London eS School of Business (-™ & Finance | powered by InterActive ACCA Paper F6 (UK) Taxation (TX) Class Notes June 2011 books 2000 blogspot.com© The Accountancy College Ltd, January 2011 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of The Accountancy College Ltd. 2 ‘ebooks2000 blegspet.com www.studyinteractive.orgContents PAGE INTRODUCTION TO THE PAPER s CHAPTER 1: FUNDAMENTALS OF TAXATION n CHAPTER 2: CAPITAL ALLOWANCES 35 CHAPTER 3: TRADING PROFITS & THE BASIS OF ASSESSMENT 59 CHAPTER 4: EMPLOYMENT INCOME 8s CHAPTER 5: PERSONAL TAX COMPUTATIONS 13 CHAPTER 6; TRADING LOSSES AND PARTNERSHIPS 14s CHAPTER 7; CORPORATION TAX COMPUTATIONS 171 CHAPTER 8: CORPORATION TAX LOSSES as CHAPTER 9; CORPORATION TAX GROUPS AND OVERSEAS ASPECTS 229 CHAPTER 10: FUNDAMENTALS OF CAPITAL GAINS TAX 253 CHAPTER 11: VARIATIONS TO THE CAPITAL GAINS PROFORMA 275 CHAPTER 12: CAPITAL GAINS TAX ~ SHARES AND SECURITIES 285 CHAPTER 13: CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS 297 CHAPTER 14: INHERITANCE TAX 329 CHAPTER 15: VALUE ADDED TAX 359 war. studyinteractive, org ost0it Bempaiean 3‘ebooks2000 blegspet.com www.studyinteractive.orgIntroduction to the paper InterActive sboole2000 Bae pelea www.studyinteractive.orgINTRODUCTION TO THE PAPER AIM OF THE PAPER To develop knowledge and skills relating to the tax system as applicable to individuals, single companies, and groups of companies, OUTLINE OF THE SYLLABUS Trading profits Capital allowances Employment Income Rental Income Investment Income Personal tax computations National Insurance Corporation tax Capital gains tax computations Inheritance tax 1. Value Added Tax FORMAT OF THE EXAM PAPER ‘The syllabus is assessed by a three-hour paper based examination. ‘The paper will be predominantly computational and will have five questions, all of which will be compulsory, Question one will focus on income tax and question two will focus on corporation tax. The two questions will be for a total of 55 marks, with one of the questions being for 30 marks and the other being for 25 marks, Question three will focus on chargeable gains (either personal or corporate) and will be for 15 marks. Questions four and five can be on any area of the syllabus and will respectively be for 15 marks each. Question 4 or 5 could be on inheritance tax or corporation tax including groups and overseas aspects of corporation tax. There will always be at a minimum of 10 marks on value added tax. These marks will normally be included within question one or question two, although there might be @ separate question on value added tax. National insurance contributions will not be examined as a separate question, but may be examined in any question involving income tax or corporation tax, Questions one or two might include a small element of chargeable gains. Any of the five questions might include the consideration of issues relating to the minimisation or deferral of tax liabilities. ‘The syllabus is assessed by a three hour paper-based examination. 6 ebooks2000 Beaspet.com www.studyinteractive.orgINTRODUCTION TO THE PAPER It assumes basic knowledge from ACCA paper F3 - (basic format Income Statements, the straight line and reducing balance method of depreciation etc) ‘The examiner is David Harrowven - he has been a very long standing examiner with the ACCA. He was the examiner for ACCA Paper 2.3 from December 2001 to June 2007. Be OR etd SUPPLEMENTARY INSTRUCTIONS 1 Calculations and workings need only be made to the nearest £. 2 All apportionments should be made to the nearest month. 3 All workings should be shown. The following tax rates and allowances are to be used In answering the questions in the June 2011 and December 2011 F6 exams. Income tax 2010/11 Other Dividends % % Basic rate £1 to £37,400 20 10 Higher rate £37,401 and above 40 32.5 Additional rate £150,000 and above 50 42.5 A starting rate of 10% applies to savings income where it falls within the first £2,440 of taxable income. Personal allowances £ Personal allowance 6,475 Personal allowance for those aged 65 to 74 9,490 Personal allowance for those aged 75 and over 9,640 Income limit for age-related allowances 22,900 Income limit for standard personal allowance 100,000 Cars benefit percentage The base level of CO, emissions is 130 grams per kilometre. A lower rate of 5% applies to petrol cars with a CO; emission of 75 grams per kilometre or less and a lower rate of 10% applies to petrol cars with CO2 emissions of 76 - 120 grams per kilometre. Car fuel benefit ‘The base level figure for calculating the car fuel benefit is £18,000. Authorised mileage allowance payments (AMAP) First 10,000 business miles is 40p per mile Any miles in excess of 10,000 is 25p per mile wow. studyinteractive,or =e=ei00 Donssteam 7INTRODUCTION TO THE PAPER Pension scheme limits Annual allowance £255,000 Lifetime allowance £1,800,000 ‘The maximum contribution that can qualify for tax relief without any earnings is £3,600. Capital allowances Plant and machinery Main pool - writing down allowance 20% Special rate poo! - writing down allowance 10% Motor cars C02 emissions up to 110g per kilometre 100% CO2 emissions between 111 and 160g per kilometre 20% C02 emissions over 160g per kilometre 10% Annual investment allowance £100,000 Industrial buildings allowance Writing down allowance 1% Corporation tax Financial year 2007 2008 2009 2010 Small profits rate 20% 21% 21% 21% Main rate 30% 28% 28% 28% Lower limit (£) 300,000 | 300,000 | 300,000 | 300,000 Upper limit (£) 1,500,000. | 1,500,000 | 1,500,000 | 1,500,000 Marginal relief fraction 4/40 71400 | 7/400 7/400 Marginal relief (U ~ A) x N/A x Standard fraction Value added tax Standard rate of VAT Up to 3 January 2011 17.5% From 4 January 2011 20% Registration limit, £70,000 Deregistration limit £68,000 8 ebooks2000 Beaspet.com www.studyinteractive.orgINTRODUCTION TO THE PAPER Capital gains tax Annual exemption Rate of CGT Lower rate Higher rate Entrepreneurs’ relief = Lifetime limit - Rate of CGT Inheritance tax £1 - £325,000 Excess ~ Death rate - Lifetime rate Nil Rate Bands 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 and 2010/11 Taper Rel Over 3 years up to 4 years Over 4 years up to 5 years f Rates Over 5 years up to 6 years Over 6 years up to 7 years Over 7 years Rates of interest Official rate of interest Interest on underpaid tax: Interest on overpaid tax £10,100 18% 28% £5,000,000 10% Nil 40% 20% é 255,000 263,000 275,000 285,000 300,000 312,000 325,000 Percentage Reduction 20% 40% 60% 80% 100% 4.00% 3.00% 0.5% National Insurance (not contracted out rates) Class 1 Employee £1 to £5,715 per year £5,716 to £43,875 per year £43,876 and above per year Nil 11% 1%. www. studyinteractive.orgoeeKs2000 blogspet.comINTRODUCTION TO THE PAPER Class 1 Employer £1 to £5,715 per year Nil £5,716 and above per year 12.8% Class 1A 12.8% Class 2 £2.40 per week Class 4 £1 to £5,715 per year Nil £5,716 to £43,875 per year 8% £43,876 and above per year 1% LP December | gune | December | June | December | une | December 2007 | 2008/ 2008 | 2009| 2009 2010 2010 Pass fate | 48% | 50% | 53% | 61% | 51% 46% How do I get the most from my course? * Try and be seated and pick up your handout by the start of the lecture. This will ensure we have the maximum lecture time. Your course notes will be in divided into chapters, please make sure you bring the relevant chapters with you to class. + Due to the vast scope of material we have to cover we do not have time to work through sufficient exam questions in class. To expose you to exam questions I give you an exam question on each major area for you to attempt at home in your own time. It is essential that you find the time to do the little homework given and the tests that will be provided. Failure to do this may result in misunderstanding and panic in the revision phase. + Manage your time effectively. If you have a busy work schedule use your study planner to catch up. Do not allow yourself to fall behind. + Learning tax is like building a house. You need a strong foundation. Take time to learn the basic lectures and this will help you with the more involved areas. + If you have any difficulties or questions please do not hesitate to contact me either before the lecture or during the break as most students are in 2 desperate hurry to leave at the end of the lecture. Alternatively, you can always email me or phone me through our helpline. + In the event of an emergency you can come for the same lecture on a corresponding part-time course as all the courses run parallel to each other. It is crucially important that you attend the full course of lectures. 10 ebooks2000 Beaspet.com www.studyinteractive.orgChapter 1 Fundamentals of taxation London FZ School of Business & Finance powered by InterActive ANALYSIS OF PAST EXAM QUESTIONS pitot | Pec | June | Dec | june | Dec | June | Dec 2007 | 2008 | 2008 | 2009 | 2009 | 2010 | 2010 Question | + . . . : ° ° Question 2 . : . Question 3 Question 4 . Question 5 a1 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 1 - FUNDAMENTALS OF TAXATION baa ed 13 BACKGROUND AND THE EXAM FOCUS PROFORMA - PERSONAL TAX COMPUTATION ~- 14 CURRENT TAX LEGISLATION 15 METHODS OF COLLECTING TAX -- 16 BADGES OF TRADE 19 ADJUSTMENT OF PROFIT 21 ADJUSTMENT OF PROFIT PROFIT ~ EXAM TECHNIQUE aa DISALLOWABLE EXPENDITURE 22 SCHEDULE OF ALLOWABLE AND DISALLOWABLE EXPENDITURE 24 ANSWERS- 30 12 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 1 - FUNDAMENTALS OF TAXATION erie Sci teh eu ial tek hd In order to understand income tax it is important to know what constitutes income. One type of income which is being studied in this chapter comes from running a business, this is called self employed income or trading profits. ‘The income tax computation is used to compute the total income tax payable by a person each tax year. It Is a very important area of the syllabus, and will always be tested in question one of the paper. A person who has self employed income will pay income tax and another tax on that income which is called national insurance. The calculation of the national insurance will be covered in a later chapter, www.studyinteractive.orgbemks2000 blogspot.com 13CHAPTER 1 - FUNDAMENTALS OF TAXATION PROFORMA -— PERSONAL TAX COMPUTATION 2010/11 £ Trading Income x Rental Income x Employment Income x Pension Income x Interest Income (received net x 100/80) x Interest Income (received gross ~ NSB interest) x Dividend Income (received net x 100/90) x Total Income x Less: Interest on qualifying loans (paid gross) Co) Net Income x Less: PA/PAA CoMCril) Taxable income x Part 2 ~ Income Tax £ 37,400 x 20% x 37,401 ~ 150,000 x 40% x 150,001 + x 50% x Income Tax liability x Part 3 Less: Tax deducted at source Notional tax credits on dividends 9 20% x Interest ®) PAYE 9) Tax payable/repayable under self assessment XX) * It is necessary to extend the basic rate band if a person is a higher rate taxpayer and * makes a donation to charity under the gift aid scheme, or makes a payment into a personal pension plan. 14 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 1 - FUNDAMENTALS OF TAXATION cS eee) Each year the Chancellor introduces his budget (Finance Bill). Once this Bill has been passed by Parliament it becomes a Finance Act. ‘The budget given in March 2010 became the Finance Act 2010 Each Finance Act is normally the current tax legislation for 12 months - the financial year for companies and the tax year for individuals. The financial year runs from 1 April to 31 March. ‘The financial year 2010 (FY 2010 = 1 April 2010 - 31 March 2011) The tax year runs from 6 April to the following 5 April The current tax year runs from 6 April 2010 ~ § April 2011 (2010/2011 = 10/11) Types of tax Income tax : National Insurance Capital gains tax : Corporation tax - VAT - Inheritance tax : www.studyinteractive.orgbemks2000 blogspot.com 15CHAPTER 1 - FUNDAMENTALS OF TAXATION METHODS OF COLLECTING TAX Tax is collected in one of two ways. [By deduction at source ] Some income Is received net of income tax. This tax is deducted at source and pald directly to Her Majesty’s Revenue and Customs (HMRC). Examples include: (4) Bullding society interest (2) Bank interest (3) Dividends from UK companies (4) Interest received from unquated companies (5) Salary from employment By assessment Some income is received gross (i.e. no tax is deducted at source). The tax on this income is collected by Her Majesty's Revenue and Customs (HMRC) under the self assessment rules. Examples include: (1). Profits of a trade, profession or vocation (2) Rental income (3) Interest from the Government (interest from gilts, interest from the National Savings and Investment Bank (NS&I bank). (4) Interest from quoted companies (corporate bond interest and debenture interest) 16 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 1 - FUNDAMENTALS OF TAXATION Example 1 - Bill Bunter Bill runs @ business selling mobile phones. He also has some additional types of income. Bill needs some help in completing his tax return and computing his Income tax payable for 2010/11 The following information relates to Bill (1) He receives dividends from his BT ple shares of £1,800 on 30 June 2010. (2) Bill received interest on a building society account of £4,000 on 30.4.10 and £5,000 on 30.4.1 (3) _ Bill receives interest from corporate bonds in BT pic of £10,000 each year, (4) Bill prepares his income statements up to 31 December each year and in the year ended 31 December 2010 he has sales revenue from selling mobile phones of £120,000 (gross) and incurred allowable expenses of £30,000 during the year. Bill claims depreciation of £15,000 anc capital allowances of £10,000. Bill employs his wife Betty in the business and pays her a salary of £8,000. (5) Bill owns some offices which he lets to another company called Brother Ltd for an annual rent of £25,000. Bill incurs allowable expenses of £5,000 in connection with this property. (6) In December 2010 Bill sold some BT shares for £40,000. Bill had bought all the shares for £20,000. Required (a) Detail the different amounts taxable on Bill in the tax year 2010/11. (b) What taxes will Bill pay on his income and capital gains? www.studyinteractive.orgbemks2000 blogspot.com 17CHAPTER 1 - FUNDAMENTALS OF TAXATION Description | Name Amount Subject to Assessment | Taxable in Which Tax 10/11 18 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 1 - FUNDAMENTALS OF TAXATION CEI eal A trade is like @ monkey or an elephant, easy to describe but difficult to define - 7 P Harrison v Griffiths. TA 1988 states that word trade ‘includes every trade, manufacture, adventure or concern in the nature of trade’ This is very subjective, generally the more badges which are found to be present then the greater is the probability that a trade exists. However in some cases the existence of only one badge can be sufficient, this was found to be the case in CIR v Rutledge. The badges of trade are indicators or sign posts which if present are Indicative that 2 person Is trading and therefore should pay income tax and national insurance on their profits from trading, Subject matter Anything can be Inventory stock but some Items are more likely to be so than others. CIR v Rutledge A sale of a substantial number of tollet rolls was trading. There are a number of reasons for acquiring something - Buy for personal use and enjoyment Buy as an investment = Buy for the purposes of trading (by default). Length of period of ownership Normally inventory stock is held for 2 short period of time, i.e., rapid turnover. Wisdom v Chamberlain ~ Silver bullion held for a short time was held to be trading, Frequency of similar operations ‘The more often a deal takes place the greater the presumption that it is a disposal of inventory stock. Martin v Loury ~ a large number of sales of aircraft linen were trading. Subsequent work (improvements) Change of character of an asset is likely to be an indication of trading. Buying bulk and breaking down into smaller saleable units hence increasing profitability. Advertising and making the Item more marketable may also indicate trading Cape Brandy Syndicate v CIR - Raw South African brandy bought dy syndicate of accountants. www.studyinteractive.orgbemks2000 blogspot.com 19CHAPTER 1 - FUNDAMENTALS OF TAXATION Circumstances (reason) Sudden emergency for ready money (cash flow) can negate 2 presumption of trading, Motive Intention to trade is trading. Intention to make a profit is necessary for trading and a lack of profit will not necessarily negate trading CIR v Reinhold ~ Houses bought for investment purpose. Grove v YMCA - YMCA canteen advertised and made a profit. Badges of trade can be remembered by the mnemonic: Trading Not Trading Subject Matter Ownership Length Frequency of Transactions Improvements Reason Motive 20 ‘ebooks ZO00 Boaspeteom www.studyinteractive.orgCHAPTER 1 - FUNDAMENTALS OF TAXATION Ce a ae Re eee ‘Accounting profit | 9] Texable pront | Adjustment of Profit per the Income Statement to Give Tax Adjusted Accounting Profit Step 1 Toss Profit Profit or loss per the income statement x x Step2 Consider each item of exp which has been debited decide Allow ~ LEAVE Disallow - ADD x Step 3 (2) Consider each item of income which has been credited and decide. Trading ~ LEAVE Non Trading - DEDUCT x (0) Consider any items which should be debited but aren’t and deduct. (e.g. premiums paid on short lease) x (©) Consider any items of income which should be credited but aren’t and add. x (e.g. goods withdrawn by the owner) Step 4 Deduct capital allowances on plant and machinery industrial buildings x (this will normally be done In a working) x x Taxable trading (loss)/profit This figure may be used to determine the taxable profits or losses by applying opening or closing year rules to It. www.studyinteracti ve. orgbeks2000 blogspet.com 2aCHAPTER 1 - FUNDAMENTALS OF TAXATION Disallowable expenditure a (2) @) «@ (5) (6) @” (8) Not wholly and exclusively incurred for trade, Dual purpose expenses - if business and private elements can be split allowed business element. Malleliew v Drummond. Withdrawals of profit by the owners of the business. Depreciation and amortisation. Capital items Legal expenses Law breaking (parking fines allowed if paid for staf’) Tax appeal Capital (disallowed) Law Shipping v CIR Capital Revenue (allowed) Odeon Associated Theatres v Jones Theft by directors and senior staff (junior staff allowed) Cost of git is £50 (max) Customers << Exclude food. drink. and tobacco / (only Ok if) Conspicuous advertisement Staff ok cits 22 ‘ebooks 2000 Bogspatcom www.studyinteractive.orgCHAPTER 1 - FUNDAMENTALS OF TAXATION (9) Loans to employees, customers and suppliers written off (10) Charitable gifts under gift aid (11) Donations to national charities and political parties (local charities allowed) (12) Lease premiums (allowable expense = rent in advance/duration of lease) (13) Hire charges for cars if the CO2 emissions are greater than 160 grams/kilometre. The disallowable amount of the hire charge Is computed as 15% of the leasing costs. (14) Entertaining of customers/suppliers (entertaining of staff is however allowable). Example — Simon Swift Simon Swift is a sole trader and has decided to lease a motor car to use in his business from 1 November 2009. The retail price of the motor car is £11,000. The C02 emission of the car is 175grams/ kilometre. Simon pays £150 per month to hire this car. Required Compute the amount which is 2 disallowable expense when Simon is computing his tax adjusted trading profits for the year ended 31 October 2010. www.studyinteractive.orgbemks2000 blogspot.com 23CHAPTER 1 - FUNDAMENTALS OF TAXATION SO ELS Urs allowable expen: Ci Description of ‘expense Disallowable expense (add back) Allowable expense (leave) Capital expenditure Cost of registering a patent. Repairs Acquisition of asset in 2 state of disrepair If the asset cannot be used for the purposes intended at the date of acquisition. If the asset can be used for the purposes intended at the date of acquisition. Depreciation/ Amortisation Get capital allowances instead on the cost of plant and machinery and industrial buildings. Loss on disposal of fixed assets Fines and penalties Incurred breaking the law. Incurred paying tax late, Interest paid on overdue tax Parking fines paid for staff while on business. Legal expenses Incurred acquiring a capital asst Incurred acquiring a short lease, Incurred in Issuing shares. Incurred for a tax appeal. Incurred collecting bad debts. Incurred renewing a short lease, Incurred defending reputation of the business, Incurred in issuing loan notes (debentures). Accountancy fees Fees incurred for personal tax advice. Staff costs Cost of staff seconded to a charity, Staff counselling costs. ‘Theft by staff Loan to employee or customer written off Specific provisions Entertaining Of customers and suppliers. Of staff. 24 ‘ebooks ZO00 Boaspeteom www.studyinteractive.orgCHAPTER 1 - FUNDAMENTALS OF TAXATION Gifts To customers and suppliers. To staff. To customers/supplier, provided ‘© Not food, drink or tobacco + Cost < £50 per person per year (If the gift costs > £50 the whole amount. is disallowed.) * Carries a large advertisement for business. Subscriptions Non trade, Trade. Donations To national charity. To political parties. To local charities. Impaired debts Patent royalties paid Dividends paid by companies Issue costs for companies issuing shares Issue costs for companies issuing Loan notes (debentures) Cost of a short lease (Lease< 50 years) 2% x (years on lease ~ 1) x premium paid = Capital element Xb Premium paid = Xa Less Capital element = (Xb) Xe X c divided by years on the lease, Interest payable If incurred for non trading purposes. If incurred for trading purposes eg. - Overdraft interest - Interest paid on loan notes www.studyinteracti ve. orgbeks2000 blogspet.com 25CHAPTER 1 - FUNDAMENTALS OF TAXATION Leasing of a high Coz 15% x lease payment 85% x lease payment Gift aid donations ACCOUNTING TERMINOLOGY USED IN THE F6 EXAM From the June 2011 paper onwards, international accounting standard terminology will be used when preser \9 accounting information contained in exam questions. ‘The most important change is that the term “profit and loss account” will no longer be used. Instead, the term statements being presented in the intern: following terminology will also change: “income statement” will be used, with income nal accounting standard format. The Previous terminology New terminology Profit and loss account Income statement Sales Sales revenue Fixed assets Non-current assets Stock Inventory Debentures Loan notes 26 ‘ebooks ZO00 Boaspeteom www.studyinteractive.orgCHAPTER 1 - FUNDAMENTALS OF TAXATION Example i - Shrek Shrek has been in business as a whisky distiller for many years preparing income statements to 30 June annually. His income statement for the year ended 30 June 2010 was as follows £ E Sales revenue (excluding VAT) 45,000 Cost of sales 12,541 Light and heat 120 Bank deposit interest 40 Office salaries 9,060 _ Dividends (net) 147 Repairs to premises (a) 2,620 _ Interest from National Savings Bank 83 Motor expenses (f) 1,740 Depreciation Motor vans 2,800 Equipment 770 Rent and rates (9) 2,740 Amortisation of lease (9) 150 Loss on sale of equipment 40 Impaired debts (b) 680 Professional charges (c) 425 Loan interest 240 Sundry expenses (4) 1,770 Salary Shrek 4,000 Wife, as secretary 450 Net profit 5,124 45,270 45,270 The following information is given. (a) Repairs to premises comprise £ Alterations to flooring in order to install new machines 1,460 Decorations 475 Replastering walls damaged by minor explosions 685 2,620 (b) Impaired debt The figure of £680 for impaired debts includes a loan to an employee of £200 which was written off. www.studyinteractive.orgbemks2000 blogspot.com 27CHAPTER 1 - FUNDAMENTALS OF TAXATION (c) Professional charges: Accountancy Cost of action for failing to obtain spirit licence Cost of tax appeal (successful) Cost of renewing snort lease Debt collection (4) Sundry expenses: Fine re failure to obtain spirit licence Subscription to trade association Donation to police welfare fund (local charity) Entertaining UK customers Customers resident in Sicily Staff Christmas party ~ five staff Calendars sent to 300 customers bearing firm’s name Miscellaneous allowable expenses 200 130 20 25 425 Eg 250 50. 20 60 340 375 620 55 1,770 (e) During the year Shrek had withdrawn goods from his stock inventory for his own consumption. The cost of this inventory stock was £169. The business makes a uniform gross profit of 20% on selling price. No entry had been made in the books in respect of the goods taken. (f) Motor expenses include hire charges of £1,000 for a BMW 325i with a Coz emission of 1769/km. (9) Rent includes a lease premium of £1,500 for @ 10-year lease. (h) Capital allowances for the year ended 30 June 2010 are agreed at £2,500, Required Compute Shrek’s tax adjusted trading profit for the year ended 30 June 2010. Note: Your computation should commence with the net profit figure of £5,124, and should list all Items referred to in notes (a) to (a) indicating by the use of zero (0) any items that do not require adjustment, 28 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 1 - FUNDAMENTALS OF TAXATION Example 2 - Trek Greenhouse ‘Trek Greenhouse Is an unincorporated wholesaler who has prepared a draft income statement for the year ended 31 March 2011 which shows @ profit of £38,500. In arriving at the £38,500 the following items nave been debited and Trek wants to know what adjustments he must make to the profit per the income statement. (1) I spend £30 per head on a Christmas dance for 15 members of staff. In addition I gave 300 customers calendars costing £4 each and for 25 sclacted customers, bottles of Brut Champagne costing £12 each. (2) Thave been paying myself a salary of £20,000 per year and Mrs Greenhouse, who is the business secretary, a salary of £15,000, and my other secretary doing the same job is paid £12,500. These amounts have been debited in arriving at the profit per the income statement. (3) The repairs include £60,000 for repair work to the roof of a storage building that I bought very cheap. 1 had to fix the roof before I could use the building, (4) In the past I have never taken inventory stock from the business but I did withdraw items costing £1,200 that would normally be sold for £2,000 and gave them to my family as Christmas gifts. This has not been reflected in the accounts. (5) T have to look smart for business meetings thus I bought four suits, each costing £175 and included them in sundry expenses. (6) Legal fees charged in the income statement include the following expenses: Defending action for poor workmanship 760 Breach of Trading Act: Verdict ~ Guilty 490 Bad debt recovery 7,400 Recovery of loans to employees ‘500 Renewal of short lease 350 (7) Sundry expenses include £ Parking fines paid on behalf of staff while on business 760 ‘Subscriptions to Wholesalers’ Association 380 Donation to National Charity 100 Donation to Liberal Democrat Party 500 (8) Motor expenses include hire charges of £5,000 for a Jaguar Sovereign with a CO2 emission of 182a/km (9) Amachine costing £6,000 was purchased on 15 August 2010. Depreciation of £2,400 has been charged in the income statement. Capital allowances of £6,000 are claimed. (10) Rent and rates includes £1,200 relating to patent royalties paid in the period. Required (a) _ Draft notes in preparation for a meeting with Trek Greenhouse advising him of whether his adjustments are correct. Give full explanations to support your reasoning. (b) Compute Trek’s tax adjusted trading profit. Note: Your computation should commence with the net profit figure of £38,500, and should list all items referred to in notes (1) to (10) indicating by the use of zero (0) any items that do not require adjustment. www.studyinteractive.orgbemks2000 blogspot.com 29CHAPTER 1 - FUNDAMENTALS OF TAXATION Answer 1 - Shrek Greenhouse ‘Taxable profits for year ended 30 June 2010 £ £ - + Net profit per the income statement 5,124 Step 2 Light and heat ~ allowable Ni Office salaries - allowable Nil Decoration - allowable Nil Replastering the walls - allowable Nil Motor expenses (W2) 150 Alterations to flooring 1,460 Depreciation (2,800 + 770) 3,570 Amortisation of lease 150 Lease premium 41,500 Capital loss (equipment) 40 Loan to employee written off 200 Accountancy fee ~ allowable Nil Renewal of a short lease - allowable Nil Debt collection - allowable Nil Loan interest payable ~ allowable Nil Professional fees for spirit licence 130 Professional fees ref tax appea’ 50 Fine for not acquiring a spirit licence 250 Subscription to trade association ~ allowable Nil Donation to a local charity ~ allowable Nil Entertaining ~ UK customers 60 Entertaining ~ Foreign customers 340 Staff christmas party ~ allowable Nil Calendars for customers - allowable Nil Shrek's salary 4,000 Salary to wife: allowable Nil Step 3 (a) Bank deposit interest 40 Dividends (net) 147 NSB interest 83 (b) Consider any items of expenditure which should be debited but isn’t and deduct it Lease premium paid on the grant of a short lease (W1) 123, (c)_ Consider any items of income which should be credited but isn’t and add it. (Good withdrawn by the owner for personal use (W3)) 200 Step 4 Deduct capital allowances on plant and machinery 2,500 Tax adjusted trading profits 2,893 17,224 Tax adjusted trading profits (T) £14,331 30 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 1 - FUNDAMENTALS OF TAXATION Workings (1) Lease premium £ Premium paid 1,500 Less: 2% (10 - 1) x 1,500 (270) Rent paid in advance 1,230 Deductible expense for tenant e123, ‘Add back 1,500 - 123 = 1,377 (2) Motor expenses Disallowed hire charge for a high CO2 emission car 5% x 1,000 £150 (3) Goods withdrawn from stock at selling price Cost 80% 160 Gross profit 20% 40 Selling price 100% 200 www. studyinteracti ve. orgeeot2000 Begspat.om 34CHAPTER 1 - FUNDAMENTALS OF TAXATION Answer 2 - Trek Greenhouse (a) @ (2) 3) @ (5) (6) 7) (8) ) (10) Notes for mee! 9 with Trek Greenhouse While entertaining is generally disallowed, reasonable staff entertaining Is specifically allowed. Thus the cost of the Christmas dance is allowable. Gifts to customers/suppliers costing up to £50 per person are allowable as long as they have a conspicuous advertisement. However this specifically excludes food, drink or tobacco. Thus the calendars would be an allowable expense as long as they have an advertisement but the cost of the champagne is disallowed. Wages are allowable only to the extent that they are reasonable in relation to the work done. The salary paid to Trek’s wife is in excess of the salary paid to the other secretary doing the same job so £2,500 (15,000 ~ 12,500) of the wife's salary is disallowable. Trek is the owner of the business and his salary will be a disallowable expense. The repair work to the building relates to its condition pre-acquisition and was reflected In its purchase price. The bullding could not be used until the repair work was carried out. Thus the repair should be treated as capital expenditure as in Law Shipping v CIR (the ship case). Thus the repair work would be disallowed as capital expenditure. Inventory stock withdrawn must be added back to profit at selling price and not cost thus increasing profit by £2,000. The suits are a dual purpose expense. They have a personal element which Is warmth and decency and a professional element which is the business use. As it is impossible to quantify the business and professional elements the whole amount should be disallowed 4 x 175 = 700. Legal fees are allowable except for ‘law-breaking’ items and non-trade items. Legal fees for a renewal of a short lease are specifically allowed. The poor workmanship: normal trade expense - allowable. Breach of Trading Act: ‘Law Breaking’ - disallowed. Sad debts recovery: normal trade expense - allowable. Loans to employees ~ non-trade item ~ disallowed. Sundry expenses Parking fines - specifically allowed Subscription - _normal trade expense ~ allowed Donations to national charity and political parties are disallowed Hire charges for high COz emission cars. CO2 emission > 160g/km. The disallowable element is £750 (15% x 5,000). Depreciation is a disallowed expense and instead HMRC gives tax depreciation called capital allowances. The machine was dought on 15 August 2010 thus the annual investment allowance (100%) is available. Capital allowances of £6,000 are available in the year ended 31 March 2011. Patent royal s are allowable in computing taxable trading profit. 32, ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 1 - FUNDAMENTALS OF TAXATION (b) Tax adjusted trading profit year end 31 March 2011 - + Step 1 Net profit per the income statement 36,500 Step 2 Consider each item of expenditure debited and decide allowable leave it disallowable add it (2) Champagne (25 x 12) 300 Staff entertaining ~ allowable Nil Customer gifts of calendars ~ allowable Nil (2) Trek's salary 20,000 Wife's salary 2/500 (3) Repairs to roof 60,000 (5) Suits (4x 175) 700 (6) Legal fees disallowed Defending reputation of business ~ allowable Nil Bad debt collection ~ allowable Nil Breach of trading act 490 Loans to employees 500 Renewal of short lease - allowable Nil (7) Sundry expenses disallowed Parking fines paid for staff carrying out business ~ allowable il Donation to national charity 100 Donation to political party 500 Subscription to trade association ~ allowable Nil (8) Hire charges 750 (9) Depreciation 2,400 (10) Patent royalties - allowable Nil Step 3 (2) Consider all income credited and decide Tracing income leave It Non trading deduct it (©) Consider any income which should be credited but isn’t and add It Goods withdrawn by the owner of the business 2,000 Step 4 Deduct capital allowances Tax adjusted trading profits 6,000 6,000 128,740 £122,740 www.studyinteracti ve. orgbeks2000 blogspet.com 33CHAPTER 1 - FUNDAMENTALS OF TAXATION 34 ‘ebooks2000 blogspet.com www. studyinteractive.orgChapter 2 Capital allowances London, School of Business & Finance powered by InterActive ANALYSIS OF PAST EXAM QUESTIONS Dec | June | Dec | June | Dec | June ] Dec Pilot | 2007 | 2008 | 2008 | 2009 | 2009 | 2010 | 2010 Questiona| + | + ~t-f- . Question 2 . . . . . . . . Question 3 Question 4 Question 5 35 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 2 - CAPITAL ALLOWANCES baa ed 37 BACKGROUND AND THE EXAM FOCUS WHAT IS PLANT AND MACHINERY? --. 38 CAPITAL ALLOWANCES - TAX DEPRECIATION-- 40 CAPITAL ALLOWANCES ON PLANT AND MACHINERY 40 CATEGORIES OF PLANT AND MACHINERY 40 CAPITAL ALLOWANCES AVAILABLE TO THE OWNER OF PLANT AND MACHINERY at PLANT AND MACHINERY PROFORMA FOR INCOME TAX. 4s INDUSTRIAL BUILDINGS 49 WHAT IS AN INDUSTRIAL BUILDING? 49 DEFINITION OF THE QUALIFYING Cost st CAPITAL ALLOWANCES AVAILABLE TO THE OWNER OF AN INDUSTRIAL BUILDING 83 ANSWERS- 54 36 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 2 - CAPITAL ALLOWANCES erie Sci teh eu ial tek hd This is the second chapter and is still focusing on the rules for determining self employed income. One point which must be remembered is that a person who is self employed must prepare en income statement for an accounting period. Under the tax rules depreciation is a disallowable expense but the tax equivalent capital allowances are an allowable expense. The rules for computing capital allowance are covered in this chapter. This is a very important exam topic and will usually be tested in both questions 1 and 2. www.studyinteractive. or Goe0ks2000 blogspet.com 37CHAPTER 2 - CAPITAL ALLOWANCES WHAT IS PLANT AND MACHINERY? Functional test assets used in the business as opposed to the setting in which the business Is carried out. Plant comprises of goods or chattels kept for the Permanent employment in the business. iin Qualifying as plant ~ Capital allowances given as per case law = Swimming pool installed by owners of a caravan park + The law books of a barrister - Moveable office partitioning - Light fittings, décor and murals of a hotel and pud business - Free-standing screens used in a window display by building society ‘Not qualifying as plant - No capital allowances given as per case law + Laboratory and gymnasium of a school = Canopy over petrol station - Ship used asa floating restaurant - Football club's spectator stand - False ceiling containing conduits, ducts and lighting apparatus = Lighting in department store Steak ee ed Qualifying as plant - Fire regulation expenditure + Thermal insulation of industrial building - Sports ground safety requirement expenditure - Expenditure on a security asset, such as alarms, bullet proof windows to improve personal security of those under special threat, e.g., from terrorists. Bini roe Computer, telecommunication and surveillance systems, including wiring, ete - Safes and burglar alarm systems - Advertising hoardings, signs and displays, ete Refrigeration/cooking equipment, washbasins, sinks, sanitary ware and furniture/furnishings - Display equipment, counters and checkouts 38 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 2 - CAPITAL ALLOWANCES - Lifts and escalators - Space/water heating, ventilation and air conditioning systems. = Electric, cold water, gas and sewerage systems which are specific to trade requirements or connected with specific trade plant items + Any machinery and expenditure on altering buildings to accommodate plant or machinery which qualifies for capital allowances. www.studyinteractive. or Goe0ks2000 blogspet.com 39CHAPTER 2 - CAPITAL ALLOWANCES CAPITAL ALLOWANCES - TAX DEPRECIATION CAPITAL ALLOWANCES ON PLANT AND MACHINERY Capital allowances are the means by which a standard measure of depreciation is given on qualifying capital expenditure. Capital allowances are given to the owner of the capital asset and are deducted in arriving at the tax adjusted trading profits of the business. Capital allowances are given on the following types of capital expenciture: = Plant and machinery - Industrial buildings Categories of plant and machinery a ower dive | Plant and Machinery — Main Pool + Plant and machinery is desenbed as tools of the trade andincludes: + computers + Equipment + shelving + Vans ad tories + Cars with low CO2 (CO2 of upto 110g/kmy Pr] + Cars with medium CO2(CO2 of between 111 and 160g/km' + loyeles . Tables and chairs o=e + Photocopiers + Fire regulation expe! PEs sama + alterations to a building inddenta toi machinery. Capital allowances are given for each accounting period. The plant and machinery must be divided into the following categories: Main pool Expensive Short life Special Asset with car asset Rate Pool private use ry ‘ebooks2000 blogspet.com www.studyinteractive.orgCHAPTER 2 - CAPITAL ALLOWANCES Short life assets A trader may elect that an asset other than a motor car should be treated as a short life asset. Such an election has the following consequences © The asset is treated as non pooled and the election is technically known as a depooling election. © If the asset is not disposed of within the four years of the end of the accounting period in which It is acquired, it joins the main pool at Its tax written down value and the depooling election will have no effect. © If the short life asset is disposed of within the four-year period a balancing allowance or balancing charge will arise in the accounting period In which it is disposed of. Poo rik UCR Gunn ieee) A) The Annual investment allowance (AIA) As from 6 April 2019, the first £100,000 per annum of expenditure on plant and machinery (other than cars) qualifies for the annual investment allowance (AIA). In effect, the AIA provides a 100% allowance for the first £100,000 invested in plant and machinery each year. Key Points to remember * The £100,000 allowance is for qualifying expenditure in a 12 month accounting period. If the accounting period is < 12 months or > 12 months then the £100,000 allowance is reduced or increased accordingly. ‘* Ifa business spends more than £100,000 then the expenditure beyond the £100,000 enters the main pool or special rate pool and is eligible for the WOA at 20% (in the main pool) or 10% (in the special rate pool). B) The First year allowance (FYA) The 100% FYA Expenditure on a low emission motor car is eligible for 2 100% FYA so long as the expenditure is incurred on or before 31 March 2013, The definition of a low emission car for the purposes of the 100% FYA is one with an emission rating not exceeding 110 a/km. Key Points to remember ‘The FYA is never increased or decreased if the accounting period is greater than or less than 12 months. © The low emission car should normally be included in the main pool. © The low emission car should be kept separately if the car has private use by the owner of the business. www.studyinteractive. or Goe0ks2000 blogspet.com a1CHAPTER 2 - CAPITAL ALLOWANCES a eer ia7| imecdivg Description Dates Rate _| Maximum + AN plant and [6.4.10 + Jaus 100% | £100,000 {machinery except (12morth period) cars) + Low CO; Emission 17.402 ~ 31.3134 10%| No maximum Cars AIA - Annual investment allowance; FYA - First year allowance C) The Writing down allowance (WDA) In general, a business may claim a writing down allowance for each category of plant and machinery in each accounting period. ‘The WDA Is available in each accounting period except in the final accounting period and on the disposal of a non-pooled asset, ‘The WDA is normally computed at 20% on all categories of plant and machinery except in the special rate pool where it is computed at 10%. Medium CO2 emission cars (CO2 emission between 111 and 160 g/km) Motor cars with COz emissions of between 111 and 160 9/kilometre are included in the main pool and qualify for the WDA at 20%, High Coz emission cars (CO2 emissions of more than 160 g/km) Motor cars with COz emission of more than 160g/kilometre are included in the special rate pool and qualify for the WDA at 10%. All cars with private use by the owner of the business are not pooled but are kept separately so that the private use adjustment can be calculated. 