of a business asset are spent on areplacement business asset under rollover relief

Conditions:

Old assets sold and new asset bought are both used only in the trade Old and new assets both fall within either land and buildings or fixed

plant and machinery

Reinvestment of proceeds takes place in a period beginning 1 yearbefore and ending 3 years after date of disposal

New asset is brought into use in the trade on its acquisition

Note: Goodwill is not a qualifying asset.

The gain deferred is the indexed gain (i.e the gain after IA)


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Losses

Trading losses may be relieved.

The following reliefs are available:

Set-off against current profits

Carry back against earlier profits

Carry forward against future trading profits

A company must set off a trading loss which is

carried forward against income from the same

trade in future APs.

Relief is against the first available profits


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Losses

Example: Poppy Ltd has a current tax adjusted trading loss of 25,000 forthe year ended 31 March 2009.

The companys projected trading profits are as follows:

Y/ended 31 March 2010: 14,000

Y/ended 31 March 2011: 6,500

Y/ended 31 March 2012: 15,600Poppy Ltd also receives property business income of 5,000 each year.

Calculate Poppy Ltds PCTCT for the 4 years ended 31 March 2012 assumingthat the loss for year ended 31 March 2009 is carried forward and offsetunder s393(1) ICTA 1988.

Loss relief against total profits is given before gift aid donations.

A company may claim to set a trading loss incurred in an AP against total

profits before deducting gift aid donations of the same AP


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Losses

Current year relief: must be for the whole loss. Itis not possible to restrict the amount of the lossoffset.

Carry back relief: trading losses are set offagainst total profits (before deduction of Gift Aid)of the previous 12 months (LIFO basis)

Where loss-making period is < 12 months, noapportionment

The loss can be carried back in full, againstprofits within the preceding 12-month period


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Losses

Terminal loss:

Trading losses in the last 12 months of tradingcan be carried back and set against profits of

the previous 36 months without limit Property business losses:

Set off first against non-property businessincome and gains for the current period and

then carried forward against future income


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Groups A group exists for taxation purposes where 1company is a subsidiary of another

The % shareholding involved determines the

taxation consequences of the fact that there is agroup

3 types of relationship for tax purposes: Associated companies

75% subsidiaries Groups for chargeable gains purposes


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Associated companies

Associated companies: 2 companies are associated with each other if either:

One of the companies is under the control of the other or

They are both under the control of the same person or persons(can be company, individual or partnership)

Control means ownership of more than 50% of thecompanys issued ordinary share capital

Note: Companies which are associated for part of an AP are deemed

to be associated for the whole AP Both UK resident and overseas resident companies are included

Dormant companies are excluded


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Associated companies

Tax implications:

Upper and lower limits forCT are divided by

the number of associated companies

Intra-group dividends are not treated as FII

when calculating profits

Only one AIA is available for the group

(50,000 per annum)


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Groups

Within a 75% group: A company is a 75% subsidiary of another.

2 companies are members of a 75% group where one is a 75%subsidiary of the other or both are 75% subsidiaries of a 3rd

company current period trading losses, excess property business lossesand excess gift aid donations can be surrendered between UKcompanies.

CGT group: At each level, there is a 75% holding

The top company has an effective interest of over 50% in thegroup companies

assets are transferred at no gain and no loss

O Ltd e.g and P Ltd e.g

Lecture 10 - Corp tax

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