42 ‘ookx2000 Hoqepet.com www.studyinteractive.orgCHAPTER 2 - CAPITAL ALLOWANCES Key Points to remember © The WDA must be increased or reduced if the accounting period is greater than or less than 12 months. © The Finance Act 2009 has significantly changed the rules for computing capital allowances on cars. Prior to 6.4.09 a car costing more than £12,000 was categorised as an expensive motor car and was eligible for the WDA at 20% subject to a maximum WDA of £3,000 in a 12 month accounting period ‘These rules still apply to cars bought prior to 6 April 2009 but these rules no longer apply to cars purchased after 6 April 2009. Summary of the new rules for capital allowances on cars Low Coz Medium Coz High Coz emission ‘emission emission 110 9/km | 111-160g/km | > 160g/km Category Main pool Main pool Special rate pool Capital allowances | FYA 100% — | WDA 20% WDA 10% ‘The treatment of motor cars acquired before 6.4.09 is to remain unchanged for a period of five years. Motor cars costing more than £12,000 will continue to be kept separately and qualify for the WDA at 20% restricted to 2 maximum WDA of £3,000. This Is regardless of the cars CO2 emission, The treatment of an expensive motor car acquired before 6 April 2009 is still examinable. The small pools of plant and machinery If the TWOV brought forward plus additions less disposals during the accounting period on the main pool or the special rate pool is £1,000 or less, the business may claim a small balance relief equal to the value of the balance, instead of claiming the WDA. D) Balancing allowance(BA) and balancing charge(BC) On the disposal of a non pooled asset, the sole trader is not entitled to claim the AIA, WDA or FYA for that item of plant and machinery so a balancing allowance or balancing charge is given instead. www.studyinteractive. or Goe0ks2000 blogspet.com 43CHAPTER 2 - CAPITAL ALLOWANCES a Lar eae eae) ead sovorkctve [aoe 41)This is a pool of assets which are acquired as an —, daa + Electticfl systems and lighting systems + Cold witer systems + Central hesting syster + Airconditioning and ventilation systems + Lifts 2) Thermal insulation in 2 buil 3) Long Life assets costi £100,000 and have a life of at least 25 years, 44) Motor cars with high CO2 emission > 160g/km, The plant and machinery in the special rate pool can get the AIA but the WDA is limited to 10%. aa ‘ebooks2000 blogspet.com www.studyinteractive.orgCHAPTER 2 - CAPITAL ALLOWANCES rena a ee kes Accounting period AIA Main Special Exp Carwith BU ‘Total pool rate car_—_private Capital peal we Allowances £ £ £ £ £ ‘TWDV bt x x x x AIA additions Cost x Less: AIA 100% x cost x (UL =£100,000 for 12 months) == ——— XIN XIN XIN Add: x (CO>160gkm) Add: Medium CO, cars x (CO; 11 1gfken - 160g/krn} Disposal of plant and machinery imited to cost) o w w x x x Balancing allow/Bal charge xBU XAX) ‘Small balance relie ifthe Dalance on the main pool or special rate pool is < £1,000 WDA (20% or 10%) o w© x (Max £3,000 for expensive cars) ~ x |Add: Low CO; cars Cost of low CO, cars Xa &) Xa TWDV olf x x xX Nil Total capital allowances x www.studyinteractive. or Goe0ks2000 blogspet.com 45CHAPTER 2 - CAPITAL ALLOWANCES Example 1- Cinderella Cinderella trades as an interior designer in the London area, preparing income statements up to 31 December each year. Cinderella started trading on 1 July 2010. During the first two accounting periods the following transactions were undertaken: Purchases £ 1 May 2010 Car (1) with a CO2 emission 140g/km (15% private use)9,000 9 June 2010 Equipment 27,000 11 July 2010 Car (2) a CO2 emission 180g/km (only business use) 16,000 25 October 2010 Computer for graphic design 9,100 15 November 2010 New car with CO2 emission 105g/km 8,200 19 December 2010 Plant 33,000 14 April 2011 Machinery 25,000 47 July 2011 Car (3) with CO2 emission 185 g/km (15% private use)15,000 sales 6 July 2011 Car (1) (15% private use) (6,000) 31 December 2011 _ Part of the equipment purchased in June 2010, (2,800) The tax adjusted trading profits for the first two accounting periods before deducting capital allowances are: £ Period ended 31.12.10 65,000 Year ended 31.12.11 90,000 Required Compute Cinderella's capital allowances for ner first two accounting periods. 46 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 2 - CAPITAL ALLOWANCES Capital allowances computation - Cinderella template Med Special High Total aa MB car Rate car Capital ps with PU Pool — with PU allowances £ £ fs £ ¢€ £ www. studyinteractive.orgerets2000 biogspat.com a7CHAPTER 2 - CAPITAL ALLOWANCES Example 2 - Jack Bean Jack trades as an aggressive business consultant in the Lake District, preparing income statements up to 30 April each year, At 1 May 2010 the written down value of plant and machinery was: Main poo! £7,940 Motor car (originally acquired in July 2008) £16,000 The following transactions have taken place: Purchases 19 May 2010 New art-deco hand-made furniture for new offices, 10 June 2010 10 July 2010 11 August 2010 14 September 2010 29 November 2010 15 February 2011 25 April 2011, Sales 29 August 2010 Car CO2 1859/km (Used 15% privately by Jack’s personal assistant) Computer Car with CO2 emission 107g/km (35% private use) Painting Van Car with CO2 emission 1569/km used for business use Shelving and office equipment Machinery Jack’s accounting profits before deducting capital allowances Year ended 30 April 2011 Required 15,300 17,000 800 15,600 6,700 23,000 9,600 14,200 1,400 £78,000 Compute Jack’s capital allowances for the period of account ending 30 April 2011. Compute Jack’s tax adjusted accounting profit. (11 marks) 48 ‘ebooks2000 blogspet.com www.studyinte: ractive.orgCHAPTER 2 - CAPITAL ALLOWANCES INDUSTRIAL BUILDINGS What is an industrial building? Industrial buildings include © Factories ‘+ Warehouses used to store raw materials and finished goods manufactured by the occupier. A hotel is an Industrial building provided the necessary conditions are met (see below). lower dtiv | Industrial building Industrial buildings include + Factories ihe, + Warehouses used to store raw materials and finished goods manufactured by the occupier ewer dive | tere ate Ceol) + Ahotel is an industrial building + Conditions It must have at least 10 letting bedrooms Services provided for quests must include the provision of breakfast, evening meals ete. Must be open for at least 4 months during the season April to October. www. studyinteractive, ar Gee0ts2000 Bleaspet.com 49CHAPTER 2 - CAPITAL ALLOWANCES Capital allowances can be claimed by the owner of an industrial building. These allowances are being phased out. For 2010/11 the points which the examiner has highlighted as being important are: 1. firstly, where an industrial building is being sold there is no writing down allowance or balancing adjustment for the seller of an industrial bullding in the accounting period of cisposal; 2. secondly, the examiner has stated that for the June 2011 and December 2011 he will not test the rules applicable to second hand industrial buildings. Qualifying (get IBAs) Non qualifying (no IBAs) (1) Factories (1) Offices (2) Staff welfare buildings (2) Shops and showrooms (3) Warehouses used to store raw materials (3) Dwelling houses and finished goods manufactured by the occupier. (4) Workshops (4) Land and legal costs (5) Hotels (6) Drawing office (7) Structural costs Levelling Architect's the land fees 25% tule Chim TBA’ Non-qualifying on 100% 25% or less Qualifying 153% 50 evoke ZOOD gpa www.studyinteractive.orgCHAPTER 2 - CAPITAL ALLOWANCES Industrial building allowance (1) What is an industrial building? (2) Who can claim industrial building allowances? (3) What cost qualifies for industrial building allowances? (4) What is qualifying cost? Pri fee lifying cost Description of cost Include Exclude Cost of land Cost of tunnelling and levelling of the land Cast of the design/arawing office Cost of the staff canteen Cost of admin office, accounts office, general office, showrooms (non- industrial parts) Cost of architects fees Cost of plant and machinery E.g. cost of lift, ventilation system, central heating system, fire regulation expenditure, burglar alarm www.studyinteractive. or Goe0ks2000 blogspet.com 51CHAPTER 2 - CAPITAL ALLOWANCES Example 3 - Donald Duck Donald Duck has trading profits of £460,000 each year (this figure is before deducting capital allowance). Donald had a new factory constructed at a cost of £513,600 that was brought into use on 30 September 2010. Donald has an accounting date of 31 March. a (2) 3) @ £ Land 100,000 Levelling of land 19,200 Architect's fees 24,300 Heating system 43/800 Ventilation system 18,200 Cold water systems 41,600 Strengthened floor to support machinery 16,500 General offices 62,500 Factory 187,500, 513,600 In which accounting period can Donald first claim capital allowances on the purchase of the new factory? Compute the capital allowances on the plant and machinery if the TWDV on the main pool is £84,600 at 1 April 2010. Compute the capital allowances available for the industrial building. Compute the tax adjusted trading profits for the year ended 31 March 2011, 52, ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 2 - CAPITAL ALLOWANCES The writing down allowance This allowance is available in each accounting period provided the building is in industrial use at the end of the accounting period. The WOA is not available in the accounting period In which the building is disposed of. ‘The WDA Is computed on the straight line basis. ‘The WDA Is computed as follows: WDA = 1% x Qualifying cost Key Points to remember + Capital allowances are computed for each accounting period, © The WDA is increased or decreased if the accounting period is more than 12 months or less than 12 months. Example 4 - Steffi Graf Steffi Graf buys a new factory making high-tech tennis racquets. She prepares accounts to 30 April 2010. Bought factory 1 July 2009 for £275,000 £ Land 50,000 Factory 120,000, Works canteen 25,000 Offices 80,000 275,000 ‘The tax adjusted trading profit before deducting capital allowances is: Year ended 30 April 2010 £62,000 Required Calculate the industrial building allowances available to Steffi Graf in the year ended 30 April 2010 and calculate her tax acjusted trading profits for 2010/2011. www.studyinteractive. or Goe0ks2000 blogspet.com 53CHAPTER 2 - CAPITAL ALLOWANCES Answer 1 - Cinderella 1.7.10 ~ 31.12.10 (6 months) AIA additions Equipment Computer Plant ‘AIA 100% x 69,100 UL100,000x 6/12 = £50,000 Add: Medium C02 car Car Less: Disposals Less: WDA 20% x 19,100 x 6/12 20% x 9,000 x 6/12 10% x 16,000 x 6/12 Low Coz car Cost FYA 100% x 8,200 Tax WDV cif Total allowances to be claimed AIA Main pool £ £ 27,000 9,100 33,000 69,100 (60,000) 19,100 19,100 19,100 (1.810) 8,200 (8.200) 17,190 Med coz car with Pu £ 9,000 9,000 (900) 8,100 Special Rate Pool £ 16,000 16,000 (600) 15,200 Bu 85% X 85% Capital allowances| 0,000 1910 765 800 8,200 61,675 54 ‘ebooks ZO00 Boaspeteom www.studyinteractive.orgCHAPTER 2 - CAPITAL ALLOWANCES 4.4.41 - 31.02.01 Main Med Special High BU Capital AIA pool Cz Rate COz 85% allowance Carwith Pool Car with PU (1) PULs) £ £ £ £ £ £ TWDV bit 17,190 8,100 15,200 Add: AIA additions Equipment 25,000 Less: AIA (25,000) 25,000 Nil Nil ADD: High CO2 cars. Car with private use 15,000 Less: Disposals Car used privately (6.000) Equipment (lower of cost and sale (2,800) proceeds) 14,380 15,200 15,000 Balancing allowance 2.100 85% = 1,785 Less: WDA 20% x 14,390 (2,878) 2878 102% x 15,200 (1,520) 1,520 10% x 15,000 (1,500) -X85% 1.275 Tax WDV cit 11,812 Ni 13,880 13,500 32,458 Total allowances to be claime: www.studyinteractive. or Goe0ks2000 blogspet.com 55CHAPTER 2 - CAPITAL ALLOWANCES Answer 2 - Jack Bean Capital allowances - period of account 1.5.10 - 30.4.11 1.5.10 - 304.11 AA Main Exp Special LowCOz BU Total pool Car_—‘Rate Poo! with PU 65% allowance £ £ £ £ £ £ ‘TWoV bit 7,940 16,000 Add: AIA Additions: Furniture 15,300 Computer 800 Van 23,000 Equipment 14,200 53,300 AIA (53,300) 53,300 100% x 53,300 Nil Nil ADD:High CO2 cars Car 17,000 ADD: Medium Coz Car 9,600 Disposals Machinery (1,400) 16,140 16,000 17,000 Nil WDA 16,140 x 20% (3,228) 3,228 16,000 x 20% = 3,000 3,200 restricted to (3,000) 17,000 x 10% (4,700) 41,700 Add: Low C02 cars Cost 15,600 FYA (100%) (15,600) X 65% 10,140 Nil TWDVc/f 15,694 Capital allowances 71,368 The tax adjusted trading profit for the year ended 30 Aril 2011 £6,632 (78,000 - 71,368) Note: The painting does not satisfy the functional test and is not used in the business but rather contributes to the setting thus is not plant and machinery and no capital allowances can be claimed on i 56 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 2 - CAPITAL ALLOWANCES Answer 3 - Donald Duck (1) In which accounting period can Donald first claim capita! allowances on the purchase of the new factory? Answer ~ Year ended 31 March 2011 (2) Compute the capital allowances on the plant and machinery if the TWDV on the main pool is £84,600 at 1 April 2010 Year ended 31 March 2011. AIA Main Special_—Capital rate pool allowances poo! £ £ £ £ TWov bit 84,600 ‘Add: Additions ATA Heating system 43,800 Ventilation system 18,200 Cold water system 41,600 103,600 Less: AIA 100% x 103,600 £100,000 (100,000) 100,000 3,600 3,600 84,600 3,600 Writing down allowance 20% x 84,600 (16,920) 16,920 30% x 3,600 (360) 360 TWDV c/f 67.680 3.240 Capital allowances 117.280 (3) Compute the capital allowances available for the industrial building WDA = 1% x Qualifying Cost = 1% x 310,000 = £3,100 Qualifying cost £ Cost per the question 513,600 Less: * Cost of the land (100,000) + Cost of plant and machinery Heating system 43,800 Fire alarm 18,200 Cold water system 41,600 193.600 (103,600) Building cost 310,000 wow. studyinteractive, or G=es2200 eespteam 57CHAPTER 2 - CAPITAL ALLOWANCES £ Building cost 310,000 Less: Cost of non industrial parts if > 25%. 62,500/ 310,000 x 100 = 20% < 25% all Qualifying cost 310,000 (4) The tax adjusted trading profits of Donald Duck for the year ended 31 March 2011 are £339,620 (460,000 ~ 120,380). - + Trading profit per the question 460,000 Less Capital allowances on plant and machinery 117,280 Capital allowances on industrial buildings 3,100 120,380 460,000 Answer 4 - Steffi Graf Steffi Graf Step 1 - Calculate qu Building cost = £225,000 25% x 225,000 = 56,250 Non qualifying = offices = 80,000 80,000 > 56,250 therefore no IBAs on offices 5,000 ifying cost using 25% rule Qualifying cost Step 2 Compute the writing down allowance as 1% x qualifying cost. WDA = £1,450 (1% x 145,000) Profit Capital Allowances £ £ Year ended 30 April 2010 62,000 (1,450) Tax adjusted trading profits for 2010/11 Tax adjusted trading profits £ 60,550 £60,550 5a ‘ebooks ZO00 Boaspeteom www.studyinteractive.orgChapter 3 Trading profits & the basis of assessment London FZ School of Business & Finance powered by InterActive ANALYSIS OF PAST EXAM QUESTIONS Pilot] Dee | June | Dec | June | Dec | June | Dec 2007 | 2008 | 2008 | 2009 | 2009 | 2010 | 2010 Question1| © . : . ° . Question 2 ° Question 3 Question 4 | + : : . . . Question 5 . 59 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT baa ed BACKGROUND AND THE EXAM FOCUS WHAT IS THE CURRENT YEAR BASIS? BUSINESSES OWNED BY SOLE TRADERS-- THE TRADING CYCLE A. THE PRE-TRADING PERIOD B, STARTING TO TRADE OPENING YEAR RULES ExAM TECHNIQUE WHEN THE SOLE TRADER IS STARTING TO TRADE OVERLAP PROFITS CHANGE OF ACCOUNTING DATE --- CONDITIONS TO CHANGE THE ACCOUNTING DATE C. CEASING TO TRADE: WHEN TO USE THE CLOSING YEAR RULES ‘THE PLANT AND MACHINERY PROFOMA TO USE IN THE FINAL ACCOUNTING PERIOD EXAM TECHNIQUE WHEN THE SOLE TRADER IS CEASING TO TRADE NATIONAL INSURANCE -~ 61 62 63 63 63 64 65 66 67 69 69 70 70 70 7 73 Ewp.oveD 73 eur ewpLoveD 74 SELF ASSESSMENT- 75 Tax RETURN 7s CCHeckin THe RETURN 75 RecoRDs 75 PAYMENTS ON ACCOUNT 78 BALANCING PaYMeNTS 76 LATE PAYMENT OF Tax 76 PEnacries 76 ENALTIES FOR INCORRECT RETURN 7 ANSWERS- 78 60 sokezo00 eget eam wow. studyinteractive.orgCHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT erie Scie Ui eel This is the third chapter and is still focusing on the rules for determining self employed income. One point which must be remembered is that a person who is self employed must prepare an income statement for an accounting period. Under the tax rules the total taxable profits made by the business will be assessable over the total period of trading. The first tax year in which some of these trading profits will be subject to tax is the tax year in which the business starts and the final tax year in which some profits will be assessed to tax is the tax year in which the business ends, The problems covered in this chapter are firstly to determine how much of the business profits will be subject to tax in the first and second tax years of trading This will require knowledge of the opening year rules and secondly to determine how much of the business profits will be subject to tax in the final tax year, this will require knowledge of the closing year rules, These rules are very frequently examined and could appear In question 1, question 4 and question 5 of the exam paper. www.studyinteractive.orgbeeks2000 blogspet.com 61CHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT WHAT IS THE CURRENT YEAR BASIS? Income tax is charged for tax years, which run from 6 April to the following 5 April It would be convenient if sole traders would choose an accounting date of the 5 April. Sole traders are free to choose any annual accounting date they wish and so It is necessary to devise some means of establishing a link between the period of account profits and the periad of profits which are taxable, The general rule states, taxable profits (T) = the profits of the accounting period ending in that tax year. This is known as the normal basis or the “current year basis” (CYB). The exception to this general rule can apply in the first, second tax years and in the final tax year when special rules must be applied to convert the accounting profits into taxable trading profits (7). Example 1 - Trading profits and current year basis a (2) Complete the table below on the assumption that alll sole traders have been trading for a number of year. Tax year in Sole Accounting which profits are trader Results date subject to tax Tom | Year ended 315.10 £10,000 Janice | Year ended 282.17 £19,000 Sammy | Year ended 31.12.11 £50,000 Ricky _ | ear ended 3.3.12 £35,000 Gemima Is 2 sole trader and has an accounting date of 31 March. Her recent results have been as follows: Profits before Capital capital allowances allowances £ £ Year ended 31 March 2010 10,000 2,000 Year ended 31 March 2011 50,000 4,000 Year ended 31 March 2012 75,000 5,000 Gemima is completing her income tax computation for 2011/2012 and is Unsure as to which of her profits she must pay tax on. Which profits will she pay income tax on in 2011/12? 62 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT BUSINESSES OWNED BY SOLE TRADERS This chapter will consider businesses owned by sole traders and partnerships. The fact that a sole trader owns a business technically means the sole trader owns assets; the profits/loss made by the business belongs to the sole trader/partners. . Owns | Goodwill ‘a Business” Freehold Offices Stock Debtors Investment Property Cash THE TRADING CYCLE A B c D pe 1 Pretrading Starting to trade Continuing to trade Ceasing to trade THE PRE-TRADING PERIOD Where expenditure is incurred before the business commences this expenditure is described as pre-trading expenditure and Is treated as if incurred on the first day of trading, provided it is incurred within seven years of the business commencing, If the expenditure is revenue expenditure it is allowable expense and reduces the sole traders taxable trading profits. Examples include: www.studyinteractive.orgbeeks2000 blogspet.com 63CHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT CAL ee Goma When does a business commence trading? When does a sole trader first become assessable to income tax on the profits made by the business? Way is the date of commencement important? Waat is the length of the first accounting period? Way is it important to establish the length of the first accounting period? 64 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT Opening year rules Special rules are used to determine the taxable trading profits when a sole trader starts trading. The first tax year in which trading profits are taxed is the tax year in which the trade commences. www.studyinteractive.orgbeeks2000 blogspet.com 65CHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT Exam technique when the sole trader is starting to trade Step 1 Determine the accounting date. Start date = Stop date Tax year 1 = Final tax years AP (1) begins on = AP final ends on Step 2 Write the length of APA at the side, Determine the tax adjusted accounting profit if necessary by adjusting the accounting profits and calculating the capital allowances for each accounting period Step 3, Set up the proforma to determine the taxable profits in the first and second tax years, Year | 7% Period of profit assessable year 1 Profits from start date up to the end of the first tax year 2 Q1 Does an accounting date end in this tax year? Answer = No (T =profits from beginning to end of tax year 2) Answer = Yes (ask question 2) Q2 Which accounting date ends in the second tax year? Underline the accounting period ending on that date. Q3. What is the length of the accounting period underlined? < 12 months (T = profits of first 12 months of trading) 212 months (T = profits of 12 months to the accounting date ending In the second tax year.) 3 Normal basis ce evoke ZOOD gpa www.studyinteractive.orgCHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT Overlap profits If @ business chooses an accounting date of 5 April which coincides with the end of the tax year there will be no overlap profits. If any other accounting date is chosen then some of the sole tracer’s taxable accounting profits will be taxed in more than one tax year. These profits which are taxed twice are called overlap profits and relief is given on change of accounting date and on cessation of trading when the taxable trading profits of the final tax year are reduced by the overlap profits. Example 2 - Opening year rules (2) Casper Casper started trading as a ghost on 1 November 2009 making up accounts to 31 October each year. His profits are: Year ended 31 October 2010 £18,000 Year ended 31 October 2011 £37,500 Required Calculate the taxable tracing profits for all tax years. (2) Dracula Count Dracula started trading as @ vampire on 1 January 2011 making up accounts to 31 July each year. His profits are: 7 months to 31 July 2011 £10,500 Year ended 31 July 2012 £33,600 Required Calculate the taxable trading profits for all tax years. www.studyinteractive.orgbeeks2000 blogspet.com 67CHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT (3) Frankenstein Frankenstein started trading as 2 monster on 1 December 2009 making up accounts for 16 months to 31 March 2011 and annually thereafter to 31 March. His profits are 16 months to 31 March 2011 £48,000 Year ended 31 March 2012 £26,600 Required Calculate the taxable tracing profits for all tax years. (4) Milton Milton the monster started trading on 1 February 2010 making up accounts for 18 months to 31 July 2011 and annually thereafter to 31 July. His profits are: 18 months to 31 July 2011 £9,000 Required Calculate the taxable tracing profits for all tax years. Example 3 - Armani ‘Armani commenced trading on 1 June 2010 and decided to prepare his annual accounts to 31 October. His income statements show the following adjusted profits, before the deduction of any capital allowances Period to 31 October 2010 £58,000 Year ended 31 October 2011 £64,400 Year ended 31 October 2012 £79,200 Armani made the following acquisitions: 1 May 2010 Purchased a car for £7,920. During the year he drives 10,000 miles of which 4,000 miles were for private journeys. The car has a CO2 emission of 105 g/km 1 November 2011 Purchased plant for £23,500. Required Calculate Armani’s taxable trading profits for all tax years and his overlap profits. 68 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT Pec eee ES If a sole trader changes his accounting date from one date (the “old accounting date") to another (the "new accounting date”), special rules are used to determine the period of profits assessable in the tax year of the change. Conditions to change the accounting date ‘©The first set of accounts made up to the new date must not cover a period of more than 18 months. * An election to change the accounting date must be made to HMRC by 31 January following the tax year of the change. * No previous change of accounting date in the last 5 years. www.studyinteractive.orgbeeks2000 blogspet.com 69CHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT CEASING TO TRADE AAT So LL Ro 9 year rules ‘The closing year rules apply to a sole trader In the following circumstances: (1) When the sole trader sels the business to another sole trader. (2) When the sole trader sells the business to a company. (3) When the sole trader gifts the business. The donor applies the closing year rules and the donee applies the opening year rules. (4) When a partner leaves the partnership. On cessation the sole trader must prepare a final set of accounts for the period up to the date of cessation In the final accounting period there is no AIA, WDA or FYA, only balancing allowances and balancing charges on all categories of plant and machinery. ‘The final tax year in which trading profits are assessable is the tax year in which the cessation occurs. The plant and machinery profoma to use in the final accounting period Final accounting period Main | Car uth Business | Allowances pool | Private use use TWDV b/f x x Additions x Disposals o) x Balancing Allowance ~ x Balancing Charge x x BU ~ TWDV c/f Nil Ni 70 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT Exam technique when the sole trader is cea: bier Step 1 Determine the accounting date. Start date Stop date Tax year 1 Final tax year AP (1) begins AP final ends Step 2 Write the length of APL at the side, Determine the tax adjusted accounting profit if necessary by adjusting the accounting profits and calculating the capital allowances for each accounting period remember In the final accounting period, only balancing allowances and charges, no AIA, WDA or FYA. Step 3 Set up the proforma to determine th: taxable profits. Tax year Basis Penultimate CYB (Profits of 12 months to the accounting date ‘ending in the tax year) Final Remaining profits to cessation Deduct overiap profits (profits taxed twice ‘on commencement) www.studyinteractive.orgbeeks2000 blogspet.com 7CHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT Example 4 — CYB closing year rules (2) Calvin Klein Calvin ceased trading on 31 January 2011 making up a final set of accounts for seven months. Previously he prepared accounts to 30 June each year. His results were: Year end 30 June 2009 £12,000 Year end 30 June 2010 £10,000 7 months to 31 January 2011 £3,640 Calvin had £2,100 of overlap profits. Required Calculate taxable trading profits for all tax years. (2) Christian Dior Christian ceased trading on 31 May 2011 making up a final set of accounts for five months. Previously he prepared accounts to 31 December each year. His results were: Year end 31 December 2010 £45,200 Smonths to 31 May 2011 £15,000 Christian had £7,200 of overlap profits. Required Calculate the taxable trading profits for all tax years. (3) Ralph Lauren Ralph started trading on 1 August 2007 and prepared accounts to 31 July. He ceased tracing on 31 July 2011, Yearend 31 July 2008 £15,000 Year end 31 July 2009 £23,000 Yearend 31 July 2010 £27,000 Yearend 31 July 2011 £35,600 Required Calculate the taxable trading profits assessable in all tax years 72 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT DEC oer Ene ce) Class 1 and Class 1A national insurance contributions (NIC) For the tax year 2010/11 the rates of employee class 1 primary NIC is 11% and 1%. The rate of 11% is paid on earnings between £5,715 per year and £43,875, per year, and the rate of 1% is paid on all earnings over £43,875 per year. ‘The rate of employer class 1 secondary NIC is 12.8%, and is paid on all earnings over £5,715 per year. The rate of class 1A NIC that employers pay on taxable benefits Is 12.8% ‘The class 1 and class 1A NIC information will be given in the tax rates and allowances section of the examination paper. For the June and December 2011 sittings the rates are as follows: Class 1 Primary £1 - £5,715 per year Nil £5,716 - £43,875 per year 11.0% £43,875 and above per year 1.0% Class 1 Secondary £1 - £5,716 per year Nil £5,715 and above per year 12.8% Class 18 12.8% Illustration ‘Simon Ltd has one employee Simon who is paid a salary of £45,000 per year. Calculate the class 1 primary national insurance payable by the employee and the class 1 secondary payable by the employer in 2010/11. www.studyinteractive.orgbeeks2000 blogspet.com 73CHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT Self employed Class 2 and Class 4 National Insurance Contributions For 2010/11 the rate of class 2 NIC is £2.40 per week. ‘The rates of class 4 NIC are 8% and 1%. The rate of 8% is paid on profits between £5,715 and £43,875, and the rate of 1% is paid on all profits over £43,875. The class 4 NIC information that will be given In the tax rates and allowances section of the examination paper is as follows: Class 4 £1 - £5,715 per year £5,716 - £43,875 per year £43,875 and above per year Nil 8.0% 1.0% Illustration Simon is self-employed has trading income of £45,000 per year. Calculate the class 2 and class 4 national insurance payable by Simon in 2010/11. 74 ‘ebooks ZO00 Boaspeteom www.studyinteractive.orgCHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT sa Self assessment puts the responsibility for calculating the tax on the taxpayer who must submit the completed tax return by 31 January following the tax year. If the taxpayer wants to submit a paper tax return it must be submitted by 31 October following the end of the tax year. Additionally, if the tax return is submitted by 31 October HMRC will calculate the tax due, If the return is submitted electronically the due date is 31 January following the end of the tax year. For tax returns filed online a self-assessment is automatically provided as part of the filing process. If the return is filed late (after 31 January) an automatic penalty of £100 arises. If a return is more than three months late, a daily penalty of up to £10 per day (for 2 maximum of 90 days). If a return is more than six months late a penalty of 5% of the tax due will be charged (subject to a minimum of £300). If the return is more than 12 months late a further 5% of the tax due will be charged, although a higher percentage will be charged if the failure to submit is deliberate, Checking the return HMRC will not make any judgement on the accuracy of the figures submitted but will just calculate the tax liability based on the information submitted. However, any arithmetical error or errors of principle will automatically be corrected within 9 months of the date on which the return Is filed, General Rule If HMRC are going to make enquires into a self assessment tax return they must notify the taxpayer within twelve months of receiving the return. Exception to the General Rule However HMRC may raise a later “discovery assessment” if it is discovered that Insufficient tax has been pald, the taxpayer can be notified of this up to four years from the end of the tax year in which the discovery relates. This can be extended to six years if the loss of tax has been caused by negligence on the part of the taxpayer and 20 years in the case of dishonesty. ‘Taxpayers who have a business must retain their records unttl five years after the filing date, Other taxpayers must retain until the latest of: (a) 12 months after filing date. (b) date of completion of enquiry into return. Penalties of up to £3,000 may be charged for failure to keep or retain adequate records for the required period. www.studyinteractive.orgbeeks2000 blogspet.com 75CHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT Payments on account Payments on account are required if the taxpayer had to pay some income tax in the previous tax year. The due dates for payments on account are in two equal instalments 31 January in the tax year and 31 July following the tax year. Payments are required In respect of Income tax and class 4 national insurance. No Payments on account are required in respect of CGT. No payments on account are required if the tax for the previous year was less than £1,000 or more than 80% of the total tax liability was deducted at source. For 2010/11 the payment on account 1 is due on 31 January 2011 and the second payment on account is due on 31 July 2011 and the balancing payment is due on 31 January 2012. Each POA is equal to 50% of the taxpayer's income tax and class 4 NIC payable for the previous tax year. However, if the tax payable of the current year is expected to be lower than the previous year it is possible to reduce the payments on account and pay half of the actual income tax liability and class 4 NIC liability instead. Balancing payments After the actual tax liability for the tax year has been determined a balancing payment is due on 31 January following the tax year. If the taxpayer has overpaid any tax HMRC will refund the excess amount this is called a balancing repayment. If the tax due changes as a result of an amendment, any extra tax is payable within 30 days of the amendment date if it is later than the normal due date Ee Ub’ Interest on overdue tax Interest is automatically charged on tax paid late at 3.0%. It runs from 31 January In the tax year even if the tax was not actually due until 2 later date. Interest Is also charged when an excessive claim is made to reduce payments on account. ‘The amount, which should have been paid, is the lower of: Penalties Interest on tax pald late compensates for the advantage of paying tax late. Thus HMRC imposes additional penalties on income tax, class 4 NIC or CGT paid late, If the tax is paid more than one month late a penalty of 5% of the amount due. Further penalties of 5% will be charged after six months, and again after 12 months. These penalties only apply to the balancing payment, and not to payments on account 76 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT Pe A single penalty regime has been introduced for incorrect returns, The amount of penalty is based on the amount of tax understated, but the actual penalty payable is linked to the taxpayer's behaviour, as follows: ‘= There will be no penalty where a taxpayer simply makes a mistake. © There will be a moderate penalty (up to 30% of the understated tax) where @ taxpayer falls to take reasonable care. ‘© There will be a higher penalty (up to 70% of the understated tax) if the error is deliberate, and an even higher penalty (up to 100% of the understated tax) where there is also concealment of the error. However a penalty will be substantially reduced where a taxpayer makes disclosure, especially when this is unprompted by HMRC. For example, if a taxpayer makes an unprompted disclosure of an incorrect return following a failure to take reasonable care, the penalty could be reduced to nil Example 5 - Sal Rant Sal Rant has been a self employed dress designer since 1990, and prepares her Income statements up to 30 June. Sal's tax liabilities for the tax years 2008/09, 2009/10 and 2010/11 are as follows: 2008/09 | 2009/10 | 2010/11 £ £ £ Income tax liability 3,240 |4,100 | 2,730 Class 2 National insurance contributions 109 114 120 Class 4 National insurance contributions | 1,240 ‘| 1,480 990 No income tax has been deducted at source Required (a) Prepare a schedule showing the payments on account and balancing payments that Sal will have made or will have to make during the period 1 July 2010 to 31 March 2012, assuming Sal makes any appropriate claims to reduce her payments on account. (p) State the implications if Sal had made a claim to reduce her payments on account for the tax year 2010/11 to nil (©) Advise Sal of the latest date by which her self assessment tax return for 2010/11 should be submitted if she wants HMRC to prepare the self- assessment tax computation on her behalf. (d) State the date by which HMRC will have to notify Sal if they intend to enquire into her self-assessment tax return for the tax year 2010/11 and the possible reasons why such an enquiry would be made. www.studyinteractive.orgbeeks2000 blogspet.com 77CHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT ‘Answer 4 — Trading profits & current year basis (en) Tax year in which Sole Results Accounting _ profits are subject trader date to income tax Tom Year ended 31.5.10£10,000 31 May 2010/11 Janice Year ended 28.2.11£19,000 28 February 2010/11 Sammy Year ended 31.12.11£50,000 31 December 2011/12 Ricky Year ended 31.3,12£35,000 31 March 2011/12 (2) Gemima is a sole trader and has an accounting date of 31 March. Her recent results have been as follows: Profits before Capital capital allowances allowances £ £ Year ended 31 March 2010 10,000 2,000 Year ended 31 March 2011, 50,000 4,000 Year ended 31 March 2012 75,000 5,000 ‘The profits which she will pay income tax and class 4 national insurance on in 2011/12 are £70,000 (75,000 ~ 5000). ‘Answer 2 ~ Opening year rules (2) Casper Tax year Basis period Profits assessed (T) £ First 2009/10 Actual; 1.11.09 ~ 5.4.10 Sy12'x 18,000 7,500 Second 2010/11 CyB 31.10.10 18,000 Third 2013/12 cve 31.10.11 37,500 Overiap profits = 7,500 (2) Dracula Tax year Basis period Profits assessed (T) £ First 2020/11 Actual: 11.11 - 5.4.11 25/7 x 10,500 4,500 Second 2011/12 First 12 months @17.41) (1.1.41 2 31.52.11) 10,500 + 5/12 x 33,600 24,500 Third 2012/13 cye 31.712 33,600 Overlap profits = 18,500 (8 months) 78 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT (3) Frankenstein Tax year Basis period Profits assessed (T) £ First 2009/10 Actual: 1.12.09 ~ 5.4.10 ‘16x 48,000 12,000 Second 2010/11 CYB (ye 31.3.1) (313.11) /16 x 48,000 36,000 Third 2013/12 cys 31.3.12 26,600 No overlap profits (4) nm Tax year Basis period Profits assessed (T) £ First 2009/10 Actual: 1.2.10 - 5.4.10 2/18 x 9,000 1,000 Second 2010/11 Actual: 6.4.10 ~ 5.4.11 (31.7.10) ¥/18 x 9,000 6,000 Third 2011/12 CyB (y/e 31.7.1) #18 x 9,000 6,000 Overlap profits = */18 x 9,000 = 4,000 www.studyinteractive.orgbeeks2000 blogspet.com 79CHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT Answer 3 - Armani Step 1 Accounting dat 31 October Start date 1 June 2010 First tax year 2o10/ia Step 2 Adjust the accounting profits, remember capital allowances are computed for each accounting period. Armanis capital allowances will be as follows: 1.6.10- 31.10.10 AIA Main LowCO2,« BU _—Tootal pool Carwith 60% © Capital PU allowance 2 £ £ 2 £ Additions FYA Car 7,920 FYA (100%) (7920) X60% 4,752 Nil Nil 4,752 1.11.10- 31.10.11 Nil 1.11.11 - 31.10.12 Main Low Oz Capital Pool Carwith Allowances PU TWDV bit Nil Nil Additions AIA 23,500 Less: AIA (23.500) 23,500 Nil TWDV et Nil Nil Capital allowances 23,500 80 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT After the deduction of these capital allowances, Armani’s tax adjusted accounting profits will be as follows: Income statements to 31.10.10 BU1011 31.10.12 E E E Profits 58,000 64,400 79,200 CAs (4,752) (nil) (23,500) Tax adjusted accounting profit 53,248 64,400 55,700 Step 3- After applying the commencement rules, Armani will have the following taxable trading profits as follows £ oyi1 1.6.10 ~ 5.4.11 (£53,248 +5/12 x 64,400) 80,081 3/12 (31.10.11) CYB y/e 31.10.11 64,400 2/13 CYB y/e 31.10.12 55,700 Armani has profits eligible for overlap relief of £26,833. These have been computed as follows: 11110 5.4.11 £64,400 x 5/22 26,833 www.studyinteractive.orgbeeks2000 blogspet.com 81CHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT Answer 4 = CYB clo: 19 year rules (2) Calvin Klein Tax year Penultimate 2009/10 Final 2010/11 Basis period Profits assessed (T) £ CYB 30.6.09 12,000 1.7.09 - 31.111 Remaining profits 10,000 + 3,640 13,640 Less: Overlap relief (2,100) 11,540 (2) Christian Dior Tax year Basis period Profits assessed (T) € Penultimate 2010/11 CYB 31.12.10 45,200 Final 2011/12 Remaining profits Lil - 315.1 15,000 Less: Overlap relief (7,200) 7,800 (3) Ralph Lauren Tax year Basis period Profits assessed (T) £ First 2007/08 Actual: 1.8.07 - 5.4.08 8/12 x 15,000 10,000 Second 2008/09 CYB 31.7.08 15,000 Third 2009/10 CYB 31.7.09 23,000 Fourth 2010/11 CyB 31.7.10 27,000 Fifth ~ Final 2011/12 1.8.10 ~ 31.7.11 Remaining profits 35,600 Less: Overlap profits (10,000) 25,600 ‘ebook: 2000 biogspet.com www.studyinteractive.org 82CHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT Answer 5 - Sal Rant (a) Schedule of payments Payment Date siaat |3n7a1 |3iaa2 Payment on Account 2- 09/10 | £2,240 Ye x (3,240 + 1,240) Balancing payment - 09/10 £1,100 (4,100 + 1,480) ~ 4,480 Payment on account 1 ~ 10/11 £1,860 Ya x (2,730 + 990) Payment on account 2 ~ 10/11 £1,860 Balancing payment ~ 10/11 EN Payment on account 1 ~ 11/12 £1,860 (b) If Sal reduced her payments on account for 2010/11 to nil then she will be charged interest on overdue tax at 3.0% per annum Months Late Interest Due Date Date Paid Amount Due Bat 31.142 £1,860 12 months 31741 31.112 £1,860 6 months £56 £28 (©) The due date for submitting the self assessment tax return for 2010/11 is 31 January 2012. If the taxpayer wants to submit a paper return or wishes HMRC to compute the tax liability on behalf of the taxpayer the return must be submitted by 31 October 2011. (4) HMRC must notify Sal within 12 months from the date they receive her return if they intend to make enquires into her self assessment tax return. reason for making an enquiry is either that the taxayer has been selected randomly or HMRC have discovered an error or omission in the return The www.studyinteractive.orge0%ks2000 blogspet.com 83CHAPTER 3 - TRADING PROFITS & THE BASIS OF ASSESSMENT 84 ‘ebooks2000 blogspet.com www. studyinteractive.orgChapter 4 Employment income London School of Business & Finance powered by InterActive ANALYSIS OF PAST EXAM QUESTIONS Pitot | Dee | June] Dec ] June | Dec | June | Dec 2007 | 2008 | 2008 | 2009 | 2009 | 2010 | 2010 Question1| + . . : . ° Question 2 Question 3 Question 4 Question 5 ° 85 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 4 - EMPLOYMENT INCOME baa ed BACKGROUND AND THE EXAM FOCUS EMPLOYED v SELF EMPLOYED EMPLOYMENT INCOME SALARY AND BONUS TAX FREE BENEFITS IN KIND -~ TAXABLE BENEFITS ASSESSABLE ON P11D EMPLOYEES THE PAYE SYSTEM -: IMPORTANT ORTES FOR THE PAYE SYSTEM IN 2010/11 ANSWERS-. PROFORMA EMPLOYMENT INCOME ‘SALARY Bonus MEDICAL INSURANCE BENEFIT MILEAGE ALLOWANCE BENEFIT Company cars FUEL SeNEFIT VAN BENEFIT ACCOMMODATION 8¢! COUNCIL TAX BENEFIT ANNUAL RUNNING COSTS BENEFIT Use aenentT 10. TRANSFER BENEFT 111. CHEAP LOANS: 12. GIFT BENERTT 87 90 90 91 on OL 92 93 93 94 96 97 98 99 101 102 103 104 104 105 108 109 ‘eeakSZOOU BRST www.studyinteractive.orgCHAPTER 4 - EMPLOYMENT INCOME erie Sci teh eu ial tek hd The examiner expects students to be aware of the factors that determine when a person should be treated as employed or self employed. It is usually obvious whether a person is employed or self employed. When it is not clear there is 2 great deal of case law on this subject and several criteria have been established which should be considered in deciding the correct tax treatment for the income. This chapter is focusing on the rules for determining a person's employment Income. This is another frequently tested topic and will often appear in question one of the paper. Employment income is received net of tax. The employer acts as, a tax collector and deducts the tax at source this is called the PAYE system of collecting tax. Employment income is assessable based on the employee's earnings during the tax year. Individuals pay both income tax and class 1 primary national Insurance on this income. Additionally the employer pays national insurance which is called class 1 secondary and class 1A national insurance. www. studyinteractive. or GoeeKs2000 blogspet.com 87CHAPTER 4 - EMPLOYMENT INCOME EMPLOYED v SELF EMPLOYED Employment is a contract of service while self employment is a contract for services, Relevant factors to consider are: (1) Contract - contract of service = employed; contract for services = self employed. (2) Integral position - if the individual holds an integral position within the organisation, e.9. chairman, he must be employed (3) Risk ~ where a person bears individual risk in respect of work performed, this would be a sign of self employment. If a person bears financial risk this is an indication of self employment. (4) Control - can the individual choose place of work, hours of work and method? If so he is likely to be self employed. Is he subject to direction of another person? Does a master/servant relationship exist? If so he is likely to be employed, (5) Legal rights - If a person has the legal right to receive regular remuneration, holiday pay, redundancy pay or benefits, this can indicate employment rather than self employment. (6) Equipment - where 2 person has to provide his own equipment he is more likely to be self employed. (7) Substitute - an employed person cannot provide a substitute worker to do the job, This can be remembered by the mnemonic: c umrogn ‘eeakSZOOU BRST 38 www.studyinteractive.orgCHAPTER 4 - EMPLOYMENT INCOME Example 1 — Exam standard question William Wong Is the finance director of Glossy Ltd. The company runs @ publishing business. The following information is available for the tax year 2010/11 (1) William is paid director's remuneration of £2,400 per month by Glossy Ltd. (2) In addition to his director's remuneration, William received two bonus payments from Glossy Ltd during the tax year 2010/11. The first bonus of £22,000 was paid on 30 June 2010 and was in respect of the year ended 31 December 2009. William became entitied to this bonus on 15 March 2010. ‘The second bonus of £37,000 was paid on 31 March 2011 and was in respect, of the year ended 31 December 2010. William became entitled to this second bonus on 15 March 2011, (3) From 6 April 2010 until 31 December 2010 William used his private motor car for business purposes. During this period William drove 12,000 miles in the performance of his duties for Glossy Ltd, for which the company paid an allowance of 30 pence per mile. The relevant HM Revenue & Customs authorised mileage rates to be used as a basis of an expense claim are 40 pence per mile for the first 10,000 miles, and 25 pence per mile thereafter. (4) From 1 January 2011 to 5 April 2011 Glossy Ltd provided Willlam with a diesel Powered company motor car with a list price of £46,000. The motor car cost Glossy Ltd £44,500, and it has an official CO, emission rate of 239 g/km. Glossy Ltd also provided William with fuel for his private journeys. (5) William was unable to drive his motor car for two weeks during February 2011 because of an accident, so Glossy Ltd provided him with a chauffeur at a total cost of £1,800. (6) Throughout the tax year 2010/11 Glossy Ltd provided william with 2 television for his personal use that had originally cost £3,825, (7) Glossy Ltd has provided william with living accommodation since 1 January 2009. The property was purchased in 2000 for £90,000, and was valued at £210,000 on 1 January 2009. It has an annual value of £10,400, (8) Glossy Ltd pays an annual insurance premium of £680 to cover William against any liabilities that might arise in relation to his directorship. (9) During May 2010 William spent ten nights overseas on company business. Glossy Ltd paid him a daily allowance of £10 to cover the cost of personal expenses such as telephone calls to William's family. (10) William pays an annual professional subscription of £450 to the Institute of Finance Directors, this is a HM Revenue & Customs approved professional body, and a membership fee of £800 to a golf club. He uses the golf club to entertain clients of Glossy Ltd. (11) Glossy Ltd had provided William with an interest-free loan of £30,000 on 1 January 2010. He repaid £10,000 of the loan on 30 June 2010. Required (a) State the rules that determine when a bonus paid to a director is treated as being received for tax purposes. (b) Calculate William’s taxable income for the tax year 2010/11. (©) Calculate the total amount of both class 1 and class 1A national insurance contributions that will have been paid by William and Glossy Ltd in respect of Williams's earnings and benefits for the tax year 2010/11. (25 marks) www. studyinteractive. or GoeeKs2000 blogspet.com 89CHAPTER 4 - EMPLOYMENT INCOME EMPLOYMENT INCOME Employment income is based on the emoluments received in the tax year of assessment irrespective of when the emoluments were earned. Emolumei are treated as being received on the earliest of the following: (1) When the emoluments are received (2) When the person was entitled to receive the emoluments, Proforma employment income £ (a) Salary (b) — Bonus/Commission (©) Benefits in kind (d) Reimbursed expenses Gross emoluments Less (e) Allowable expenses + Donation to charity under a payroll deduction scheme + Contributions to an occupational pension pian + Travel, subsistence and entertaining incurred wholly, exclusively and necessarily in the performance of the office or employment + Subscription to a professional body + Deficit on a mileage allowance Plus: Redundancy payment x Less: Exemption under $148 w Employment income xx x &) & ~ & &) 90 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 4 - EMPLOYMENT INCOME Ama aed Era ‘The amount of salary assessable in a particular tax year is the actual amount earned in the tax year. ‘The bonus/commission is normally assessable in the tax year in which the bonus is received The rule to determine when a bonus is treated as being received Is on the earliest of the following (1) When the bonus is actually received. (2) When the person was entitled to receive the bonus. Example 2 - Employment income Tom is employed by ABC plc and his salary was £36,000. On 1 January 2011 his salary was increased to £42,000, Additionally Tom receives a bonus each February based on the companies results, Bonus Y/e 31 December 2009 £3,000 Y/e 31 December 2010 £10,000 Additionally Tom pays 6% of his salary into his employer's occupational pension plan and donates £1,500 to charity under a payroll deduction scheme. Required Compute Tom's employment income for 2010/2011. www. studyinteractive. or GoeeKs2000 blogspet.com 94CHAPTER 4 - EMPLOYMENT INCOME BY Gi a ee el) Certain forms of employment income are exempt from income tax. The main examples of tax free benefits include: P arking provided by the employer. E ye care testing paid for by the employer. R clocation expenses paid by employer up to £8,000. S taff canteen provided by employer. © ccupetional and personal pension contributions from the employer. NN ursery and childcare payments and vouchers up to £55 per week paid to all staff. ‘Accommodation which is job related. Authorised mileage allowance paid by employer when employee uses own car, motor bike or bicycle for their employers business. Luncheon vouchers provided by employer up to 15p per working day. Loan of bicycles and safety equipment to use mainly for travel to and from work and for business purposes, I nterest saved on a cheap loan provided the loan < £5,000. Indemnity insurance premiums paid by employer. P hone (mobile) provided by employer and used by employee to make private calls Overnight personal expenses paid by employer such as telephone calls home, newspapers etc. Up to £5 per night for overnight says in UK and up to £10 per night for overnight says overseas. D eath in service benefit, S taff training courses, staff christmas parties (up to £150 per person per year) and staff counselling Subscriptions paid by an employer to professional bodies 92 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 4 - EMPLOYMENT INCOME TAXABLE BENEFITS ASSESSABLE ON P11D EMPLOYEES (1) Medical insurance (2) Mileage allowance benefit (3) Company cars (4) Fuel for private motoring (5) Van benefit (6) Accommodation benefit (7) Council tax benefit (8) Annual running costs benefit ) Ancillary services (9) Use benefit ) (10) Transfer benefit (11) Cheap loans (12) Gift benefit 1. Medical insurance benefi Employer pays for medical insurance premiums. Medical insurance benefit arises when an employer pays medical insurance Premiums for the benefit of an employee. The taxable amount is equivalent to the medical insurance premiums paid. sa serve Utter Mee Lg Private Hospital Emalover sais Medical Insurance premium to an insurance ‘company each year. www. studyinteractive, or Gooots2000 Beaspetcom 93CHAPTER 4 - EMPLOYMENT INCOME 2. Mileage allowance bene = sncerdetive Ue tele Neh ee arog + Employee uses their own car on employers business. Employer pays arileage allowance of 45p per business mile Business miles 12,000 Employee pays Road tax 178 Incurance 750 Repairs 1,100 Petal If an employee uses their own car/motorbike or bicycle to carry out their employer's business then the employee Is entitled to receive a mileage allowance from the employer to compensate for the additional costs incurred in running the vehicle ‘The amount which can be received tax free is the amount set by HMRC and the amount is called the Authorised Mileage Allowance Payment (AMAP). Up to 10,000 Excess over 10,000 business miles business miles Motor cars 40p 25p Motor bikes 24p 24p Bicycles 209 20p 24 beaks Z00 Bogspet com worw.studyinteractive.orgCHAPTER 4 - EMPLOYMENT INCOME sncerdtive Cees aS UNE Cna cr > Private miles / i’ miles business mies Rommatpace ot) ¢ OT _, (Femrorary co Temporary ee place (<2years) or Not normal wark place e.g.clent Example 3 - Mileage allowance benefit Benny has a salary of £20,000 and uses his own car for his employers business and receives a mileage allowance of 45p per business mile. Benny drives 12,000 business miles during the year 2010/11. (i) Compute Benny's employment income for 2010/11. (ii) Compute the employment income for 2010/11 if instead Benny received 35p per business mile, www. studyinteractive, or Gooots2000 Beaspetcom 95CHAPTER 4 - EMPLOYMENT INCOME Company cars ard | nerve forte -T Cig + Employer provides employee with private use of a petrol engined car. a] Busi 80% _— oo, ness Use Private Use 20% Employer costs Road Tax 175 Insurance 550 Repars 1.100 Running costs 1,926 ListPrice ofear £15,000 COzEmission 187ghen Petrol engined car The car benefit is assessable on an employee where an employer provides an employee with the private use of a motor car. [car benefit = % x .¢ pays employer towards the running cost List price of car (Xa) - UPPER LIMIT = £80,000 List price of car when first registered Plus: x Cost of extras paid for by employer (sun roof, ai condivoning etc.) x Less: Contribution employee gives employer towards the capital (x) cost of the car (Upper Limit £5,000) xa Table to determine the percentage to use in the calculation of the car benefit Option 1 ‘Option 2 ‘Option 3 ‘Option 4 Very Low emission Low emission Medium emission | High emission 02 EMISSION 02 EMISSION co? EMISSION C02 EMISSION $75 g/km 76120 g/km | 121 ~ 130 GRAMS/km| 130 + g/km PETROL 5% PETROL 10% — | PETROL 15% 159%/ 189% + (CO2 - 130) DIES 8% DIESEL 13% DIESEL 18% UPPER LIMIT = 35% 96 ‘eeakSZOOU BRST www.studyinteractive.orgCHAPTER 4 - EMPLOYMENT INCOME Ce ~s id ee lnwerdetive + Employer pays for private fuel for the car he is letting the employee use. Employer Costs £ i CostofPetral 3,500 Business use Private use 80% 20% ‘The fuel benefit applies when the employer pays for all or just some fuel for private mileage for the car he provides to the employee. The taxable benefit is calculated as a percentage of a base figure. For 2010/11 the base figure is £18,000 which is given in the exam: Fuel benefit = % x 18,000 x X/12 ‘The percentage used in the calculation of the fuel benefit is exactly the same as the percentage used in the calculation of the car benefit Key Points ‘© If an employee gives the employer a contribution towards the cost of the private fuel this does not reduce the fuel benefit. © If the employee reimburses the employer for the full cost of the private fuel then the fuel beneftt is nil. Example 4 - Richard Care Richard has an annual salary of £32,000 and is supplied with a Ford Granada on 1.7.10 which has a list price of £15,000. Richard contributed £6,000 towards the cost of the car. The company paid £1,925 for his road tax, insurance and other Tuning costs. His total mileage during 2010/11 amounted to 14,000 and he estimated that 80% is related to business use. Richard is required to pay £20 per month towards the car (£5 is for private fuel). All petrol is paid by the company. ‘The CO2 emission is 187 grams per kilometre. Required Compute Richard’s employment income for 2010/11. What effect does it make to Richard's employment income in 2010/11 if the Coz emission of the car was 729/km? www. studyinteractive, or Gooots2000 Beaspetcom 97CHAPTER 4 - EMPLOYMENT INCOME Van benefit sa sncerdetive Clef aoiia + Employer provides employee with the private use of a van Employer pays for Road Tax 175 Insurance 800 ¥ Repairs 1.100 Running costs 2075 - ——, Pu Ea 20% The annual scale charge used to calculate the van benefit when an employer provides the employee is provided with a company van for private use is £3,000 ‘The van benefit is proportionately reduced if the van is only available for part of the tax year. The van benefit is also reduced if the employee gives the employer a contribution toward the running costs of the van, A further taxable benefit arises if the employer provides fuel for private use, with no reduction for any partial contribution made by the employee towards the cost of such fuel, The amount of this taxable benefit for 2010/11 is £550, This figure is reduced if the fuel is only available for part of the tax year. Van benefit £3,000 x x/12 - contribution employee makes to the employer| towards the vans running costs. Van fuel benefit = £550 x x/12 98 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 4 - EMPLOYMENT INCOME + Employer provides employee with somewhere to live. Employer pays Cost ofthe property pays for the rent of the property Job related accommodation If accommodation provided by the employer is “job related” then no taxable benefit, arises. Accommodation is job-related if: - it Is necessary for the employee to reside in the accommodation for the proper performance of his job (e.g. @ nanny who is required to live in the employer's accommodation in order to look after the children.); - the accommodation is provided for the better performance of the employee's duties and it is customary for such accommodation to be provided (e.g soldiers living In army barracks provided by the employer); - there is a special threat to the employee's security and the accommodation Is. provided as part of the security arrangements. Not job related accommodation If accommodation provided by the employer is “not job related” then a taxable benefit arises by evaluating the basic charge and sometimes the additional charge which Is described on the next page. www. studyinteractive, or Gooots2000 Beaspetcom 99CHAPTER 4 - EMPLOYMENT INCOME Example 5 — Sally House Sally has @ salary of £2,500 per month and was provided with the use of 2 company fiat on 6.4.05 the flat cost her employer £105,000 on 1 June 1997. The annual value of the flat is £4,500. ‘The market value of the flat on 6 April 2005 was £155,000 and on 6 April 2010 was £200,000. The employer built on a conservatory on 30 June 2009 which cost £20,000. Sally pays her employer £100 per month in rent to live in the flat. Required Evaluate Sally's employment income in 2010/11 official rate is 4.00%. Table benesit— Not job related Job related £ 1) Basic charge, greater of: (i). Rent paid by employer(X1) X4 or X2 Taxable benefit = ENil (ii) Annual value x x/12 (X2) (if employer owns the property then use X2) 2) Additional charge (only applies if employer owns the property and it cost the employer > £75,000) (Xi ~ 75,000) x 4.00% x X/12_ XB 3)Less: Rent employee pays employer (x) ‘Accommodation benefit, x Additional charge ~ Xi £ XI Is defined as original cost of the property or MV x (if the property was acquired by the employer more than six years before it was made available to the employee use MV of the property when first occupied by the employee) Add: Cost of capital improvements paid by employer before the start of the current tax year x xi 100 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 4 - EMPLOYMENT INCOME Ake ad 7 | ncerdtive fore e ME haat ais + Employer pays for the council tax for the property that the employer is providing. Employer Cost £ Counciltax 2,000 If an employer provides living accommodation to an employee, the employee is taxed not only on the accommodation but also on the cost to the employer of paying for the council tax in connection with the accommodation. Council tax benefit amount employer has paid for the council tax ~ any contributions from employee. www. studyinteractive, or Gooots2000 Beaspetcom 101CHAPTER 4 - EMPLOYMENT INCOME fifete] Annual running costs benefit + Employer pays for the annual running costs in connection with the accommodation that has been provided. a Enso pee Coll Evecy 840 Cleaning costs 200 \ Annual rurring costs 2,840 ; a If an employer provides living accommodation for an employee, the employee is taxed not only on the accommodation benefit but also on the cost to the employer of providing ancillary services In connection with that accommodation. Ancillary services include such items as heating and lighting, repairs and maintenance and cleaning. The provision of furniture for the employee's use is also included under the heading of ancillary services and is assessed in the same way as assets with private use. If the accommodation is job related then the benefit attributable to ancillary services cannot exceed 10% of the net earnings (excluding ancillary services). ‘eeakSZOOU BRST 102 www.studyinteractive.orgCHAPTER 4 - EMPLOYMENT INCOME =i ee sncerdtive + If an employer lends assets to an employee for private use, the employee must pay income tax on a use benefit. Employer costs Costofturnture —§,000 ‘The use benefit applies to the use of computers, furniture, TV sets, motorbikes and boats. ‘The assessable use benefit is determined as follows: £ 20% x Open market value when first provided x x/12 x Less: Rent employee pays employer for the use of the asset (X) Use benefit x Exception to the general rule Bicycles and safety equipment made available on loan to employees for travelling to and from work and for business purposes are defined as a tax free benefit Example 6 - Leon Factor Leon is provided with living accommodation and his employer pays for living expenses of £2,840 and lends him furniture to use in the accommodation which cost his employer £5,000. = Assume Leon has a salary of £20,000, - Assume the taxable accommodation benefit is £7,000. Required (2) Compute Leon's employment income in 2010/11 if the accommodation is not job related. (b) Compute Leon’s employment income in 2010/11 If the accommodation Is job related www. studyinteractive, or Gooots2000 Beaspetcom 103CHAPTER 4 - EMPLOYMENT INCOME Pe hy If the asset loaned to an employee is subsequently sold or given to an employee, then the employee is additionally assessed on the transfer benefit. Bieta ‘The Transfer benefit is Greater of X1 and x2 1, MV of asset when first provided x Less: use benefits already assessed 9 Less: contribution paid to employer for gift (x) x 2. MVattime gifted x Less: contribution paid to employer for gift (x) x2 PP ed This occurs where an employer makes a loan to an employee and the rate of interest paid on this loan is less than the official rate 4,00%. ‘The interest saved on this loan is a tax free benefit to the employ: total amount of loans provided to that employee are S£5,000. provided the If the loans provided to the employee are > £5,000 then the employee must pay income tax on the interest they have saved Method of computing the loan benefit Method 1 - The average method ‘The amount of loan outstanding at the start and end of the tax year are averaged and then multiplied by the official rate (4.00%). The interest actually paid by the employee is then subtracted, giving the assessable loan benefit. Exam technique for the average method £ Average Loan x official rate of interest x Less Interest actually paid 0) Assessable benefit xX ‘The taxable benefit is based on the average loan Opening balance + Closing balance average loan 2 91 104 osPO00 Hlgspe eam www.studyinteractive.orgCHAPTER 4 - EMPLOYMENT INCOME Method 2 - The accurate method ‘The amount of interest at the official rate is computed precisely. Interest actually paid is then subtracted, giving the assessable loan benefit. ‘The first method is quicker and easier and is generally used. However, either the employee or HMRC may insist that the accurate method should be used. The employee will presumably do so if this results in a lower assessment and HMRC may do so if it appears that the “average” method Is being used to deliberately exploit tax avoidance. The exam technique for the accurate method £ Actual loan(1) x official rate x months of loan (1)/12, x Actual loan(2) x official rate x months of loan (2)/12 Less Interest actually paid ~ Assessable benefit x bce ii The taxable benefit is the market value of the asset at the time of the gift, ‘The employee is then treated as if that asset cost market value. ‘The most common type of gift made by an employer is shares in the company the employee is working for. www. studyinteractive. or GoeeKs2000 blogspet.com 105CHAPTER 4 - EMPLOYMENT INCOME Example 7 - Hector H Hector Hill is managing director of Hill plc. He is also a substantial shareholder in the company, ‘The company’s accounts show the following information: Years ended 30 April 2009 2010 2011 £ £ £ Salary, as managing director 13,620 43,560 44,100 Performance bonus 10,000 15,000 18,000 ‘The performance bonus is determined and paid in the July following the accounting year end. Mr Hill has the use of a motor car with a list price of £34,000. The CO; emissions were 70 g/km. All diesel and expenses were paid by the company. Mr Hill drove 2 total of 18,000 miles in 2010/11, of which 10,000 were for private purposes. He reimbursed the company £30 per month towards the cers running expenses and £20 per month in respect of private fuel. Mr Hill also has had the use of a company house since 6 April 2010, whose annual value is £1,200 and which is provided rent free, The house had cost £90,000 in 1999 and its market value in April 2010 was £135,000 Mr Hill was provided with @ plasma television for his personal use since 6 April 2008 when it cost £1,200, On 6 April 2010 the television was sold to Mr Hill for £225 when its market value was £375. The company pays private medical insurance for all its employees. Mr Hill's share of the group premium was £320 for 2010/11. In June 2010 he needed to have treatment following 2 motor accident and the cost to the insurance company was £1,720. In 2010/11 Mr Hill was reimbursed £1,500 in respect of business travelling in the UK. Required Calculate Mr Hill's employment income for 2010/11 after his claim for a deduction from employment income. 106 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 4 - EMPLOYMENT INCOME THE PAYE SYSTEM Sugar | Hi! Branson why are you looking so sad? Branson | I've started a business recently and I don’t understand the PAYE system! Sugar | Don’t be upset! I'll explain it to you. It’s really quite simple. Employers are actually unpaid tex collectors of HMRC. Before paying their ‘employees’ salaries they have to deduct tax and National Insurance and then pay the net salaries to the employees. Branson | But how much tex and National Insurance will I have to deduct? sugar | PAYE works on a cumulative basis. HMRC gives employers tax and national insurance tables (Tables A-D) which allow you to work out the relevant calculations based on the salaries. You record your calculations ‘on deduction working sheets called P1is. The tables also enable you to work out your employer's national insurance that you have to pay over to HMRC. Don't forget the total tax and National Insurance must be paid over to HMRC 14 days after the end of the tax month, i.e. the 19" Branson | I'm also confused about these tax-free allowances that employees are entitled to. Sugar | Well, every tax year HMRC will send you a code for each employee on 2 form called a P9. The most common coding is L ~ which indicates the ‘employee is entitled to the basic personal allowance of £6,475. Codings are also used cumulatively so every month the employee gets '/12 of his, allowances, which reduces his taxable income. In certain cases where the ‘employee receives large benefits in kind he could have a K code which is a negative allowance and will increase his taxable income. Branson | I think I'm beginning to understand the system. So as long as I carry out the monthly procedures I should be okay! Sugar | Not so fast! During the year one of your employees could decide to leave. You would then have to fill in a P45 showing the total tax and pay to date and the code number used, Three copies of the P45 are given to the employee: two parts pass on to his new employer and one copy for himself. The old employer sends a copy to HMRC. If a new employee does not have a P45 you have to make sure he fills in a P46 which will enable you to deduct tax on a cumulative basis right away. Branson | That sounds quite straightforward! I hope that's all there beginning to get hungry! as I'm Sugar | All you think of is food, my friend! Finally, you have to do your year end returns. You have to fill in a P60 for each employee showing his total pay, tax and national insurance for the tax year. A copy of this form, a P60, is given to each employee by 31 May following the end of the tax year. These details are then further summarised on a P35 which shows the total tax and national insurance for your business. You have to send wow. studyinteractive, or Seoea00 Donspsteam 107CHAPTER 4 - EMPLOYMENT INCOME these forms to HMRC by the 19" May following the end of the tax year. Don't forget to submit your P11Ds showing any taxable benefits in kind for directors anc employees earning more than £8,500 pa a bit later on the 6" July. Class 1A NIC on all taxable benefits is payable on the 19 July following the tax year, mae eee All employers are required to operate PAYE and NIC and make deductions for these from employees’ pay. Whilst the basic operation of this system is for you to self-study, please ensure you are aware of the following forms: P35 Employers’ end of year summary. P14/P60 Given to each employee listing gross pay, tax deducted and NIC for the year. The P60 must be given to the employee by 31 May 2011. PID _Retun of taxable benefits for employees earning below £8,500. PLID Return of taxable benefits for directors and higher paid employees. The PLLD must be given to the employee by 6 July 2011. P45 Given to employee on leaving employment. ioe osteo Bente wiv studyinteractive.orgCHAPTER 4 - EMPLOYMENT INCOME (ATTEMPT QUESTIONS FIRS Answer 2 - Tom 2010/11 £ (a) Salary (9/12 x 36,000 + 3/12 x 42,000) 37,500 (b) Bonus (February 2011) 10,000, (c)_ Benefits Nil (d) Reimbursed expenses Nil (e) Allowable expenses - Contribution to employer's pension plan (6% x 37,500) (2,250) - Donation to charity under a payroll deduction scheme (1,500) Employment income 43,750 Answer 3 - Benny (i) — £ (a) Salary 20,000 (b) Bonus Nil (©) Benefits Mileage allowance received (45p x 12,000) 5,400 Less: AMAP (10,000 x 40p) (4,000) (2,000 x 25p) (500) Mileage allowance benefit, 900 20,900 «wy £ £ (a) Salary 20,000 () Bonus Nil (c) Benefits Mileage allowance received (35p x 12,000) 4,200 Less: AMAP (10,000 x 40p) (4,000) (2,000 x 25p) (500) (e) Mileage allowance deficit (300) Employment income 19,700 www. studyinteractive. or GoeeKs2000 blogspet.com 109CHAPTER 4 - EMPLOYMENT INCOME Answer 4 - Richard Care 2ot0/i1 (1) Salary (2) Bonus (3) Benefits Car benefit 15% + (185 - 130)/5 26% x (15,000 ~ 5,000) x 9/12 Less: Contributions towards the running costs of the car (15x 9) 6% Fuel benefit 26% x 18,000 x 9/12 ployment income Nil (135) 1,815 3,510 37,325 If the CO2 emission of the car is $ 75g/km and petrol the percentage which should be used when computing the car and fuel benefit is 5%. The car benefit will be reduced to £240 (5% x 10,000 x 9/12 - £135) and the fuel benefit t 18,000x 9/12) £675 (5% x ‘Answer 5 ~ Sally House 2010/11 Accommodation Benefit Salary 2,500 x 12 Basic Charge Greater of (Rent paid by employer Nil Gi) Annual value 4,500 4,500 Additional charge 4.00% x (155,000 + 20,000 - 75,000) 4,000 Less Rent Sally pays her employer for the use of the accommodation (2,200) (12 x 100) ~ Accommodation benefit 7,300 Employment income 30,000 7,300 37,300 tio ‘eeakSZOOU BRST www.studyinteractive.orgCHAPTER 4 - EMPLOYMENT INCOME Answer 6 - Leon Factor (a) Not job related accommodation £ (1) Salary 20,000 (2) Bonus Nil (3) Benefits ‘Accommodation benefit 7,000 Living expenses benefit 2/840 Use benefit (20% x 5,000) 4/000 Employment income 30,840 (b) Job related accommodation £ (1) Salary 20,000 (2) Bonus Nil (3) Benefits Accommodation benefit Nil Living expenses benefit, lower of = 10% x 20,000 ~ £2,000 ~ Cost of ancillary services (2,840 + 1,000) = £3,840 2,000 Employment income 22,000 wow. studyinteractive, or Seoea00 Donspsteam 1aCHAPTER 4 - EMPLOYMENT INCOME Answer 7 = Hector Hill Employment income 2010/11 £ £ (a) Salary (1/12 x £43,560 + 11/12 x £44,100) 44,055 (b) Performance bonus (received in July 2010) 15,000 (©) Benefits ‘The CO; emissions are < 75a/km ‘Therefore the ‘relevant percentage’ Is restricted to a maximum of 8% for diesel cars (Car benefit (8% x £34,000) 2,720 Less! amount Hector pays his employer for running cost _(360) 2.360 2,360 (il) Fuel (8% x £18,000) There is no deduction for the reimbursement of part of the diesel provided 1,440 (iil) Living accommodation: = Basic charge 1,200 = Additional charge (£135,000 - £75,000) x 4,00% 2/400 (iv) Transfer benefit Greater of a) MV when first provided 1,200 Use benefits 08/09, 09/10 (480) (20% X 1,200) x2 Less Price paid 225) Transfer benefit 495 495 b) MV when transferred 375 Price paid by employee (225) ‘Transfer benefit 15 (v) Private medical insurance 320 (d)__Reimbursed expenses 41,500 68,770 (2) Less: Allowable deduction from employment income claim (1,500) Employment income 67,270 Note: * The house was acquired by the employer more than six years before it was, made available to the employee, therefore MV is used instead of the cost, 112 osPO00 Hlgspe eam www.studyinteractive.orgChapter 5 Personal tax computations London FZ School of Business & Finance powered by InterActive Ue Ee eee ed pilot] Dee | June | Dec | June | Dec | June | Dec 2007 | 2008 | 2008 | 2009 | 2009 | 2010 | 2010 Question | + . ° . . . . Question 2 Question 3 Question 4 ° ° . Question 5 . ° 413 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 5 - PERSONAL TAX COMPUTATIONS baa ed BACKGROUND AND THE EXAM FOCUS -115 THE SCOPE OF INCOME TAX -116 PROFORMA - PERSONAL TAX COMPUTATION 2010/11 “117 INCOME FROM LAND AND BUILDINGS IN THE UK - INVESTMENT PROPERTIES-~ -118 PROFORMA FOR PROPERTY BUSINESS PROFITS/LOSSES 118 ALLOWABLE ExPEN: 118 PREMIUMS RECEIVED ON THE GRANT OF & SHORT LEASE 119 RENT A ROOM 119 RENTAL LOSSES (OR PROPERTY BUSINESS LOSSES) 119 FURNISHED HOLIDAY LETTING 120 INTEREST INCOME AND DIVIDEND INCOME INTEREST INCOME (SAVINGS INCOME) 124 Divipeno INCOME 122 INVESTMENT GENERATING TAX FREE INCOME AND GAINS --- INTEREST PAYABLE ON QUALIFYING LOANS: PAYMENTS ELIGIBLE FOR TAX RELIEF ~ 124 PERSONAL ALLOWANCE OLDER TAXPAYERS, 126 INCOME TAX CALCULATIONS -127 RATES OF INCOME TAX FOR DIFFERENT TYPES OF INCOME 127 GIFT AID DONATIONS AND EXTENDING THE BASIC AND ADDITIONAL RATE SANDS 127 PERSONAL PENSION PLAN PAYMENTS AND EXTENDING THE BASIC AND ADDITIONAL RATE BANDS 128 REGISTERED PENSIONS -129 (GENERAL RULES FOR ALL REGISTERED PENSION PLANS 129 DEFINITION OF RELEVANT EARNINGS 130 OCCUPATIONAL PENSION PLANS 130 SONAL PENSION PLANS 130 -133 114 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 5 - PERSONAL TAX COMPUTATIONS erie Sci teh eu ial tek hd Individuals may have @ number of sources of income, some will be received gross and some received net. At the end of the tax year it Is necessary for an individual to bring together all of these sources of income in their personal tax computation and calculate thelr net income. It must be remembered that some individuals will get a certain amount of income free of income tax each tax year this is called their Personal allowance. It is then necessary to compute the total income tax liability for the tax year. One complication which arises when calculating the income tax liability is that cifferent types of income suffer income tax at different rates. Non savings income has one set of income tax rates; savings income has another set and dividend income a different set. This chapter is concerned with explaining the rules for determining the total income tax liability for individuals and is very important as the F6 examiner has stated that it will always be tested in question 1 of the paper for either 25 or 30 marks. www.studyinteractive.orgbeeks2000 blogspot.com 115CHAPTER 5 - PERSONAL TAX COMPUTATIONS THE SCOPE OF INCOME TAX If a person is UK resident in a particular tax year they must pay income tax on their UK and overseas income, Residence A person will be treated as resident in the UK during the tax year if they are present in the UK for 183 days or more during the tax year. A person js also treated as resident in the UK if they visit the UK regularly, with visits averaging 91 days or more per tax year over a period of four or more consecutive tax years. 116 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 5 - PERSONAL TAX COMPUTATIONS PROFORMA -— PERSONAL TAX COMPUTATION 2010/11 Tracing income Rental income Employment income Pension income Interest income (received net x 100/80) Interest income (received gross ~ NS&IB interest) Dividend income (received net x 100/90) Tot Less | income Interest paid on qualifying loans (paid gross) Net income Less PA/PAA Taxable Income Part 2 ~ Income tax 37,400 x 20% 37,401 ~ 150,000 x 40% 150,001+ x 50% Income tax liability Part 3 Less Tax deducted at source Notional tax credits on dividends 20% x Interest which is received net PAYE Income tax payable/repayable under self assessment Co/nil) Ox) &) & X/0X) 2010/41 Income tax payable x Less payments on account (X) 2011/42 Payments on acs fant 31412 34.7.12 Yex IT Payable Xi 2 Balancing payment/(repayment) _ X/(X) in 2010/11 Due and payable to HMRC _31.1.12 www. studyinteracti ve, orgeear2000 Nogspatom 137CHAPTER 5 - PERSONAL TAX COMPUTATIONS INCOME FROM LAND AND B DINGS IN THE UK Bi ee td Unfumished Fumished Room Let to a Lodger) Proforma for property business profits/losses £ Rent receivable in the tax year x Plus: Premiums received in the tax year Xa Less: Capital element = 2% (years on lease ~ 1) x Xp, ~) Less: Allowable expenses ~ Property business profit or (Joss) x/) Aree These are exoenses incurred by the landlord and reduce the taxable property business profits. Allowable expenses include repairs; decorating; council tax and water rates insurance premiums payable in the tax year; irrecoverable debts; advertising costs; cost of replacing the windows and boiler; interest payable on a loan to buy or improve an investment property; premiums paid (rent in advance element x years on sublease/years on head lease); wear and tear allowance if landlord has furnished the investment property. Wear and tear = 10% x rent receivable ~ council tax and water rates if paid by landlord ‘ebooks 2000 Bogspatcom www.studyinteractive.orgCHAPTER 5 - PERSONAL TAX COMPUTATIONS LRU Lk ed on the grant of a short lease When an individual grants (gives) a short lease on a building part of the premium received is subject to income tax in the tax year It is received, ecelved on the grant of a + When an individual grants (gives) a short lease on a building, Part of the premium recelved Is subject to income tax in the tax year in which it s received. 1aoororad yer tease LSU Soi This applies if an individual lets a furnished room in their main residence. The Individual can receive up to £4,250 of gross rent each tax year exempt from income tax. Method 1 - Special method Method 2 - Normal method Rent recelvable X___ Rent recelvable x Less: Rent @ room relief (4,250) Less: Allowable expenses ® Rental profit X/Nil_ Rental profit/(loss) X/00) Pele ed as a er) If an individual lets out investment properties and the allowable expenses are greater than the rent receivable, the individual makes losses. ‘These rental losses can be carried forward and offset against the first available rental profits. www.studyinteractive.orgbeeks2000 blogspot.com 119CHAPTER 5 - PERSONAL TAX COMPUTATIONS Furnished holiday letting Conditions to qualify for special treatment F _umished in the UK or in the European Economic Area (EEA) H_oliday lets - this means that the property is normally let for short periods which are period of < 31 consecutive days et on a commercial basis vailable for letting > 20 weeks in the tax year tually let for = 10 weeks in the tax year per Advantages of an investment property meeting the conditions to be FHLA T Treat any property business loss from a furnished holiday letting property like a trading loss, R___ Relevant earnings when calculating the maximum that can be invested in a registered pension plan E Entrepreneurs’ relief is available on the disposal of a FHLA. Capital allowances can be claimed on the cost of furniture instead of claiming the wear and tear allowance. All five conditions listed above must apply to the property before the advantages listed are relevant, Example i - Howard Howard owns a number of properties. Detalls of income and expenditure in respect of each of the properties in 2010/11 are as follows: () Property 1: An unfurnished house which was rented for £800 per month, payable quarterly In advance until 31 December 2010. The tenant left owing fone months rent which Howard was unable to recover. The property remained empty until 1 April 2011 when it was rented for £1,100 per month, payable quarterly in advance. Allowable expenses amounted to £500. (il) Property 2: A furnished flat which Howard acquired on 1 June 2010. He paid mortgage interest of £700 on a loan which he took out to acquire the property. On 1 June 2010 Howard incurred advertising fees of £500 and paid an insurance premium of £300 for the year to 31 May 2011. He paid decorating costs of £900 on 15 June 2010. The flat remained empty until 1 December 2010 when it was rented for £500 per month, payable monthly in advan (ii) Property 3: A retail shop which Howard rented for £1,000 per month payable quarterly in advance. On 1 January 2011 the tenant left the property and on 1 March 2011 Howard granted a 10 year lease to a new tenant for a premium of £12,000 and a monthly rent of £450 payable quarterly in advance. Required Calculate Howard's property business income assessment for 2010/11. (10 marks) 120 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 5 - PERSONAL TAX COMPUTATIONS INTEREST INCOME AND DIVIDEND INCOME Interest income (sa Tee} Income assessable Bank, building society interest and interest received from quoted companies (from corporate bonds) Income actually received in the tax year. of assessment How. the tax collected? ‘Some interest income is received net of basic rate tax (20%). To calculate amount assessable we gross it up. Income received 122 = Gros ince Tax credit (20%) available for relief, If taxpayer is: (a) higher rate or additional rate taxpayer (pay income tax at 40%/50%) - the extra 20%/30% is collected by raising an assessment; (b) basic rate taxpayer ~ received interest net of 20% tax and pays tax at 20% has no further tax to pay. ‘© Interest received from the government is always received gross. © Interest received from the National Savings and Investment Bank (NS&JB) is received gross ‘© Interest received from Government securities is received gross. ‘* Interest received from loan notes in 2 quoted company is always gross. www.studyinteractive.orgbeeks2000 blogspot.com 121CHAPTER 5 - PERSONAL TAX COMPUTATIONS Tard urs Income assessable Dividends from UK and foreign companies. Basis of assessment and collection of tax Dividends are received net of tax credit of 10% To calculate amount assessable we gross it up 100 Income received x 129 = Gross income 90 Tax credit (10%) available for relief. If the taxpayer is a: (a) higher rate or additional rate taxpayer - dividends are taxed at 32,5%/42.5%. The extra 22.5%/32.5% is collected by raising an assessment; (b) basic rate taxpayer - he receives dividends net of 10% tax and has no additional income tax to pay. 122 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 5 - PERSONAL TAX COMPUTATIONS INVESTMENTS GENERATING TAX FREE INCOME AND CAPITAL GAINS Fo. individuals investing in an ISA aa ower dive | Dr aU ee Cece) Mini ISAs (Two Separate Investments) | Maximum Investment | £6,100 10,200 -Cash ISA The following investments generate income which is exempt from income tax Premium Bond Prizes. It is possible to invest up to £30,000 in Premiurn Bonds I _ ISA interest and ISA dividends. It is possible to invest up to £10,200 per tax year in ISAs. The maximum amount which can be invested in cash ISAs each tax year is £5,100. N National saving certificate interest. It is possible to invest up to £15,000 in NSC Scholarships and educational grants. www.studyinteractive. orgeees2000 Bleaspet.com 123CHAPTER 5 - PERSONAL TAX COMPUTATIONS INTEREST PAID ON QUALIFYING LOANS Interest paid on certain loans is deductible from a taxpayer's total income. This interest is generally paid gross. The main types of eligible loans are: * Aloan to purchase plant and machinery which is necessarily acquired for use in the taxpayer's employment * A loan to purchase plant and machinery for use in the business of a partnership in which the taxpayer is a partner. * loan to purchase an interest in a partnership, PAYMENTS ELIGIBLE FOR TAX RELIEF Description of the payment | Method of reducing income tax Interest paid on a loan to buy partnership share Interest on a loan to buy an investment property Interest paid on a loan to buy plant and machinery to use In employment Patent royalties paid Payments into an employers pension plan 124 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 5 - PERSONAL TAX COMPUTATIONS PERSONAL ALLOWANCE (PA) Personal allowances may be claimed by UK residents and by some non residents. The personal allowances for 2010/11 are as follows: £ Basic (age 0 - 64) 6,475 ‘Age (65 - 74) 9,490 ‘Age 75 and over 9,640 Income limit for age related allowances 22,900 Income limit for standard personal allowance 100,000 Reduction in the ba: The full basic personal allowance Is £6,475. personal allowance For the tax year 2010/11 the amount of the basic personal allowance is reduced (possibly to nil) if a taxpayer's adjusted net income for the tax year exceeds £100,000, If the adjusted net income exceeds £100,000, the basic personal allowance is reduced by one-half of the excess. Therefore the allowance is reduced to nil if the taxpayer's adjusted net income is £112,950 or more. The personal allowance the person is entitled to is deducted from the taxpayer's net income. Adjusted Net Income Net income ~ Personal pension contributions (gross) ~ Gift aid donations (gross) Example 2 - Betty Bubble Betty is 35 years of age and has net income of: (a) £35,000; (b) £103,150 © £115,600 Required Compute Betty’s Taxable Income in 2010/11. www.studyinteractive.orgbeeks2000 blogspot.com 125CHAPTER 5 - PERSONAL TAX COMPUTATIONS Older taxpayers As can be seen from the list of allowances given above, the amount of the personal allowance depends upon the taxpayer's age (a) A taxpayer who is over 65 years old, or who reaches the age of 65 during the tax year, is entitled to an increased personal allowance (£9,490 in 2010/11), and (b) The allowance is higher still (£9,640 in 2010/11) for taxpayers who are over 75 years old or who reach the age of 75 during the tax year. These higher personal allowances are granted instead of the usual personal allowance, not in addition to it Age-related personal allowances are reduced if the taxpayer's “adjusted net income” exceeds a specified limit (£22,900 in 2010/11). Adjusted net income is defined as the taxpayer's net income less the gross amount of any gift aid donations or pension contributions made during the year. If adjusted net income exceeds the specified limit, the personal allowance is reduced by one-half of the excess. However, the allowance is never reduced to less than the personal allowance for those aged < 65 years. Example 3 - Elvis Presley Elvis is 81 years of age and has net income of: (a) £24,000; (b) £30,000. (c) £103,150 (d) £115,600 Required Compute Elvis’s Taxable Income in 2010/11 126 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 5 - PERSONAL TAX COMPUTATIONS i ee Ee eee ty Peed ake RATES OF INCOME TAX - PART 2 gs income £ 2,440 x 20% 2,440 x 10% 2,440 x 10% 34,960 x 20% 34,960 x 20% 34,960 x 10% 37,400 37,400 37,400 37,401 - 150,000 x 40% | 37,401 - 150,000 x 40% | 37,401 - 150,000 x 32.5% 150,001+ x 50% 150,014 x 50% 150,001+ x 42.5% For taxpayers who have taxable income in excess of £150,000, the additional rate of income tax is 50% for non-savings and savings income and 42.5% for dividend CCH Cur te CM hdc er oe UR leibateat 1 Deh The Gift Aid scherne was established several years ago as a means of providing a tax incentive for individuals to make charitable donations. ‘The gift is treated as if it were made net of 20% income tax and the charity can then recover the amount of tax which is deemed to have been deducted at source. The gift is not shown in the donor's tax computation, but the following provisions apply: * The donor's basic and additional rate bands are extended by the gross amount of the gift (Amount paid x 100/80). This extension ensures that relief at the higher rate and adcitional rate Is automatically given www.studyinteractive.orgbeeks2000 blogspot.com 127CHAPTER 5 - PERSONAL TAX COMPUTATIONS LTT and ad ension plan payments and extending the basic Cie Ooi If 2 person pays into a personal pension plan the payment is treated as if it were made net of 20% income tax and the pension pian can then recover the amount of tax which is deemed to have been deducted at source from HMRC. The payment is not shown in the donor's income tax computation, but the following provisions apply if the person is a higher or additional rate taxpayer and makes a payment into @ personal pension plan. * The donor's basic and additional rate bands are extended by the gross amount (Amount paid x 100/80) of the contribution. This extension ensures that relief at the higher and additional rates is automatically given. Example 4 - Gerri Spice Gerri Spice is a single woman and received dividends of £1,800 (net) and bank Interest of £1,200 net in 2010/11. Her trading income in 2010/11 is: £ A 8,000 B 22,935 c 45,745 D 45,745 (assume that Gerri pays £1,000 of interest on a qualifying loan) E 45,745 (assume that Gerri pays £800 of donation under gift aid scheme) F 165,000 (assume that Gerri pays £8,000 of donation under gift aid scheme) Required Show the total income tax payable for each situation in 2010/11. 128 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 5 - PERSONAL TAX COMPUTATIONS REGISTERED PENSIONS a REGISTERED PENSIONS nerve Total Pension Inputs Pp, Contributions tram employee * employer Fund Manager Invests the Capital Held in Employer the Fund Pak een aa If a person pays into a registered pension plan this will reduce thelr income tax payable. The maximum amount that a person can invest in a registered pension plan and qualify for tax relief is the same for both personal and occupational pension plans and Is defined below: a *+ Types of registered pension plans _ a Occupational Personal Pension Pension Plans Plans Maximum amount that an be investedina pension plan each Grater of +. 3.600 2 100% x Relevant Eamings www.studyinteractive. orgeees2000 Bleaspet.com 129CHAPTER 5 - PERSONAL TAX COMPUTATIONS in of relevant earnings Relevant earnings are defined as the total of the individual's employment income, trading income and property business profits (only from furnished holiday letting properties) during the current tax year. The greater the relevant eamings the greater the amount that can be invested in a registered pension plan and the greater Is the Income tax saving. Trading profits Employment income Property business profits (from FHLAA) Occupational pension plans These pension plans are run by the employer. The amount invested by the employee in their employer plan is treated as an allowable expense and reduces their employment income. When the employee retires they will receive pension Income from their employer. een ene These pension plans are run by insurance companies. If a person pays into a personal pension plan the payment Is treated as if it were made net of 20% Income tax and the pension plan can then recover the amount of tax which is deemed to have been deducted at source from HMRC. When the investor retires they will receive pension income from the insurance company. 130 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 5 - PERSONAL TAX COMPUTATIONS Example 5 — Sally Red, David Black and Valerie Purple The following information relates to three taxpayers who have all made personal pension contributions during the tax year 2010/11. Sally Red Sally, is self employed as a dress designer. Her trading profits for the year ended 5 April 2011 were £48,000. Sally made contributions of £52,000 (gross) into a personal pension scheme during the tax year 2010/11 David Black Davi, is employed by Global Telecom pic as the marketing director. During the tax year 2010/11 David was paid 2 gross salary of £240,000. David made contributions of £80,000 (gross) into a personal pension scheme during the tax year 2010/11, He Is not a member of the Global Telecom ple occupational pension scheme. Valerie Purple Valerie, lets out investment properties. For the tax year 2010/11 her property business profit was £23,900. Valerie made contributions of £8,200 (gross) into a personal pension scheme during the tax year 2010/11 Required State, what amount of personal pension contributions will have qualified for tax relief for the tax year 2010/11 for each of the investors Sally Red, David Black and Valerie Purple and calculate their income tax liabilities for that year. (22 marks) www.studyinteractive.orgbeeks2000 blogspot.com 131CHAPTER 5 - PERSONAL TAX COMPUTATIONS Example 6 - Aladdin, Bob and Dick (2) Aladdin Aladdin has the following information for 2010/11 £ Salary (PAYE = £505) 9,000 Aladdin pays 5% of his salary into his employer's pension plan Abbey interest (received) 800 ISA interest received 300 National Savings and Investment Bank Interest (EASA) received _165 British Telecom dividends received 3,600 Required Calculate Aladdin’s income tax payable for 2010/11. (2) Bob the builder Bob is a single man and has the following information for 2010/1 E Bob's share of partnership profits 48,000 Barclay’s interest received 1,920 Interest from National Savings Certificates ‘800 British Gas dividends received 2,700 Bob pays £2,400(net) into his personal pension plan. Bob also pays £1,000 of interest on a loan to buy plant and machinery to use in his partnership. Required Calculate Bob’s income tax liability for 2010/11. (3) Dick Whittington Dick is aged 67 years. During the tax year 2010/11 he received the state pension of £4,500 and private pension of £2,300. In adcition to his pension income Dick received building society interest of £14,400 and interest of £600 on the maturity of a savings certificate from the National Savings and Investment Bank during the tax year 2010/11. These were the actual amounts received. During the tax year 2010/11 Dick made donations of £300 (gross) to local charities, These were not made under the gift aid scheme, Required Calculate Dick’s income tax liability for 2010/11. 132 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 5 - PERSONAL TAX COMPUTATIONS Answer 1 - Howard Howard - Property business income assessment 2010/11 Property £ £ 1 Rent: 9 x £800 7,200 Impaired debt (800) Allowable expenses (500) 5,900 2 Rent: 4x £500 2,000 Mortgage interest (700) Advertising (s00) Insurance £300 x 10/12 (250) Decoration (900) Wear & tear allowance (10% x (200) £2,000) (550) 3 Rent: (9x £1,000) + £450 9,450 Lease premium: £ Premium 12,000 Less: £12,000 x 2% «(10 (2.160) -1) 9,840 19,290 Property business profits 26,640 www.studyinteractive.orgbeeks2000 blogspot.com 133CHAPTER 5 - PERSONAL TAX COMPUTATIONS Tutorial notes: (1) Property business income is assessed on the accruals basis, The date that rent Is received Is irrelevant. (2) Relief is available for bad debts as an allowable expense. (3) Profit and losses of all properties are pooled. There is therefore automatic loss relief for current year losses. (4) The receipt of a premium on the grant of a short lease gives rise to taxable property income on the landlord in the year of receipt of the premium. ANSWER 2- BETTY BUBBLE (@) o% © £ £ £ € Net income 35,000 103,150 115,600 PA (6,475) PA 6,475 Less: 1/2 x (103,150 - 100,000) (1,575) 4,900 (4,900) PA 6,475 Less: 1/2 x (115,600 - 100,000) (7,800) (1,325) Restricted to (nit) Taxable income 28,525 98,250 115,600 (a) The standard PA is £6,475 in 2010/11 and is deducted from net income. (b) Betty's net income exceeds £100,000, this means that her standard PA of £6,475 must be reduced by £1,575 [1/2 x (103,100 - 100,000)], (c) Betty's net income is £115,600 and >£112,950 which means that she is not entitled to a PA. 134 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 5 - PERSONAL TAX COMPUTATIONS Answer 3 - Elvis Presley a (b) (2) @ £ £ € £ £ Net income 24,000 30,000 103,150 115,600 PAA 9,640 Less 1/2 x (24,000 - 22,900) _(550) (9,090) PAA, Less 1/2 x (30,000 - 22,900) (3,550) 6,090 Restricted to (6,475) Restrict to 6,475 Less 1/2 x (103,150 - 100,000)(1,575) 4,900 (4,900) Net income > £112,950 (nit) Taxable Income 98,250 115,600 www.studyinteractive.orgbeeks2000 blogspot.com 135CHAPTER 5 - PERSONAL TAX COMPUTATIONS Answer 4 - Gerri Spice 2010/11 A Non savings 8,000 Dividends (1,800 x 100/90) 2,000 Bank interest (1,200 x 100/80) 1,500 Total income 411,500 Less: Interest paid on @ qualifying loan Net income 411,500 Less: PA (6475) Taxable income 5,025 Part 2 ~ Income tax (A) Non savings 1,525 Non savings 1,525 x 20% Savings 915 x 10% 2,440 '585 x 20% 3,025 Dividend 2,000 x 10% 5,025 Income tax liability Part 3 - Tax deducted at source Less: Tax credits Income tax payable B c 22,935 45,745 2,000 2,000 4,500 1,500 26,435 49,245 26,435 49,245 (6,475) (6,475; 19,960 42,770 Savings 1,500 D 45,745 2,000 41,500 49,245 (1,000) 48,245, (6,475) 41,770 E F 45,745 165,000 2,000 2,000 1,500 1,500 49,245 168,500 49,245 168,500 (6.475) 42,770 168,500 Dividends 2,000 305 1 417, 200 713 (500) 213 ae ‘ebooks ZO00 Boaspeteom www.studyinteractive.orgCHAPTER 5 - PERSONAL TAX COMPUTATIONS Part 2 ~ Income tax (B) Non savings Savings 16,460 1,500 Non saving 16,460 x 20% Savings 41,500 x 20% Dividend 2,000 x 10% 19,640 Income tax liability Part 3 - Tax deducted at source Less: Tax credits Income tax payable Part 2 - Income tax (C) Non savings Savings 39,270 1,500 Non savings 37,400 x 20% 1,870 x 40% 39,270 Savings 1,500 x 40% Dividend 2,000 x 32.5% Income tax liability Part 3 - Tax deducted at source Less: Tax credits Income tax payable Dividends 2,000 3,292 300 200 3,792 (500) 3,292 Dividends 2,000 7,480 748 600 650 9,478 500 8.978 www.studyinteracti ve. orgbeeks2000 blogspot.com 137CHAPTER 5 - PERSONAL TAX COMPUTATIONS Part 2 - Income tax (D) Non savings Savings Dividends 38,270 1,500 2,000 Non savings 37,400 x 20% 7,480 870 x 40% 348 38,270 Savings 1,500 x 40% Dividend 2,000 x 32.5% 600 650 Income tax liability 9,078 Part 3 - Tax deducted at source Less: Tax credits (500) Income tax payable 8,578 Part 2 - Income tax (E) Extend Non savings Savings Dividends basic rate 39,270 1,500 2,000 —_ 37,400 + 000 38,400 38,4014 Non savings 38,400 x 20% 7,680 870 x 40% 348 39,270 Savings 1,500 x 40% 600 Dividend 2,000 x 32.5% 650 Income tax liability 9,278 Part 3 - Tax deducted at source Less: Tax credits (00) Income tax payable 8,778 138 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 5 - PERSONAL TAX COMPUTATIONS Part 2 - Income tax (F) Non-savings £165,000 Non-savings income 47,400 x 20% 112,600 x 40% 160,000 5,000 x 50% 165,000 Savings income 1,500 x 50% Dividend income 2,000 x 42.5% Income tax liability Part 3 Less: Tax credits Income tax payable 9,480 45,040 2,500 750 Savings Dividends £1,500 £2,000 Extend basic rate band 37,400 + 10,000 = 47,400 Extend additional rate band 150,000 + 10,000 = 160,000 ‘Answer 5 — Sally Red, David Black and Valerie Purple Sally Red - Income tax computation 2010/11 Trading profits Personal allowance Taxable income £ 48,000 (6,475) 41,525 41,525 x 20% £ 8,305 www.studyinteracti ve. orgbeeks2000 blogspot.com 139CHAPTER 5 - PERSONAL TAX COMPUTATIONS (yy 2) David Only £48,000 of Sally's pension contributions of £52,000 will have qualified for tax relief, since relief is only available up the amount of her relevant earnings. The pension contributions result in Sally's basic rate band being extended to £85,400 (37,4004 48,000) Black ~ Income tax computation 2010/11 £ Employment income 240,000 Personal allowance (nil) Taxable Income 240,000 Income tax £ 117,400 x 20% (37,400 + 80,000) 23,480 112,600 x 40%, 45,040 230,000 (150,000 + 80,000) 10,000 x 50% 5,000 240,000 Income tax lability 73,520 (1) All of David's pension contribution of £80,000 will have qualified for tax relief. The maximum contribution that qualifies for tax relief is £240,000 (2) The pension contribution results in David's basic rate band being extended to £117,400 (37,400 + 80,000) and his additional rate band is extended to £230,000 (150,000 + 80,000). (3) David's adjusted net income is £160,000 (240,000 - 80,000) so he is not entitled to a personal allowance. 140 ‘ebooks 2000 Bogspatcom www.studyinteractive.orgCHAPTER 5 - PERSONAL TAX COMPUTATIONS Valerie Purple ~ Income tax computation 2010/11 E Property business profits 23,900 Personal allowance 6,475) 17,425 Taxable income Income tax 17,425 x 20% £3,485 Valerie has no relevant earnings in 2010/11, so only £3,600 of her pension contribution of £8,200 will have qualified for tax relief. Answer 6 - Aladdin and Bob (2) Aladdin - 2010/11 tax computation Tax credits and PAYE £ £ £ Salary 9,000 Less: Allowable expenses 450) Employment income 8,550 505 Bank interest (800 x 100/80) 1,000 200 ISA interest (no income tax) Ni NS@IB interest 165 Dividend income (3,600 x 100/90) 4,000 400 Total Income 13,715 Less: Interest paid on a qualifying loan (wil) Net income 13,715 Less: PA (6475) Taxable Income 2,240 Part 2 - Income tax Non savings Savings Dividends 2,075 1,165 4,000 www.studyinteractive.orgbeeks2000 blogspot.com 141CHAPTER 5 - PERSONAL TAX COMPUTATIONS Non savings 2,075 x 20% Savings 365 x 10% 2,440 800 x 20% 3,240 Dividend 4,000 x 10% Income tax liability Part 3 Less: Tax deducted at source Income tax repayable (2) Bob the builder 2010/11 Trading profits Bank interest (1,920 x 100/80) Interest from National Savings Certificates Dividends (2,700 x 100/90) Total income Less: Interest paid on a qualifying loan Net income Less: PA Taxable income 48,000 2,400 Nil 3,000 53,400 (1,000) 52,400 (6,475) 45,925 415 36 160 400 1,011 (1,105) (94) Tax credits and PAYE £ 480 300 142 ‘ebooks ZO00 Boaspeteom www.studyinteractive.orgCHAPTER 5 - PERSONAL TAX COMPUTATIONS Part 2 ~ Income tax Extend Non savings Savings Dividends basic rate 40,525 2,400 3,000 — 37,400 +3000 = 40,400 40,4014 Non savings 40,400 x 20% 8,080 125 x 40% 50 40,525 Savings 2,400 x 40% 960 Dividend 3,000 x 32.5% 975 Income tax liability 10,065 (3) Dick Whittington 2010/11 £ State pension 4,500 Private pension 2,300 Bank interest (14,400 x 100/80) 18,000 Interest from National Savings Certificates (tax free income) Nil Total income 24,800 Less: PA 9,490 Less Ye (24,800 - 22,900) ( 950) (8,540) Taxable income 16,260 Non savings Savings a 16,260 Savings 2,440 x 10% 244 13,820 x 20% 2,764 16,260 Income tax liability 3,008 www.studyinteractive.orgbeeks2000 blogspot.com 143CHAPTER 5 - PERSONAL TAX COMPUTATIONS 144 ‘ebooks2000 blogspet.com www. studyinteractive.orgChapter 6 Trading losses and partnerships London FZ School of Business & Finance powered by InterActive Ue Ee eee ed Pilot | Dec | June | Dec | june | Dec | june | Dec 2007 | 2008 | 2008 | 2009 | 2009 | 2010 | 2010 Question 1 Question 2 Question 3 Question 4 . Question 5 . . 145 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 6 - TRADING LOSSES AND PARNERSHIPS baa ed BACKGROUND AND THE EXAM FOCUS -147 TRADING LOSSES: -149 1. CARRY FORWARD LOSSES ~ S83 ITA 2007 149 2. $64 ITA 2007 150 3. $261 TCGA 1992 151 TRADING LOSSES MADE AT THE BEGINNING OF THE TRADING CYCLE. 4. s721TA 2007 151 TRADING LOSSES MADE AT THE END OF THE TRADING CYCLE- 5. S89 ITA 2007 152 EXAM TECHNIQUE FOR QUESTIONS INVOLVING TRADING LOSSES 153 PARTNERSHIP -- COMPARISON BETWEEN SOLE TRADERS AND PARTNERSHIPS: 156 ALLOCATING PROFITS AND LOSSES BETWEEN THE PARTNERS 157 CHANGES IN PROFIT SHARING ARRANGEMENTS (PSA) 157 CHANGES IN THE MEMBERSHIP OF & PARTNERSHIP 157 ANSWERS-. 146 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 6 - TRADING LOSSES AND PARNERSI erie Sci teh eu ial tek hd This chapter is going to return to the topic of individuals who are self employed and who are the owners of a business. When a self employed person is running a business and is preparing accounts for an accounting period it is possible that instead of making a profit the business might make a trading loss. If a sole trader makes a trading loss in a particular accounting period this means the trader has trading income of nil in that tax year. The trader can then use the trading loss in order to reduce his tax liability in the current, previous or future tax years. This chapter is going to cover the different ways in which the trader can use the trading loss. ‘The other topic which is covered in this chapter Is partnerships. A partnership is a number of sole traders in business together with the overall objective being that the business should make a trading profit. Partners are the owners of the business and they each have trading income. Partners cannot be employees of their own business. All partners have the same accounting date and they all have a legally binding contract which is called the partnership agreement which; © states the names of all partners and © states the way in which the profits and losses of the business are divided between the partners - the profit sharing arrangements (psa) The partnership agreement is drawn up by @ solicitor and sometimes uses terminology which is not very accurate from a tax point of view. For example the agreement may talk about a partner getting: © asalary, or © interest on their capital account balance. This just means that the partner has a fixed amount of trading profits with any balance of profits or losses shared in the profit sharing ratio (psr). www.studyinteractive.orgbeeks2000 blogspot.com 147CHAPTER 6 - TRADING LOSSES AND PARNERSI Example 1 — Exam standard question Sally Slim has been a self employed manufacturer or clothing since 1 June 2000. She has the following gross income and chargeable gains. 2008/09 | 2009/10 | 2010/11 | 2011/12 Trading profit/loss 6,100 | 51,600 | (84,000) | 12,200 Building society interest | - 2,100 3,800 | 1,700 Chargeable gains/(loss) | 18,800 | 23,300 | (3,400) | 13,900 The chargeable gains are before taking account of loss relief and the annual exemption (a) _ State the factors that will influence an individual's choice of loss relief claims. (b) Calculate Sally’s taxable income and taxable gains for each of the tax years 2008/09, 2009/10, 2010/11 and 2011/12 on the assumption that she relieves the trading loss of £84,000 made in the tax year 2010/11 against her total income and chargeable gains made in 2009/10 (i.e the carry back option) You should assume that the tax rates and allowances for 2010/11 apply throughout. 148 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 6 - TRADING LOSSES AND PARNERSI TRADING LOSSES Objectives when deciding how to use the loss. a) @) 3) The taxpayer wants relief for the loss as early as possible, ‘The taxpayer wants to preserve the personal allowances whenever possible. ‘The taxpayer wants to optimise his tax saving by reducing his liability at his highest marginal rate (saving tax at 50% is better than 42.5% is better than 40% is better than 32.5% is better than 20% which is obviously better than 10%). Carry forward losses — s83 ITA 2007 The trading loss may be carried forward and offset against the first available future trading profits of the same trade. Partial or restricted claims are not possible in order to preserve the personal allowance. Disadvantage 583 gives rellef for the loss In the future which is not tax efficient. Advantages The trading loss is offset against one source of income. If the taxpayer has sufficient other income it may be possible to preserve the personal allowance by carrying the loss forward and leaving the other income to cover the PA. If the taxpayer expects profits to rise in the future or expects tax rates to increase, it may be tax efficient to claim relief under s83 and benefit from tax relief at the increased rate, www.studyinteractive.orgbeeks2000 blogspot.com 149CHAPTER 6 - TRADING LOSSES AND PARNERSI 2. s64 ITA 2007 64 relief is available in a maximum of two tax years, the tax year of the loss and/or the previous tax year. It is not possible to make partial or restricted claims in order to preserve the personal allowance, ‘The trading loss is offset against the taxpayer's “Total Income”. Tax planning Disadvantage 864 relief involves setting the trading loss against the Net Income, which may result in a wastage of the PA. Advantage 364 gives earlier relief for the loss than S83 (cash flow advantage to the taxpayer) If $64 is claimed in the year prior to that In which the assessable trading profit is nil, this will give rise to a repayment of income tax previously paid. 150 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 6 - TRADING LOSSES AND PARNERSHIPS ra Lys If a claim has been made under 64 in a particular tax year then additionally it is possible to make a claim to reduce capital gains in the same year and hence will reduce CGT, yee ews TRADING LOSSES MADE AT THE BEGINNING OF THI TRADING CYCLE Trading losses incurred in any of the first four tax years of trading can be relieved under $72. The trading loss can be carried back for three years on @ FIFO basis and offset against the "Total Income” of the previous three years. Disadvantage 572 relief involves setting the loss against Total Income which may result in a wastage of the PA. Advantages 572 gives earliest relief for the trading loss (cash flow advantage to the taxpayer) If $72 relief is claimed it will give rise to a repayment of income tax previously paid. www.studyinteractive.orgbeeks2000 blogspot.com 151CHAPTER 6 - TRADING LOSSES AND PARNERSI TRADING LOSSES MADE AT THE END OF THE TRADING aie 5 3 s89 ITA 2007 In normal circumstances a trader who incurs a trading loss may choose between carrying the loss forward against future profits of the same trade or relieving the loss against total income. But if a trading loss is incurred in the final 12 months of trading, it is not possible to carry forward the loss so instead s89 terminal loss relief is available, The trading loss incurred in the final 12 months of trading can be carried back for three years on a LIFO basis and offset against the trading profits of the previous three years, 152 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 6 - TRADING LOSSES AND PARNERSI EXAM TECHNIQUE FOR QUESTIONS INVOLVING TRADING ees Step 1 ‘Accounting date = Start date - Stop date = Tax year 1 = Final tax year = Step 2 Determine the tax adjusted accounting loss, this step may involve capital allowances for each accounting period. Step 3 Determine the trading loss allocated to each tax year this step may involve the opening and closing year rules if the loss is made at the beginning or end of the trading cycle, Step 4 State the possible ways of using each loss, this will depend on where on the trading cycle the loss is made. Beginning (first four tax years of trading) ~ $83, s64, 5261, s72, Middle = 64, 5261, 583, End ~ $64, 5261, 589 Step 5 Set up the tax computations for all relevant tax years in columns across the page putting the loss relief sections into the preformed at the correct position Put the losses into the loss memo. If more than one loss keep them separately in the loss memo. Remember to use the losses on @ FIFO basis (oldest first like the milk). Then use the losses in the most tax efficient way trying to use them as early as possible, trying to preserve personal allowances and trying to save tax at the www.studyinteractive.orgbeeks2000 blogspot.com 153CHAPTER 6 - TRADING LOSSES AND PARNERSI Example 2 — Cinnamon, Scribbler and Yui Zong (2) Cinnamon Cinnamon is a sole trader running @ music business. She started trading on 1 May 2010 and her first accounts are prepared for the 15 months to 31 July 2011 and show a tax adjusted loss of £105,000. Required Show the trading losses for 2010/11 and 2011/12 and discuss the various methods of loss relief available to Cinnamon. (2) Scribbler Scribbler commenced business as a freelance journalist on 1 June 2010, preparing annual accounts to 31 May. The following profits and losses have been ascertained Year ended 31 May 2011 Loss (16,200) Year ended 31 May 2012 Profit’ £5,500 Scribbler acquired plant and machinery on 1 June 2010 at a cost of £12,500. ‘There have not been any subsequent purchases or sales of plant. Before starting his business, Scribbler was a reporter for his local newspaper. Details of other incomes of Scribbler and his wife are as follows: 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 £ £ £ £ £ £ Scribbler Salary from employment 12,000 17,500 3,500 2,900 - - Interest (gross) 3,000 3,000 +©—-3,000-«-3,000-«3,000-—«3,000 Wite Salary : - : - 8,000 8,500 Required Advise, with the aid of computations, how Scribbler should relieve his trading loss. Use 2010/11 rates and allowances throughout, 154 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 6 - TRADING LOSSES AND PARNERSI (3) Yui Zong Yui Zong has been self-employed since 1998, but ceased trading on 30 September 2010. She has always prepared accounts to 30 September. Her results for the final five years of trading were as follows: Year ended 30 September 2006 | Trading profit | £11,400 Year ended 30 September 2007 | Trading profit £9,300 Year ended 30 September 2008 | Trading profit £9,100 Year ended 30 September 2009 | Trading profit £800 Year ended 30 September 2010 | Trading loss £(9,600) For each of the years 2006/07 to 2010/11 Yui has rental income of £5,000. Yui has unused overlap profits brought forward of £2,300. Required ‘Assuming that Yui claims terminal loss relief (under s89 ITA 2007), calculate her taxable income for each year 2006/07 to 2010/11 after claiming the relief. www.studyinteractive.orgbeeks2000 blogspot.com 155CHAPTER 6 - TRADING LOSSES AND PARNERSI Eo c Dor more Must exist Ta individuals substance in business and form to make profit fe URES UUs Ld ‘* Apartnership is a number of sole traders in business together with the overall objective being that the business should make a profit. * Each partner is an owner of the business and cannot be an employee of their own business. * Each partner is self-employed and has Trading Profits. ‘* Capital allowances are given to the business. ‘© Capital allowances must be restricted to the business use if a partner uses an item of plant and machinery for private use. © Profits/losses (after capital allowances) of the business accrue evenly over the accounting period and must be divided between the partners according to the profit sharing arrangements during the accounting period. © The partnership agreement is often drawn up by a solicitor ané may talk about: © partner getting a salary = share of profits © interest on their capital account balances = share of profits Any balance of the partnership profits/losses must be shared in the profit, sharing ratio (psr). 156 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 6 - TRADING LOSSES AND PARNERSI Allocating profits and losses between the partners ‘The partnership profits or losses are shared between the partners according to the profit sharing arrangements (PSA) during the accounting period ‘The profit sharing arrangements (PSA) can have up to three elements. 3 elements to the PSA Salary (allocate in full) Interest in capital (allocate in full) Balance on profit (allocate per PSR) Trading Profit Changes in profit sharing arrangements (psa) The profits or losses of the partnership are deemed to accrue evenly over the accounting period. If the partners decide to change the profit sharing arrangements during the accounting period the partnership profits/losses must be time apportioned. Changes in the membership of a partnership This involves the situation where 2 partner joins or a partner leaves the partnership. It should always be remembered that each individual partner has a trading cycle. ‘The partner's trading cycle begins when the partner joins the partnership and the taxable trading profits for the joining partner are determined using the opening year rules. ‘The partner's trading cycle ends when the partner leaves the partnership and the taxable trading profits for that partner are determined using the closing year rules. a a a“ a ~~ Joining CYB Leaving CYB Continuing ‘opening closing cys www.studyinteractive.orgbeeks2000 blogspot.com 157CHAPTER 6 - TRADING LOSSES AND PARNERSI Example 3 - Partnership (2) Holder, Roberts and White Holder, Roberts and White have for many years shared profits in the ratio 5:3:2, after charging salaries of Holder £8,000 and Roberts £10,000, with interest at 6% per annum on the capitals of Holder £20,000, Roberts £18,000 and White £22,000 ‘The profits for the firm were £35,000 for 31 December 2010 and capital allowances agreed at £3,400. Required Show the division of the taxable trading profits for 2010/11. (2) Barnard and Harrison Barnard and Harrison have traded since 1990 sharing profits 3:2 after charging salaries of £3,000 and £2,000 respectively. From 1 April 2010 they altered their agreement, the new terms being that the salaries should be doubled, the balance of profit being shared 2:1, ‘The adjusted profit for the year ended 30 September 2010 was £18,500 and capital allowances were agreed at £2,000. Required You are required to show the amounts to be included in respect of each partner’s income for 2010/11. 158 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 6 - TRADING LOSSES AND PARNERSI (3) Dominic and Justin Dominic and Justin commenced in partnership on 1 July 2009 and decided to produce their accounts to 30 June annually. On 1 January 2011 Simon joined the partnership. The partnership’s accounts show the following adjusted profits Year ended 30 June 2010 £10,000 Year ended 30 June 2011 £13,500 Year ended 30 June 2012 £18,000 Required Show the amounts assessed on the individual partners assuming profits are shared equally. www.studyinteractive.orgbeeks2000 blogspot.com 159CHAPTER 6 - TRADING LOSSES AND PARNERSI Example 1 — Exam standard question (a) Factors that will influence an individual's choice of loss relief claim are (i) The rate of income tax or capital gains tax at which relief will be obtained, with preference being given to income or capital gains charged at the highest rate. (ii) The timing of the relief obtained, with a claim against general income/capital gains of the current year or preceding year resulting in earlier relief than a carry forward claim against future trading profits. (lil) The extent to which the income tax personal allowance and the capital gains tax annual exemption will be wasted by using a claim against total income/capital gains, (b) Sally Slim - taxable income 2008/09 2009/10 2010/11 2011/12 £ £ £ £ Trading Income 6,100 51,600 ° 12,200 Less: trading loss relief . . - (7,000) carried forward Building society interest 0 100 3,800 1,700 6,100 53,700 3,800 6,900 Less: trading loss relief against total income (53,700) Net income 6,100 0 3,800 “6,900 Less: personal allowance _(6,475) _ (6,475) (6,475) (6,475) Taxable income nil o o 425 Sally Slim- taxable gains 2008/09 2009/10 2010/11. 2011/12 £ £ £ £ Chargeable gains 18,800 23,300 0 13,900 Less: capital loss c/f (3,400) 23,300 10,500 Trading loss against gains (23,300) 18,800 ~ 0 “0 ~ 10,500 Less: Annual exemption (10,100) __(10,100)__(10,100) (10,100) Taxable gains Note Loss relief has been claimed against total income and gains for 2009/10 since this gives relief at the earliest cate and at the highest rate of tax, No claim should be made to set the loss against total income in 2010/11 since this is already covered by the personal allowance for that year. 160 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 6 - TRADING LOSSES AND PARNERSI Trading loss memorandum é Loss 2010/11 84,000 Less: used 2009/10 (income) (53,700) used 2009/10 (gains) (23,300) Available for c/f 7,000 Less: used 2011/12 (7,000) Loss unrelieved 0 ‘Answer 2 - Cinnamon and Scribbler (1) Cinnamon Year Tax year Period profit assessable Loss T £ £ 1 2010/11 1.5.10 - 5.4.11 4/15 x 105,000 (77,000) Nil 2 2011/12 Does an accounting date fall in 2011/12 Yes (31,7.11) ‘Y/e 31.7.11 (105,000 - 77,000) (28,000) Nil Methods of relieving the losses 583 ITA 2007 The trading losses can be carried forward and offset against the first available taxable trading profits of the same trade in 2012/13 ete. 864 ITA 2007 ‘The trading loss can be relieved against the Total Income in the tax year in which the trading loss is made and/or the previous tax year. 2010/11 (77,000) - This loss can be relieved in 2010/11 and or 2008/10 2011/12 (28,000) - This loss can be relieved in 2011/12 and or 2010/11 872 ITA 2007 A trading loss incurred in any of the first four tax years of trading may be carried back for three years on a FIFO basis and offset against the total income for the previous three years, 2010/11 (77,000) - This loss may be carried back to 2007/08, 2008/09 and 2009/10 2011/12 (28,000) - This loss may be carried back to 2008/09, 2009/10 and 2010/11 (2) Scribbler Step 1 Accounting date 31 May Start date 1 June 2010 www.studyinteractive.orgbeeks2000 blogspot.com 161CHAPTER 6 - TRADING LOSSES AND PARNERSI First tax year 2010/11 Step 2 Determine the capital allowances for each accounting period Main AIA poo! £ £ Y/e 31.5.11 Addition 1.6.10 12,500 AIA: 12,500 x 100% (12,500) 12,500 TWOV c/f Nil Capital allowances 12,500 Y/e 31.5.12 (nit) Nil TWOV c/f nil Capital allowances nil Deduct the capital allowances from the tax adjusted accounting profit/ (loss). Accounting Capital Tax adjusted profit/(loss) allowances profit/loss £ £ £ Ye 31.5.11 (16,200) (12,500) (28,700) Ye 315.12 5,500 (nil) 5,500 162 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 6 - TRADING LOSSES AND PARNERSI Step 3, Determine the tax adjusted trading profits. Year Tax year Period of profits assessable Loss. T é £ 1 2010/11 1.6.10 ~ 5.4.11 */32 x (28,700) (23,917) Nil 2 2011/12 CYB Y/e 31.5.11 (28,700 - 23,917) (4,783) Nil 3 2012/13 CYB Y/e 31.5.12 5,500 Step 4 Consider the various methods of oss relief available to Scribbler. 564 2010/11(Loss) £ (23,917) This can be relieved in 2010/11 and/or 2009/10 against the Total Income. It Is not possible to make partial or restricted clalms to preserve personal allowances, By claiming in 2010/11 and 2009/10 he will waste his personal allowances. 2011/12 (Loss) £ (4,783) This can be relieved in 2011/12 and/or 2010/11 against Scribbler’s Total Income. By claiming in 2011/12 and 2010/11 he will waste his personal allowances. Therefore S64 is not a feasible option for this loss. 872 This method of loss relief is available where a loss is incurred in any of the first four tax years of a new trade. ‘The loss can be carried back for three years on a FIFO basis. 2010/11 (Loss) £ (23,917) This can be carried back to 2007/08, 2008/09, 2009/10. The loss must be relieved against the Total Income of each year. It is not possible to make partial or restricted claims. 2011/12 (Loss) £ (4,783) This can be carried back to 2008/09, 2009/10 and 2010/11. This appears to be a better use of his loss as relicf is obtained earlier. Personal allowances will be wasted in 2007/08, but are preserved in all other years. Scridbler will get @ repayment of income tax previously pald in 2007/08 and 2008/09, www.studyinteractive.orgbeeks2000 blogspot.com 163CHAPTER 6 - TRADING LOSSES AND PARNERSI 583 This method of loss relief and involves carrying the trading loss forward and offsetting It against the first available trading profits of the same trade. The trading loss made in 2010/11 (23,917) can be carried forward to 2012/13, The trading loss made in 2011/12 (4,783) can be carried forward to 2012/13. This gives relief for the loss in the future which is not always the best option, In the case of Scribbler carrying the loss forward will result in him wasting Personal allowances and relieves his loss in the future which is not to be recommended. Step 5, Set up personal tax computations for all relevant years. 2007/08 2008/09 2009/10 2010/11 2011/12 £ £ £ £ £ Employment income 12,000 17,500 3,500 2,900 - Interest income 3,000 3,000 3,000» 3,000 3,000 Total income 15,000 20,500 6,500 5,900 3,000 $72 (1) (15,000) $72 (2) (8,917) 72 (3) (4,783) Net income Nil 6,800 6,500 5,900 3,000 PA ~ (6,475) (6,475) (6,475) (6,475) Taxable income Nil 325 25 Nil Nil Loss memo tot 14/12 z é 23,917 4,783 $72 (1) 07/08 (45,000) 8,917 $72 (2) 08/09 (8,917) $72 08/09 (4,783) Nil Nil 164 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 6 - TRADING LOSSES AND PARNERSI (3) Yui Zong Step 1 ‘Accounting Date 30 September Stop date 30.9.10 Final tax year 2010/11 AP final ends 30.9.10 Step 2 Adjust the accounting profits/losses. Compute the capital allowances. Step 3 Convert the accounting profits into taxable profits by applying the closing year rules Tax year Period Assessable Loss T 2006/07 Year ended 30.9.06 11,400 2007/08 Year ended 30.9.07 9,300 2008/09 Year ended 30.9.08 9,100 2009/10 Year ended 30.9.09 800 2010/11, 1.10.09 - 30,9,10 (9,600) (final tax year) Less Overlap profits (2,300) 11,900) (11,900) Nil The trading loss in 2010/11 is £ (11,900) as this is the loss of the final 12 months of trading. Step 4 Consider the possible ways of using the loss. In this example the examiner says to assume terminal loss relief is claimed www.studyinteractive.orgbeeks2000 blogspot.com 165CHAPTER 6 - TRADING LOSSES AND PARNERSI Step 5 Set up the income tax computations for all tax years and show relief for the trading loss. 2006/07 | 2007/08 | 2008/09 | 2009/10 | 2010/14 Trading profits | 11,400 9,300 9,100 800 Nil 89 (2,000) (9,100) (800) Rental income | 5,000 | _5,000 5,000 5.000 | 5,000 Total income 16,400 | 12,300 5,000 5,000 5,000 Less Interest on loans | _(Nil) nin. cui, wil) tui Net Income 16,400 | 12,300 5,000 5,000 5,000 PA 6,475: 6,475) 6,475) 6,475) 6,475) Taxable Income | 9,925 | 5,825 —ail ail —ail ‘The terminal loss is carried back on a LIFO basis and offset against trading profits. This leaves other income to cover personal allowances. A repayment of income tax previously paid will result from carrying the loss back in this way. This will result in a repayment income tax previously paid. 166 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 6 - TRADING LOSSES AND PARNERS! Answer 3 — Partnerships (2) Holder, Roberts and White Salary Interest Balance (2) Barnard and Harrison 1.10.09 - 31.3.10 salary Balance 1.4.10 - 30,9.10 Salary Balance Totals Total £ 18,000 3,600 10,000 31,600 8,000 1,200 5,000 14,200 Total 8,250 5,000 3,250 8,250 16,500 10,000 1,080 3,000 14,080 men 1,320 2,000 3,320 1,000 2,300 3,300 2,000 1,083 3,083 6,383 www.studyinteracti ve. orgbeeks2000 blogspot.com 167CHAPTER 6 - TRADING LOSSES AND PARNERSI (3) Dominic and Justin Step 1 Accounting date 30 June Dominic Justin. Simon Start date 1.7.09 1.7.09 0 LLdt First tax year 2009/10 2009/10 2010/11 Step 2 Adjust the partnership accounting profits Share the partnership accounting profits between the partners in the profit sharing arrangements during the accounting period. You should have started by allocating the profits between the partners. Remember that as Simon joins the partnership part way through the accounting year ended 30 June 2011, the profits for that year will need to be time-apportioned prior to allocation, itis treated like a change in the profit sharing arrangements, Total Dominic Justin Simon £ £ £ £ Year ended 30.6.10 10,000 5,000 5,000 Year ended 30.6.1 ha) 6,750 3,375 3,375 - C2) 6,750 2,250 2,250 2,250 13,500 5,625 5,625 2,250 Year ended 30.6.12 18,000 6,000 6,000 ~—«6,000 Once the profits have been allocated between the partners, each partner is then treated as if he is carrying on a business alone. Step 3 Determine the taxable trading profits separately for each partner by applying the opening year rules. Dominic and Justin will both be assessed on the following figures: £ 2009/10 £5,000 x */12 3,750 2010/11 A/cs to 30.6.10 5,000 2011/12 Afcs to 30.6.11 5,625 2012/13 Afcs to 30.6.12 6,000 ‘They will both be entitled to overlap relief to £3,750. 168 ‘ebooks2000 blogspet.com www. studyinteractive.orgCHAPTER 6 - TRADING LOSSES AND PARNERSI Simon is treated as commencing trading on 1 January 2011. He will therefore be assessed as follows: 2010/11 14.11 5.4.11 £2,250 x/6 1,125 2o1yi2 14d 31.42.11 £2,250 + (£6,000 x/12) 5,250 2012/13 Year ended 30.6.12 6,000 Simon's 2011/12 assessment is based on the profits of the first 12 months of trading as his share of the accounts to 30.6.11 does not cover a full 12 months. Simon will be entitled to overlap relief of £4,125 which is made up as follows: £ 111 to 5.4.11 1,125 7.11 to 31.12.11 3,000 4,125 www.studyinteractive.orgbeeks2000 blogspot.com 169170 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS Chapter 7 Corporation tax computations London FZ School of Business. & Finance powered by InterActive Ue Ee eee ed pilot] Dee | June | Dec | June | Dec | June | Dec 2007 | 2008 | 2008 | 2009 | 2009 | 2010 | 2010 Question 1 Question 2| + : : : . : : . Question 3 Question 4 . Question 5 . ° °. wow. studyinteractive, or =ei00 Donssteam 174CHAPTER 7 - CORPORATION TAX COMPUTATIONS baa ed CHAPTER BACKGROUND AND EXAM FOCUS: 173 DEFINITIONS AND TERMS FOR CORPORATION TAX: 177 ACCOUNTING PERIOD 477 CCHARGEALE ACCOUNTING PERIOD (CAP) 178 PROFORMA CORPORATION TAX COMPUTATION -- 179 A. PROFITS FROM TRADING (P) -- ALLOWABLE AND DISALLOWABLE EXPENSES 181 CAPITAL ALLOWANCES CLAIMED IF A COMPANY OWNS PLANT AND MACHINERY 182 PLANT AND MACHINERY PROFORMA FOR CORPORATION TAX 186 (CAPITAL ALLOWANCES CLAIMED IF A COMPANY OWNS AN INDUSTRIAL BUILDING 187 B, PROPERTY BUSINESS PROFITS- 189 RELIEF FOR PROPERTY BUSINESS LOSSES. 191 C, INTEREST INCOME 193 D. CHARGEABLE GAINS AND CAPITAL LOSSES 193 PROFORMA FOR COMPUTING CHARGEABLE GAINS AND CAPITAL LOSSES FOR COMPANIES 193 DisPOsALs OF SHA WHERE THE COMPANY HAS BOUGHT SHARES AT DIFFERENT DATESI9S THE CORPORATION TAX LIABILITY -. 198 CALCULATING CORPORATION TAX FOR SMALL, MEDIUM AND LARGE COMPANIES 199 POINTS AFFECTING THE UPPER AND LOWER LIMITS 199 SELF ASSESSMENT FOR CORPORATION TAX -: 200 PENALTY FOR FAILING TO NOTIFY HMRC THE COMPANY STARTED TRADING 200 DUE DATES FOR PAYING CORPORATION TAX AND THE DUE DATE FOR FILING RETURNS 200 ENQUIRIES INTO SELF-ASSESSMENT CORPORATION TAX RETURNS 201, PENALTIES FOR INCORRECT RETURNS. 202 LONG PERIOD OF ACCOUNT -- 205 206 iva SEezaOa oRST ET wow studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS arate i SSS Meal oats ieee oh ed This chapter is concerned with the tax payable by a company. A company is intangible but it is a legal person and as such has the right to own a business and to own assets. ‘The people responsible for running a company are called employees or staff. In this chapter the tax Implications for companies will be considered, focusing on the similarities and differences between a person owning a business (a sole trader/partnership) and a company owning a business. From the June 2011 paper onwards, international accounting standard terminology will be used when presenting accounting information contained in exam questions. ‘The most important change is that the term “profit and loss account” will no longer be used. Instead, the term “income statement” will be used, with Income statements being presented in the international accounting standard format. The following terminology will also change: Previous terminology New terminology Profit and loss account Income statement Sales Sales revenue Fixed assets Non-current assets Stock Inventory Debentures Loan notes This particular topic will always be tested as question 2 on the paper for between 20 and 30 marks and may also be tested in question 4 and 5. www, studyinteractive. orGoeeKs2000 blogspet.com 173CHAPTER 7 - CORPORATION TAX COMPUTATIONS Example i - Exam standard question (December 2001) Geronimo Ltd is a UK resident company and has one associated company and it manufactures motorcycles. The company's summarised income statement for the year ended 31 March 2011 is as follows: £ £ Gross profit 921,540 Other income Patent royalties (note 1) 24,700 Bank interest (note 2) 2,800 Loan note interest (note 3) 22,000 Overseas dividends (note 4) 36,000 Expenses Impaired debts (note 5) 22,360 Depreciation 83,320 Gifts and donations (note 6) 2,850 Professional fees (note 7) 14,900 Patent royalties (note 8) 7,200 Repairs and renewals (note 9) 42,310 Other expenses (all allowable) 136,520, (309,460) Finance costs Interest payable (note 10) (45,000) Profit before taxation 652,580 Note 1 Patent royalties receivable Other operating income consists of patent royalties derived from patents which the company registered in 2001 to protect a manufacturing technique it has developed. Royalties of £8,900 and £15,800 were received from other UK resident companies on 30 September 2010 and 31 March 2011 respectively. Note 2 Bank interest received ‘The bank interest was received on 31 March 2011. The bank deposits are held for non-trading purposes. 174 osPO00 Hlgspe eam www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS Note 3 Loan note interest received The figure for loan note interest received is calculated as follow: £ Accrued at 31 March 2010 (5,500) Recelved 30 June 2010 11,000 Received 31 December 2010 11,000 Accrued at 31 March 2011 5,500 22,000 The loan notes were issued for non-trading purposes. Note 4 Overseas jends received ‘The dividends were received from overseas companies. These overseas companies are not associated with Geronimo Ltd. Note 5 Impaired debts Impaired debts are as follows £ Trade debts written off 19,890 Loan to customer written off 600 Increase in allowance for trade debtors 1,870 22,360 Note 6 Gifts and donations Gifts and donations are as follows: £ Donation to national charity (made under the Gift Aid scheme) 1,800. Donation to national charity(not made under the Gift Aid scheme) 100 Donation to local charity (Geronimo Ltd received free advertising in the charity's magazine) 50 Gifts to customers (food hampers costing £60 each) 900 www, studyinteractive. orGoeeKs2000 blogspet.com 175CHAPTER 7 - CORPORATION TAX COMPUTATIONS Note 7 Professional fees Professional fees are as follows: Accountancy and audit fee 4,100 Legal fees in connection with the renewal of a 20-year property 2,400 lease Legal fees in connection with the issue of a debenture loan 8,400 (see note 10) 14,900 Note 8 Patent royalties € Paid 31 July 2010 3,500 Paid 31 January 2011 2,300 Accrued at 31 March 2011 1,400 7.200 The patent royalties were trade related and were payable to other UK resident companies. Note 9 Repairs and renewals The figure of £42,310 for repairs includes £6,200 for replacing part of a wall that was knocked down by a lorry, and £12,200 for initial repairs to an office building that was acquired during the year ended 31 March 2011. The office building was not usable until the repairs were carried out, and this fact was represented by a reduced purchase price. Note 10 Interest payable Geronimo Ltd issued loan notes on 1 July 2010. The loan was used for trading purposes. Interest of £30,000 was paid on 31 December 2010, and £15,000 was accrued at 31 March 2011. These figures are gross and were paid to other UK resident companies, Note 11 Plant and machinery On 1 April 2010 the tax written down value of the main pool of plant and machinery was £52,800, There were no purchases or sales of plant and machinery during the year ended 31 March 2011. Required (a) Calculate Geronimo Ltd’s tax adjusted trading profit for the year ended 31 March 2011. Note: Your computation should commence with the net profit before taxation figure of £652,580, and should also list all the items referred to in notes (1) to (10) indicating by the use of zero (0) any items that do not require adjustment. (b) Compute the corporation tax liability for the year ended 31 March 2011. 176 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS i Businesses are owned by Companies 1. A company owns a business 2. A company owns assets, the profits/loss made by the business belong to the company. — = DEFINITIONS AND TERMS FOR CORPORATION TAX Accounting period wa + This is the period for which a company prepares its financial statements. + The period of account can be: Annually = 12 months Short period < 12 months Long period > 12 months <18 months www. studyinteractive, orGeeets2000 Bleaspetcom 177CHAPTER 7 - CORPORATION TAX COMPUTATIONS Creer ant ha hc) E¥% | Chargeable Accounting Period sowie FAG + Achargeable accounting period is the period for which a charge to corporation tax is made. A Chargeable accounting period begins when: + acompany starts to trade;or + the profits of a company first become liable to UK corporation tax; or + the previous chargeable accounting period ends The company must notify HMRC within 3months of the start of the company’s first CAP. ie) = ia eae ert lowerdtive he + Usually the CAP ends on the accounting date The CAP ands on the earlier ofthe following 12 Months after of account or the period of *Company ceases to account started trade, or *Company ceases to be UKrresident or *Company ceases to be liablo fo CT or ‘eeakSZOOU BRST 178 www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS PROFORMA CORPORATION TAX COMPUTATION Corporation tax computation - for the CAP £ Profits from trading (adjusted profits less capital allowances) x Overseas income (gross of overseas tax suffered) x Rental income x Chargeable gains (chargeable gains less capital losses) x Interest income (from non trading) x Total Profits 7 Gift aid donations to charity ~ Taxable total profits x Corporation tax (CT) at relevant rate x Less Marginal relief (if any) Oo Corporation tax x Less Double tax relief (DTR) OO Corporation tax (CT) payable xin Due date 9 months and one day after the end of the CAP (unless a large company which pays in quarterly instalments) File date 12 months after the end of the period of account, (a) In general a company’s income is computed in accordance with income tax principles and its chargeable gains are computed in accordance with CGT Principles. However, this general rule is overridden by special corporation tax provisions in several instances which are considered in this chapter (b) A company cannot be an employee and so cannot have employment income. (c) A company is not a “person” and is not entitled to claim personal allowances. (2) A company does not pay corporation tax on UK anc overseas dividends received. www, studyinteractive. orGoeeKs2000 blogspet.com 179CHAPTER 7 - CORPORATION TAX COMPUTATIONS Profits from trading Overseas Income Rental Profits Chargeable Gains Interest Income Total profits Donation to charity under gift aid Taxable total profits ‘ Steet Cane toraceuay Be part 1 x OK OK KD kis 180 ‘eeakSZOOU BRST www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS A. PROFITS FROM TRADING (P) ‘A company’s trading income for an accounting period consists of its trading profits for that period, as adjusted for tax purposes. The starting point for the calculation is the company’s pre-tax profit for the relevant period of account. This figure is then adjusted by excluding non-trading income, adding back disallowed expenses and deducting any capital allowances that are claimed RET aeeereraes sa erative | ee ame Trading Profits x Patent royalties receivable x Staff costs (salary+ NIC+ pension contribution) (x) Impaired debts ) Costs of issuing loan notes/ corporate bands ®) Interest payable on loans fortrading purpose (x) Loan arrangement fee (provided loan for trading) (x) Patent royalties payable () Premium paid on grant of a short lease () (Rent part /no. of years on lease) Capital allowances of P&M ) Capital allowances on IB & Trading Profit/(Loss) x00 snwerdetive aCe nr CR ects Disallowable expenses include + Entertaining of customers and suppliers + Capital expenditure (e.g, cast of computers, equipment, cars, vans, lorries, shelving) + Legal costs of acquiring a capital asset + Depreciation Legal costs of acquiringa short lease (legal costs of renewing a short leaceis allowable) + Costs of issuing shares Interest payable on loans fornon trading purpose + Loans to customers/suppliers/employee written off + Hire of a high CO2 emission (+160 g/km) mator car, 15% of the hire charge is disallowable. www. studyinteractive, orGeeets2000 Bleaspetcom 181CHAPTER 7 - CORPORATION TAX COMPUTATIONS =4%, | Premiums paid on the grant of a (overAciive FE + When a company buys a short lease, the cost of the lease is called a premium paid Company ua Prerrium paid forthe 21 year lease £16,000, 4_ DD Capital allowances cl. Paras CM uD Uaioe Uae tl Plant and machinery - categories =a sncerAtive CPU ts ee + Plant ard machinery is descibed as teas ofthe trade andincludes © computers + Equipment + shelving + Vans an lontes + Cars with low C02 (CO2 of upto 110g/km) Bey + Cars with meduum Coa (Coz of between 111 and 160g/kr + Bleydes «Tables and chars & oa + Photocopiers + Fire regulation expen« + alterations to a building, inadental to ingpsratTOn of plant and machinery. a 182 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS ome 7] ERT Cis aes) ee sncerAetive 1)This is a pool of assets which are acquired as an integral feature of building y + Electrol systems and lighting systems + Cold witer systems + Central heating syster + Airconditioning and ventilation systems, + Lifts 2) Thermal insulation in a bul 3) Long Life assets costing-etiesct________ £100,000 and have a life of at least 25 years, 4) Motor cars with high CO? emission > 160g/km, Capital allowances for plant and machinery A) The Annual investment allowance (AIA) As from 1 April 2010, the first £100,000 per annum of expenditure on plant and machinery (other than cars) qualifies for the annual investment allowance (AIA). In effect, the AIA provides a 100% allowance for the first £100,000 invested in plant and machinery each year. Key Points to remember * A company Is free to allocate the AIA between different types of expenditure in any way that it sees fit. For example, a business which invests £40,000 in main pool plant and machinery and £70,000 in “integral features” in a 12-month chargeable accounting period might allocate £30,000 of the AIA to the main pool of plant and machinery and the remaining £70,000 to the special rate pool. This would maximise allowances for the period, since main poo! plant and machinery attracts the WDA at 20%, whereas the special rate pool only attracts a WDA at only 10% © The £100,000 allowance is for qualifying expenditure in 2 12 month chargeable accounting period, If the chargeable accounting period is < 12 months then the £100,000 allowance is reduced accordingly. * Ifa business spends more than £100,000 then the expenditure beyond the £100,000 enters the main pool or special rate pool and is eligible for the WDA at 20% or 10% www. studyinteractive, orGeeets2000 Bleaspetcom 183CHAPTER 7 - CORPORATION TAX COMPUTATIONS B) The First year allowance (FYA) The 100% FYA Expenditure on low emission motor cars is eligible for a 100% FYA so long as the expenditure is incurred on or before 31 March 2013. The definition of a low emission car for the purposes of the 100% FYA is one with an emission rating not exceeding 110 g/km. Key points to remember © The FYA Is never decreased even if the chargeable accounting period is less than 12 months. ‘* Low emission cars should always be included in the main pool C) The Writing down allowance (WDA) In general, @ business may claim a writing down allowance for each of its pools of plant and machinery in each chargeable accounting period. ‘The WDA is available in each chargeable accounting period except in the final chargeable accounting period and on the disposal of @ non-pooled asset (expensive car, short life asset). The WDA Is normally computed at 20% on all categories of plant and machinery except in the special rate pool where it is computed at 10%. The special rate pool consists of any plant and machinery which is integral to a building for example electrical and lighting systems, cold water systems, central heating systems, ventilation and air conditioning systems, lifts and escalators. ‘The special rate pool also includes the cost of long life assets, the cost of thermal insulation in a building and cars with a CO2 emission of > 160g/km, ‘The WDA is computed on the reducing balance. Key points to remember © The WDA must be reduced if the chargeable accounting period is less than 12 months. © Expensive cars purchased before the 1 April 2009 are still exeminable and the WDA is calculated at 20% and in a 12 month accounting period must not exceed £3,000. If the chargeable accounting period is less than 12 months then the limit of £3,000 must be decreased Summary of the new rules for capital allowances on cars Low coz Medium Coz High Co2 110 9/km | 111 - 1609/km | > 1609/km Category Main pool Main poo! Special rate pool Capital allowances | FYA 100% | WDA 20%. WDA 10% 184 osPO00 Hlgspe eam www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS The small balance relief on the pools of plant and machinery If the TWDV brought forward at the beginning of the chargeable accounting period plus any additions or disposals during the period on the main pool or the special rate pool is £1,000 or less, the business may claim allowances called the small balance relief - which basically means that the balance on the pool is treated as an extra amount of capital allowance and is given instead of the WDA. Rates of AIA and FYA sncerAetive Description lbates Rate | Maximum + All plant and 1.4.10 + Jaa toms £100,000 (machinery except (12month period) cars) + Low CO, Emission }17.4.02 —31.3.13 Fva100%| No maximum Cars AIA ~ Annual investment allowance; FYA - First year allowance www. studyinteractive, orGeeets2000 Bleaspetcom 185CHAPTER 7 - CORPORATION TAX COMPUTATIONS Plant and machinery proforma for corporation tax cap AIA Main Short Special Exp car Exp car Total pool life rate (1) (2)— capital asset pool allows £ ‘ £ © £ £ £ ‘Tax WDY b/t x x x Add: Additions AIA x Less: ATA (UL = £100,000) ~ XIN XINil ‘Add: High CO; car x Add: Medium CO; car x Less: Disposal proceeds (lower of SP and cost) ~o ~ x x x Balancing allow/Balancing Xi) charge XI XIX) ‘Small balance relief ifthe balance on the main pool or special rate pool is <£1,000 wpa. @ 20%/10% ~ oo x © 20% restricted to (amax of £3,000 pa) mo x Add: Low CO, cars x FYA 100% oo x Tax WDV olf xX NX Nl x Allowances to he claimed x 186 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS al allowances claimed if a company owns an GS Sr cs Lor I ena Industrial building Industrial buildings include + Factories + Warehouses used to store raw materials and finished goods manufactured by the occupier =i Industrial Buildings (contd) + Ahotel is an industrial building + Conditions It must have at least 10 letting bedrooms Services provided for guests must include the provision of breakfast, evening meals etc Must be open for at least 4 months during the season April to October. www. studyinteractive.ol 187CHAPTER 7 - CORPORATION TAX COMPUTATIONS Industrial Buildings + Capital allowances can be claimed by the owner of an industrial builcing. + Capital allowances are claimed on the qualifying cost of the industrial builsing, Cost per the question x Less: cost of land © Less: cost of plant and machinery & Building cost Xa Less: cost of non- industrial parts (iftheir total costis > 25% xa) anil Qualifying cost x cerctive Cr Lecce + Stanley Ltd acquired a new industrial bullding on 1 June 2010 the ‘company brought It inta industrial use immediately, The total cost of £117,500 1s matie up as follows: é Land 12,500 site dearance 2,500 Foundstion 7,500 General office 5,000 Drawing office 2,500 Canteen 3,750 Accounts office 4500 Ventilation and heating system 5,500 Other allowable expenditure 63,750 Total expenditure 113,500 Allowances available to the owners of an industrial building The writing down allowance This allowance is available in each chargeable accounting period provided the building is in industrial use at the end of the accounting period. The WDA is computed on the straight line basis. The WDA is computed as follows: WDA = 1% x Qualifying cost Key Points to remember * The WDA is decreased if the chargeable accounting period is less than 12 months. ‘eeakSZOOU BRST 188 www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS © In the chargeable accounting period in which an industrial building is disposed of there is no WDA, no balancing allowance and no balancing charge, only a chargeable gain or capital loss. B. PROPERTY BUSINESS PROFITS In general a company’s income from property (or property business profits) is calculated in much the same way as an individual's Income from property with several significant differences such as: © the property business profits are based on the rent receivable during the chargeable accounting period and ‘+ any interest payable on a loan to buy an investment property is disallowable when computing the property business profits. S¥% | Income from Land and Buildings in fous the UK — Investment Properties me@ A a Commercial Unfurnished Fumished Fumished Premises Holiday Letting www. studyinteractive, orGeeets2000 Bleaspetcom 189CHAPTER 7 - CORPORATION TAX COMPUTATIONS. Bertet® | Proforma For Property Business ace £ Rent receivable in the CAP x Plus: Premiums received in the CAP Xa Less: Capital element 2%( years on lease — 1) x X, ® Less: Allowable expenses ~ Property Business Profit or (Loss) XI) sowAcin EAS ee See + Expenses paid by the landlord and incurred wholly and exclusively for the purposes of the letting. Repairs and decorating Managing agents fees Insurance of the building and contents Replacement of the boiler, roof and windows Premium paid on the head lease (rent paid in advance x sub-leasef head-lease) Advertising costs Council tax, water rates Impaired debts Wear and tear allowance for furniture 190 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS St | Premiums received on the grant of a ‘overactive Fa + When a company grants a short lease, the amount Company received is called a premium received. Premium received £10,000 Leaseholt Ofces fora 10 year lease Interest payable on a loan to acquire or improve property This Is not an allowable expense under property business profits for companies. The interest payable must be treated as a non-trading expense and offset against interest receivable which will reduce the company’s interest receivable. Relief for property business losses a sncerAetive Property Business Losses + This arises when the allowable expenses incurred in connection with investment praperties owned by a company are greater than the rent receivable £ Rent receivable Premiums received Less: Capital element eo) Less: Allowable expenses & Property business loss ® Rental losses can be relieved against total profits of the loss making CAP with any remaining loss being carried forward against total profits of future chargeable accounting periods or surrendered by way of group relief. www. studyinteractive, orGeeets2000 Bleaspetcom 191CHAPTER 7 - CORPORATION TAX COMPUTATIONS Illustration — Rental Losses Year ended 31 March 2011 Property 1 £ Rent 5,000 Less: Expenses (3,000) Rental Income The loss available for relief Trading profits Interest income Rental income Capital gains Total Profits Less property business loss Revised total profits Less Donations under the gift aid scheme Taxable total profits FIL “Augmented profits” 2 3 Total £ £ £ 6,000 7,000 (8,000) (9,000) 106,000 ( ) (Nil) Te2 ‘eeakSZOOU BRST www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS INTEREST INCOME lowerdetive £ Bank and building society interest receivable x Gilt interest receivable x Loan note interest receivable x Less Loan arrangement fee (loan for non trading) Interest on loan to buy investment property ( Interest payable on a loan to buy shares (9 Interest payable on overdue tax 6 Loan to employee/customer/supplier written off (x) Interest surplus x CHARGEABLE GAINS AND CAPITAL LOSSES Sean Tntme Ceen iGEM acl losses for companies Consideration x Less Incidental costs of sale © Net sale proceeds Ns Less Allowable expenditure ~ Acquisition cost = Incidental costs of acquisition x ~ ~ Enhancement expenditure oo Unindexed gain/loss X/00) Less _Indexation allowance ARP at cisposal -RPl at acquisition OS RPat acquisition = O.XXX x Cost (a) Indexed gain x/Nil www, studyinteractive. orGoeeKs2000 blogspet.com 193CHAPTER 7 - CORPORATION TAX COMPUTATIONS et IncerAetive Indexation Allowance (IA) + Removes the element of gain due to inflation RPI disposal —RPI acquisition = xyz RPI acquisition A= xyz x Cost Sometime the examiners gives 1. The RPIs 2. The indexation factor 3. The indexed cost Indexed cast = Cost + 1A 4° The indexation allowance Example 2 — Disposal of a factory A Ltd sold a factory on 15 February 2010 for £320,000, The factory was purchased on 24 October 1995 for £164,000, and was extended at 2 cost of £37,000 during March 1997. During May 1998 the roof of the factory was replaced at a cost of £24,000 following a fire, A Ltd incurred legal fees of £3,600 in connection with the purchase of the factory, and legal fees of £6,200 in connection with the disposal. Retail price indices (RPIs) are as follows: October 1995 149.8 March 1997 155.4 May 1998 163.5 February 2010 219.2 Required (a) Compute A Ltd's chargeable gain on the disposal of the factory. (b) Assuming A Ltd prepares accounts to 31 March each year state the chargeable accounting period in which the chargeable gain will be subject to tax ‘eeakSZOOU BRST 194 www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS Example 3 - Greenwood Ltd Greenwood Ltd disposed of an investment property on 31 December 2010 legal costs and estate agents fees of £5,000 were incurred in relation to the disposal Greenwood Ltd had purchased the property originally on 21 June 1986 for £15,000 and incurred acquisition costs of £1,500. Greenwood spent £25,000 on an extension to property on 31 May 1994, Required Assuming the sale proceeds were: (a) £105,000 (b) £45,000 (©) £53,500 compute the indexed gain assessable on Greenwood Ltd in the chargeable accounting period to 31 March 2011. RPI. June 1986 97.79 May 1994 144.7 December 2010 226.4 Pi te mm eM MM th Td ES RU eho (1) Shares and securities that are bought in a particular company of the same class are not distinguishable from one another. (il) Each time shares are bought in any quoted company the price paid may be different, (il) When it comes to selling some shares, the taxpayer (company or an individual) would want to deduct the highest possible cost that they might have paid for a particular ‘block’ of shares bought so that they would then have the lowest possible gain. (iv) This is why we have specific matching rules to Identify the order In which different packets of shares are disposed of These rules of matching/identification are required as they enable us to decide which shares have been sold and also work out the allowable costs on disposal. Matching/Identification rules on disposal by companies (1) Same day. No indexation & not examinable (2) Within previous nine days on LIFO basis. No indexation & not examinable (3) FA 1985 holding poo!’ (new holding pool) www, studyinteractive. orGoeeKs2000 blogspet.com 195CHAPTER 7 - CORPORATION TAX COMPUTATIONS Exam technique for determining gains and losses on disposal of shares by companies Step 1 - Set up the proforma computation Sale proceeds Less: Selling costs Less: Cost(Step 2) Less: Indexation allowance (Step 2) Indexed gain Step 2 - set up the working to determine cost and IA Set up the 1985 pool working Description No. Cost Purchase x x Index to 1*operative event Purchase x x Index to 2operative event x x Disposal ~ ~ (1) 1985 Pool carried forward | _X x Indexed Cost (Cost+Indexation) Toe ‘eeakSZOOU BRST www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS Example 4 - Forward Ltd (On 30 November 2010 Forward Ltd sold 5,000 £1 ordinary shares in Backward plc, a quoted company for £62,500. Forward Ltd had originally purchased 9,000 shares in Backward ple on 30 April 1986 for £18,000 and purchased a further 500 shares on 1 November 2006 for £6,500. The retail price index for April 1986 it was 97.7, for November 2006 it was 201.1 and for November 2010 it was 226.0. (Compute the chargeable g: ple Advise Forward Ltd of the carr gains purposes. on the disposal of the shares in Backward d forward indexed base cost for capital Bonus and right issues A bonus and rights issue is the distribution of shares to existing shareholders in proportion to the number of shares owned at the date of the issue. A bonus issue is the distribution of free shares to shareholders, whereas the rights issue involves the shareholders paying for the new shares. In both cases this is an acquisition of shares and they will be added to the 1985 pool. ‘A bonus issue is not an operative event and the bonus shares are simply added to the 1985 pool. A rights issue is a purchase of shares, the acquisition of these shares should be treated as an operative event. www, studyinteractive. orGoeeKs2000 blogspet.com 197CHAPTER 7 - CORPORATION TAX COMPUTATIONS THE CORPORATION TAX LIAB: a This represents the period for which corporation tax rates and limits are set, The financial year 2010 runs from 1 April 2010 to 31 March 2011 =a sncerdetive Penge trum 2007 2008 2000 Hain te 30% 20% 20% SmmanPromts Rate 20% 21% 21% 2% Leer 300000 ©300.000 £30000 £300,000 Limit ‘Upper 900,000 £1,500,000 £1,500,000 £1,500,000 Lima Fraction for i ' ' ; Margnaranet = 1 & 4 & i ert ie onera ter ere Determine the relevant rate of corporation tax & Taxable total profits 3 Add: Franked Investment Income (Fil) (UK& overseas dividends received x 100/90) x (Dividnas rots fem asocated cmpane & nat rankedinvetmentincome) “Augmented profits” x Compare the “Augmented profits” to the statutory limits to decide the rate of corporation tax to apply, ‘eeakSZOOU BRST 198 www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS g corporation tax for small, medium and large Large company “Augmented profits" > Upper limit CT = Taxable total profits x Main rate Medium company “Augmented profits” > Lower limit < Upper limit £ Taxable total profits x Main rate x Less: Marginal relief Taxable total pr 7 standard fracton> (Upper mit Augmented profs) x Taxable total profits 0 ‘Augmented profits cr x ‘Small company “augmented profits” < Lower limit CT = Taxable total profits x Small profits rate Peis me Ch Ct cd (a) For short accounting periods the limits must be pro-rated. (b) A company Is associated with another if one company is controlled by the other or both are under the control of the same person/company. Control means possession of > 50% of the Issued share capital or voting rights. ‘The significance of associated companies is that the limits are divided by the total number of associated companies www, studyinteractive. orGoeeKs2000 blogspet.com 199CHAPTER 7 - CORPORATION TAX COMPUTATIONS SELF ASSESSMENT FOR CORPORATION TAX ing to notify HMRC the company started trading Failure to notify HMRC within the first three months is subject to the following penalty structure and the amount of the penalty is based on the tax due but unpaid as a result of failure to notify HMRC. Reason for Penalty Reasonable excuse None No excuse but non - deliberate 30% Deliberate failure 70% Concealment 100% Tne tke CR rc etuiuy ies =4% | Due date for paying corporation tax and ceacive BUTE CL OLE) Due Date 9 months and one day after the end of the AP (unless a large company which pays in quarterly Instalments). If the company pays Its corporation tax late then interest on overdue taxis payable at 3.0% pa, File Date 12 months after the end of the period of account 200 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS sid ee aee Lac tank cr nerve In four instalment len eres Seen) enn inthe current Crain Ss ans ene 2) £10 06 ars Cae aaa iaca Incerdtive + Automatic penalties apply for late fling Tila Fed Penaly or100, “This rises to £200 the return Ismore than $ months late tthe return was between 6 & 12 ‘months late there is an extra tax ‘geared penalty of 10% x unpaid comoraton tax Ifthe retum is > 12: months late the tax geared penalty is 20% Caneel ae This enquire window has now changed to 12 months from the date that a corporation tax return is received by HMRC. www. studyinteractive, orGeeets2000 Bleaspetcom 201CHAPTER 7 - CORPORATION TAX COMPUTATIONS LAU RR Ld A single new penalty regime has been Introduced for incorrect returns, The amount of penalty is based on the amount of tax understated, but the actual penalty payable is linked to the company’s behaviour, as follows: © There will be no penalty where a taxpayer simply makes a mistake. © There will be a moderate penalty (up to 30% or the understated tax) where a taxpayer fails to take reasonable care. © There will be a higher penalty (up to 70% of the understated tax) if the error is deliberate, and even higher penalty (up to 100% of the understated tax) where there is also concealment of the error. However the penalty will be substantially reduced where the company makes disclosure, especially when this is unprompted by HMRC. A company which fails to keep and preserve adequate records ii penalty of up to £3,000. liable toa 202 osPO00 Hlgspe eam www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS Example 5 - Corporat in tax (2) Magic Ltd had the following results for the year ending 31 March 2011, £ Trading income 100,000 Rental income 20,000 Bank interest 25,000 Capital gains 18,000 Dividends received (net) 90,000 Required Calculate the corporation tax liability. (2) Crystal Ball Ltd had the following results for the year ending 31 December 2010. £ Trading profits 1,450,000 Dividends received (net) 45,000 Required Calculate the corporation tax liability, www, studyinteractive. orGoeeKs2000 blogspet.com 203CHAPTER 7 - CORPORATION TAX COMPUTATIONS (3) Cinderella Ltd had the following results for the year ending 31 July 2010. £ Trading income 397,880 Bank interest 720 Capital gains 2,000 Donation to charity under gift aid (1,000) Dividends received (net) 90,000 Required Calculate the corporation tax liability. (4) Spellbound Ltd had the following results for the year ending 30 September 2010. £ Trading income 21,200 Rental income 3,700 Bank interest 3,000 Capital gains 14,600 Donation to charity under gift aid 2,300 Dividends received (net) 2,250 Required Calculate the corporation tax liability. Example 6 - Illusion ple Illusion pic has the following results for the 12 month CAP ended 31 December 2010. E Tracing profits 360,000 Patent royalties receivable (gross) 24,000 Loan interest received (gross) 10,000 Bank interest received 15,000 Capital gains 20,000 UK dividends received (net) 13,950 Patent royalties payable (25,000) Donation to charity under the gift aid scheme (2,000) The following balances were brought forward: Trading Loss £60,000 Capital loss £5,000 Required Compute the corporation tax for Illusion plc assuming Tilusion plc has one associated company. 204 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS Dictidsis tel elas For accounting purposes the company’s accounting period can be up to 18 months in length. If a company prepares accounts for more than 12 months then it is necessary to divide the period of account into two chargeable accounting periods. ‘This is because a chargeable accounting period (period of account for tax purposes) cannot exceed 12 months, ‘The two chargeable accounting periods (CAPs) will be as follows: (2) First 12 months (2) Remainder of account When computing capital allowances and allocating income and charges use the following procedure: Capital allowances Two separate computations for each CAP Trading profits Time apportion Rental income Receivable basis, Interest income Receivable basis Capital gain/loss Date of realisation Franked investment income _| Date the UK dividend is received Prepare separate corporation tax computations for each chargeable accounting period Example 7 - Longitude Ltd Longitude Ltd is a United Kingdom resident company that installs smoke detectors. ‘The company commenced trading on 1 April 2010 and its results for the fifteen month period ended 30 June 2011 are summarised as follows: ‘The trading profit as adjusted for tax purposes is £315,000. This figure is before taking account of capital allowances. Longitude Ltd purchased equipment for £12,000 on 20 May 2010, On 21 December 2010 Longitude Ltd disposed of some investments and this resulted in a capital loss of £4,250. On 28 June 2011 the company made a further disposal and this resulted in a chargeable gain of £50,000. Franked investment income of £25,000 was received on 22 May 2011. Longitude Ltd has two associated companies. Required Calculate Longitude Ltd’s corporation tax liabilities in respect of the fifteen month period ended 30 June 2011 and advise the company by when these should be paid. (You should assume that the rates in the FY 2011 are the same as the FY 2010) www, studyinteractive. orGoeeKs2000 blogspet.com 205CHAPTER 7 - CORPORATION TAX COMPUTATIONS Example 1 - Geronimo Ltd protts trom | | Overseas Rental income ]{ Chargeable || Interest income Tse income gains 00 +2350 | Git Aid fi800 Tax Adjusted Trading Profits for Year ended 31 March 2011 - + Step 1 Profits per the question 652,580 step 2 Trade debts written off - allowable ° Loan written off 600 Increase allowance for trade debts -allow ° Depreciation 83,320 Donation under gift aid 1,800 Donation 100 Donation to local charity - allowable ° Gifts to customers of food hampers 900 Audit and Accountancy ~ allowable ° Renewal of short lease ~ allowable ° Issue costs for loan notes ~ allowable ° Patent royalties payable ~ allowable o Replacing part of a wall - allowable o Initial repairs to new offices 12,200 Interest payable on a trading loan - allow ° step 3 Bank interest 2,800 Loan interest 22,000 Dividends 36,000 Step 4 10,560 CAs (52,800 x 20% = 10,560) 71,360 751,500 206 EeaReDOOT HPT wow studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS (b) Corporation tax liability for the year ended 31 March 2011 Lower Limit + 2 £ Profits from trading 680,140 (751,500 - 71,360) 24,200 Interest income(2,800 + 22,000 - 600) Total profits 704,340 Less: Gift aid donation 1,800) Taxable total profits 702,540 FII (36,000 x 100/90) 40,000 “Augmented profits” 242,540 Upper Limit + 2 750,000 150,000, Mediurn company Corporation tax liability 702,540 x 28% Less: Marginal relief 7/400 x (750,000 ~ 742,540) x 702,540/742,540 196,711 (124) 196,587 www, studyinteractive. orGoeeKs2000 blogspet.com 207CHAPTER 7 - CORPORATION TAX COMPUTATIONS Answer 2 = posal of factory Chargeable gain - disposal of factory E Eg Disposal proceeds 320,000 brary 2010) Incidental costs of disposal (6,200) Net sale proceeds 313,800 Cost (October 1995) 164,000 Incidental costs of acquisition 3,600 (167,600) Enhancement expenditure (37,000) (March 1997) Unindexed gain 109,200 Indexation - Cost 167,600 x .463, (77,599) (219.2 - 149.8)/149.8 = .463 Indexation ~ Enhancement 37,000 x 411 (15,207) (219.2 ~ 155.4)/155.4 = 411 Chargeable gain 16,394 (1) The factory extension Is enhancement expenditure as it has added to the value of the factory. (2) The replacement of the roof is not enhancement expenditure, being in the nature of a repair. (0) The gain in chargeable in y/e 31.3.10. 208 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS Answer 3 - Greenwood Ltd (a) Sale proceeds £105,000 £ £ Gross sale proceeds 105,000 Less costs of sale (5,000) Net sale proceeds 100,000 Less Cost 415,000 Incidental acquisition costs 1.500, (16,500) Enhancement expenditure 25,000 Unindexed gain 58,500 Less _Indexation allowance Cost (Dec 2010 ~ June 1986) 226.4 97.79 ERAASTE = (1.315 x £16,500) ‘778 ( ) 21,698 Enhancement(Dec 2010 - May1994) 2264-1447 28S “MAT _ (0,565 x £25,000) fe ‘aay ( ) 14,125 (35,823) Indexed gain (b) Sale proceeds £45,000 Gross sale proceeds 45,000 Less costs of sale (5,000) Net sale proceeds 40,000 Less Cost 16,500 Enhancement expenditure 25,000 (41,500) Capital loss (1,500) (©) Sale proceeds £53,500 Gross sale proceeds Less costs of sale Net sale proceeds Less Cost 16,500 Enhancement expenditure 25,000 Unindexed gain Less: Indexation allowance Cost 1.315 x £16,500, 21,698 Enhancement 0.565 x £25,000 14.125 Restricted as indexation cannot 35,823 create a loss Indexed gain/loss www, studyinteractive. orGoeeKs2000 blogspet.com 209CHAPTER 7 - CORPORATION TAX COMPUTATIONS Answer 4 = Forward Ltd Ordinary Shares in Backward plc (i) The disposal is matched against shares in the 1985 pool £ Disposal proceeds 62,500 Cost (W) (12,895) Unindexed gain 49,605 IA (25,759 ~ 12,895) (W) (12,865) Chargeable gain 36,740 Working: 1985 Pool Number _Cost £ Purchase April 1986 9,000 18,000 18,000 Indexation to November 2006 18,000 x (201.1 - 97.7)/97.7 19,050 37,050 Addition November 2006 500 6500 6,500 9,500 24,500 43,550 Indexation to November 2010 43,550 x (226.0 ~ 201.1)/ 201.1 5,392 9,500 24,500 48,942 Disposal 5,000) (12,895) (25,760) Cost x 5,000/9,500 Balance carried forward 4,500 11,605 23,182 (ii) The indexed base cost of the £23,182 shares c/f ‘eeakSZOOU BRST 210 www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS Answer 5 — the corporation tax liability (2) Magic Ltd CAP y/e 31 March 2011 Trading profits Rental income Interest income Chargeable gains Total profits Less: Donation to charity under gift aid Taxable total profits Add: FIL Net div x !*/90 90,000 x *%/30 “Augmented profits” Lower limit 300,000 Upper limit 1,500,000 ‘Small company 163,000 x 21% (2) Crystal Ball Lea CAP y/e 31 December 2010 Taxable total profits Add: FIT £45,000 x "790 “Augmented profits” Lower limit 300,000 Upper limit 1,500,000 Large company Corporation tax £1,450,000 x 28% £ 100,000 20,000 25,000 18,000 163,000 (Nil) 163,000, 100,000, 263,000 34,230 £ 1,450,000 50,000 1,500,000 406,000 www, studyinteractive. orGoeeKs2000 blogspet.com 24aCHAPTER 7 - CORPORATION TAX COMPUTATIONS (3) Cinderella Ltd CAP y/e 31 July 2010 Profits from trading Interest income Capital gain Total profits Less: Donation under gift aid Taxable total profits Add: FIT £90,000 x !°°/o0 augmented profits” Lower limit 300,000 Upper limit 1,500,000 Medium company Corporation tax liability £399,600 x 28% Less: Marginal relief ’/400 ((1,500,000 - 499,600) Corporation tax (4) Spellbound Ltd £ 397,880 720 2,000 400,600 (1,000) 399,600 100,000, 499,600 € 111,888 399,600 (14,003) 499,600 97,885 CAP y/e 30 September 2010 Trading profit Rental income Interest income Capital gain Total profits Less: Donation under gift aid Taxable total profits Add: FIT £2,250 x *%/s0 “Augmented profits” The company is small The corporation tax liability (40,200 x 21%) 21,200 3,700 3,000 14,600, 42,500 (2,300) 40,200 2,500 42,700 8,442 ia ‘eeakSZOOU BRST www.studyinteractive.orgCHAPTER 7 - CORPORATION TAX COMPUTATIONS Answer 6 - Illusion plc CAP 12m ended 31 December 2010 £ £ ‘Trading profits [(360,000 - 15,000) + 24,000} 369,000 Less: Trading loss b/f (60,000) 309,000 Interest income 25,000 Capital gains 20,000 Less: Capital losses b/f (5,000) 15,000 Total profits 349,000 Less: gift aid donation to charity (2,000) Taxable total profits 347,000 Add: FIL £13,950 x oo 15,500 “Augmented profits” 362,500 Lower limit 300,000/2 150,000 Upper limit 1,500,000/2 750,000 Medium company € FY 09 and FY10, £347,000 x 28% 97,160 Less: Marginal relief > 347,000 1400 x (750,000 - 362,500) x 32 599 (6,491) 90,669 www, studyinteractive. orGoeeKs2000 blogspet.com 213CHAPTER 7 - CORPORATION TAX COMPUTATIONS Answer 7 - Longitude Ltd 1.4.10- 31.311 | 1.4.11 30,611 Trading profits £ g 12/15 x 315,000 252,000 63,000 Capital allowances 12,0001 —twil) (AIA 12,000x 100% = 12,000) Profits from trading 240,000 63,000 Chargeable gain 50,000 Capital loss (4.250. 45,750 45.750 Total Profits 240,000 108,750 Less Donations under gift aid (nt) (nil) Taxable total profits 240,000 108,750 ‘Add:FIL —Nil 25,000 “augmented profits” 240,000 133,250 12 Months 3 Months Upper Limit / 3 500,000 125,000 Lower Limit / 3 100,000, 25,000 Medium company | Large company Corporation tax Fy 10 240,000 x 28% 67,200 Less Marginal relief 7/400 (500,000 - 240,000) x 240,000 (4,550) 240,000 Fu 108,750 x 28% 30,450 62,650 30.450 Due date for payment 11.42 1.4.12 214 ‘oakeZO00 bogspeteom www.studyinteractive.orgChapter 8 Corporation tax losses London School of Business & Finance powered by InterActive ANALYSIS OF PAST EXAM QUESTIONS Dec | June | Dec | June | Dec | June ] Dec Pilot | 2007 | 2008 | 2008 | 2009 | 2009 | 2010 | 2010 Question 1 ‘Question 2 . . * ‘Question 3 ‘Question 4 Question | + ° 215 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 8 - CORPORATION TAX LOSSES baa ed CHAPTER BACKGROUND AND EXAM FOCUS: -217 TRADING Loss-. -218 (OBJECTIVES WHEN DECIDING HOW TO USE THE LOSS 218 DEFINITION OF THE TRADING LOSS FOR A COMPANY 218 POSSIBLE WAYS OF RELIEVING A TRADING LOSS MADE BY A COMPANY ~ 219 1. CARRY FORWARD ~ 45 CTA 2010 219 2. CURRENT USE - S37 CTA 2010 219 3. CaRry BACK ~ $37 CTA 2010 219 4. CURRENT USE ~ GROUP RELIEF 220 PROFORMA - CORPORATION TAX LOSSES-- PROFORMA - CORPORATION TAX TERMINAL LOSSES ANSWERS- 216 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 8 -CORPORATION TAX LOSSES ea Ls Se Lab SLi Od heen Lect ih oad This chapter is concerned with the tax payable by a company and is building on what was learned in the previous chapter. A company can make profits but similarly it can make losses. ‘The focus in this chapter is to consider how a company can use its losses in order to reduce its corporation tax © Inthe current CAP ‘© in the previous CAP or © in future CAPs. This chapter is going to concentrate particularly on trading losses and considers the uses of this type of loss. The different losses a company can have include capital losses, rental losses and trading losses and each type of loss should be considered like the different types of drink one has in the fridge, and of course it Is very important not to mix up the contents of your drinks or mix up how you use them, The rules covered in this chapter will frequently be examined and the F6 examiner has stated that corporation tax will always be tested in question 2 but could also be tested in questions 3, 4 or 5. Wow studyinteractive or eoomti00Baspaizom RayCHAPTER 8 - CORPORATION TAX LOSSES TRADING LOSS Objectives when de ing how to use the loss (1) The company wants relief for the loss as early as possible. (2) The company wants to save tax at the highest marginal rate. PTC R mmr Ce me elise rt % | Evaluating a Company’s Trading overactive | eee Definition of a trading loss Trading profitfoss per Q x Add Disallowable expenses x Less Income credited but not trading x Less Capital allowances on P&M x Cepital allowances on IB x x The tax adjusted trading loss feat hie EeaReDOOT HPT www.studyinteractive.orgCHAPTER 8 -CORPORATION TAX LOSSES POSSIBLE WAYS OF RELIEVING A TRADING LOSS MADE ela ae 1. Carry forward - s45 CTA 2010 A trading loss may be carried forward and offset against the first available future trading profits of the same trade. CAR At) ie AOL AE A trading loss may be offset against total profits of the loss making chargeable accounting period (Claim 1). This Is called s37 current, 3. Carry back - s37 CTA 2010 It is also possible to make a second claim under s37 to carry back any remaining loss for 12 months on a LIFO basis and offset the loss against total profits of the previous 12 months (claim 2). If 2 537 claim is made to carry back the trading loss this will result in a repayment of corporation tax previously paid. Cash flow advantage to the company ‘The time limit for claims under $37 CTA 2010 is two years from the end of the loss making CAP. Two separate claims must be made if relief is to be claimed in the loss making CAP and in the previous 12 months. Termi jal loss relief - 539 CTA 2010 carry back If the company makes a loss in the final 12 months of trading it is possible to carry back the terminal loss for 36 months www.studyinteractive.orgbem2000 blogspot.com 219CHAPTER 8 - CORPORATION TAX LOSSES Current use — group relief UK members of a 75% loss group can transfer trading losses to other UK group members. This type of loss relief is called group relief. Alté_] Company with loss (surrendering company) Latte | 75% BLic_] Company with profit (claimant company) Claimant Company (B Ltd) £ Taxable total profits x Group relief ~ Adjusted taxable total profits X/Nil ‘ebooks2000 blegspet.com www.studyinteractive.org 220CHAPTER 8 -CORPORATION TAX LOSSES Example 1 - Sonic Ltd (a) Year ended 31 March 2010 € Trading profit 320,000 Interest income 50,000 Capital gains 80,000 450,000 Less: Gift ald donation to charity (10,000) Taxable total profits 440,000 Required Compute the corporation tax liability for the year ended 31 March 2010. Wow studyinteractive or eoomti00Baspaizom RatCHAPTER 8 - CORPORATION TAX LOSSES (b) The results of Sonic Ltd for the year ended 31 March 2011 were as follows € Trading loss (120,000) Capital gain 50,000 Patent royalties payable (15,000) Gift aid donation to charity (6,000) Required Compute the corporation tax liability for the year ended 31 March 2011 and the amount of the tax refund as a result of claiming loss relief in the most beneficial way. 222 osPO00 Hlgspe eam www.studyinteractive.orgCHAPTER 8 -CORPORATION TAX LOSSES PROFORMA — CORPORATION TAX LOSSES Year1 Year2 Year3 £ £ E Trading profits x : x S45 carry forward ~ Property business profits x x x Interest income x x x Capital gains x x x Total profits x x x $37 current (x1) 537 carry back (x2) Nil Nil x Less Gift aid donation to charity ® © & Taxable total profits Nil Nil x Working - Loss memo £ Trading loss x $37 current (x1) x 37 carry back (x2) x S45 carry forward &) X/Ni www.studyinteractive.orgbem2000 blogspot.com 223CHAPTER 8 - CORPORATION TAX LOSSES PROFORMA — CORPORATION TAX TERMINAL LOSSES Year1 Year2 Year3 Year 4 £ £ £ £ Trading profits x x x Nil Property business profits x x x x Interest income x x x x Capital gains x x x x Total profits x x x x $39 current oa $39 carry back (x4) (x3) (x2) Nl NNN Less: Gift aid donation to charity @ @ © ) 2 @® @® ww Unrelieves Taxable total profits Nil Nil NTN Working ~ Loss memo £ Trading loss x 539 current (xa) x 539 carry back (x2) x 539 carry back (x3) x $39 carry back (x4) X/Ni 224 ‘ebooks2000 blegspet.com www.studyinteractive.orgCHAPTER 8 -CORPORATION TAX LOSSES Example 2 - Half-Life Ltd Half-Life Ltd commenced trading on 1 July 2007 and ceased trading on 31 December 2011. The company's results for all its periods of trading are as follows: Year ended 6 months Year Year Year 30 June 31 Dec ended ended ~—ended 2008 2008 BiDec —-31Dec 31 Dec ‘2009 2010 2011 £ £ £ £ B Total adjusted profit/ 240,100 67,400 38,200 (61,700) (258,800) (loss) Property business 8,200 12,200 6,500 4,400 - profits Chargeable gains 5,600 23,700 Gift aid donation to (1,200) (1,000) - - (700) charity Half-Life Ltd does not have any associated companies. Required (a) Assuming that Half-Life Ltd claims the maximum possible relief for its trading losses, calculate the company’s taxable total profits for the year ended 30 June 2008, 6 months to 31 December 2008, years ended 2009, 2010 and 2011. Your answer should clearly Identify the amounts of losses which are unrelieved. (b) State the dates by which Half-Life Ltd must make the loss relief claims in part (a). (©) Calculate the amount of corporation tax that will be repaid to Half-Life Ltd as a result of making the loss relief claims in part (a). www.studyinteractive.orgbem2000 blogspot.com 225CHAPTER 8 - CORPORATION TAX LOSSES Answer 1 = Sonic Ltd (2) Mainstream corporation tax for the year ended 31 March 2010 Trading profits Interest income Capital gains Total profits Less: Donations under gift ald Taxable total profits cr 440,000 x 28% Less: |’/+00 x (1,500,000 - 440,000) (0) Corporation tax computation after claiming loss relief Trading profits Interest income Capital gains Total profits 837 current S37 carry back Less: Donation under gift ald Revised taxable total profits Revised CT 355,000 x 28% Less: 7/400 x (1,500,000 - 355,000) £ 320,000 50,000 80,000 450,000 (10,000) 440,000 123,200 (18,550) 104,650, Ye We 313.10 313.11 Loss £ £ £ 320,000 Nil 135,000 50,000 80,000 50,000 450,000 50,000 (50,000) (50,000) 85,000 (85,000) (85,000) 365,000 Nil Nil (10,000) (5,000) 355,000 Nil cT oN 99,400 (20,038) 79,362 Nil Corporation tax refund = £25,288 (104,650- 79,362) 226 ‘eeakSZOOU BRST www.studyinteractive.orgCHAPTER 8 -CORPORATION TAX LOSSES Answer 2 - Half Life Ltd (a) Total taxable prof Year ended 6 months Year ended Year ended Year ended 30 June 31 Dec 31Dec 31Dec 31Dec 2008 2008 2009 2010 2011 £ £ £ £ £ Trading profit 240,100 67,400 38,200 Nil Nil Property business 8,200 12,200 6,500 4,400 - income Capital gains 5,600 23,700 248,300 79,600 50,300 23,700 S 37 current 5 37 c/b (50,300) 537 current (23,700) 539 c/back (79,600) (nil) (nil) (6/12 x 248,300) (124,150) 124,150 Nil Nil Nil Nil Gift aid donation (1,200) —_unrelieved - = unrelieved Taxable total profits 122,950 Revised corporation tax FYO7 122,950 x 9/12 x 20% £24,897 Enil Enil FY 08 122,950 x 3/12 x 21% £ £ Loss for the year ended 31 December 2010 61,700 Loss for the year ended 31 December 2011 258,800 Losses utilised - Year ended 31 December 2010 (4,400) = Year ended 31 December 2009 (50,300) = Year ended 31 December 2011 (23,700) = 6 months 31 December 2008 (79,600) = Year ended 30 June 2008 (124,150) Losses unrelieved 7,000 31,350 Tutorial notes: (1) Gift aid donations of £1,000 and £700 for respectively the six months ended 31 December 2008 and the year ended 31 December 2011 are unrelieved. (2) The trading loss for the period ended 31 December 2010 can be relieved against total profits of the current period and the previous 12 months under 8.37. (3) The trading loss for the year ended 31 December 2011 can be relieved against total profits of the current year and the previous 36 months under 5.39 CTA 2010 because it is a terminal loss no maximum carry back in the case of terminal loss relief. (4) For the year ended 30 June 2008 loss relief is restricted to £124,150 (248,300 x 6/12), www.studyinteractive.orgbem2000 blogspot.com 227CHAPTER 8 - CORPORATION TAX LOSSES (b) Due date for loss relief claims (1) The loss relief claims under s.37 CTA 2010 in respect of the loss for the year ended 31 December 2010 must be made by 31 December 2012 (2) The loss relief claims under s.39 CTA 2010 in respect of the loss for the year ended 31 December 2011 must be made by 31 December 2013. (©) Corporation tax repayments (1) Corporation tax refund in the year ended 30 June 2008 of £25,141 (50,038 - 24,897) ‘The corporation tax originally paid £50,038 (FY 07 247,100 x 9/12 x 20% + FY 08 247,100 x 3/12 x 21%). The revised corporation tax after relieving the losses is £24,897. (2) The taxable total profits for the 6 months ended 31 December 2008 were originally £78,600 (79,600 - 1,000), so corporation tax of £16,506 (78,600 at 21%) will be repaid. (3) The taxable total profits for the year ended 31 December 2009 were originally £50,300, so corporation tax of £10,563 (£50,300 x 21%) will be repaid. The total corporation tax repayable is £52,210, (25,141 + 16,506 + 10,563) ‘eeakSZOOU BRST 228 www.studyinteractive.orgChapter 9 Corporation tax groups & overseas aspects London FZ School of Business. & Finance powered by InterActive ANALYSIS OF PAST EXAM QUESTIONS Pitot] Dee | June | Dec | June ] Dec | June] Dec 2007 | 2008 | 2008 | 2009 | 2009 | 2010 | 2010 Question 1 Question 2 : : . : ° . . Question 3 Question 4 Question 5 ‘ebooks2000 blegspet.com www.studyinteractive.orgCHAPTER 9 - CORPORATION TAX AND OVERSEAS ASPECTS baa ed BACKGROUND AND THE EXAM FOCUS REVISION OF CORPORATION TAX -- PROFORMA CORPORATION TAX COMPUTATION, RATES OF CORPORATION TAX ‘THE CORPORATION TAX LIABILITY DEPENDS ON THE SIZE OF THE COMPANY MARGINAL RATES OF CORPORATION TAX CORPORATION TAX GROUPS 1. ASSOCIATED COMPANIES 2. VAT crours 2. 75% Loss Grours 3. CAPITAL GAINS GROUPS CORPORATION TAX AND OVERSEAS ASPECTS - Derini TON OF WHEN A COMPANY IS TREATED AS UK RESIDENT (OVERSEAS BRANCH V OVERSEAS SUBSIDIARY RELIEF FOR THE FOREIGN TAX SUFFERED FOREIGN TAX ANSWERS: 231 232 232 233 233 234 235 238 239 243 246 246 246 247 248 230 ‘eeakSZOOU BRST www.studyinteractive.orgCHAPTER 9 - CORPORATION TAX GROUPS AND OVERSEAS ASPECTS erie Sci teh eu ial tek hd This chapter is called corporation tax groups and overseas aspects and is going to build on the two earlier chapters 7 and 8 in which we covered the basic principles of corporation tax. The F6 examiner has stated that the contents of this chapter maybe tested as part of question two on the exam paper or could be tested as a completely separate question and so could be tested in questions 4 or 5 for a maximum of 15 marks. wow. studyinteractive,or S=oei00 Donspsteam 234CHAPTER 9 - CORPORATION TAX AND OVERSEAS ASPECTS GTS Reyer reds we os meee Proforma corporation tax computation Corporation tax computation - for the CAP £ Profits from trading (adjusted profits less capital allowances) x ‘Overseas income (gross of overseas tax suffered) x Rental income x Chargeable gains (chargeable gains less capital losses) x Interest income (from non trading) x Total Profits x Gift Aid donations to charity 00 Taxable total profits x Corporation tax (CT) at relevant rate x Less Marginal relief (if any) 00 Corporation tax liability x Less Double tax relief (DTR) oO Corporation tax (CT) payable X/Nil Due date 9 months and one day after the end of the CAP (unless 2 large company which pays in quarterly instalments) File date 12 months after the end of the period of account 232 osPO00 Hlgspe eam www.studyinteractive.orgCHAPTER 9 - CORPORATION TAX GROUPS AND OVERSEAS ASPECTS Petes eh =i eek cums lnwerdetive vv Fv Fv rv 2007 2008 2009 2010 Main Rate 20% 28% 20% 23% ‘Small Profits Rate 20% 21% 21% 21% Lower £300,000 £300,000 £300,000 £300,000 Limit Upper 1,500,000 €1,500,000 1,500,000 £1,500,000 Limit Fraction for jl 7 A 7 ‘Marginal Relief on fas 3 4 Bem irl Cen = ferrin Con erat ere snevdtive Determine the relevant rate of corporation tax & Taxable total profits x Add: Franked Investment Income (Fil) (UK& overseas dividends received x 100/20) (Divdena waned remasecned compan 8 et anledivetimertncne) “Augmented profits” x Compare the “Augmented profits” to the statutory limits to decide the rate of corporation tax to apply www, studyinteractive, orGeoets2000 Beaspetcom 233CHAPTER 9 - CORPORATION TAX AND OVERSEAS ASPECTS =i fords stele em hal Cll eg Corporation tax (CT) at relevant rate x Less Marginal relief (if relevant) oa Corporation Tax Liability x calculated Marginal reli Fraction x (Upper Limit ~ “Augmented profits”) x Taxable total profits/"Augmented profits” Marginal rates of corporation tax % | Marginal Rates of Corporation Tax foro FY 2010 Large Co. - 1,500,000 Medium Co. 234 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 9 - CORPORATION TAX GROUPS AND OVERSEAS ASPECTS CORPORATION TAX GROUPS A group of companies is like a family, the overall objective is to minimise the total tax liability of the group as a whole. Different tax implications arise depending on the degree of control that exists between the companies. There are four different group relationships that must be studied for the F6 exam: 1 ~ Associated companies 2 = VAT groups 3 ~ 75% loss groups 4-~ 75% capital gains groups Pn ke Definition of associated companies (a) A company is associated with another in either of the following situations: () One company controls the other(s) Huta Hus 100% rom / lady si% ska s 2 \Ss oR (ii) Both are controlled by the same ‘person’ (company or individual) yr wef Ae xd Zud X Ltd and Z Ltd are associates. Mr X is the controlling link, although as an Individual he does not impact upon the number of associated companies. www, studyinteractive.orgoeeKs2000 blogspet.com 235CHAPTER 9 - CORPORATION TAX AND OVERSEAS ASPECTS (il) Control © owns more than 50 per cent of the issued share capital of another company (the subsidiary) or * controls more than 50 per cent of the votes or * has the right to receive more than 50 per cent of distributable profits or * has the right to receive more than 50 per cent of the net assets in the event of a winding up. (iv) Control can be exercised directly or indirectly. Hts 51% — Direct Indirect Wha 51% Both W Ltd and Z Ltd are © associates of H Lid ZLtd (v) It is not necessary to have effective interest for associates therefore it does not matter that H Ltd's effective interest in Z Ltd is only 26.01% (0.51 x 0.51). (b) The definition of associated companies specifically includes (Overseas resident companies (i) subsidiaries joining/leaving during the accounting period but exclude (i) dormant companies (ii) non-trading holding companies. Effect of associated companies ‘The upper and lower limits for starting and small profits rate purposes are divided by the total number of associates, so potentially increasing the effective rate of tax each company pays. Dividends received from associated companies are excluded from FIT in the calculation of "Augmented profits” 236 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 9 - CORPORATION TAX GROUPS AND OVERSEAS ASPECTS Wea Z utd Aud 100% on/ \ os Zine Cutd Butd (dormant) All companies except Z Inc are UK resident and prepare accounts to 31 March 2011. Required How many associates does A Ltd have for corporation tax purposes? wow. studyinteractive,or S=oei00 Donspsteam 237CHAPTER 9 - CORPORATION TAX AND OVERSEAS ASPECTS 2. VAT Groups Group registration for VAT (i) Two or more companies can elect for @ VAT group registration to apply where they are under common control. All companies must be UK resident or trading in the UK via a permanent establishment, (ii) A VAT group is treated for VAT purposes as if it was a single company registered for VAT on its own (ii) Where there is a registration in force the VAT group appoints a representative member, this company Is then responsible for completing and submitting a single VAT Return and paying VAT on behalf of the group. The representative member is treated as having all input and output tax for the group. Advantages advantages (a) VAT on intra-group supplies (a) All members remain jointly and eliminated severally liable (b) Only one VAT return required for | (b) A single return may cause the group and so admin costs administrative difficulties should be saved collecting and collating information (c)_ The inclusion of a net repayment company (zero rated supplies) would result in loss of monthly repayments (4) Various limits, such as those for the cash and annual accounting schemes, will apply to the VAT group as a whole rather than on an individual company basis. 238 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 9 - CORPORATION TAX GROUPS AND OVERSEAS ASPECTS Ea ee ee (a) 475% loss group exists where a parent company: = owns at least 75 per cent of the ordinary shares of another company (the subsidiary) and © has the right to receive at least 75 per cent of distributable profits and © has the right to receive at least 75 per cent of the net assets in the event of a winding up. Two (or more) companies are members of a 75% loss group where one is a 75% subsidiary of another, or both are 75% subsidiaries of a third company. A company can belong to more than one 75% loss group, (b) For associated company purposes, it Is sufficient to satisfy any ‘control’ requirement, i.e. shares or profits or assets. For loss group purposes, the company must satisfy all the requirements. This ensures the parent has ‘effective economic interest’. (©) Effective interest is usually identified by shareholding considerations only, but in written questions you need to be able to give the full definition. Direct and indirect shareholding interests should be taken into account. Effect of 75% loss group(s) UK members of a 75% group can surrender losses to other UK group members. This form of loss relief is called group relief (S402 ICTA 1988). £ Taxable total profits x Group relief ~ Adjusted taxable total profits X/Nil Group relief ‘Altd] Company with loss (surrendering company) T 75% ! Bed] Company with profit (claimant company) Group loss relief is normally only available between UK resident companies within the 75% group. Surrendering company (a) The surrendering company can surrender all the following types of current Period losses © Trading losses © Unrelieved donations under the gift aid scheme www, studyinteractive.orgoeeKs2000 blogspet.com 239CHAPTER 9 - CORPORATION TAX AND OVERSEAS ASPECTS © Unrelieveé management expenses © Unrelieved property losses © Non trading deficits (b) The surrendering company can surrender to whichever UK group company it wants to, provided the receiving company is in the 75% loss group. The surrendering company can surrender any amount of the loss, and it can surrender to more than one other group company if it wants to. (©) There is no requirement for the surrendering company to use any of the loss against its own profits first. It can surrender all of its losses if it wants to. However there may be a restriction on the amount of loss the claimant company can receive, Claimant company The maximum amount of loss that the claimant company can claim is the amount whieh will reduce its Taxable Total Profits down to all Points to watch (2) Only “excess” property losses and management expenses can be surrendered. This means they cannot be surrendered if they can be set against current available profits. (b) Overlapping periods (i) Group relief is available for the corresponding accounting period for companies with non-coterminous accounting periods. (ii) Group relief is available for joiners and leavers for “matching periods” i.e. group relief is set against profits of the “corresponding accounting period”, eS 7 ee iocencive LETC ELE + The maximum amount of loss that the claimant company can daim is the ammount which will reduce the Taxable total profits down to nil. Altd Loss (100,000) BLtd Taxable total profits 120,000 240 ‘sbooks2000.Siogspetcom www.studyinteractive.orgCHAPTER 9 - CORPORATION TAX GROUPS AND OVERSEAS ASPECTS Non coterminous accounting periods © Group relief can only be claimed in the corresponding accounting period * The corresponding accounting period is the period common to both the surrendering company and claimant company’s accounting periods. © Ifthe accounting periods are not coterminous, profits and losses must be time apportioned © The surrend: the CAP, ing company can only surrender the time-apportioned loss of ‘* The claimant company can only relieve against time apportioned Taxable total profits for the CAP, Group relief and tax planning Group relief should ideally be claimed as follows in order to maximise the tax saving i.e. claiming relief at the highest rate of tax first. Therefore we need to establish companies under common control so that we can divide the relevant upper’ and ‘lower’ limits accordingly in order to decide the rate of corporation tax applicable to each relevant group member. Order of claiming group relief 1. To companies that are subject to tax at 29.75% (normal marginal company) to bring them down to ‘small profits rate’ of 21%. 2. To companies that are subject to tax at 28% (main rate) to bring them down to the ‘small profits rate’ of 21%. 3. To companies that are subject to tax at the small profits rate of 21%, www, studyinteractive.orgoeeKs2000 blogspet.com 241CHAPTER 9 - CORPORATION TAX AND OVERSEAS ASPECTS Exam technique step 1 | raw the group structure if tis not drawin in the question Step 2_| Analyse the group Associated companies, Upper/ lower limits, 75% loss groups 75% capital gains groups. Step 3. | Set up columns across the page, @ separate one for each UK group company required by the question. PORCI for each group company. No losses should appear at this stage but the loss relief sections should be inserted at the correct position in the proforma step 4 | Set up the loss memo, two losses two memos and write on the memo the possible ways of using each loss, step 5 | Write the size of each company at the top of each column, before allocating any losses and then decide how to use each loss in the most tax efficient way. Firstly to medium companies - enough loss to reduce "Augmented profits" down to the lower limit (tax relief at 29.75%) Secondly to large companies (tax relief at 28%) Thirdly to small companies (tax relief at 21%) Remember: if companies have different accounting dates you must draw the CAPs for each company in order to identify the corresponding accounting periods, Step 6 | at the bottom of each column record the revised sizes of each company then compute the corporation tax for each group company using the adjusted Taxable total profits Baa SEezaOa oRST ET wow studyinteractive.orgCHAPTER 9 - CORPORATION TAX GROUPS AND OVERSEAS ASPECTS Fee ae ee Consists of parent company plus 75% subsidiaries a sncerdetive 75% Capital Gains Group 75% capital gains group is a special type of 75% group. (a) Itconsists of a principal member(parent company) andits 75% subsidiaries, and the 75% subsidiaries of the subsidiaries. (b) The principal member can't be a 75% subsidiary of another company. (c) The principal member must have an effective interest of more than 50% in all of the subsidiaries indirectly. a sncerdtive Peer ye React ts Auld uta cud OLtd eu Assets are automatically transferred between companies in the capital gains group at no gain and no loss. www, studyinteractive.orgoeeKs2000 blogspet.com 243CHAPTER 9 - CORPORATION TAX AND OVERSEAS ASPECTS (2) Notional transfer of assets within a 75% gains group Capital losses cannot be group relieved, but capital losses and capital gains can be matched within a 75% capital gains group thus maximising the use of capital losses. This rule allows companies which are members of the same 75% capital gains group to net off capital gains and capital losses in the company/ companies paying corporation tax at the lowest marginal rate. (b) Rollover relief ome 7] MENS Cece) soceacive FEE CELICKCEILE! + When 3 company disposes of s chargeable asset used in its trade eg. freehold offices the company will realise a chargeable gain or capital loss Disposal of office wase ‘ = bates yon maser Prifsnontearg 0000 ] 3 eee L Sale rood 680000 _ rote eee Less: Git sid CN 00.0000 2eeo0 Tapas Pinup 00-1705 seiari0=2207 For rollover relief purposes all the companies within a capital gains group are treated as carrying on a single trade. ‘Therefore an asset can be sold by one company realising a chargeable gain and that company’s gain can be rolled over by another company in the same 75% gains group which is reinvesting in a qualifying asset within 48 months (12 months before the disposal and 36 months after the disposal). 244 osPO00 Hlgspe eam www.studyinteractive.orgCHAPTER 9 - CORPORATION TAX GROUPS AND OVERSEAS ASPECTS Pea en Seer sncerdtive SP = £360,000 Altd 8) } Kea 75% Buta Bid buys office 2for £400,000 www. studyinteractiveorgerKs2000 Biogspetcom 245CHAPTER 9 - CORPORATION TAX AND OVERSEAS ASPECTS CORPORATION TAX AND OVERSEAS ASPECTS A UK resident company is chargeable to corporation tax on all profits/gains wherever they arise. Defi Woe ers Incorporated inne ue Directors’ board meetings held overseas in the UK See MA hob ceicholccd Overseas branch ‘The profits of the branch are subject of UK corporation tax under trading profits. ‘The presence of the branch does not affect the limits of the UK company. If the branch makes a loss it can be relieved using $37 current, S37 carry back, Group relief or s45 carry forward. If the branch buys plant and machinery capital allowances can be claimed, 246 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 9 - CORPORATION TAX GROUPS AND OVERSEAS ASPECTS Overseas subsidiary ‘The profits of the subsidiary are subject to foreign corporation tax The presence of the subsidiary does affect the limits of the UK company if the UK company has control of the foreign subsidiary. If the subsidiary makes a loss, the loss cannot be relieved in the UK. ‘The overseas subsidiary will remit dividends to the UK. These dividends will not be subject to UK corporation tax but may count as franked investment income. Relief for the foreign tax suffered Income from abroad is taxed in the country of origin and in the UK. Relief for the double tax may be given unilaterally or bilaterally. Bilateral relief In recent years the UK has concluded many treaties with other countries in order to reduce the burden of double tax. These treaties exist between the UK and the overseas country either exempting certain income or all income from taxation in one country. Unilateral relief This is where no treaty exists between the UK and the overseas country. Double tax relief is still in principle available in the UK. wow. studyinteractive,or S=oei00 Donspsteam 2a7CHAPTER 9 - CORPORATION TAX AND OVERSEAS ASPECTS Lads ey Withholding tax (WT) A direct tax imposed by the overseas country and withheld by the paying company when income is remitted to the UK. The rate of withholding tax is always given in the question, Underlying tax (UT) A tax on overseas profits out of which a dividend is paid to the UK (equivalent to UK corporation tax in the overseas country) Overseas dividends - Reforms ‘There has been a major reform to the treatment of overseas dividends. Overseas dividends are exempt from UK corporation tax and are treated in exactly the same way as UK dividends received Exempt overseas dividends are included as franked investment income in exactly the same way as UK dividends, unless they are group income. In this case they are completely ignored for tax purposes. Example 1 - Various Ltd During the year ended 31 March 2011 Various Ltd received an overseas dividend of £67,500 (net). Withholding tax was withheld from the dividend at the rate of 15%. (1) Explain the corporation tax implications for Various Ltd receiving this dividend If it owns 50% or less of the voting power of the overseas company. (2) Explain the corporation tax implications for Various Ltd receiving this dividend if it owns > 50% of the voting power of the overseas company paying the dividend, 248 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 9 - CORPORATION TAX GROUPS AND OVERSEAS ASPECTS Example 2 - Local Ltd Local Ltd is a UK resident company. The company's UK trading profit for the year ended 31 March 2011 is £375,000. Local Ltd has a trading loss brought forward of £20,000 at 1 April 2010. Local Ltd has an overseas branch and owns 45% of the shares in a company Foreign Inc which is resident overseas, The overseas branch js controlled from overseas. It has a trading profit of £65,000 for the year ended 31 March 2011. The overseas corporation tax on these profits is £26,000, Overseas company Local Ltd owns 45% of the ordinary share capital of Foreign Inc, a company that is resident overseas. The results of Foreign Inc for the year ended 31 March 2011 are as follows: £ Trading profit 150,000 Corporation tax (22,500) 127,500, Dividend paic Net 80,750 Withholding tax 4,250 (85,000) Retained profits 42,500 Local Ltd received its 45% share of Foreign Inc’s dividend during the year ended 31 March 2011. All of the above figures are in pounds sterling. Required (a) Explain the difference between of operating overseas through a branch or overseas subsidiary. (b) Calculate Local Ltd's UK corporation tax liability for the year ended 31 March 2o11. (©) Explain the effect on the UK corporation tax if instead Local Ltd owned 60% of the shares in Foreign Inc. www, studyinteractive.orgoeeKs2000 blogspet.com 249CHAPTER 9 - CORPORATION TAX AND OVERSEAS ASPECTS Answer 1 = Various Ltd (2) If Various Ltd owns 50% or less of the voting power of the overseas company, then the overseas dividend will be exempt from UK corporation tax but included as franked investment Income. The amount of franked investment income is £75,000 (67,500 x 100/90). (2) If Various Ltd owns > 50% of the voting power of the overseas company, then the dividend will be exempt from UK corporation tax and not included as franked investment Income. This Is because the overseas dividend Is group 250 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 9 - CORPORATION TAX GROUPS AND OVERSEAS ASPECTS Answer 2 - Local Ltd (a) The differences between operating overseas through an overseas branch rather than an overseas subsidiary are (b) Dividends from an overseas subsidiary are exempt from UK corporation tax, whilst the profits of an overseas branch (computed under normal corporation tax rules) are taxable. Relief is available for the trading losses of an overseas branch, but generally no relief for the trading losses of an overseas subsidiary. UK capital allowances are allowable as a deduction from the trading profits of an overseas branch whilst no relief is available in respect of plant and machinery purchased by an overseas branch. An overseas subsidiary is an associated company for the purposes of the small company lower and upper limits. Double tax relief is available for foreign tax suffered on branch profits (up to a limit of the UK corporation tax on those profits). Since foreign dividends are exempt no double tax relief is available for withholding tax deducted Corporation tax computation year to 31 March 2011 £ UK trading profits 375,000 Less: Trading loss brought forward (20,000) Overseas branch profits 65,000 Foreign Inc dividend - exempt - Taxable total profits 420,000 FIL £80,750 x 45% x 100/90 40,375 “Augmented profits” 460,375 Corporation tax payable £420,000 x 28% Less marginal relief (W1) 7/400 x (1,500,000 ~ 460,375) x 420,000/460,375 101,002 Less: double tax relief (W2) (25,631) Corporation tax payable 85,371 www, studyinteractive.orgoeeKs2000 blogspet.com 254CHAPTER 9 - CORPORATION TAX AND OVERSEAS ASPECTS Workings (wa) Local Lid 45% Foreign Ine (W2) Foreign Inc. is not an associated company, so the upper limit for corporation tax purposes is £1,500,000. (W3) Double tax relief is the lower of (1) the foreign tax suffered and (2) the UK tax on the overseas income. (b) ° £ £ Overseas branch Foreign tax 26,000 26,000 suffered UK corporation tax on overseas branch 101,002/420,000 x 65,000 Uk cT 15,631 17,306 111,825/420,000 x 65,000 suffered © If Local Ltd owned 60% of the share in Foreign Inc they are associated. © Upper and lower limits must be divided by 2. The upper limit is £750,000 and the lower limit is £150,000. © Dividends from Foreign Inc are no longer counted as franked investment income, when computing the * Augmented profits” of Local Ltd, Revised corporation tax computation of Local Ltd Taxable total profits FLL “Augmented profits” Corporation tax payable £420,000 x 28% Less marginal relief (W1) £ 420,000 Nil 420,000, 600 7/400 x (750,000 - 420,000) x 420,000/420,000 (5,775) Less double tax relief (W3) Corporation tax payable (825 (27,306) 94,519 If Local Ltd owns 60% of the shares in Foreign Inc instead of 45% the corporation tax of Local Ltd will increase by £9,148 (94,519 - 85,371) 252 ‘eeakSZOOU BRST www.studyinteractive.orgChapter 10 Fundamentals of capital gains tax London School of Business & Finance powered by InterActive ANALYSIS OF PAST EXAM QUESTIONS Pilot] Dee [June] Dec | June] Dec | June] Dec '°t | 2007 | 2008 | 2008 | 2009 | 2009 | 2010 | 2010 Question 1 Question 2 Question 3 | + : . : : ° °. ° Question 4 Question 5 . 253 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 10 - FUNDAMENTALS OF CAPITAL GAINS TAX baa ed CHAPTER BACKGROUND AND FOCUS-- -255 THE CHARGE TO CAPITAL GAINS TAX -257 DEFINITION OF TERMS FOR TAXING CAPITAL GAINS: -257 1. BASIS OF ASSESSMENT 287 2. CONNECTED PERSONS 257 3. THE DIFFERENT TYPES OF DISPOSAL 259 4, THE DIFFERENT TYPES OF ASSETS 260 SUMMARY OF THE STAGES INVOLVED IN DEALING WITH QUESTIONS ON TAXING CAPITAL GAINS CALCULATING CAPITAL GAINS AND CAPITAL LOSSES 262 PROFORMA FOR CALCULATING GAINS AND LOSSES. 263 INDEXATION ALLOWANCE 263 CAPITAL LOSSES 264 RATES OF CAPITAL GAINS TAX FOR INDIVIDUALS 264 ENTREPRENEURS’ RELIEF CONDITIONS To GET THE RELIEF 265 QUALIFYING ASSETS FOR ENTREPRENEURS’ 266 ANSWERS-. 269 254 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 10 -FUNDAMENTALS OF CAPITAL GAINS TAX erie Sci teh eu ial tek hd ‘The tax implications of disposing of assets are a very important area of the syllabus and will always be tested in question 3 for 15 marks. ‘The capital gains implications of making disposals of assets can also be tested in question 1 and 2 as was demonstrated in many of the recent F6 exams including the June 2010 exam. www, studyinteractive. orgbeeKs2000 biogspet.com 255CHAPTER 10 - FUNDAMENTALS OF CAPITAL GAINS TAX Example i - Exam standard question — Fred and Fanny Fook Fred and Fanny Fook are a married couple. They disposed of the following assets during 2010/11: Jointly owned property (1) On 29 duly 2010 Fred and Fanny sold a classic Ferrari car for £34,400, The motor car had been purchased on 17 January 2000 for £27,200. (2) On 30 September 2010 Fred and Fanny sold 2 house for £281,000 selling costs of £6,500 were incurred. The house had been purchased on 1 October 1987 for £87,000, Fred and Fanny occupied the house as their main residence from the date of purchase until 31 March 1991. The house was then unoccupied between 1 April 1991 and 31 December 1994 due to Fanny being required by her employer to work elsewhere in the UK. From 1 January 1995 until 31 December 2001 Fred and Fanny again occupied the house as their main residence. The house was then unoccupied until it was sold on 30 September 2010. Throughout the period 1 October 1987 to 30 September 2010 Fred and Fanny did not have any other main residence. Fred Fook (1) On 18 April 2010 Fred sold an antique table for £5,600. The antique table had been purchased on 27 May 2005 for £3,200, (2) On 5 May 2010 Fred transferred his entire shareholding of 20,000 £1 ordinary shares in Apple Ltd, an unquoted trading company, to Fanny. On that date the shares were worth £64,000. Fred’s shareholding had been purchased on 21 June 2005 for £48,000. (3) On 14 February 2011 Fred made a gift of 15,000 £1 ordinary shares in Fruity pic to his son. On that date the shares were quoted on the Stock Exchange at 2.90 - 3.10. Fred had originally purchased 8,000 shares in Fruity plc on 15 June 2006 for £17,600 and he purchased a further 12,000 shares on 24 August 2006 for £21,600. Fred's total shareholding was less than 1% of Fruity plc's issued share capital Fanny Fook (1) On 5 May 2010 Fanny sold an antique clock for £7,200, The antique clock had been purchased on 14 June 2005 for £3,700. (2) On 7 July 2010 Fanny sold 15,000 of the 20,000 £1 ordinary shares in Apple Ltd that had been transferred to her from Fred. The sale proceeds were £62,400. Fred and Fanny have taxable income of £8,000 and £45,000 respectively in 2010/12 Required Compute Fred's and Fanny's respective capital gains tax liabilities for the tax year 2010/11 and state the due date for paying the tax. 256 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 10 -FUNDAMENTALS OF CAPITAL GAINS TAX THE CHARGE TO CAPITAL GAINS TAX To be chargeable to capital gains tax, there must be a chargeable disposal of a chargeable asset by a chargeable person. A person is liable to capital gains tax on the disposal of chargeable assets during any tax year in which they are either resident or ordinarily resident in the UK. Chargeable Disposal ‘A disposal occurs on: + the sale or gift of the whole or part of an asset * loss or destruction of an asset * compensation in connection with an asset © receipts of capital sums following the surrender of rights to assets. Exempt disposals include (i) transfers on death (ii) gifts to charities. DEFINITION OF TERMS FOR TAXING CAPITAL GAINS Pa us ‘A person‘s CGT liability for a tax year is based upon the chargeable disposals made by that person during the tax year. 1. The gain or loss arising on each disposal made during the year is calculated separately. 2. The total chargeable gains are then reduced by the amount of the annual exemption £10,100 and any excess is called the taxable gain. The taxable gains are then added to the top of an individual's taxable Income and is subject to tax at either 18% or 28%. When entrepreneurs’ relief is claimed for a particular disposal the capital gains tax is computed at the reduced rate of 10%. 3, The due date for paying the tax to HMRC is 31 January following the tex year of assessment. pee ue Husbands and wives and civil partners are each entitled to the full annual exemption. Husband and wife and civil partners can transfer chargeable assets at no gain and no loss as they are defined as connected persons. www, studyinteractive. orgbeeKs2000 biogspet.com 257CHAPTER 10 - FUNDAMENTALS OF CAPITAL GAINS TAX Disposals to connected persons + Husband and wife transfers and transfers between civil partners and between companies in the same 75% gains group take place at no gain no loss. This means that one spouse takes over the asset and is treated as if they acquired the asset atthe same date and at the same cost as the original spouse HuSband donor cost £10,000 1.6.05 My at time of transfer £80,000 30.6.10 258 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 10 -FUNDAMENTALS OF CAPITAL GAINS TAX us ifferent types of disposal aid Types of disposals : a A gift between unconnected persons + Father and daughter cost €10,000 Father is the donor | 1.6.05 My at time of transfer £80,000, 30.6.10 \ www, studyinteractive,orGbeots2000 Beaspetcom 259CHAPTER 10 - FUNDAMENTALS OF CAPITAL GAINS TAX =i et et ROR ores Before After ‘Cost of cottage = £10,000, Where an asset is insured and is lost or destroyed, this is treated as a disposal of the purposes of capital gains tax. The consideration is the amount received from the insurance company (this is called the sale proceeds). The disposal is treated as occurring in the tax year in which the insurance proceeds are received: Coe) ifferent types of assets =i aR Ce mechs mmc pees 260 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 10 -FUNDAMENTALS OF CAPITAL GAINS TAX SUMMARY OF THE STAGES INVOLVED IN DEALING WITH QUESTIONS ON TAXING CAPITAL GAINS 1 Oaee cRce oR] LUSK MUCOUS edt ncerdtive sncerdtive + Methods of computing gains/losses chargeable for assets acquired after 31 March 1982 and the variations to the basic computation. + Part disposals + Chattels + Shares and securities + Mergers and takeovers www, studyinteractive,orGbeots2000 Beaspetcom 261CHAPTER 10 - FUNDAMENTALS OF CAPITAL GAINS TAX CALCULATING CAPITAL GAINS AND CAPITAL LOSSES ‘The computation of the capital gain or loss arising on the disposal of a chargeable asset begins by subtracting the acquisition cost of the asset from its disposal value. It may then be necessary to adjust the gain to take account of inflation but only for companies. ‘The basic proforma that you need to use to compute the capital gain or loss both for Individuals and for companies has eight basic lines which you must remember. ‘The basic proforma Is shown over the page. Example 2 - Mr Green Mr Green disposed of an investment property on 31 December 2010. Assume he incurred legal costs and estate agents fees of £5,000. Mr Green had purchased the property originally on 21 June 1986 for £15,000 and incurred acquisition costs of £1,500. Mr Green spent £25,000 on an extension to property on 31 May 1994, Required Assuming the sale proceeds were: (a) £85,000 (b) £45,000 (©) £53,500 Compute the capital gains assessable on Mr Green in 2010/11 under each alternative. 262 osPO00 Hlgspe eam www.studyinteractive.orgCHAPTER 10 -FUNDAMENTALS OF CAPITAL GAINS TAX UC RCCL CMU Cy £ £ NOTES Consideration (note (2)) X_ | (@) Disposal proceeds or market value Less Incidental costs of sale (note (b)) (X)_| (b) Legal expenses, valuation fees, advertising, stamp duty, auctioneers fees Net sale proceeds NSP Less Allowable expenditure = Acquisition cost (note (c)) x (©) Use cost, market value or probate = Incidental costs of acquisition (note (b)) value — &) ~ Enhancement expenditure (x) Unindexed gain/(loss) X/ OX] Less Indexation allowance (notes (d), (e), (f) (4) A cannot create or Pl spol RP auton increase a loss, jal acquisition y re companies (e) IAis only available to companies, not individuals (9 Tamust be computes Separately foreach item of texpenciture but only for companies = O.XXX x Cost (IA) 7 (Nil) X/Nil Indexed gain/Capital gain BO CC eld Indexation allowance was introduced in 1982 with the intention of ensuring that capital gains caused by the effects of inflation should not be subject to tax. Indexation is not available for individuals. Indexation allowance is basically attempting to inflate the cost from the date the expenditure was incurred up to the date of disposal (only available for companies). www, studyinteractive. orgbeeKs2000 biogspet.com 263CHAPTER 10 - FUNDAMENTALS OF CAPITAL GAINS TAX nee If a taxpayer has net capital losses for a particular that year is ENil and the annual exemption is wasted x year, the CGT assessment in ‘The amount of the net losses may then be carried forward without time limit and set against the first available future chargeable gains. Capital losses brought forward by individuals can be restricted to preserve the annual exemption. Capital losses incurred on a disposal to a connected person (children, brothers, sisters, business partners etc) can only be offset against gains made on disposals to the same person, in the same or in subsequent years. Example 3 - Trudy, Tracey and Terry Trudy has disposed of chargeable assets and has realised chargeable gains of £10,000 and capital losses of £4,000 in 2010/11. Tracey has disposed of chargeable assets and has realised chargeable gains of £4,000 and capital losses of £9,000 in 2010/11 Terry has disposed of chargeable assets in 2010/11 and has realised chargeable gains £17,100. Terry has capital losses brought forward from 2009/10 of £16,700, Required Compute Trudy, Tracey and Terry's taxable gains for 2010/11 and in each case state the amount of unrelieved capital losses carried forward to future years, if, any, Be eee) Ley tl The normal rates of capital gains tax for an individual are fixed at a lower rate of 18% and a higher rate of 28%. Paes PE Example 4 - Mr Brown Mr Brown has taxable income of £35,000 and taxable gains of £20,000 in 2010/11. Required Compute Mr Brown’s CGT liability for 2010/11 and state the due date for paying the tax. You should assume that he did not claim entrepreneurs’ relief in 2010/11. 264 osPO00 Hlgspe eam www.studyinteractive.orgCHAPTER 10 -FUNDAMENTALS OF CAPITAL GAINS TAX ENTREPRENEURS’ RELIEF Entrepreneurs’ relief was introduced from § April 2008 and can be claimed when an individual disposes of chargeable assets which qualify for this relief. The relief covers the first £5,000,000 of qualifying gains that a person makes during his or her lifetime. If a person claims entrepreneurs’ relief on any disposals made during 2010/11, the relief operates by charging capital gains tax on these gains at the reduced rate of 10%. Se ROR ees (1) The asset must have been owned for at least one year prior to the date of disposal (2) An election must be made one year from the 31 January following the tax year of disposal (disposal in 2010/11 election by 31 January 2013). @) 1¢ a disposal of a qualifying asset. © A disposal of the whole of a business run by @ sole trader. It is not available if a sole trader merely disposes of an individual business asset. Relief is only available in respect of capital gains arising on the disposal of assets in use for the purpose of the business. '* The disposal of shares in a trading company where an individual has a 5% shareholding in the company (the company is then known as the shareholder's personal company) and the shareholder must also be an employee of the company. Provided the company is a trading company, there is no restriction to the amount of entrepreneurs’ relief even if the company holds non-trading assets such as investments. www, studyinteractive. orgbeeKs2000 biogspet.com 265CHAPTER 10 - FUNDAMENTALS OF CAPITAL GAINS TAX Qualifying assets for entrepreneurs’ reli = ARES o cer ec fieremd business/share of business ER maybe claimed Sole trader owns a business (means he owns asset) MV A 10,000 200,000 20,000 30,000 ‘00,000 ES 50,000 Sharsholser and employee ‘ot parcanat ‘ano RE = company. 266 beaks Z00 Bogspet com www.studyinteractive.orgCHAPTER 10 -FUNDAMENTALS OF CAPITAL GAINS TAX nwerdetive Businesses are owned by Companies 1. A company owns a business 2. A company owns assets, the profits/loss made by the business belong to the company. Example 5 - Mr White Mr White is a sole trader and disposed of three chargeable assets during 2010/11 and realised the following gains and loss: AL A2 AB, - The disposal of his entire sole trader business making a capital gain of £260,000, he had owned the business for 3 years. = The disposal of a chargeable asset not used in his business which realised a capital loss of £10,000. - The disposal of a 30% shareholding in Green Ltd an unquoted trading company making a gain of £40,000, he has owned these shares for 2 years. Mr White Is an employee of Green Ltd and he recelves a salary of £35,000 each year, You should assume that Mr White has no other income except his salary from Green Ltd. Required (a) Compute the capital gains tax payable in 2010/11 (b) If Mr White wants to claim entrepreneurs’ relief for his eligible disposals in 2010/11 when does he need to make the necessary election by? (©) Evaluate how much of Mr White's entrepreneurs’ relief is available to carry forward to 20/11. (4) Compute Mr White's capital gains tax in 2010/11 if he had owned asset 3 for less than one year. www, studyinteractive,orGbeots2000 Beaspetcom 267CHAPTER 10 - FUNDAMENTALS OF CAPITAL GAINS TAX Rules for allocating the annual exemption, capital losses and determining the rates of capital gains tax to be used Although capital gains that qualify for entrepreneurs’ relief are always taxed at the rate of 10%, they must be taken into account when establishing which rate of capital gains tax applies to other capital gains. Capital gains qualifying for entrepreneurs’ relief are taxed first and therefore reduce the amount of unused £37,400 band. Capital gains which are not eligible for ER should be taxed last at 18% (if any unused £37,400 band is remaining) or alternatively at 28%. The annual exemption and any capital losses should be initially deducted from those capital gains that do not qualify for entrepreneurs’ relief. This will ensure that more capital gains are taxed at 10% and less at 28% or 18% Exam technique where some disposals qualify and some do qualify for ER Step 1 Set up two columns one for capital gains eligible for ER and one for capital gains that do not get ER Step 2 Deduct current capital losses from the gains that do not get ER first but only reduce the gain down to nil (never negative). The balance of the capital loss must then be allocated to gains that do qualify for ER. Step 3 Deduct the annual exemption firstly from gains that do not get ER and any balance from gains that do get ER. Step 4 Compute the capital gains tax at 10% on the taxable gains that get ER (regardless of the level). Remember that these gains are deemed to have used up some or all of the £37,400 band. Step 5 Compute the capital gains tax for other capital gains at 18% or 28% Gains with Gains with no ER ER 2010/12 £ £ Chargeable gains x1 x2 Less: Capital loss current ~ “xn X/oil Less: Annual exemption (10,100) Taxable gains Xa /nil Xb/ nil Capital gains tax Taxed first Taxed last Xa x 10% ex Xb x 18%/ 28% ex 268 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 10 -FUNDAMENTALS OF CAPITAL GAINS TAX Answer i - Exam standard - Fred and Fanny Fook 2010/11 Disposals by Fred Fook £ Chargeable Gains no ER Disposal of Ferrari Car A car is an exempt asset for the purposes of capital gains ‘on the disposal no gain and no loss Nil Disposal of the house Sale proceeds 281,000 Less: Selling costs (6,500) Les: Cost (October 1987) (87,000) Capital gain 187,500 Less: PPR relief (W1) (140,625) Chargeable gain 46,875 +2 23,438 Disposal of table This is the disposal of a chattel bought for <£6,000 and Sold for < £6,000 so is an exempt asset for capital gains Nil No gain and no loss on disposal Disposal of 20,000 shares to Fanny Fred and Fanny are connected persons for the purposes of capital gains tax. This means they transfer the chargeable assets at no gain and no loss. Nil Disposal of 15,000 shares to the son Sale proceeds (£2.95 x 15,000) 44,250 Les: Cost (W2) (29/400) Capital gain 14,850 Gift relief (nil) Chargeable gain 14,850 Total chargeable gains 38,288 Less: Annual exemption 10,100) Taxable gain 28.188 Capital gains tax (18% x 28,188) £5,074 www, studyinteractive. orgbeeKs2000 biogspet.com 269CHAPTER 10 - FUNDAMENTALS OF CAPITAL GAINS TAX Disposals by Fanny Fook 2010/11 Disposal of House 23,437 Disposal of clock Chattel cost < £6,000 Sale proceeds> £6,000 rule 1 Method 1 - normal Sale proceeds 7,200 Cost (3,700) Capital gain 3,500 Method 2 - formula 5/3 x (7,200 - 6,000) £2,000 Take the lower gain £3,500 or £2,000 2,000 Disposal of 15,000 shares by Fanny Sale proceeds 62,400 Less: Cost 48,000/ 20,000 x 15,000 (36,000) Unindexed gain Less: Indexation allowance Capital gain Total chargeable gains 51,837 Less: Annual exemption 10,100) Taxable gain “4L737 Capital gains tax (28% x 41,737) £11,686 270 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 10 -FUNDAMENTALS OF CAPITAL GAINS TAX (wa) Principal private residence exemption Period of ownership (1.10.87 ~ 30.9.10) 276 months Exempt periods 207 months Gain attributable to the exempt periods 287,500 / 276 x 207 £140,625 11087 309.10 Total Exempt Chargeable months Months — months 1.10.87 ~ 31.3.91 actual occupation 42 42 1.4.91 ~ 31.12.94 working elsewhere in 45 45 the UK 1.1.95 ~ 31.12.01 actual occupation 8a 8a 1.1.02 ~ 30.9,07 unoccupied 69 69 1.10.07 ~ 30.9.10 last 3 years 36 36 278 «207 62, w2 Disposal of 15,000 shares in Fruity plc to Fred’s son Step 1 Determine the sale proceeds per share = MV at the date of the gift Y% up method 290 + Ye (310 ~ 290) = £2.95 per share Step 2 Set up the time line and put all shares purchased by Fred On the line at the date of acquisition No. Cost £ 15.6.06 Purchase 8,000 17,600 24,8.06 Purchase 12,000 21,600 20,000 39,200 1.5.10 Sale of shares (15,000) (29,400) 39,200+20,000 x 15,000 ot www, studyinteractive. orgbeeKs2000 biogspet.com 274CHAPTER 10 - FUNDAMENTALS OF CAPITAL GAINS TAX Answer 2 - Mr Green (a) Sale proceeds £85,000 2010/11 Gross sale proceeds Less costs of sale Net sale proceeds Less: Cost Incidental acquisition costs Enhancement expenditure Capital gain (b) Sale proceeds £45,000 2010/11 Gross sale proceeds Less costs of sale Net sale proceeds Less: Cost Enhancement expenditure Capital loss (©) Sale proceeds £53,500 2010/11 Gross sale proceeds Less costs of sale Net sale proceeds Less: Cost Enhancement expenditure Capital gain € £ 85,000 (5,000) 80,000 15,000 1,500 (16,500) (25,000) 38,500 45,000 (5,000) 40,000 16,500 25,000 (41,500) 1,500) 53,500 16,500 (25,000 D2 ‘eeakSZOOU BRST www.studyinteractive.orgCHAPTER 10 -FUNDAMENTALS OF CAPITAL GAINS TAX Answer 3 — Trudy, Tracey and Terry 2010/11 Trudy Tracey Terry £ £ £ Chargeable gains 10,000 4,000 17,100 Current capital loss (4,000) (9,000) nit) Capital loss b/t - 7.900) 6,000 (5,000) 10,100 ‘Annual exemption (40,100) (40,100) Taxable gains nil Nil ‘iL Capital losses ¢/f Nil (6,000) (9,700) (16,700 - 7,000) Answer 4 = Mr Brown 2o10/11, Mr Brown's capital gains tax is computed at 18% and 28% of his taxable gains. £ CGT 18% x 2,400 (37,400 - 35,000) = 432 28% x 17.600 4.928 20,000 £5,360 The due date to pay HMRC is 31 Jan 2012 Answer 5 - Mr White 2010/11 Asset 1 Asset 2 | Asset 3 Capital gain/loss 260,000 (20,000) | _ 40,000 Total chargeable gains (260,000 + 40,000)= 300,000 Less: Capital loss 10,000: 290,000 Less: Annual Exemption 10,100) Taxable gains 279,900 Capital gains tax (10%) £27,990 (b) ‘The necessary election for entrepreneurs’ relief must be made within 12 months from the filing date of the tax year in which the disposal occurs 311.13. ()__ Entrepreneurs’ relief of £300,000 (260,000 + 40,000) is used up. £4,700,000 (5,000,000 ~ 300,000) is left to carry forward. Therefore www, studyinteractive. orgbeeKs2000 biogspet.com 273CHAPTER 10 - FUNDAMENTALS OF CAPITAL GAINS TAX (d) If asset 3 had been owned for < 1 year this means that no entrepreneurs’ relief would have been available to on the disposal of this asset. Gains with Gains with no ER ER 2010/11 Chargeable gains 260,000 40,000 Less: Capital loss (20,000) 30,000 Less: Annual exemption (10,100) Taxable gains 19,900 Capital gains tax 260,000 x 10% 9,900 x 26% 5,572 Total capital gains tax £31,572 Tutorial note Although capital gains that qualify for entrepreneurs’ relief are always taxed at a rate of 10%, they must be taken into account when establishing which rate of capital gains tax applies to other capital gains. Capital gains qualifying for entrepreneurs’ relief therefore are taxed first and therefore reduce the amount of unused £37,400 band. The annual exemption and any capital losses should be initially deducted from those capital gains that do not qualify for entrepreneurs’ relief. Allocating capital losses and the annual exemption in this way will ensure that more gains are taxed at 10% and less are taxed at 18% and 28%. 274 osPO00 Hlgspe eam www.studyinteractive.orgChapter 11 Variations to the capital gains proforma London FZ School of Business. & Finance powered by InterActive ANALYSIS OF PAST EXAM QUESTIONS Prot | 2007 | 2008 | 2008 | 2009 | 2009 | 2010 | 2010 Question 1 Question 2 Question 3 . . . . . . . Question 4 Question 5 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 11 - VARIATIONS TO THE CAPITAL GAINS PROFORMA baa ed -277 BACKGROUND AND THE EXAM FOCUS -278 VARIATIONS TO THE BASIC PROFORMA -- 1. PART DISPOSALS -280 -281 2. CHATTELS- -283 ANSWERS-. 276 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 11 - VARIATIONS TO THE CAPITAL GAINS PROFORMA erie Sci teh eu ial tek hd The tax implications of disposing of assets are a very important area of the syllabus and will always be tested in question 3 of your exam for 15 marks This particular chapter Is going to build on the previous chapter and will concentrate on variations to the basic proforma. The areas covered will include some revision of topics covered in the last chapter then this chapter will cover the rules for part disposals and chattels. wow. studyinteractive,orGe=ori00 Donssteam 27CHAPTER 11 - VARIATIONS TO THE CAPITAL GAINS PROFORMA VARIATIONS TO THE BASIC PROFORMA Elements of the proforma are computed differently for specific disposals e.g. part disposals, and chattels. In this chapter we are going to cover these aspects which are defined as variations to the basic capital gains proforma. £ E Proforma For Computing Capital Gains/Losses Consideration x Less Incidental costs of sale Oo Net sale proceeds NsP Less Allowable expenditure = Acquisition cost x = Incidental costs of acquisition x _ ~ ~ Enhancement expenditure ” Unindexed gain/(loss) 00 Less Indexation allowance RPI disposal -RPLacauisition ~~ RPTacquisiton = O.XXX x Cost CIAY Nil) Indexed gain/ Capital gain X/Ml 278 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 11 - VARIATIONS TO THE CAPITAL GAINS PROFORMA www. studyinteractive, orgbeeks2000 blogspot.com 279CHAPTER 11 - VARIATIONS TO THE CAPITAL GAINS PROFORMA PART DISPOSALS If only part of a chargeable asset is disposed of, only part of its cost can be allowed when computing the gain or loss. The allowable cost is the full cost of the asset multiplied by a fraction A / A+B, —id ncerdtive CGT Variations to the Proforma CC le hu Bee sees This part disposal fraction applies not only to the acquisition cost of the asset but also to any other items of allowable expenditure which relate to the whole asset. Any item of expenditure which relates only to the part of the asset which has been disposed of should be allowed in full. Example i - Peter Parker Peter buys @ house with a garden for £26,000 in October 1995. Peter has never lived in the house as his main residence. He sells the garden for £100,000 in August 2010, incurring selling costs of £1,000, The value the remaining house is £160,000 in August 2010. Peter has £9,000 of capital losses brought forward from 2003/04. ‘Assume Peter only has trading income of £25,000 in 2010/11. Required (Calculate the taxable gain on the disposal of the garden in 2010/11 and calculate the CGT payable by Peter. (il) Advise Peter of the base cost carried forward of his remaining house for capital gains tax purposes, 280 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 11 - VARIATIONS TO THE CAPITAL GAINS PROFORMA CHATTELS A chattel is an item of tangible, moveable property. A wasting asset is one with a predictable useful life not exceeding 50 years. If an asset is wasting and does not qualify for capital allowances it is defined as an exempt asset for capital gains tax. = en Tangble, moveable, proper} + Painting + Boat ah e a + Racehorse/greyhound MDE ease Reruns A chattels + Computers + Equipment + Shelving + Vans and lorries + Cars + Tables and chairs + Photocopiers - = =m Sle www. studyinteractive,orGbeots2000 Beaspetcom 281CHAPTER 11 - VARIATIONS TO THE CAPITAL GAINS PROFORMA Normal Proforma 5 x (Gross Proceeds ~6,000) z Example 2 - Sonia Shad Sonia bought an antique table for £2,500 in May 1990. In September 2010 she sold the table for gross proceeds of (a) £5,900 (incurring selling costs of £100) (b) £6,900 (incurring selling costs of £100) Required Calculate the chargeable gain arising in each case. Example 3 - Verna Wong During December 2010 Verna Wong disposed of an oil painting for £150, its market value. She had bought the painting for £7,500 in July 1986 believing it to be a collector's item. Required Compute Verna’s capital loss in 2010/11 and explain how Verna can relieve this capital loss. 282 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 11 - VARIATIONS TO THE CAPITAL GAINS PROFORMA Answer 1 - Peter Parker (i) Evaluation of the chargeable gain 2010/11 £ 26,000 x 100,000/ 100,000 + 160,000 (10,000) captains rouge forvard 89.000 £ Chargeable gains 80,000 Less: Annual Exemption 10,100) Taxable gains 69,900 Capital gains tax £ 18,875 x 18% (37,400 - 18,525)(W1) 3,397 51,025 x 28% 14,287 99,900 Capital gains tax 17,684 (W4)Income tax £ Trading income 25,000 Less: PA 6.475 Taxable income 18.525, (ii) The carried forward base cost of Peter's house for capital gains tax purposes is £16,000 (26,000 ~ 10,000). www. studyinteractive.orgbeeKs2000 blogspet.com 283CHAPTER 11 - VARIATIONS TO THE CAPITAL GAINS PROFORMA Answer 2 - Sonia Shad (a) Consideration £5,900, cost = £2,500. This is the disposal of an exempt asset for CGT, therefore any gain is exempt. (b) 2oro/tt £ Method 1 Consideration 6,900 Less Selling costs (100) Net sale proceeds 6,800 Less: Cost (2,500) Capital gain 4,300 Method 2 But the capital gain cannot exceed % (£6,900 ~ £6,000) 1,500 Take the lower gains as the chargeable gain £1,500 ‘Answer 3 - Verna Wong 2o1o/11 é Deemed consideration Less cost (7,500) Capital loss (4,500) ‘The capital loss must be carried forward and reduce future chargeable gains. 284 osPO00 Hlgspe eam www.studyinteractive.orgChapter 12 Capital gains tax - shares and securities London FZ School of Business. & Finance powered by InterActive ANALYSIS OF PAST EXAM QUESTIONS Pilot] Dee | 2une | Dec ] june | Dec | June 2007 | 2008 | 2008 | 2009 | 2009 | 2010 Question 1 Question 2 Question3| + : . . . . Question 4 Question 5 285 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 12 - CAPITAL GAINS TAX - SHARES AND SECURITIES baa ed 287 BACKGROUND AND THE EXAM FOCUS VALUATION RULES FOR SHARES AND SECURITIES: 288 METHOD ONE ~ Y& uP METHOD 288 METHOD TWO ~ AVERAGE METHOD 288 SHARES AND SECURITIES -- 289 EXAM TECHNIQUE FOR DISPOSAL OF SHARES BY INDIVIDUALS 290 BONUS ISSUE (SHARES ISSUED AT NIL COST) 201 RIGHTS ISSUE (SHARES ISSUED AT COST) 291 292 TAKEOVERS, MERGERS AND REORGANISATIONS. 294 ANSWERS: 286 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 12 - CAPITAL GAINS TAX - SHARES AND SECURITIES erie Sci teh eu ial tek hd The tax implications deriving from disposing of assets and the rules relating to the taxing of gains and relief for capital losses is a very important area of the syllabus and will be tested very frequently as seen in all the recent exam papers written by David Herrowven. This particular chapter Is going to build on the previous chapters and will concentrate on the situation where an individual disposes of shares and securities. This topic must be compared with the situation where a company disposes of shares and securities which was covered in chapter 7. Capital gains aspects of disposing of shares can be tested in question two or three from the point of view of a company disposing of shares and in question three from the point of view of an Individual disposing of shares. www.studyinteractive.orgbem+2000 blogspot.com 287CHAPTER 12 - CAPITAL GAINS TAX - SHARES AND SECURITIES Se Bee ed If it is necessary to establish a market value figure for quoted shares and securities, their value is taken from the price quoted on the Stock Exchange Daily Official List: ‘The figure is the lower of: Method one — %4 up method This method is used if the examiner gives the market values as a range of values on a particular day. ‘The lower quoted value in the range plus one-quarter of the difference between the lower and the higher prices in the range Lower value + ¥%& (Higher value - Lower value) Method two - average method This method is used if the examiner gives the individual market values on a particular day. Take the higher of the individual market values and add it to the lower of the Individual values and get the average value by dividing by two. Average Value = Higher value + Lower value 2 Example 1 - Valentine pic Shares in Valentine ple are quoted on the Stock Exchange at 460p ~ 540p. On the same day the individual market values are quoted as 552p, 500p and 448p Required Compute the market value of the sheres for capital gains tax purposes. 288 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 12 - CAPITAL GAINS TAX - SHARES AND SECURITIES SHARES AND SECURITIES A disposal of shares and securities causes no CGT problems unless a taxpayer disposes of part of a shareholding which was originally acquired over a period of time in several separate transactions. If this happens it is necessary to identify the shares which are being disposed of in order to establish the cost and acquisition date of the shares concerned. ‘The purpose of this chapter is firstly to explain the matching rules for shares and securities and secondly to explain how to evaluate capital gains and losses on the disposal of each separate transaction using the very important capital gains proforma covered in chapters ten and eleven vmcractive IuAMeCARATS OLR CLES UCT) Disposals of shares are matched with 1) Firstly, with acquisitions on the same day 2) Secondly, with acquisitions in the next 30 days 3) Thirdly with shares in the $104 pool (1985 pool) a ncerdtive LENT nem OL Co ola ey 1985 Pool / 104 Pool 2) Share Pool 06.04.82 Date of Disposal 2 (i) www.studyinteractive.orgbem+2000 blogspot.com 289CHAPTER 12 - CAPITAL GAINS TAX - SHARES AND SECURITIES a c a r Exam technique for disposal of shares by in: Step 1 ‘* Determine the sale proceeds per share. Step2 © Draw boxes putting the shares purchased into the correct box ~ 0, 1 or 2. Step 3 * Using the matching rules compute the gains and losses on the disposals of the shares from each box using the normal capital gains proforma. Example 2 - Bernie Shares Bernie sold 12,500 shares in Ireland pic, a quoted company, on 19 November 2010 for £62,500. She had bought the ordinary shares in the company on the following dates Number of | Cost of the shares shares € 1 June 1988 8,000 7,450 12 December 1999 4,000 5,500 19 November 2010 1,000 3,250 10 December 2010 2,000 6,000 Required (i) Calculate the chargeable gain assessable on Bernie in 2010/11. You should assume that Bernie owns < 1% of the shares in Ireland ple, (ii) Advise Bernie of the carried forward base cost of her shares in Ireland ple for the purposes of capital gains tax. 290 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 12 - CAPITAL GAINS TAX - SHARES AND SECURITIES Bonus issue (shares issued at nil cost) This is an issue of shares to existing shareholders in proportion to the number of shares owned at the Gate of the bonus issue. ‘These shares are deemed to be acquired on the same date and at the same cost as the original shares they relate to and have no cost. Rights issue (shares issued at cost) A rights issue occurs where @ company offers its shareholders the right to buy extra shares. Rights issues are similar to bonus issues in that the number of shares offered to each shareholder is generally in proportion to his or her existing shareholding. Shareholders who are offered rights shares may either: (a) Ignore the rights issue (b) sell their “rights” (©) buy the shares which they are offered at a price which Is usually below the market price. Example 3 - Katia Woods Katia sold 900 shares in Branch Ltd, an unquoted trading company, on 10 February 2011 for £36,000. She acquired 500 shares in the company on 21 April 1997 for £6,000. On the 8 May 2004 the company made a 1:5 rights issue at a cost £14 per share. She acquired a further 400 shares on 4 September 2007 for £5,000 and a further 200 shares on 1 March 2011 for £2,500. Katia purchased all of the shares she was entitled to under the rights issue, Branch Ltd issued 3,000 shares in total and Katia is a full time employee of Branch Ltd and has received a salary of £15,000 during 2010/11. Katia realised another chargeable gain of £11,000 during 2010/11. You should assume that entrepreneurs’ relief is not available on this disposal Katia also has £2,000 of capital losses brought forward at 6 April 2010 Required Calculate the capital gains tax arising on the sale of the shares. You should assume that Katia will claim entrepreneurs’ relief whenever possible. www.studyinteractive.orgbem+2000 blogspot.com 291CHAPTER 12 - CAPITAL GAINS TAX - SHARES AND SECURITIES Bt ra cla ea ee ca rae od A takeover occurs when one company acquires the shares in another company. Shareholders of the target company exchange their shares in return for cash, or shares of the acquiring company, or a combination of both cash and shares. The CGT treatment of such disposal is as follows: (a) If a takeover is entirely for cash the shareholders of the target company have sold their shares and have made chargeable disposals. (b) If a takeover is entirely for shares (a “paper for paper” takeover), no chargeable disposals has taken place, A shareholder's newly-acquired shares in the acquiring company replace the shares originally held in the target company and are deemed for all CGT purposes to have been acquired on the same date and at the same cost as the original holding. (c)_ Ifa takeover is partly for cash and partly for shares, a part disposal has taken place and a part disposal calculation is usually required. The value of the part disposed of Is the amount of cash received and the value of the part remaining is the value of the shares received. However, if the amount of cash received by the taxpayer is no more than 5% of the total consideration (or no more than £3,000) the cash received is treated as a small capital distribution, owerdtive rent eae i | ____, enna Piet Exchange ‘Paper’ and Cash < No CGT Implications (Provided Conditions are Met) 292 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 12 - CAPITAL GAINS TAX - SHARES AND SECURITIES Technique to determine the cost of the exchanged assets Description of exchanged Market value Original cost assets of exchanged assets at the date of exchange Exchanged asset (1) MvL Exchanged asset (2) mye, Cost of original Total mv shares Example 4 - Cedric Takeover In June 2004, Cedric bought 1,000 shares in Circle ple for £8,400. In November 2010, Sphere plc made a takeover bid for Circle plc, offering two ordinary shares and one preference share in Sphere plc for each ordinary share in Circle plc. This offer was accepted on 21 November 2010 when the market value of ordinary shares in Sphere plc was £4 per share and the market value of preference shares in Sphere ple was £2 per share. Required Show how Cedric’s cost of £8,400 should be allocated between the shares which he received by virtue of the takeover. www.studyinteractive.orgbem+2000 blogspot.com 293CHAPTER 12 - CAPITAL GAINS TAX - SHARES AND SECURITIES Answer 4 — Valentine ple The market value of the shares is £4.80, computed using the % up method as this gives the lowest value, v4 up method Average method 460 + % x (540 ~ 460) Higher value (552p) + Lower value (448p) 2 MV = £4.80 per share mv Answer 2 - Bernie Shares (i) Capital gains computation 2010/11 ‘The shares disposed of are identified with the following acauisitions: ‘© Firstly ~ 19 November 2010 - on the same day * Secondly - 19 December 2010 - within the following 30 days * Thirdly ~ the share pool Note: As we have identified the 12,500 shares sold to THREE different acquisitions, the actual computation must also be done in THREE stages. 1 19 November 2010 acquisition £ Proceeds (1,000/12,500 x £62,500) 5,000 Less: Acquisition cost (3,250) Chargeable gain 41,750 2 10 December 2010 acquisition E Proceeds (2,000/12,500 x £62,500) 10,000 Less: Acquisition cost (6,000) Chargeable gain 4,000) 3 Share pool E Proceeds (9,500/12,500 x £62,500) 47,500 Less: Acquisition cost (W1) (20,252) Capital gain 37.248 Total chargeable gain on disposal of 12,500 shares: £1,750 + £4,000 + £37,248 = £42,998 294 osPO00 Hlgspe eam www.studyinteractive.orgCHAPTER 12 - CAPITAL GAINS TAX - SHARES AND SECURITIES Working - Share poo! 1 June 1988 12 December 1999 Disposal 3" identification Number 8,000 4,000 12,000 (9,500) 2,500 Cost £ 7,450 5,500 12,950 (10,252)* 2,698 ‘The third disposal identified to the Share pool requires us to remove less than the total number of shares in this ‘pool’ - we therefore use the ‘average cost’ method. * To deduct cost of 9,500 shares: 12,950/12,000 x 9,500 = £10,252 (ii) The base cost carried forward of the 2,500 shares in Ireland plc is £2,698, Answer 3 - Katia Woods Capital gains tax in 2010/11 Disposal of 900 shares in Branch Ltd on 10 February 2011 Chargeable Chargeable gains ER gains no ER E £ £ Sale proceeds (200 x £40) 8,000 Cost (W1) 2,500) Capital Gain 5,500 5,500 Disposal from the share pool Sale proceeds (700 x £40) 28,000 Cost (W1) (8.680) Capital gains 19,320 19,320 Other capital gains realised in 2010/11 11,000 Total chargeable gains 24,820 11,000 Less capital loss b/f (2,000) Less: Annual exemption (1,100) (9,000) Taxable gains 23,720 Nil Capital gains tax 2372 Mu 23,720 x 10% Total capital gains tax £2,372 www .studyinteractive, orgbeeks2000 blogspot.com 295CHAPTER 12 - CAPITAL GAINS TAX - SHARES AND SECURITIES (wi) 6.4.82 10.211, 12.341 Share pool No Cost No Cost 21 April 1997 purchase 500 6,000 1Mar2011200 2,500 8 May 2004 RI 100 1,400 (200) (2,500) (1/5 x 500 x £14.00) Nil Nil 4 Sept 2007 purchase 400 5,000 1,000 12,400 10 February 2011 Sale (700) (8,680) (12,400/1,000 x 700) 300 3,720 Answer 4 - Cedric Takeover Description of exchanged Market value Original cost assets of exchanged assets at the date of exchange. 2,000 ordinary shares 8,000 1,000 preference shares 2,000 10,000 8,400 Since 80% of the total value of the exchanged assets is ordinary shares in Sphere plc, these shares are treated as costing 80% of the original cost of £8,400 which is £6,720. Similarly the preference shares in Sphere plc are deemed to have cost him 20% of £8,400 = £1,680. Alll of these shares are treated as if acquired in June 2004. 296 ebooks2000 Beaspet.com www.studyinteractive.orgChapter 13 Capital gains tax reliefs and exemptions London FZ School of Business. & Finance powered by InterActive ANALYSIS OF PAST EXAM QUESTIONS Pilot | Dee | June | Dec | June | Dec | June | Dec 2007 | 2008 | 2008 | 2009 | 2009 | 2010 | 2010 Question 1 Question 2 Question 3 | + : : . . . . Question 4 Question 5 297 osPO00 Hlgspe eam www.studyinteractive.orgCHAPTER 13 - CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS baa ed BACKGROUND AND THE EXAM FOCUS -299 OVERVIEW OF CAPITAL GAINS TAX --. -300 PROFORMA FOR EVALUATING THE GAIN/LOSS 301 CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS -- 302 REPLACEMENT OF BUSINESS ASSETS 302 FULL ROLL-OVER RELIEF 304 PARTIAL ROLL-OVER RELIEF 305 Howb-over RELIEF 307 GiFTs HoLoover-RELIEF 309 PARTIAL GIFT RELIEF 310 PRINCIPAL PRIVATE RESIDENCE RELIEF 313 LerTIne RELIEF 316 TRANSFER OF A BUSINESS TO A LIMITED COMPANY: INCORPORATION RELIEF 317 THE LOSS OR DESTRUCTION OF AN ASSET ANSWERS- 321 298 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 13 - CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS erie Sci teh eu ial tek hd The tax implications deriving from disposing of assets is a very important arca of the syllabus. This chapter is going to cover the very important topic of capital gains reliefs. Some capital gains reliefs such as indexation allowance (relevant to companies only), entrepreneurs’ relief and the annual exemption (relevant to individuals only) have already been covered in earlier chapters but this chapter is going to consider others. Firstly it is important to know when and where to apply these relies and secondly it is necessary to know how to apply them and the conditions which must be satisfied in order to be allowed to apply them This topic will generally be tested in question three of the F6 exam but could also appear in question two where the examiner sometimes examines rollover and holdover relief which are capital gains reliefs available to companies these reliefs are covered in detail in this chapter. www, studyinteractive. orgbeeKs2000 blogspet.com 299CHAPTER 13 - CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS OVERVIEW OF CAPITAL GAINS TAX After considering the asset being disposed of and deciding whether it is a chargeable or exempt asset, assuming it is 2 chargeable asset, the next step is to evaluate the gain or loss on the disposal of that particular asset. Evaluating the gain/loss will require the use of the basic proforma and possibly the variations, this, is called part one of the procedure and was covered in chapters nine, ten and eleven. The second part is then to consider whether any capital gains reliefs are relevant to reduce or defer the capital gains further. This second part of the procedure is being covered in this chapter. dL 300 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 13 - CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS Proforma for evaluating the gain/loss £ £ Proforma For Computing Capital Gains/Losses Consideration x Less Incidental costs of sale ) Net sale proceeds NsP Less Allowable expenditure ~ Acquisition cost x = Incidental costs of acquisition x — Oo) - Enhancement expenditure ) Unindexed gain/loss X/ (x) Less Indexation allowance RP acquis = O.XXX x Cost UV Nil Indexed gain/ Capital gain X/NiL Less Capital gains RELIEFS (GRIPL) Chargeabie gain Less: Current capital losses Less: Capital losses brought forward a Less: annual exemption oo X/Nil Texable gains Capital gains tax (x 10% or 18%/28%) x www, studyinteractive. orgbeeKs2000 blogspet.com 301CHAPTER 13 - CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS ‘After computing the gains on disposal of individual chargeable assets the next stage is to consider the availability of any possible reliefs. Some reliefs completely exempt the gains from tax, these are called complete exemptions, other exemptions only defer payment of the tax until sometime later, these are called deferral exemptions. The advantage of a deferral exemption is one of cash flow, the payment of the tax on the particular disposal is paic later. Complete Exemptions Deferral Exemptions Principal Private Residence Relief Gifts holdover relief (PPR relief) Rollover relief/ holdover relief Letting relief Incorporation relief EU id Subject to certain conditions a taxpayer may claim that the gain arising on the disposal of a business asset (the “old asset”) may be “rolled over” against the cost of acquiring a replacement business asset (the "new asset”). The main effects of a claim for roll-over relief are as follows: ‘* The disposal of the old asset is deemed to give rise to neither a gain nor a loss. ‘©The cost of the new asset is then reduced by the gain which would have been chargeable on the disposal of the old asset. This reduced cost of the new asset is called its base cost and will be used when the new asset is subsequently disposed of. 302 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 13 - CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS M4 Boeeocous sce sovoacive CoE EECELICRCLILE! + When 2 company disposes of chargeable asset used in its trade ex. freehold offices the company will realise a chargeable gain or capital loss [caren Ta Coe] Disposal of office waa ‘ bulsng by AL on 5 " etd Profits from trading $40,000 fy 21310, areal gine t Sale proveegs £350,000 = Total protits: Costororices 1 ee ay £100,000 on 2.8.00 Taxable total profits PANO imer10= 2207 Rollover and Holdover Relief ncerdctive + The gain on the disposal of a qualifying asset used in a trading business can be deferred if proceeds are reinvested in qualifying replacement assets within a qualifying period of 1 year before the disposal to 3 years after the date of disposal + Available to companies, sole traders and partnerships. www. studyinteractive, orgbenk2000 Biogspetcom 303CHAPTER 13 - CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS Full roll-over relief is available only if the disposal proceeds of the old asset are wholly reinvested in the new asset. nerve PEN ue ures’ + IFALtd reinwests some or all of the sale proceeds from office 1 in another qualifying asset that the company uses In its trade within 48 months (12 months before the disposal and 36 months after) then it is possible for the company to defer/ avold paying CT on aC IF A Ltd buys a second office building 2 cost is £490,000 on 31.12.10 304 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 13 - CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS LASIK) iat RL If only part of the disposal proceeds are used to acquire the new asset, the effect of a claim for roll-over relief is that the chargeable gain on the disposal of the old asset is partly chargeable in the period of disposal and part of the old assets gains Is deferred and reduces the cost of the new asset. ‘The amount of the gain which is chargeable on the disposal of the old asset is equivalent to the sale proceeds not reinvested (so long as this is less than the gain). lnwerdtive PEN a + IFALtdreinvests some or all of the sale proceeds from office 1 in another qualifying asset that the company uses in its trade within 48 months (12 months before the disposal and 36 months after) then itis possible for the company to defer/ avoid paying CT on aC IF A.Ltd buys a second office building 2 cost is £300,000 on 31.12.10 www, studyinteractive,orGbeots2000 Beaspetcom 305CHAPTER 13 - CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS ns for roll-over relief (a) Both the old asset and the new asset must be drawn from the following list: (i) Land, buildings (ii) Fixed plant and machinery (il) Goodwitt (iv) Ships, aircraft, hovercraft, satellites, space stations and spacecraft. (b) The old asset must have been used only for trade purposes throughout the Period of ownership and the new asset must be used only for trade purposes, (©) The new asset must be acquired during the period beginning one year before and ending three years after the date of disposal of the old asset. Example 1 - Wilson Rollover On 21 April 2010 Wilson sold a freehold office building for £246,000. The office building had been purchased on 3 January 1990 for £104,000. Wilson has made a claim to rollover the gain on the office building against the replacement new freehold office building that was purchased on 14 January 2010, Both office buildings have always been used entirely for business purposes in a wholesale business run by Wilson as a sole trader. ‘Assume the cost of the replacement office building was £260,000 £220,000 £90,000 Required Compute the chargeable gain under each alternative and the carry forward base cost of the replacement office building. 306 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 13 - CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS La eA SLaL Se If the new asset is a “depreciating asset” (an asset with an expected life of 60 years or less at the time of acquisition) then the deferral relief available is known as holdover relief. The most common examples of depreciating assets are leasehold land and buildings and fixed plant and machinery. The gain arising on the disposal of the old asset cannot be rolled-over and is not deducted from the cost of the new asset. Instead, the gain is temporarily deferred or “held-over” until it becomes chargeable on the earliest of the following: (a) The date on which the new asset is disposed of. (b) The date on which the new asset ceases to be used in the trade. (©) The 10th anniversary of the acquisition of the new asset. Clearly a gain which is held-over in these circumstances will become chargeable no more than ten years after the date of acquisition of the depreciating asset. However, if a suitable non-depreciating asset is acquired at any time before the earliest of the above three dates, the held-over gain may be transferred to this new asset, so converting a held-over gain into a rolled-over gain mye lncerdtive Peace’ + IFALtd reinvests some or all of the sale proceeds from office 1 in another qualifying asset that the company uses In its trade within 48 months (12 months before the disposal and 36 months after) then it is possible for the company to defer/ avoid paying CT on aC If ALtd buys a leasehold office building 2 cost is £315,000 on 31.12.10 The lease has 45 years to run. www, studyinteractive. orgbeeKs2000 blogspet.com 307CHAPTER 13 - CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS Assets used partly for bu: Partial roll-over and hold-over relief can also occur where part of an asset is used for trading purposes. Only the gain attributable to trading use is eligible for roll- over/holdover relief and the balance of the gain remains chargeable in the period in which the old asset Is disposed of. 2% | Commercial building used partly in sowie [eee + Partial rollover relief Sale proceeds £146,000 —=_- Business Use(80%) Cost £72,000 Example 2 - Ms Black On 8 November 2010 Ms Black sold a freehold office for £146,000. The office was Purchased on 3 January 1997 for £72,000. 75% of the office has been used in her manufacturing business run by Ms Black as a sole trader. However the remaining 25% of the office has never been used for business purposes. Ms Black has claimed roll-over relief on the office against the replacement cost of a new freehold factory that was purchased on 10 November 2010 for £156,000. ‘The new factory is used 100% for business purposes by Ms Black. Assume Ms Black is 2 higher rate taxpayer. Required Compute the capital gains tax assessable on Ms Black in 2010/11 and the carry forward base cost of the replacement factory. 308 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 13 - CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS a IVEY nT Re RCTs pe ‘The gift of a chargeable asset is a chargeable disposal and this is the case whether of not the asset is used in the business. One of the disadvantages of making a lifetime gift of a chargeable asset is that the donor will possibly pay CGT in the tax year in which the gift is made. It Is possible for the donor to defer paying capital gains tax in the tax year of the gift, by claiming to defer the gain using gifts holdover relief. However this is only possible if it is a gift of @ qualifying asset and provided all the necessary conditions are satisfied. nuerative tions for Gifts Holdover Relief + This is a CGT deferral relief and is optional Conditions 1. Applies to disposals which qualify as gifts or sales at undervalue. 2. Donee must be resident or ordinarily resident in the UK at the time of the gift. 3. A joint election must be made within 70 months from the end of the tax year in which the gift is made. www, studyinteractive,orGbeots2000 Beaspetcom 309CHAPTER 13 - CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS nerve eT ute CeCe mcr a 4 Applies to gifts of qualifying assets only Gifts of Personal company shares (Shareholder owns > 5% of the shares) Gifts of Unquoted shares Gifts by ole traders and partnerships of chargeable assets used in the business such as land and building and goodwill clad This arises in two ia jations: (1) Where the donee gives the donor some consideration (> cost to the donor but < market value) for the asset this is called a sale at undervalue, In these circumstances part of the gain remains chargeable in the tax year in which the gift is made (consideration minus original cost is chargeable) and the balance of the gain is deferred by claiming gifts holdover relief. (2) The proportion of the gain which qualifies for gift relief on shares is restricted to: Capital gain x “MV of chargeable business assets of the company MV of chargeable assets of the company Example 3 - Mr Sam Sam gave his daughter Samantha an office building that he uses in his business on 1 June 2010 when its market value was £100,000. Sam paid £45,000 for the offices on 1 May 1996, Samantha sells the asset for £140,000 on 1 October 2011 Assume Sam and Samantha both have annual taxable Income in excess of £50,000 Required (2) Compute the total capital gains tax payable by Sam and Samantha if gifts holdover relief is not claimed. (2) Compute the total capital gains tax payable by Sam and Samantha if gifts holdover relief is claimed and state by what date the election must be made, (©) Explain the effect on their total tax payable if they make the gifts holdover relief claim, (d) If Samantha gave Sam £54,000 what effect would this have on their total tax payable assuming Sam and Samantha have elected to hold over the gain as 2 gift of a business asset? 310 ebooks2000 Beaspet.com www.studyinteractive.orgCHAPTER 13 - CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS Example 4 - Patrick and Tony Patrick makes @ gift of shares in Sparrow Ltd to his son, Tony on 1 October 2010. Patrick owns 9% of the shares in Sparrow Ltd. Patrick inherited the shares from his, mother on 1 February 2010 when their market value was £32,000. The shares are ‘expected to be worth £127,500 on 1 October 2010. Tony Is an employee of Sparrow Ltd and will continue to work for the company until he sells the shares in January 2012 for £170,000. You should assume that Tony and Patrick are higher rate taxpayers. fett=at’, | Businesses are owned by eee 1. Sparrow Ltd, unquoted manufacturing company 2. Accompany owns assets, the profits/loss made by the business belongs to the company. Premi 740,000 enc MacsaiC 160,000 Concern rey than £6,000) Teg 250,000 30,000 80,000 Showing the market values of the companies assets (a) Explain whether or not capital gains tax gift relief will be available on the gift, noting any additional information required. State the latest date for submission of a claim and identify who must sign it. (b) Calculate the capital gains tax payable by Patrick and Tony if gift relief is claimed. www. studyinteractive, orgbenk2000 Biogspetcom 34aCHAPTER 13 - CAPITAL GAINS TAX RELIEFS AND EXEMPTIONS Example 5 — Winston Part On 17 August 2010 Winston made a gift of his entire holding of 10,000 £1 ordinary shares (a 100% holding) in Gandua Ltd, an unquoted trading company, to his daughter. The market value of the shares on that date was £190,000. The shares had been purchased on 8 January 2008 for £112,000. On 17 August 2010 the market value of Gandua Ltd’s chargeable assets was £180,000, of which £120,000 was in respect of chargeable business assets. Winston and his daughter have elected to hold over the gain on this gift of a business asset. ‘Assume Winston has capital losses brought forward of £3,000 and his total income of £40,000 in 2010/11 Required Compute the capital gains tax assessable on Winston in 2010/11 and state the due date by which the tax must be paid. Assume Winston is not employee of Gandua Lt. owerdtive Peat xe ale) + Aperson can have one main residence at a time + Provided this is occupied as their main residence throught out the period of ownership it is defined as an exempt asset for CGT. An individual can have one main residence at any one time. An individual who lives in more than one residence can elect which residence should be treated as their main one. Husband and wife must have the same main residence. An individual's main residence including the garden of up to 1.25 acres is an exempt asset for CGT. 342 ebooks2000 Beaspet.com www.studyinteractive.org